Canada: Economic Developments and Policies
Author: International Monetary Fund
Publication Date:
08 Jun 1995
eISBN:
9781451806823
ISBN:
9781451806823
Language:
English
Keywords:
ISCR; CR; Canada; deficit; merchandise trade surplus; merchandise export; commodity trade share; export share; volume growth; Exports; Imports; Trade balance; Foreign direct investment; Current account balance; Canada balance of payments flow; world commodity price
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This paper examines economic developments and policies in Canada during 1990–95. Spurred by the robust growth in the United States and the easing of monetary conditions between 1991 and 1993, economic growth in Canada continued to strengthen during 1994. Real GDP grew by 4.5 percent in 1994 after growing by 2.2 percent in 1993 and 0.6 percent in 1992. Economic growth in 1994 was led by exports and investment in machinery and equipment. However, growth was more broadly based in 1994; private consumption strengthened, and there was a rebound in residential and nonresidential construction.

Abstract

This paper examines economic developments and policies in Canada during 1990–95. Spurred by the robust growth in the United States and the easing of monetary conditions between 1991 and 1993, economic growth in Canada continued to strengthen during 1994. Real GDP grew by 4.5 percent in 1994 after growing by 2.2 percent in 1993 and 0.6 percent in 1992. Economic growth in 1994 was led by exports and investment in machinery and equipment. However, growth was more broadly based in 1994; private consumption strengthened, and there was a rebound in residential and nonresidential construction.

V. Balance of Payments 1/

1. Overview

Canada’s external current account deficit remained roughly constant during the 1989-92 period, averaging $27 billion (4 percent of GDP). In 1993 the deficit rose to $31 billion (4.3 percent of GDP) owing to an increase in the nonmerchandise trade deficit that outweighed an improvement in the merchandise surplus (Chart V-1). In 1994 the current account deficit declined to $25 billion (3.3 percent of GDP), because of a substantial increase in the merchandise trade surplus, particularly in the second half of the year.

CHART V-1
CHART V-1

CANADA CURRENT ACCOUNT BALANCE

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 046; 10.5089/9781451806823.002.A005

Source: Statistics Canada (supplied by DRI);

External Current Account

(In billions of dollars)

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2. Merchandise trade balance

The merchandise trade surplus rebounded from a recent low of 1/2 percent of GDP in 1991 to 2 1/4 percent of GDP in 1994. The factors explaining the increase in the surplus were an improvement in the terms of trade related to the surge in world commodity prices, and relatively strong export volume growth, related to the economic recovery among Canada’s major trading partners and the 18 percent depreciation of Canada’s nominal effective exchange rate since the fourth quarter of 1991 (Chart V-2). 2/

CHART V-2
CHART V-2

CANADA COMPETITIVENESS INDICATORS

Citation: IMF Staff Country Reports 1995, 046; 10.5089/9781451806823.002.A005

Source: International Financial Statistics; and Organization for Economic Cooperation and Development.

Merchandise Export and Import Developments

(Annual average percentage changes)

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Canada’s export volumes have grown rapidly since the trough of the last recession in 1991 (11 percent at an average annual rate). The pickup in export volume growth can be attributed both to the strong growth in foreign domestic demand and to an improvement in competitiveness. Foreign domestic demand growth accelerated from 2.3 percent in 1992 to 4.3 percent in 1994. At the same time, the price of Canada’s exports relative to the price of its major trading partners declined by 5 percent between 1991 and 1993. 3/ Export value was also bolstered during the 1992-94 period by an increase in world commodity prices (commodities include food, energy and other raw materials, and comprise 50 percent of total merchandise exports).

By contrast, the surge in import volume growth (10 percent at an annual rate in 1992-94) occurred despite relatively weak domestic demand growth. The growth of imports appears to have been driven by domestic investment in machinery and equipment investment and by the growth of exports, both of which have a high import content (Chart V-3). Despite the substantial depreciation of the Canadian dollar during the same period, import unit values rose at an average annual rate of about 3 1/2 percent during the past three years.

CHART V-3
CHART V-3

CANADA VOLUME INDICES

Citation: IMF Staff Country Reports 1995, 046; 10.5089/9781451806823.002.A005

Source: Statistics Canada (supplied by DRI); and Fund staff estimates.

The growth of intra-industry trade, particularly in the automotive industry, is an important factor explaining the close relationship between export and import growth since 1991. 1/ The rise in intra-industry trade in the motor vehicles industry is illustrated in the tabulation below. Over the period 1991-94 exports of passenger automobiles and imports of motor vehicle parts both rose by 2 1/2 percentage points of total exports and imports, respectively. In contrast, exports of motor vehicle parts rose by only 1/2 percentage points and imports of passenger automobiles declined by 2 percentage points. This suggests that Canada’s automotive trade flows are strongly affected by the demand for finished vehicles abroad (Chart V-4).

CHART V-4
CHART V-4

CANADA MOTOR VEHICLE INDICATORS

Citation: IMF Staff Country Reports 1995, 046; 10.5089/9781451806823.002.A005

Source: Statistics Canada (supplied by DRI);

Motor Vehicle Trade Shares

(In percent)

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a. Exports

In recent years, the composition of Canada’s exports has become increasingly dominated by manufactured goods, while the share of semimanufactured goods, food, and energy has fallen. Exports of manufactured goods rose from 48 percent of all exports in 1991 to 53 percent in 1994. Exports of motor vehicles, particularly to the United States, are the major contributing factor to this rise.

Merchandise Export Shares by Commodity

(In percent)

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The reorientation of Canada’s exports toward manufactured goods, the implementation of the FTA in 1989, and the strong cyclical position of the U.S. economy have both enhanced the importance of the United States as Canada’s major export market. Indeed, the export share to the United States increased by 12 percentage points since 1989, reaching 83 percent in 1994.

Merchandise Export Shares by Major Area

(In percent)

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b. Imports

During the period 1989-94, commodity trade shares have changed very little, although cyclical changes have taken place within the period. For instance, the share of imports of manufactured goods has risen by 2 percentage points since the trough of the last recession in 1991, all of which can be accounted for by a rise in motor vehicle imports from the United States. However, commodity trade shares mask considerable differences across commodities in terms of price and volume changes. Office machinery and equipment has maintained its relative trade share by generating large volume increases in response to declining prices.

Merchandise Import Shares by Commodity

(In percent)

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Canada imports two thirds of its goods from the United States. Since the implementation of the FTA, the U.S. share of Canadian imports has increased by 2 percentage points, despite having dipped temporarily in 1990 and 1991 owing to the decline in motor vehicle imports during the recession.

Merchandise Import Shares by Major Area

(In percent)

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3. Invisibles balance

Canada’s invisibles deficit was roughly stable over the 1989-92 period averaging between $31-$34 billion. However, the deficit rose to over $40 billion in 1993 and rose by a further $2 billion to $42 billion in 1994. This increase was the result of a severe worsening in the investment income balance which more than offset a slight improvement in the nonfactor services balance. The increase in net investment income paid abroad was chiefly related to the improved profit performance of foreign firms based in Canada, the increased sales of Canadian bonds and securities to nonresidents, and the rise in interest rates.1/ The travel account improved in 1993 and 1994, in part owing to delayed effects of the currency depreciation on the expenditures of incoming travellers to Canada and of Canadians traveling abroad. The other components of the services account have remained fairly stable over the past few years.

Balance on Services and Transfers

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4. Saving-investment balance

Between 1989 and 1993 the aggregate investment rate declined by 5 1/2 percentage points owing to a corresponding decline in the private investment rate. The national saving rate also declined by a comparable amount over this period, leaving the ratio of foreign saving to GDP roughly unchanged at 5 percent. The decline in the national saving rate reflected a deterioration in both federal and provincial deficits whose combined deficit rose to more than 7 percent of GDP in 1993. In 1994 the aggregate investment rate recovered by roughly 3/4 percentage point (again the result of changes in the private investment rate). The increase in investment was more than accommodated by a 1 3/4 percentage point increase in the public saving rate, which helped reduce Canada’s reliance on foreign saving by 1 1/4 percent of GDP.

Sources and Uses of Gross Saving

(In percent of GDP)

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5. Capital account

Net long-term capital flows stabilized between 1990 and 1992 averaging $13 billion each year. However, the composition of the inflows fluctuated because the surge of direct investment into Canada in 1990 was followed by a decline in direct investment inflows in 1991 and 1992 as Canada went into recession. The net aggregate long-term capital inflow was maintained in both years because of high long-term interest rates which attracted a large inflow of purchases of Canadian bonds.

In 1993 the net long-term capital inflow doubled to $25 billion. This was the result of record nonresident purchases of Canadian securities during the first half of the year as provinces sought to raise funds in international financial markets. These purchases were only partly offset by repurchases and retirements of bonds during the second half of the year (Chart V-5). In 1994 the demand for Canadian bonds by foreign investors fell to $14 billion, partly related to uncertainty about the future value of the Canadian dollar.

CHART V-5
CHART V-5

CANADA BALANCE OF PAYMENTS FLOWS AND THE EXCHANGE RATE

Citation: IMF Staff Country Reports 1995, 046; 10.5089/9781451806823.002.A005

Source: Statistics Canada (supplied by DRI); and International Financial Statistics.1/ The basic balance is the sum of the current account balance and net long-term capital flows including the statistical discrepancy.

Historically, the balance on short-term flows of the capital account has closely followed the path of the Canada-U.S. short-term interest rate differential. In 1990 and 1991 the balance reached $15 billion when the interest rate differential was at a historically high level and the Canadian currency was appreciating. Since 1991, the Canadian dollar and the interest rate differential have simultaneously declined, and the net flow of short-term capital has fallen considerably, averaging $7 billion over the period 1992-94. 1/

Capital Account

(In billions of dollars)

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Since the fourth quarter of 1991 short-term flows have not matched the basic balance (see Chart V-5). 1/ As a result, Canada’s stock of official reserves declined in 1992 and the stock would also have declined in 1993 except for the $5.4 billion sale of Canada bills and valuation effects from the sale of gold. 2/ In response to the continued decline in the stock of official reserves in the first half of 1994, two special issues of longer-term Government securities were brought to the market. In the third quarter official reserves were replenished as a result of the large improvement in the current account and long-term capital inflows. However, the increase in reserves was reversed in the fourth quarter as a result of a large disinvestment of Canadian bonds by nonresidents. In March 1995 the gross stock of reserves stood at US$14.8 billion.

Official International Reserve Position 1/

(In billions of U.S. dollars)

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The level of Canada’s net international liability rose from $225 billion (37 percent of GDP) in 1989 to $342 billion (45 1/2 percent of GDP) in 1994. The rise was the result of a $130 billion increase in net bond liabilities, associated with the sharp increase in Canadian government deficits in the early 1990s. By contrast, Canada’s net direct investment liability fell by $15 billion over the period as a result of a large increase in direct investment abroad. The rise in direct investment abroad was particularly strong in 1993 and in 1994 in response to the improved growth prospects in overseas markets.

1/

Prepared by Alun H. Thomas.

2/

Exports and imports volumes have tended to move closely in recent years because the manufactures component of imports, which now accounts for more than 50 percent of imports, is mostly a derived demand for goods that are subsequently exported as finished goods.

1/

Real domestic demand in partner countries.

2/

Calculated as the change in export unit value less the change in import unit value.

3/

The relative export price is measured as Canada’s own export price relative to a trade weighted average of the export prices of its major trading partners. The variable is supplied by the OECD.

1/

Some authors (e.g., Krugman and Helpman) have suggested that intra-industry trade is likely to be higher in a country such as Canada, which is both relatively small and has similar factor endowments to its major trading partners.

1/

A reinvested earnings series was introduced in the spring of 1994, which records equity income from direct investment when it is earned rather than when paid out as dividends.

1/

The combined total of federal and provincial saving differs from government savings because local government, hospitals, and both the Canada and Quebec Pension Plans are also included in government saving.

2/

Including statistical discrepancy.

1/

The sharp rise in purchases of treasury bills in 1993 was a response to the spike in short-term interest rates which began in the fall of 1992 and which did not unwind until a year later. The spike in interest rates followed an attempt by the Bank of Canada to counter exchange market pressures associated with the uncertain political climate.

1/

The basic balance is defined as the sum of the current account balance and net long-term capital flows including the statistical discrepancy.

2/

Canada bills are short-term Government of Canada instruments sold in the United States and denominated in U.S. dollars, which are used to bolster gross reserves.

1/

End-of-year values; gross reserves are defined as the sum of convertible foreign currencies, gold valued at 35 SDRs per ounce, SDRs, and the reserve position in the IMF.

Same Series

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Cover IMF Staff Country Reports
Canada: Economic Developments and Policies
Author: International Monetary Fund
Volume/Issue:
Volume 1995: Issue 046
Publisher:
International Monetary Fund
ISBN:
9781451806823
ISSN:
1934-7685
Pages:
178
DOI:
https://doi.org/10.5089/9781451806823.002

CANADA CURRENT ACCOUNT BALANCE

(In percent of GDP)

CANADA COMPETITIVENESS INDICATORS

CANADA VOLUME INDICES

CANADA MOTOR VEHICLE INDICATORS

CANADA BALANCE OF PAYMENTS FLOWS AND THE EXCHANGE RATE