This Selected Issues paper addresses some of the key policy and economic challenges facing the Canadian economy. The paper presents a new approach to predicting the business cycle in the context of the Canadian economy. This approach uses a range of parametric and nonparametric tests to gauge the ability of various indicators to predict turning points in the business cycle. The paper also presents a model that links the inflation rate to the business cycle and the rates of change in the exchange rate and in unit labor costs.


This Selected Issues paper addresses some of the key policy and economic challenges facing the Canadian economy. The paper presents a new approach to predicting the business cycle in the context of the Canadian economy. This approach uses a range of parametric and nonparametric tests to gauge the ability of various indicators to predict turning points in the business cycle. The paper also presents a model that links the inflation rate to the business cycle and the rates of change in the exchange rate and in unit labor costs.

VIII. Federal and Provincial Debt and Debt Management Strategies 1/

1. Introduction

Canadian public indebtedness has increased rapidly over the past 20 years. The federal net debt-to-GDP ratio more than tripled over this period, reaching 72 percent by the end of the 1994/95 fiscal year, and combined federal and provincial government debt ratio reached nearly 100 percent of GDP, the second highest ratio among the G-7 countries after Italy. At the same time, debt-service payments have claimed an increasing share of federal revenues, from around 12 percent in 1974/75 to 34 percent in 1994/95. This chapter examines some of the key issues regarding the size and composition of the public debt and analyzes federal and provincial debt management strategies.

2. The size and composition of the public debt

Table VIII-1 contains data on public sector debt as a percentage of GDP, as measured by the national accounts and the public accounts, between 1975 and 1994. 2/ On a national-accounts basis, net debt of the federal government amounted to 53 percent of GDP, and provincial net debt totaled 15 percent of GDP. Including the debt of local governments, hospitals and public enterprises, gross debt of the public sector stood at 132 percent of GDP in 1994. Debt ratios measured on a public-accounts basis are considerably higher, partly because the public accounts treat civil service retirement plans (which hold a large share of government debt) as off-budget. However, the public-accounts based debt ratios show roughly the same rate of growth. Indeed, most measures of public indebtedness have more than doubled as a percentage of GDP since 1975.

Table VIII-1.

Canada: Total Public Sector Debt

(In percent of GDP)

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Sources: Statistics Canada (supplied by DC): Federal and Provincial Public Accounts (supplied by Department of Finance); and Fund Staff estimates.

Both debt and GDP are measured on a fiscal year basis, beginning April 1. The unavailability of data on intergovernmental holdings of public debt on a public accounts basis precludes the estimation of gross debt held outside the public sector.

Data on intergovernmental holdings of public securities are not available on a public accounts basis so that combined net debt figures will be biased upward.

Estimated on a national accounts basis using the National Balance Sheet accounts.

Includes all debt owed to the nongovernmental sector.

Includes assets held by the Quebec Pension Plan (QPP) and the Canada Pension Plan (CPP).

While total net provincial debt equals about one-sixth of Canadian GDP, indebtedness varies significantly across provinces. Net debt (public-accounts basis) ranged from 12 percent of provincial GDP in British Columbia to 51 percent in Newfoundland (see Chart VIII-1). Investor concern regarding provincial indebtedness has been reflected in credit ratings for provincial bonds and the interest premium over rates on ten-year federal debt, which range from about 15 basis points for Alberta bonds to about 65 basis points for Newfoundland bonds (Department of Finance, 1995b, see Chart VIII-1).



Citation: IMF Staff Country Reports 1996, 038; 10.5089/9781451806830.002.A008

Source: Provincial Public Accounts (supplied by Department of Finance); Scotia McLeod; and Fund staff estimates.1/ Public accounts basis.2/ Interest rate on ten-year provincial debt less the interest rate on ten-year federal debt, as of September 1995.

In 1994/95 debt charges for provincial governments ranged from 4.8 percent of total expenditure in British Columbia to 19.1 percent in Nova Scotia. For the provincial governments combined, debt charges have increased from 5.4 percent of total expenditures in 1980/81 to 12.8 percent in 1994/95 (Chart VIII-2). Federal debt charges as a percentage of total federal expenditure increased from 10.5 percent in 1974/75 to 26.2 percent in 1994/95 and exceed the federal deficit (see Chart VIII-2).



Citation: IMF Staff Country Reports 1996, 038; 10.5089/9781451806830.002.A008

Source: Federal and Provincial Public Accounts (supplied by Deportment of Finance); and Fund staff estimates.1/ Fiscal year, beginning April 1.

Canada’s general government indebtedness--as measured by both gross debt and net debt as a percentage of GDP--is the fourth highest among industrial countries, after Belgium, Italy, and Greece (Table VIII-2). General government gross interest expenditures amounted to 9.1 percent of GDP in 1994, more than twice the level in the United States, Germany, and Japan. In addition to being high by international standards, by the early 1990s the maturity structure of the federal debt had become skewed toward the short end. As a result, Canada had the second highest proportion of short-term debt among industrial countries.

Table VIII-2.

Canada and Selected Industrial Countries: General Government Debt Levels and Interest Charges, 1994

(In percent of GDP)

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Source: Fund staff estimates (Canada); and World Economic Outlook, October 1995.

3. Federal debt management issues

The Canadian Department of Finance’s Debt Operation Report issued in December 1995 lists the following objectives of the federal debt management strategy:

  • to minimize the cost of funding for the Canadian Government;

  • to ensure that these costs remain relatively stable over time;

  • to maintain a diverse investor base; and

  • to ensure the continuing development of liquid and well-functioning Canadian financial markets.

To achieve these goals, the federal government focuses on four key elements. First, it aims to rebalance the stock of debt more towards longer-term fixed-rate instruments to reduce the sensitivity of public debt charges to interest rate fluctuations. The federal government uses three main classes of financial instruments to meet its domestic financing requirements. These are marketable bonds (including fixed-coupon bonds and Real Return Bonds), treasury bills, and Canada Savings Bonds. 1/ Currently, about 45 percent of total federal government borrowing will mature or be repriced within one year, compared to a ratio of about 35 percent among other industrialized sovereign borrowers. This leaves the federal government finances relatively sensitive to increases in interest rates. The Department of Finance has estimated that under the current debt structure, a one percentage point increase in interest rates would increase debt charges by $1.3 billion (0.2 percent of GDP) in the first year.

With a positively sloped yield curve, a lengthening of the average maturity of the outstanding debt leads to higher interest costs, but these costs tend to be more stable over time. The Government has set itself the target of increasing the share of fixed-rate debt to 65 percent by 2004/05, which is expected to provide a balance between cost minimization and cost stability. The average term to maturity of federal debt already has increased from a low of 4 years in 1990/91 to 4 years and 10 months in 1994/95; the Government’s current debt strategy will bring the average term to maturity closer to the OECD average of around 5 years and 3 months.

The second element of the Government’s debt management strategy is the development of a retail debt program aimed at stopping the decline in the retail investor base. The share of the domestic federal debt held by small private investors has fallen from over 40 percent in the mid-1980s to 16 percent in 1994 (Department of Finance, 1995a, p. 3). A retail debt program has been launched to shift the focus from a single product, the Canada Savings Bond, to a family of products that are intended to meet the needs of a broader group of investors.

A third element of the Government’s debt management strategy is to reduce borrowing costs through the development of innovative financing instruments and the promotion of the liquidity and efficiency of Canadian bond markets. The Government has estimated that its efforts to improve the transparency of its debt-issue program have lowered its borrowing costs by up to 10 basis points over the past few years (Department of Finance, 1995a). These efforts include large benchmark issues, a regular bond calendar, quarterly bond and note auctions, and common coupon dates.

A fourth aspect of the debt management strategy is the maintenance of active relations with investors and credit rating agencies to promote Canada’s attractiveness to international investors. As of March 1995, non-residents held 25 percent of outstanding federal market debt, compared to 11 percent in 1984/85. 1/ Most of the non-resident holdings are in Canadian dollars, and only 4 percent of the outstanding market debt is denominated in foreign currency.

4. Provincial debt management issues

The fiscal position of the provinces has improved markedly over the past few years. However, due to large debt refinancing requirements, gross provincial borrowing requirements are still expected to increase over the next decade (Chart VIII-3). More than 70 percent of existing provincial debt falls due within 10 years, reflecting the fact that a large part of the provincial deficits in the past decade were financed using medium-term instruments.



Citation: IMF Staff Country Reports 1996, 038; 10.5089/9781451806830.002.A008

Source: CIBC Wood Gundy.

However, less than 20 percent of provincial debt has a maturity of less than two years, suggesting that the provincial governments are relatively unexposed to the short-run effects of interest-rate shocks. For example, gross provincial debt charges have been estimated to increase by only about 2 1/2 percent in response to a 1 percentage point increase in interest rates. 1/ While the effect on debt-service outlays would be relatively modest in the short term, the large amounts of debt falling due in the next few years leaves the provinces vulnerable to interest-rate developments over the medium term.

The large volume of provincial debt scheduled to fall due over the next ten years takes place against the backdrop of a relatively modest domestic market for provincial securities. In the past decade, provincial governments increasingly looked abroad for financing, and by the end of the 1993/94 fiscal year about 35 percent of provincial debt was denominated in currencies other than the Canadian dollar before hedging. The share of foreign currency-denominated debt varies greatly by province (Table VIII-3). Prince Edward Island has issued only Canadian dollar debt; among the other provinces the share of provincial debt denominated in foreign currencies ranges from 11 percent in British Columbia to 67 percent in Nova Scotia.

Table VIII-3.

Canada: Distribution of Provincial Government Direct Debt by Currency, Before and After Hedging

(In percent of total debt)

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Source: Provincial Public Accounts, as of March 31, 1994 (supplied by Department of Finance).

Original data do not add up to 100 percent.

However, most of the provinces’ exposure to foreign exchange rate risk is at least partially hedged. Table VIII-3 indicates that hedging activity changes the foreign currency exposure of some of the provinces substantially. In the case of Ontario, hedging increased its domestic currency component of the debt from 71 percent to 97 percent. Others are hardly hedged at all: Newfoundland retains almost 50 percent foreign currency exposure. Most of the provinces’ remaining foreign currency exposure consists of U.S. dollar-denominated liabilities. 2/


  • CIBC/Wood Gundy, 1996 Provincial Profiles (Toronto: CIBC/Wood Gundy Economics, 1995).

  • Department of Finance Canada, Debt Operations Report (Ottawa: Department of Finance Canada, 1995a).

  • Department of Finance Canada, The Economic and Fiscal Update (Ottawa: Department of Finance Canada, 1995b).


Prepared by Jeffrey Cole and S. Erik Oppers.


Canadian fiscal data are generally presented either on a public-accounts or a national-accounts basis. The public accounts generally record revenues on a modified-cash basis and expenditures on an accrual basis, while the national accounts are booked on an accrual basis. The national accounts measure of the fiscal position facilitates international comparisons, as well as aggregation and comparisons of the fiscal positions of the various levels of government in Canada. The national accounts fiscal deficit is typically lower than the public accounts deficit, mainly reflecting the inclusion of the net surplus of the government employees’ pension funds.


These instruments account for around 80 percent of total federal government borrowing. The remainder of its financial needs are met by loans from internal government sources, such as the civil service retirement plans.


Department of Finance (1995a), Table V. This is according to the Bank of Canada classification, which differs from the public accounts classification.


Unpublished Department of Finance estimates.


Some provinces enjoy a “natural hedge” in the form of substantial foreign currency revenues, which reduces the budgetary impact of changes in the exchange rate. For example, it is estimated that Alberta’s net revenues would increase as a result of a depreciation of the Canadian dollar.

Canada: Selected Issues
Author: International Monetary Fund