KEY ISSUESEconomic outlook: The Canadian economy has expanded at a solid pace since 2013, butrebalancing of growth away from household consumption and residential investment remains incomplete, owing mainly to weak business investment. Growth momentum is expected to continue alongside a strengthening U.S. recovery despite substantially lower oil prices. Risks to the outlook are modestly tilted to the downside given sluggish global growth, effects unfolding from sharply lower oil prices, and housing market risks. Key domestic vulnerabilities in housing markets and the household sector remain elevated but contained fro m a financial stability perspective.Policies for balanced and sustained recovery: An appropriate policy mix should help facilitate rebalancing to generate a broader and more durable recovery, reduce domestic vulnerabilities, and further strengthen financial system resilience:• Macro policies: Monetary policy can remain accommodative for now given that inflation expectations are well-anchored, stronger business investment is still a missing link, risks to an export-led recovery are to the downside, and housing markets are expected to cool as U.S. interest rates rise and with lower oil prices. Fiscal consolidation should proceed in light of longer-term challenges at the provincial level, but federal authorities should consider adopting a neutral stance going forward, using available fiscal resources for targeted measures to support growth. Structural policies to improve productivity in the economy would increasingly need to complement this policy mix.• Housing sector and financial sector policies: Further macro-prudential policy action may be needed to guard against risks to financial stability if household balance sheet vulnerabilities resume rising. Reforms to limit government exposure to housing markets and encourage appropriate risk retention by the private sector should continue. Improving complex coordination across federal and provincial authorities in supervision and stress- testing of depository institutions and strengthening macro-prudential and crisis management frameworks will reinforce the resilience of Canada’s financial system.Policy response to past advice: Since the 2013 Article IV Consultation mission, the authorities have taken some further steps to limit taxpayer exposure to the housing sector and strengthen mortgage insurance underwriting practices. Some work on FSAP recommendations has also started to enhance stress testing, address data gaps, and towards establishing a cooperative capital markets system. The authorities have also intensified theirefforts towards addressing interprovincial trade barriers and export diversification.

Abstract

KEY ISSUESEconomic outlook: The Canadian economy has expanded at a solid pace since 2013, butrebalancing of growth away from household consumption and residential investment remains incomplete, owing mainly to weak business investment. Growth momentum is expected to continue alongside a strengthening U.S. recovery despite substantially lower oil prices. Risks to the outlook are modestly tilted to the downside given sluggish global growth, effects unfolding from sharply lower oil prices, and housing market risks. Key domestic vulnerabilities in housing markets and the household sector remain elevated but contained fro m a financial stability perspective.Policies for balanced and sustained recovery: An appropriate policy mix should help facilitate rebalancing to generate a broader and more durable recovery, reduce domestic vulnerabilities, and further strengthen financial system resilience:• Macro policies: Monetary policy can remain accommodative for now given that inflation expectations are well-anchored, stronger business investment is still a missing link, risks to an export-led recovery are to the downside, and housing markets are expected to cool as U.S. interest rates rise and with lower oil prices. Fiscal consolidation should proceed in light of longer-term challenges at the provincial level, but federal authorities should consider adopting a neutral stance going forward, using available fiscal resources for targeted measures to support growth. Structural policies to improve productivity in the economy would increasingly need to complement this policy mix.• Housing sector and financial sector policies: Further macro-prudential policy action may be needed to guard against risks to financial stability if household balance sheet vulnerabilities resume rising. Reforms to limit government exposure to housing markets and encourage appropriate risk retention by the private sector should continue. Improving complex coordination across federal and provincial authorities in supervision and stress- testing of depository institutions and strengthening macro-prudential and crisis management frameworks will reinforce the resilience of Canada’s financial system.Policy response to past advice: Since the 2013 Article IV Consultation mission, the authorities have taken some further steps to limit taxpayer exposure to the housing sector and strengthen mortgage insurance underwriting practices. Some work on FSAP recommendations has also started to enhance stress testing, address data gaps, and towards establishing a cooperative capital markets system. The authorities have also intensified theirefforts towards addressing interprovincial trade barriers and export diversification.

Recovery Continues but Remains Unbalanced

Canada’s recent growth performance has been solid alongside a stronger U.S. recovery. The awaited pickup in exports is encouraging although it has yet to translate into strong investment and hiring. Thus, the composition of growth has not yet rebalanced away from private consumption and residential investment to generate a broader, more durable recovery. Substantially lower crude oil prices will be a drag on activity, mainly through weaker investment in the energy sector. Risks to the outlook are modestly tilted to the downside, mainly reflecting external risks including weaker global growth and still-unfolding effects from the unusually large fall in oil prices. Domestic vulnerabilities in housing markets and the household sector remain elevated but contained from a financial stability perspective. Risks of faster-than-expected tightening in financial conditions associated with U.S. monetary normalization or weaker terms of trade could also interact with domestic risks and vulnerabilities—mainly, elevated house prices and high indebtedness of Canadian households.

1. The Canadian economy has been expanding at a solid pace since 2013 (Figure 1). Growth remained slightly above potential, averaging 2½ percent in the first three quarters of 2014. Regionally, a multi-speed recovery was led by resource-rich Alberta, while the pickup in activity was more modest in other large provinces, driven in part by non-energy exports. CPI inflation has been running over 2 percent since April 2014, up from very low readings in 2013, reflecting largely temporary factors and the effects of exchange rate pass-through, despite a still-negative output gap and pressures from retail competition (Figure 2).

Figure 1.
Figure 1.

Solid Growth Driven by Private Consumption and Exports

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Statistics Canada; Haver Analytics; Bank of Canada; and IMF staff estimates.1/ The Bank of Canada’s foreign activity measure captures the composition of foreign demand for Canadian exports by including components of U.S. private final domestic demand and economic activity in Canada’s other trading partners.
Figure 2.
Figure 2.

Monetary Conditions Remain Accommodative

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Statistics Canada; Haver Analytics; Bloomberg; and IMF staff calculations.

2. Despite the welcome pickup in exports, rebalancing of growth remains incomplete—owing mainly to weak investment (Chart, Figure 1).

  • Stronger exports. U.S. recovery momentum, exchange rate depreciation (about 10 percent in real terms since early 2013), and high energy demand in early 2014 have provided a needed push to Canada’s exports. In real terms, exports expanded on average 4½ percent (y/y) over the last four quarters, led by non-energy exports. Although the rebound in most sectors remains modest, a few (including the transportation sector) are performing strongly relative to external demand growth.1 Energy exports (in volume terms) have also been strong, and Canadian crude oil continued gaining market share in the United States amid some easing in infrastructure bottlenecks associated with transporting crude oil to U.S. Midwest to Gulf Coast refineries.2

A01ufig01

Canada: GDP Growth and Contributions from Main Components

(Percentage change)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Statistics Canada; and IMF staff estimates.1/ Data for 2014 are based on staff’s estimates of 2014:Q4.
  • Weaker-than-expected investment. Business nonresidential investment has slowed in recent years (following a strong rebound initially after the crisis). The slowdown has been widespread—including both the energy sector and broader spending on machinery and equipment (Charts). Companies focused on upgrading or replacing existing capital, in part owing to uncertain future demand, despite higher corporate profits since mid-2013, resilient domestic consumption, and strengthening external demand. Moreover, there are indications that lower oil prices will dampen investment in the energy sector. However, business investment outside the energy sector could provide some offset, especially in the sectors benefiting most from the U.S. recovery, and given rising capacity utilization rates.

A01ufig02
Sources: Statistics Canada; and IMF staff estimates.1/ Estimates are derived from a regression model where the changes in real private nonresidential fixed investment are explained by lagged changes in real private consumption, lagged changes in real goods exports, and a lag of profit rate. Dashed lines deno te the 95% confidence interval. The negative constant term is subtracted from the reported coefficient estimates.
  • Resilient private consumption amid a steady labor market. Consumers—benefiting from rising household wealth and disposable income and exceptionally easy financial conditions—increased their spending on housing-related goods and automobiles. Labor markets have been relatively static until recently. Echoing tentativeness in business investment, the pace of hiring has been modest with a composition focused on adding temporary capacity (e.g., half of jobs added in 2014 were part-time—a share above its historical average). The unemployment rate had been hovering around 7 percent since end-2012, before edging down to a post-2008 low in recent months (about 6½ percent in October-December). The unemployment gap persisted while labor force participation rate has been largely flat, unlike the declining trend in the United States (Figure 3).

  • Housing markets strong with signs of overvaluation to differing degrees. After a brief pause, Canada’s housing market rebounded in 2014, fueled by low and declining interest rates (Figure 4). House prices have been rising at 5–6 percent (y/y) nominally through most of 2014 (almost twice the average pace in 2013). Most of the appreciation has been driven by Calgary’s housing market and single-family homes in Toronto and Vancouver (Charts).3 Since 2001, house prices have risen significantly—similar to other Commonwealth commodity-exporter countries—though Canada’s cycle seems to be lagging and relatively smoother. Staff analysis suggests a national real house price overvaluation (relative to levels justified by long-run fundamentals) between 7–20 percent, although with significant differences across regions and market segments.4

Figure 3.
Figure 3.

Canada’s Labor Market Has Fared Relatively Well

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Statistics Canada; Haver Analytics; and IMF staff estimates.
Figure 4.
Figure 4.

Housing Sector Remained Strong

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: CREA; CMHC; Haver Analytics; Statistics Canada; and IMF staff estimates.1/ The demand (supply) shock in the housing market is defined based on whether house prices and sales move by at least one standard deviation in the same (opposite) direction.
A01ufig03
Sources: Haver Analytics; CREA; and IMF staff calculations.
  • Stable household debt, albeit at high levels. Total mortgage borrowing and household indebtedness have broadly stabilized in recent quarters—albeit the latter at record high levels (over 150 percent of disposable income), while household net worth continued rising on the back of rising housing and equity market valuations (Chart).

A01ufig04

Household Net Worth and Debt

(Percent of disposable income)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Haver Analytics; Statistics Canada; and IMF staff estimates.

3. Public finances continued improving in 2014, reflecting federal and some provincial consolidation efforts (Figure 5). The general government fiscal deficit is expected to narrow from about 2¾ percent of GDP in 2013 to 1½ percent in 2014, representing a ¾ percent of GDP improvement in structural terms.

Figure 5.
Figure 5.

Fiscal Consolidation Proceeds but Provinces Continue Facing Challenges

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Budget documents; Statistics Canada; Royal Bank of Canada; Institute de la Statistique Québec; and IMF staff estimates.
  • The federal government is essentially on track to achieving its balanced budget target in FY2015/16. This reflects better-than-expected revenue because of stronger-than-projected growth, one-off measures (including ¼ percent of GDP from an auction of broadband spectrum license), and lower spending ahead of planned restraint initiatives. Recently introduced income tax cuts and enhanced child care benefits, as well as lower oil prices that will affect nominal tax revenues, are not expected to materially delay reaching budgetary balance in FY2015/16.5

  • Provinces, while remaining committed to their balanced budget targets, continue struggling with consolidation. Headline and cyclically-adjusted deficits at the provincial level are expected to improve in 2014 by about ½ percent of GDP (given the outturn in the first three quarters of 2014). Fiscal situations vary across provinces. Ontario and Québec are facing challenges with consolidation while expecting to return to balanced budget by FY2017/18 and FY2015/16, respectively (Box 1). Fiscal positions in Western provinces are relatively strong, but a sharp and persistent drop in the crude oil prices will impact public finances, especially in Alberta, directly through lower royalties and lower corporate profits and household incomes.6

  • Gross public debt ratio remains high but should continue declining after 2015. General government gross debt, as a share of GDP, has risen from 67 percent in 2007 to nearly 90 percent of GDP in 2012–13, but is expected to decline after 2015.

4. Canada’s external position has improved and is broadly consistent with medium-term fundamentals and desirable policy settings (Annex I). The trade balance has tended to improve and the currency has weakened since 2013. Based on staff’s External Balance Assessments (EBA), the cyclically-adjusted current account (CA) balance in 2014 is estimated at -1.8 percent of GDP, implying a narrower CA gap of 1.6 percent of GDP according to the latest EBA CA approach (against 3.4 percent CA gap for 2013). Staff assesses the 2014 CA gap to be smaller than the EBA estimate, ranging between 0 to 1 percent of GDP, closing which would require policy actions aimed at boosting productivity and addressing energy infrastructure bottlenecks (see below). Reflecting exchange rate depreciation over the past year (up to end-October 20147), the Canadian dollar is estimated at 0–5 percent above the level consistent with medium-term fundamentals and desirable policy settings in 2014 (compared to 5–10 percent REER gap for 2013). In the last two months of 2014, the exchange rate depreciated further by an estimated one percent in real effective terms, less than what would be implied by its past relationship with real energy prices.8

Fiscal Consolidation Challenges at the Provincial Level: Ontario and Québec

Ontario and Québec—the two largest provinces in Canada—face important fiscal challenges. Combined, they account for about two-thirds of Canada’s population, near 60 percent of its GDP, and over half of its exports given a large presence in manufacturing. At the same time, Ontario and Québec are the most challenged provinces when it comes to their public finances—with Québec having the highest stock of public debt and Ontario the highest budgetary deficit among all Canadian provinces. This box describes provincial authorities’ recent efforts to place public finances on a sounder footing and the prospects over the short and medium term.

Fiscal consequences of the Great Recession

The 2008–09 recession abruptly interrupted healthy debt reduction that started in the mid-1990s. Loss of fiscal revenues, automatic stabilizers, and higher discretionary spending led to wide budgetary deficits and higher public debt.

  • Ontario was hit harder by the global recession with its GDP falling cumulatively between 2007 and 2009, about 5 percent more than Québec’s. A rapid deterioration of the fiscal balance is mainly accounted by a large discretionary increase in program spending (beyond health care and education) in FY2009/10 and lower revenues (revenues returned to pre-crisis levels only in FY2011/12). After an initial rapid improvement in the fiscal position, the progress slowed, and in 2013–14 the deficit is estimated to stand at about Can$10.5 billion (1½ percent of Ontario’s GDP).

  • The loss of tax revenues in Québec was milder with revenues reaching pre-crisis levels already in FY2010/11. Similarly, the increase of program spending was mainly driven by structural factors such as health care spending (growing at almost 7 percent between FY2007/08 and FY2009/10). In FY2013/14, the deficit is estimated to stand at Can$1.7 billion (½ percent of Québec’s GDP).

  • As a consequence, gross-debt-to-GDP ratio increased in these provinces. The bond yield spread between the two provinces and federal government has widened and remained around 100 basis points, twice the level before the crisis.

A01ufig05
Sources: Ontario and Québec budget reports.

Policy commitments and prospects for balanced budgets 1/

The Ontario government is committed to balancing the budget in FY2017/18. Provincial authorities also aim to reduce net debt to its pre-recession level of 27 percent of GDP (though without a specific date). After increasing to Can$11.8 billion in FY2014/15, the deficit is projected to gradually narrow before reaching a surplus in FY2017/18.2/ Overall, an improved economic outlook and health care cost containment seem crucial for Ontario to meet its fiscal targets. The burden of the adjustment will be mainly on program spending which is projected to grow well below CPI inflation.3/ Since the two-year wage freeze for public servants will have only modest impact on spending, much will depend on the ability to further contain health care costs.4/ In addition, steps are being taken to improve provincial asset management, including by considering options to divest non-core assets. Such actions, as identified by the Premier’s Advisory Council on Government Assets, could yield Can$2–3 billion for potential investments in Ontario’s infrastructure. The Council’s final recommendations are expected to help inform Ontario’s 2015 budget.

The Québec government is committed to balancing the budget in FY2015/16. Over a longer horizon, authorities aim to reduce gross debt and accumulated deficits to 45 percent and 17 percent of GDP in 2025–2026, respectively. The return to budget balance, however, has been postponed for the last two years, and fiscal outturns have consistently disappointed over the last four years. The slippages were related to lower-than-expected revenues and especially higher-than-expected spending. According to the Fall 2014 budget update, the government has identified about 85 percent measures (from the total of Can$7.3 billion) needed for FY2015/16 to meet the balanced budget target. Most of the effort is focused on restraining expenditure growth, by increasing savings from ministries and government organizations, freezing public service hiring for two years, and reducing tax expenditures and subsidies. In comparison to Ontario, Québec’s fiscal challenges appear more structural, related to slower potential economic growth, a greater role of the government, and structurally higher health care spending growth (in part related to demographic differences despite Québec’s lower health expenditure in per capita terms).

A01ufig06
Sources: Ontario and Québec budget reports.
1/ Ontario’s fiscal framework is legislated in the “Fiscal Transparency and Accountability Act” (2004), which prohibits forecasting ex ante deficits in each of the 3-year ahead budget planning horizon. Québec’s “Balanced Budget Act” (2009) prohibits ex post deficits but it has been amended to allow temporary deficits in specific years.2/ The budget figures are before accounting for the contingency reserve and, thus, represent the most likely scenario. The government’s objective is, however, expressed with prudence taking into account the use of the contingency reserves.3/ It is worthwhile noting that in Ontario’s program spending already declined from 18 percent of Ontario’s GDP in FY2009/10 to almost 16½ percent in FY2013/14. This makes Ontario the province with the lowest program spending per capita.4/ For discussion of trends in health care spending, see IMF Country Report, No. 14/27.

Outlook and Risks

5. Recovery momentum is expected to continue, gradually reabsorbing remaining slack in the economy. Above-potential GDP growth is envisaged for 2014 and 2015, as exports and non-energy investment benefit from the U.S. recovery where growth momentum remains strong (Chart). As a drag on growth, the adverse impact of significantly lower oil prices will especially dampen near-term investment in the energy sector. Headline CPI inflation is expected to decelerate in 2015 as a result of lower oil prices, but core CPI inflation will likely remain close to the Bank of Canada’s target rate of 2 percent (y/y) as output and unemployment gaps gradually close.

A01ufig07

Canada: Contributions to GDP Growth

(Percentage change)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Statistics Canada; and IMF staff estimates.

6. Growth is expected to become more balanced going forward, along with a cooling housing market. Spurred by the stronger U.S. recovery, which is expected to continue, stronger exports and non-energy investment should mostly offset an expected moderation of private consumption and residential and energy investment with rising interest rates, much lower oil prices, and high household indebtedness. Looking beyond the recent strength and overvaluation in Canada’s housing market, staff continues to expect a “soft-landing” (Chart) as higher interest rates and weaker terms-of-trade prospects would temper housing demand, especially in those markets where signs of overvaluations are stronger and where the regional economy is more reliant on the energy sector.

A01ufig08

Estimates of House Price Overvaluation

(Real price, logarithmic scale) 1/

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff estimates.1/ 10th, 50th, and 90th percentiles of estimates and residuals (overvaluation) from reverse recursive regressions.

7. A transition to more balanced and sustainable growth is not without risks (Risk Assessment Matrix, Box 2). Risks to growth are modestly tilted to the downside—led by external risks that could also interact with domestic risks and vulnerabilities.

  • Key external risks facing Canada’s economy involve tighter global financial conditions and effects from substantially weaker oil prices. Moreover, external risks—e.g., tighter-than-expected global financial conditions or weaker terms of trade on a sustained basis—could further harm domestic demand by interacting with vulnerabilities in the housing sector and high household indebtedness. In the energy sector, substantially lower global oil prices, if they persist, and concerns about still-unresolved prospects for major infrastructure projects would pose risks for domestic investment and energy production (Box 3).9

  • Given house price overvaluation, the housing sector is the main domestic risk—alongside high household debt. A sharper-than-expected correction of house prices would have an adverse impact on household wealth and access to finance, reducing domestic demand and output, but risks to financial stability are likely to be limited. It remains, however, unlikely that a sharp house price correction could take place in the absence of external demand triggers.

  • Downside risks could occur in unison. A deeper downside scenario would have key external risks and a housing market correction occurring together.

  • On the upside, external demand (U.S. investment and housing) may be stronger than expected, and a faster resolution of infrastructure bottlenecks could support energy exports and investment.

8. Both monetary and fiscal policy have space to respond if adverse shocks materialize or intensify. The federal government and some provinces have fiscal space for automatic stabilizers to operate fully. A further fiscal loosening for these governments could be considered in the event of a larger and/or more persistent adverse shock, complemented by greater reform efforts aimed at improving productivity and addressing energy infrastructure bottlenecks over the medium term. Monetary policy has room to ease if downside risks materialize or intensify.

9. Canada is heading towards general elections in 2015. The general election to elect members to the House of Commons of the Canadian Parliament is tentatively scheduled for October 19, 2015. At the provincial level, with most elections over, including the 2014 elections in Ontario and Québec, some policy uncertainty remains especially in Québec relating to potential fiscal policy changes as a result of (needed) ongoing expenditure and tax system reviews.

Canada: Risk Assessment Matrix 1/

article image

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Risk Scenarios and Spillovers 1/

Main external risks. Canada can be adversely affected by unexpectedly sharp monetary normalization in the United States, a more protracted period of slow growth in advanced and emerging market economies, and a further decline in oil prices.

  • Sharper U.S. monetary normalization. Monetary conditions could tighten unexpectedly in the United States and the United Kingdom (with a 100 basis point rise in term premium in 2015), triggered by market fears over a sooner-than-expected policy rate hike reflecting financial stability concerns (2014 Spillover Report). Even assuming a quick policy response to address market misperception and lowered short-term interest rates, the output loss for Canada could still be significant in the near term. On the other hand, if tightening is accompanied by a private domestic demand-driven expansion in the U.S., Canada’s higher net exports and depreciation against the U.S. dollar are expected to more than offset the negative impact of financial tightening in Canada due to spillovers. In this case, Canada’s output would rise, or stay around the baseline after accounting for a likely house price correction (IMF Country Report, No. 14/27, Annex I).

  • Slower growth in advanced and emerging economies. A protracted period of slow growth in advanced and emerging markets could also hurt Canada over the medium term, mainly through weaker U.S. demand and lower prices for commodities, including oil. The impact on Canada, however, from further downward pressure on energy prices would be smaller if the additional shock is primarily driven by weaker demand outside the U.S. (and/or supply factors in oil markets).

Main domestic risk

  • Housing shock. House price correction can be more abrupt than expected, triggered by, for example, an overreaction to factors affecting fundamentals, such as an increase in mortgage rates and deterioration in the terms of trade. Model estimates suggest that a 10 percent decline in house prices could lead to about 0.1 percent decline in Canada’s private consumption. The rise in interest rates would further subtract from consumption through higher mortgage debt service, with a 100 basis point increase in interest rates translating into about 0.3 percent decline in private consumption in one year.

Combined risk scenario. Given interconnections between external and domestic risks, some could materialize together. A deeper downside scenario would include tighter financial conditions, amplified by a debt-service channel, a further deterioration in the terms of trade (for example, from an additional 10 percent decline in oil prices), and a housing market correction occurring in unison, where, for example, financial tightening would increase debt service costs while lower commodity prices would trigger a reassessment of house price fundamentals. The combined effect on real GDP would be about 1 percent drop in the first year, rising to about 1¼ percent reduction over the medium term. Consumption and especially investment would be significantly hurt, while exports would increase as monetary policy is expected to react by easing its stance (Chart).

A01ufig09

Canada: Downside Risk Scenario

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff estimates.

Inward spillovers. Canada remains mainly exposed to spillovers from the United States through trade and financial linkages. Canada’s merchandise exports are predominantly directed to the United States, although the U.S. share has declined from about 85 percent in 2003 to 75 percent in 2013. Reflecting this tight trade link, export growth is highly synchronized with the U.S. business cycle and especially with U.S. business investment (through imports of manufacturing goods).2/ Meanwhile, Canada has become more exposed to emerging markets over recent years, mainly through commodity prices.3/ On the financial side, Canadian banks’ consolidated claims on non-residents as of 2014Q2 stood at about 70 percent of GDP, of which two-thirds were vis-à-vis the United States. While Canada’s liabilities to foreign banks is relatively small (about 20 percent of GDP) compared to other advanced economies, Canada’s financial and non-financial sectors could be affected by the materialization of the risk of runs on U.S. mutual funds in the event of an interest rate shock.

Outward spillovers. External effects on the Caribbean could be substantial given Canadian banks’ dominant presence in the region and large tourist and remittance flows from Canada. A network analysis based on BIS banking statistics indicates significant cross-border financial linkages to the region and could be a potential source of significant spillovers for a number of Caribbean islands where Canadian financial institutions have a dominant market position. For example, Canadian banks account for about 60 percent of the ECCU’s banking system assets. Changes in Canada’s economic conditions can also affect the Caribbean islands through tourism and remittance flows. In 2013, Canadian tourists accounted for about 12 percent of total arrivals in the region, which is the second after the United States (Caribbean Tourism Organization, 2014). Remittance inflows from Canada are also sizeable for countries such as Guyana and Jamaica, amounting to about 3 and 2 percent of their GDP in 2012, respectively.

1/ The discussion on assessing macroeconomic implications of shocks has benefited from inputs by Benjamin Hunt, Keiko Honjo, and Dirk Muir (all RES).2/ Staff estimates that a one percentage point increase in U.S. business investment growth is associated with ½ percentage point increase in Canada’s real exports of goods and services growth after one year.3/ Canada is particularly exposed to fluctuations in China’s fixed asset investment given its high commodity-intensity: a one-percentage point decline in China’s fixed asset investment growth could reduce Canada’s export growth by up to ¼ percentage point (IMF Country Report, No.13/40).

Lower Oil Prices: Implications for Canada

Energy sector in Canada

Energy sector plays an important role in Canada’s economy. The sector accounted for almost 10 percent of GDP (over half of which oil and gas extraction) and over 25 percent of exports in 2013–14. Capital expenditure in Canada’s oil and gas sector comprises about ¼ of total non-housing private investment, about equally split between conventional oil/gas and unconventional oil extraction. While the sector’s direct contribution to GDP and employment has been small, it has notable spillovers to other sectors linked to unconventional oil extraction activities. Overall, Canada has benefited from the boom in the unconventional oil production from oil sands (see, IMF Country Reports No. 14/27 and No. 14/28).

Fiscal exposure at the federal level to oil is limited but important for oil-rich provinces, mainly through royalties. At the general government level, direct revenues from oil amount to about 1½ percent of total revenue or ½ percent of GDP (over two-thirds of which in Alberta). Corporate income tax from oil-and oil-related companies is also an important source of revenue. Other effects would work through indirect taxes and other revenues affected by the reduction in the tax base (lower nominal growth). To this end, the Fall 2014 update of the federal budget introduced an adjustment to largely account for the sharp decline in oil prices, lowering the level of nominal GDP over the medium term.

Implications of persistently lower crude oil prices

A persistent and sizeable decline in oil prices dampens Canada’s growth through a number of channels. The adverse direct effects would be on investment and employment in the energy sector. Breakeven prices for Canadian oil sands are believed to be wide ranging from US$50 per barrel to over US$85 per barrel; more advanced projects would be able to expand even at lower prices, but further increases in investment would more likely be delayed if low oil prices were to persist.1/ Canadian equity prices would decline as energy companies represent an important share of the Canadian stock market. Deteriorating terms of trade, weaker domestic income, and lower financial wealth would negatively affect private consumption–more so, if the housing market was negatively affected as well. Public consumption in oil-producing provinces may also be negatively affected (assuming they do not adjust their fiscal balance targets). Interprovincial trade and labor mobility (which increased alongside the energy boom in Canada’s western provinces) would also be negatively affected. The historically strong relationship between oil prices and the Canadian exchange rate would indicate a weaker currency that would help cushion the growth effects through non-energy exports. Lower energy costs could also benefit consumers and help increase exports, investment, and employment in non-energy sectors and provinces, especially in the context of a slightly stronger U.S. growth.

Simulations suggest that typically a 10 percent decline in oil prices, driven largely by supply factors, reduces Canada’s GDP growth by less than 0.1 percentage point per year, cumulating to about ¼ percent lower level of GDP over the medium term (Chart). The output losses would, however, be noticeably larger if demand factors increasingly drive lower oil prices. The effects on headline inflation are felt on impact while the pass-through to core inflation is small. The effects of falling energy prices would in part be offset by exchange rate depreciation (and monetary policy would ease to react). The deterioration in the current account is small and short-lived. Overall, the effects would be smaller if U.S. demand remains strong, oil price decline is perceived as temporary, and/or there is meaningful progress on important energy infrastructure projects which would support exports and investment and keep the margin between WCS and WTI narrow.2/

A01ufig10

Canada: Oil Price Shock

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff estimates.

Preliminary reactions from the industry

Canadian oil sands producers are taking a long-term view of the global oil market but have indicated spending cuts in the near term in response to the current low crude price environment. Typically, oil sands projects are based on long-term price expectations and decades-long production profiles. Suncor Energy, the largest Canadian energy company by market capitalization, plans to cut capital spending by $1 billion in 2015 from previously planned $7.2–$7.8 billion while keeping average production of 540,000–585,000 barrels of oil equivalent per day, compared to $7.8 billion capital spending and 565,000–610,000 barrels of oil production planned for 2014. Canadian Natural Resources, the largest oil and gas producer and the second largest energy company by market capitalization, plans a somewhat lower production in the short term along with a large cut in its 2015 capital budget (from $8.6 billion to $6.2 billion). The companies expect major projects that are already underway for oil sands and heavy oil to move forward as planned but new projects will be deferred. Over a longer run, pipeline capacity remains the main issue for Canada’s crude oil production.3/

1/ According to Alberta’s government, most projects have already committed large amounts of capital and are increasingly shifting to the production phase. More broadly, investment decisions are also linked to infrastructure issues, and progress on any major infrastructure projects to export oil would likely help sustain investment.2/ The price discount between the Canadian oil sands price (WCS) and WTI, which has varied between US$15–20 per barrel recently, is only in part driven by quality differentials.3/ While approval or implementation of major pipeline projects continue to face significant resistance, other projects have become operational in 2014 enhancing pipeline capacity to and from the U.S. refining center in Cushing (such as Keystone XL’s southern leg, Enbridge’s Flanagan South pipeline, Seaway twinning). In addition, transporting crude oil by rail remains an important alternative.

Policies for Balanced and Sustained Recovery

The authorities should continue pursuing a combination of macroeconomic and structural policies that would facilitate the rebalancing of growth from consumption and residential investment towards exports and business investment, further strengthen the resilience of the financial system, improve the composition of fiscal policy, and boost the economy’s growth potential. To secure a broader and more durable recovery, maintaining monetary accommodation along with gradual fiscal consolidation at the general government level would be conducive for achieving a growth composition with stronger exports and, thereby, investment in the economy, while targeted macro-prudential policies would help address housing sector vulnerabilities.

A. Monetary Policy: Gradual Normalization Ahead

10. Monetary policy remains accommodative given slack in the economy and stable inflation outlook. The policy rate has been on hold at 1 percent since September 2010. Overall financial conditions have been easing until recently, with interest rates across maturities declining since end-2013 and business credit growth picking up (Figure 6). Staff estimates of the (time-varying) neutral rate of interest suggest that monetary policy has been supportive throughout the recovery, and currently, with a negative interest rate gap (i.e., actual policy rate below the neutral rate) (Chart, Selected Issues).10

Figure 6.
Figure 6.

Financial Sector Remains Resilient

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Bank of Canada; Haver Analytics; Banks’ Annual Reports; and IMF staff estimates.
A01ufig11

Neutral Interest Rate Estimates and Projections

(Percent, nominal 3-month T-bill rate)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Sources: Bank of Canada; and IMF staff estimates.

11. Monetary normalization is expected to begin later in 2015. Looking forward, the short-term neutral rate should eventually rise from current low levels reflecting the normalization in the U.S. monetary policy and solid economic activity in Canada driven by external factors (mainly, the U.S. recovery) and domestic factors (pickup in non-energy business investment). In this setting, a gradual increase in policy rates starting in the second half of 2015 is suggested by staff analysis toward a medium-term neutral rate estimated to be between 3 and 4 percent over the medium term. Market expectations of policy tightening more towards the end of 2015 have increased recently.

12. Monetary policy can afford to stay accommodative for now. With well-anchored inflation expectations and downside external risks to growth, the Bank of Canada (BOC) can embark on policy tightening after firmer signs emerge of a more balanced and durable recovery led by stronger investment. Also, a negative impact on domestic growth and inflation from the recent decline in oil prices provides additional room for maintaining monetary accommodation. Moreover, given the strong co-movement between Canadian and U.S. long-term interest rates, an expected gradual increase in U.S. rates around mid-2015 along with terms-of-trade deterioration should help cool down the housing sector.

B. Macro-Prudential Policies: Options for Further Targeted Action

13. Further macro-prudential policy action may be needed if household balance sheet and housing market vulnerabilities resume rising. Evolving risks to the financial system and the ability of macro-prudential tools to influence these developments need to be monitored closely. Measures introduced over the past few years have been effective in significantly lowering growth of insured mortgage loans (Chart). At the same time, however, uninsured mortgages—loans with the maximum loan-to-value (LTV) ratio of 80 percent—which recently comprise more than two-thirds of mortgage originations have been rising noticeably (on average, 10 percent per year since mid-2010) alongside house price increases, especially in high-end, single-family housing markets (Chart). With some of this new lending, particularly by smaller and less regulated financial institutions, going to non-prime borrowers, it may partly reflect greater use of borrowed funds for larger down payments to avoid insurance premiums or tighter conditions on insured mortgages.

A01ufig12
Sources: OSFI; and CREA.1/ For insured mortgages over the period of 2011Q4–2012Q4, four-quarter rolling average Q/Q growth rates are used to adjust for a structural break in 2011Q4 due to classification of securitized mortgages.
  • As an initial step to address evolving risks in mortgage markets, low-LTV mortgage loans to be insured on a portfolio basis could be subject to the same mortgage insurance rules applied to high-LTV mortgage loans, especially since the largest proportion of uninsured low-LTV loans have LTVs in the upper range between 75–80 percent and given the fact that down payments can be borrowed. Data on borrowed down payments would help assess possible avoidance from tighter mortgage insurance rules.

  • Additional actions targeted at uninsured mortgages to consider may include tighter amortization and lower LTV limits for market segments where they remain relatively high and caps on debt-service-to-income (DSTI) ratios that would also address the issue of borrowed down payments.11 These measures would also have a particularly dampening effect on the most overheated regional markets.12

14. Policies should aim at further limiting exposure of taxpayers to the housing market and encouraging appropriate risk retention by the private sector, as recommended by the 2013 FSAP. Staff welcomes the tightening mortgage insurance measures implemented by the Canada Mortgage and Housing Corporation (CMHC) over the past year, CMHC’s plans to increase capital, and a new guideline issued by the Office of the Superintendent of Financial Institutions (OSFI) to strengthen mortgage insurance underwriting practices.13 The elimination of some CMHC’s mortgage insurance products will marginally limit the federal government’s exposure to the housing market since they represent a small proportion of CMCH’s business and can still be insured by private mortgage insurers.14

  • In the near term, the authorities will need to implement current plans to prohibit the use of government-backed insured mortgages in non-CMHC securitization programs and gradually limit portfolio insurance that will be tied to CMHC securitization. Further reduction of portfolio insurance for both CMHC and private mortgage insurers and changes to introduce more risk-sharing should also be considered, which would complement current prudential measures in cooling off the housing market.

  • To help encourage market alternatives to insured mortgage related instruments, the 4 percent threshold on covered bonds’ share in total assets (one of the lowest among Canada’s peers), could be increased as the issuance of National Housing Act Mortgage-Backed Securities (NHA MBSs) and Canada Mortgage Bonds (CMBs) is further reduced.15 More broadly, re-examining the dimensions of extensive government-backed mortgage insurance should remain on the authorities’ longer-term agenda, including managing a transition from financial market reliance on government-backed instruments as the public sector role recedes.

C. Financial Sector Policies: Reform Agenda and FSAP Recommendations

15. Banking sector performance improved over the past year (Figure 6, Chart).

  • Canadian banks are profitable and well capitalized. Canadian banks reported record profits despite stable interest rate margins as non-interest income increased. Loan quality has remained favorable, with nonperforming loans (NPLs) below ½ percent of total loans and falling. D-SIBs are well capitalized but report CET1 ratios below the average capital ratios of G-SIB (by 1 percentage point). Banks are well positioned to meet the new Basel III Liquidity Coverage Ratio (LCR) and leverage requirements in advance of their implementation.

A01ufig13

Canada: Financial Stability Map

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff estimates.Note: Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite.
  • Financial stability risks appear contained. Given Canadian banks’ strong capital position and stable funding sources as well as extensive government-guaranteed mortgage insurance, the impact on financial stability of a tail risk shock characterized by the worst three-year recession in the last 35 years would be limited, as reported in stress tests conducted for the 2013 FSAP Update. The stress test scenario also includes a 50 percent decline in oil prices, in line with recent market developments, though banks’ exposures to the energy sector and foreign exchange are small. However, risks from operations abroad where Canadian banks have less competitive advantage and increasing reliance on capital markets and wealth management that are more volatile sources of income warrant close attention, including through conducting a possible cross-sectoral review of banks with exposure to tax haven countries and money laundering risks.

16. Risks outside of standard banking activity appear limited. Performance of life insurance and pension funds has improved noticeably. Life insurance companies have reported higher capital and profits due to insurance sales and wealth management activities. The average defined benefit pension fund has become fully funded for the first time since 2007 mainly due to strong equity returns. Financial intermediation in terms of “shadow banking” activity remains relatively limited, with banks (and other regulated institutions) playing the prominent role in all major segments.16 Overall, Canada’s robust financial regulatory and supervisory framework, together with a credible system of federal safety nets, adds to financial system strength.

17. Steady progress has been achieved on key parts of the financial reform agenda since the last Article IV consultation (Text Table).17 Progress has been made on implementing the Basel III Liquidity Coverage Ratio and leverage standards. Resolution and recovery frameworks would be enhanced if the proposed bail-in regime is implemented. The harmonized rules for reporting certain derivatives data to trade repositories will enhance transparency in the OTC derivatives market, and help detect possible systemic risks. Staff welcomed OSFI’s draft guideline for derivatives sound practices which will strengthen the OTC derivatives markets. A new market transaction reporting system for debt securities, including all repo transactions, will allow the BOC to monitor activity and potential financial stability risks in the repo market.

Canada: Progress on Financial Reform Agenda

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18. Progress has been made on some FSAP recommendations (Annex II). Welcome progress has been made on reducing government exposure to mortgage insurance; the federal authorities’ stress-testing framework for banks; and to identify financial sector data gaps, as well as toward enhancing the cooperative capital markets system. Moreover, the OSFI has increased contact with provincial regulators to harmonize regulation and improve supervisory cooperation. The OSFI and the BOC have also started discussions with some provincial regulators to help the latter enhance their stress testing capabilities. Addressing financial sector data gaps will improve the BOC’s research, analyses, and systemic risk monitoring capacity for the financial system. The recent memorandum of agreement among five provinces and the federal government setting out the terms and conditions to establish a cooperative capital markets system could prove a useful step in harmonizing provincial capital markets legislation, enhancing systemic risk monitoring, and enforcement.

19. Addressing other key FSAP recommendations would further strengthen the resilience of the Canadian financial sector. Most FSAP recommendations on financial sector oversight, safety nets, and macro-prudential framework are outstanding. In particular:

  • Enhanced supervisory cooperation across federal and provincial authorities and harmonized stress-testing are important to bolster financial system soundness. Subjecting all systemic federally- and provincially-regulated entities to common stress-testing frameworks would involve a heightened degree of collaboration. While discussions on supervisory cooperation between federal and some provincial authorities have started, two-way communication and protocols to share supervisory information on regulated entities (especially for the financial groups spanning federal and provincial regulatory boundaries) and planned guidelines should be enhanced within respective mandates, including to reduce possible regulatory fragmentation and ensure that supervision remains intensive and effective across all systemic institutions.

  • Strengthening macro-prudential and crisis management frameworks will increase the resilience of the financial system. Staff argued that providing a mandate for macro-prudential oversight to a single entity would strengthen accountability and the capacity and willingness to act, as well as reinforce Canada’s ability to identify and respond to future crises. Such an entity should have participation broad enough to allow for a complete and integrated view of systemic risks, and powers to collect all necessary data for systemic risk analysis. To this end, staff welcomed the authorities’ recent efforts to identify financial sector data gaps. For crisis preparedness, a mandate should be given to an entity that could operationalize a coordination framework to support timely and effective decision-making in a crisis situation and test the capacity of the authorities (federal and provincial) to respond to crisis scenarios.

  • Other recommendations include: (i) providing more clarity around the legal independence of the OSFI, (ii) formalizing banks’ reporting and notification obligations in some areas (such as on the acquisition and ownership of banks and related-party transactions and large exposures), (iii) adopting a transparent and consistent regulatory regime for group-wide insurance supervision, (iv) extending the scope of OSFI’s oversight of the CMHC; and (v) expanding financial sector data collection and dissemination.

D. Fiscal Policy: Changing Composition of Fiscal Adjustment

20. Fiscal consolidation should proceed at the general government level. The general government deficit is expected to gradually narrow from an estimated 1½ percent of GDP in 2014 to near balance over the medium term, with gross debt declining and remaining relatively resilient to a series of macro and fiscal shocks (Annex III). After nearly complete removal of earlier stimulus, the federal government is still projected to provide some contribution to fiscal adjustment at the general government level in 2015–17 (Chart). However, with key fiscal challenges concentrated at the provincial level, particularly arising from looming aging-related spending pressures, it is critical that the composition of fiscal adjustment shifts more substantially towards the provinces.18

A01ufig14

From Fiscal Stimulus to Consolidation 1/

(Percent of potential GDP)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff estimates.1/ Change in structural balance: improvement/deterioration=consolidation/stimulus.

Federal government

21. Federal authorities should consider adopting a neutral stance going forward. Given the strong deficit reduction achieved in recent years (about 2 percent of GDP cumulative improvement in structural balances in 2011–14), the federal authorities should consider a slower pace of adjustment after 2014. Adopting a cyclically-neutral stance would imply a small fiscal easing in the near term but still be consistent with achieving their low public debt objectives by 2021.19 As the economy gradually approaches potential, this would still allow automatic stabilizers to operate fully if growth were to weaken should further downside risks materialize. Moreover, in terms of the policy mix, a neutral fiscal stance would help monetary policy to rebuild policy space further as the recovery proceeds.

22. Available fiscal resources could be used for targeted growth-friendly measures. Against the backdrop of lackluster business investment (despite very low interest rates) and productivity, such measures could focus on providing further support for R&D, SMEs, venture capital, and strategic infrastructure projects, with little risk of crowding out private investment. Reducing federal taxes could provide more space to raise revenue at the provincial level, given that federal and provincial governments ‘co-occupy’ the same tax base.

23. Fiscal policy at the federal level can benefit from a stronger medium-term anchor. To lock in the gains from consolidation and increase effectiveness of fiscal policy, a medium-term fiscal framework at the federal level can be beneficial. This would be broadly in line with the authorities’ intention to introduce balanced budget legislation.20 If the federal authorities were to introduce balanced budget legislation, it would be important for a new rules-based framework to be transparent, easy-to-communicate, and ensure convergence towards the authorities’ medium-term objectives, while allowing for flexibility in the face of shocks to avoid pro-cyclicality (Selected Issues). Implications for pro-cyclical fiscal policy vary depending on how the balanced budget rule is defined (Chart). In addition, key design features for an effective fiscal rules framework would also include a legal basis to buttress the credibility of the new rules, and well-defined escape clauses to deal with exceptional events. The Parliamentary Budget Office could play a role in monitoring implementation of the new rule.

A01ufig15

Pro-cyclicality of Fiscal Rules

(Fiscal impulse, percent of GDP)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff estimates.

Provincial governments

24. Fiscal space is much more limited at the provincial level, in light of mixed progress on consolidation and long-term sustainability challenges. Provincial consolidation plans would need to proceed, and efforts stepped up, especially in the provinces with the highest levels of public debt (Québec and Ontario). For the adjustment plans to deliver, in a sustainable manner, a balanced budget, spending measures may need to be supplemented with additional measures on the revenue side, especially if the fiscal stance turns more neutral at the federal level.

25. Progress in containing health care spending should continue to ensure long-term sustainability of provincial public finances. The growth rate in health care spending has slowed in the last few years relative to historical trends and it is currently below nominal GDP growth.21 Part of this slowdown, however, is driven by temporary cost compression though more permanent structural adjustments are taking place in some provinces. Demographic factors, however, are still expected to exert a strong upward pressure on costs, and even under optimistic scenarios, health spending is projected to rise from 8 percent to almost 12 of GDP by 2050.

26. Fiscal frameworks at the provincial level should also be strengthened. Regular spending reviews should become an integral part of provincial budgetary frameworks, with a possible role for independent fiscal agencies. A permanent framework for strategic spending reviews could particularly support provinces in delivering on their consolidation needs and feed into binding medium-term ceilings that could be designed to support the implementation of balanced budget rules currently in place in most provinces. Ontario’s plan last year to establish a budget office (Financial Accountability Office) was a positive step, and it would be important for the office to become operational soon. Recent decline in oil prices once again underscores the need for the energy-abundant provinces, but also at the federal level, to revisit their fiscal frameworks (as was done in Alberta in 2013) to better manage the volatility associated with commodity prices.

27. There is scope for improving coordination of fiscal policy between different levels of government. Long-term challenges to contain aging-related spending call for extending long-term fiscal forecasts at the provincial level and publishing consolidated general government fiscal forecasts in consultation with provinces. This would help raise the public awareness of the challenges ahead and help build the necessary consensus behind the efforts needed to contain aging-related spending. To this end, a useful step could include a data sharing mechanism for long-term fiscal assumptions and forecasts.

E. Policies to Boost Productive Capacity

28. Structural measures to improve Canada’s productivity would play an increasingly important role in boosting growth over the medium term. The authorities’ policies, including in the context of the G-20 commitments, cover many reform areas, and should be fully implemented.

  • Productivity and innovation. Further efforts are needed to strengthen (lagging) labor productivity (Chart), such as through improving skills-job matching and fostering business R&D. The authorities’ recent initiatives to invigorate venture capital market and provide targeted R&D support to SMEs through the pilot Business Innovation Access Program are encouraging but more could be done to support innovative start-ups and firm growth.

  • Infrastructure, trade, and competition. Enhancing international transportation networks (such as through the planned construction of a new Windsor-Detroit International Crossing), opening up to international trade (e.g., implementation of the Canada-EU trade agreement), addressing energy infrastructure bottlenecks, and removing barriers to FDI would also be key to boosting Canada’s exports and growth potential. There is scope to improve competition in network sectors, reduce the barriers to interprovincial trade and labor mobility (by deregulating professions and skilled trades), and make the immigration system more responsive to labor market conditions. The challenges of increasing growth potential appear more pressing in some provinces than others.

A01ufig16

Labor Productivity

(Index, 2000 = 100; GDP per hour worked)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: OECD.

Authorities’ Views

29. The authorities broadly shared staff’s assessment of the recovery and outlook and the need for rebalancing. Noting Canada’s relatively better post-crisis performance than other advanced economies, including in terms of growth, business investment, and job creation, they emphasized the importance of external demand for the remaining rotation towards exports and business investment to take place. A weaker Canadian dollar over the past year was seen as helpful for exports. The moderation in investment growth in recent years was not seen as a surprise by the authorities given its strong performance earlier in the recovery and the repeated downgrades to global economic prospects. The authorities noted unused capacity in non-energy export sectors and uncertainty about the strength of the recovery as potential factors holding back business investment despite accommodative financial conditions and healthy corporate balance sheets.

30. The balance of risks was deemed to be on the downside but less so than in previous years. Staff and the authorities generally agreed on the key sources of risk facing the Canadian economy. The authorities noted weaker oil prices in the near term, slower growth in advanced and emerging economies, and a housing market correction in Canada as key risks, but emphasized that these shocks would be manageable (including through a monetary policy response) if they were to materialize on their own—provided that the U.S. recovery remained on track. They also noted that a strong external trigger and much weaker labor markets, however, would be more important than higher interest rates for domestic housing sector risks to materialize.

31. A deeper downside scenario with correlated shocks was deemed unlikely at this juncture. The authorities concurred that the recent fall in oil prices appeared mainly supply driven, but also reflected weaker oil demand excluding the United States. Thus, risks of lower oil prices and higher interest rates together could not be ruled out. They maintained that there are a number of policy options to respond in the event that combined downside risks materialize. These include further delaying monetary normalization or easing the policy rate. In the event that the policy rate reached its lower bound, the use of alternative monetary policy instruments such as forward guidance may be considered. On the fiscal side, the federal government and some provinces have fiscal room to let automatic stabilizers fully operate.

32. Given that the fall in oil prices was judged to be largely driven by supply factors and demand outside the U.S., the impact on Canada’s real GDP is expected to be modest. There was an overall consensus during the mission that, barring further significant declines in oil prices, Canada’s oil production would likely be only modestly affected in the near term given large investments in oil sands already made in recent years, increasing pipeline capacity, and longer-term views typically adopted by large energy companies. However, the authorities noted the risk that lower oil prices will have a negative impact on oil and gas sector investment. The fall in crude oil prices is in part compensated by depreciation in the Canadian exchange rate and a stronger U.S. economy, benefiting non-energy exports. However, the authorities noted that the impact on nominal GDP would be significant, through lower export prices and energy-sector profits.

33. The authorities concurred that there is a need to maintain accommodative monetary policy. Underlying inflation remains below 2 percent and inflation expectations are well anchored. In turn, higher long-term interest rates driven by expected U.S. monetary normalization could facilitate a needed moderation in Canada’s housing sector. Were concerns about household imbalances to intensify, the Bank of Canada noted that their flexible inflation targeting framework allowed them to consider using monetary policy as a last line of defense to support financial stability.

34. A shared view was that housing market imbalances would likely resolve through a “soft-landing.” Noting the “two-tiered” nature of Canada’s housing market, authorities agreed with staff’s assessment of mortgage and housing market dynamics. However, they did not see large risks from strong growth of uninsured mortgages which are less risky by nature than insured mortgages given larger down payments and limited scope of borrowed down payments. OSFI and the Bank of Canada are monitoring bank credit closely, and authorities are monitoring housing market vulnerabilities in the insured and uninsured mortgage segments.

35. Housing finance measures. Recent mortgage insurance changes by CMHC are consistent with the Government’s long term goal to reduce its exposure to the housing market. Since meeting with staff, the Government took further steps to reduce its exposure to the housing market. On December 1, 2014, CMHC notified industry that it is increasing guarantee fees for its securitization programs, effective April 1, 2015. These changes are being made in support of the Government’s efforts to enhance the Canadian housing finance framework by encouraging greater reliance on alternative mortgage funding options in the private market by mortgage lenders.

36. Authorities noted that reform of government-backed mortgage insurance needs to be gradual and deliberate. Staff indicated a deductible for mortgage insurance could be an incremental step to introduce risk-sharing with the private sector and reduce taxpayer exposure. Authorities indicated that there are significant implications that require thorough assessment when considering measures to reform the housing finance system, including with respect to a possible mortgage insurance deductible.

37. The authorities continue monitoring changes in risk appetite in the banking and life insurance sectors, including the risks stemming from their operations abroad where they face more competition.

38. Existing informal macro-prudential and crisis management frameworks and supervisory approaches are deemed appropriate and effective in safeguarding stability of the Canadian financial sector. Based on their evaluation of FSAP recommendations the authorities noted in particular that they will continue enhancing cooperation with provincial regulators to coordinate on regulatory and supervisory issues and to strengthen stress testing capacity of provincial regulators. They acknowledged the risk of regulatory fragmentation but argued that the current delineation of responsibilities between federal and provincial regulators is appropriate. They reiterated their view that introducing more formal coordination might undermine the incentives for provincial regulators to oversee, supervise, and provide a backstop to provincially-regulated financial institutions. In that context, the Bank of Canada plans to provide provincially-regulated deposit taking institutions access to its emergency lending facility, provided the institution is systemically important, has credible recovery and resolution plans, and the respective province has provided full indemnity to potential losses.

39. The federal government’s resolve to achieve its balanced budget target in FY2015/16 is firm. The authorities believe that there is scope at the federal level to maintain a neutral stance going forward, using the available resources for growth-friendly measures. Indeed, the federal government has already announced tax relief and enhanced benefits for Canadian families.

40. The federal government is committed to introducing balanced budget legislation given the thrust of the fall 2013 Speech from the Throne. The authorities favor a balanced budget rule in headline terms that would cover all fiscal aggregates because such a rule is transparent, simple and easy to communicate and implement.

41. While fiscal consolidation at the provincial level is mixed and long-term sustainability challenges remain, progress toward their budget targets was expected. Achieving budget balance at the overall provincial level over the medium term is considered manageable under current consolidation plans. The Ontario authorities stressed their commitment to return to budget balance by FY2017/18 mainly by stabilizing real spending growth. In British Columbia, the authorities have put in place a new fiscal regime for the LNG sector to make the province internationally competitive for new LNG investments and enhance fiscal revenues.

42. There are a number of policy initiatives underway which should help boost Canada’s potential growth and productivity but challenges remain. For example, the authorities have stepped up the efforts to address barriers to interprovincial trade and promote export diversification, including by signing a free trade agreement with Korea and a reciprocal currency agreement with China. As well, the government is implementing its ten-year New Building Canada Plan focusing on broadband networks, public transportation, and support for innovation. There are, however, some structural issues which could help explain Canada’s persistent productivity gap with the United States. For example, investment in Information Communication Technology per worker in Canada is half that in the United States, with ¾ of the gap explained by investment in software, and most of the gap coming from the financial sector, professional services, and the telecommunication sector.

Staff Appraisal

43. Canada’s economy experienced solid growth over the past year but rebalancing toward exports and investment remains incomplete. Exports are benefiting from the firming U.S. recovery but have not yet translated into a meaningful pick-up in business investment, as firms remained cautious about the demand outlook. Substantially lower oil prices will likely be a drag on growth mainly through weaker investment in the energy sector. Higher household wealth, rising disposable incomes, and relaxed financial conditions have continued supporting relatively strong private consumption. Housing has regained momentum but with important differences across regions and markets.

44. Solid growth is envisaged to continue while becoming more balanced. Stronger non-energy exports and business investment, spurred by the U.S. recovery, should sustain Canada’s growth above potential in the near term. Rising long-term interest rates and weaker terms-of-trade mostly due to significantly lower oil prices would moderate private consumption and residential investment, with an expected ‘soft-landing’ in housing markets. Core inflation is expected to remain close to the Bank of Canada’s target rate of 2 percent as the remaining slack in the economy is gradually reabsorbed and inflation expectations remain well anchored.

45. Balance of risks is modestly tilted to the downside for the Canadian economy. A faster-than-expected tightening of global financial conditions, effects from substantially lower crude oil prices, and sluggish global growth are the key downside risks facing Canada. While continued U.S. growth and a depreciating Canadian dollar would help dampen the adverse impact of these shocks, the net outcome for Canada can be negative. Deeper downside risks to growth involve a combination of external shocks that are amplified by high household balance sheet vulnerabilities and a sharper-than-expected correction in house prices. On the upside, U.S. demand may be stronger than expected, and a faster resolution of infrastructure bottlenecks could support activity in the energy sector.

46. Lower crude oil prices present a challenge but also an opportunity. Canada has benefited from the boom in oil sands production despite intensified challenges to competitiveness in non-energy sectors. Substantially lower oil prices would likely cool activity in oil-rich provinces, an engine of Canada’s growth in recent years, but benefit provinces reliant on manufacturing and services. The Canadian economy’s ability to deliver productivity gains in non-energy sectors will be increasingly important.

47. Monetary policy can afford to stay accommodative for now. Given well-anchored inflation expectations and downside risks to export-driven growth, a monetary policy tightening cycle can await firmer signs to emerge of a more balanced and durable recovery with stronger business investment in non-energy sectors. Further macro-prudential policy action may be needed if household balance sheet and housing market vulnerabilities resume rising, such as tighter standards for uninsured mortgages.

48. Action to further limit exposure of taxpayers to the housing market and encourage appropriate risk retention by the private sector would be desirable. These would include changes to collateral used in securitization, tightening portfolio insurance limits, and changes to mortgage insurance products to introduce more risk-sharing. Any structural change to mortgage insurance and the transition to a different regime would need to proceed gradually to avoid any unintended consequences on financial stability.

49. Financial sector performance remains strong. Canadian banks’ performance has improved, and stress tests suggest that banks are resilient to credit, liquidity, and contagion risks arising from a tail risk scenario. However, it is essential to remain vigilant against the potential risks from housing and banks’ increasing exposure to capital markets and foreign operations. Performance of life insurance and pension funds, meanwhile, has improved noticeably.

50. The international financial reform agenda has advanced, and some work on FSAP recommendations has started though key steps are still needed. Basel III Liquidity Coverage Ratio and leverage standards have been implemented and will take effect in January 2015, and banks are well positioned to meet the new requirements. Staff welcomes OSFI’s draft guideline for Derivatives Sound Practices and progress made on the federal authorities’ stress-testing framework, as well as the recent steps taken toward establishing a cooperative capital markets system. However, outstanding FSAP recommendations on financial sector oversight, safety nets, and macro-prudential frameworks remain to be addressed.

51. Fiscal consolidation should proceed at the general government level, but the federal government should consider adopting a neutral stance going forward. With key fiscal challenges concentrated at the provincial level, particularly from aging-related spending pressures, it is critical that the composition of fiscal adjustment shifts from the federal government towards the provinces.

52. Strengthening medium-term fiscal frameworks would support sound public finances at different levels of government. If the federal authorities were to introduce balanced budget legislation, the new rules-based framework should be transparent, easy-to-communicate, and ensure convergence towards the authorities’ medium-term objectives, while allowing for sufficient flexibility in the face of shocks to avoid pro-cyclicality. Long-term challenges to contain aging-related spending call for extending long-term fiscal forecasts at the provincial level and publishing consolidated general government fiscal forecasts in consultation with provinces.

53. Further advancing structural policies is increasingly important to address lagging productivity. The authorities’ policies, including in the context of G-20 commitments, cover many reform areas. Reform efforts to increase productivity in non-energy sectors should continue—focusing on improving skills-job matching, promoting penetration of information and communication technologies, and fostering business investment in R&D. Enhancing interprovincial and international trade, including through implementation of major trade agreements, improving competition in network sectors, and addressing infrastructure constraints in energy exports would also play a key role in boosting Canada’s growth over the medium term.

54. It is expected that the next Article IV consultation take place on the standard 12-month cycle.

Table 1.

Canada: Medium-Term Scenario 2012–2020

(Percentage change, unless otherwise indicated)

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Sources: Haver Analytics; and IMF staff estimates.

Contribution to growth.

Percent of GDP.

Percent.

Percent of potential GDP.

Includes the balances of the Canada Pension Plan and Quebec Pension Plan.

Percent of disposable income.

Table 2.

Canada: General Government Fiscal Indicators, 2012–2020 1/

(Percent of GDP, unless otherwise indicated)

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Sources: Statistics Canada; Department of Finance Canada; provincial budget reports; Haver Analytics; and IMF staff estimates.

National Accounts basis.

Percent of potential GDP.

Includes federal, provincial, territorial, and local governments; and Canada and Quebec pension plans.

Table 3.

Canada: Balance of Payments, 2012–2020

(Percent of GDP, unless otherwise indicated)

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Sources: Haver Analytics; and IMF staff calculations.

Includes bank, nonbank, and official transactions other than reserve transactions.

Based on market valuation of portfolio stocks and official international reserves.

Percentage change. A minus sign indicates a depreciation in the Canadian dollar.

Table 4.

Canada: Financial Soundness Indicators 2009–2014Q3

(Percent, unless otherwise indicated)

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Sources: IMF FSI database; and IMF staff calculations.

Billions of Canadian dollars.

Data is for 2014Q1.

Annex I. Canada: External Sector Assessment Report

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Annex II. Canada: Key FSAP Recommendations and Implementation

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Annex III. Canada: Public Debt Sustainability Analysis

Canada’s general government gross debt peaked at about 88 percent of GDP in 2012 and is expected to decline over the medium term under staff’s baseline scenario. Government financial assets are sizeable in Canada and represent about 50 percent of GDP, of which about 20 percent are highly-liquid assets, which put the net debt-to-GDP ratio at below 40 percent of GDP in 2013. Gross financing needs are relatively large, but are expected to be below 15 percent of GDP after 2016. The general government debt position is relatively resilient to a series of macro and fiscal shocks in the medium term.

Stress tests

  • Baseline scenario. In staff’s baseline scenario, the general government gross debt-to-GDP ratio is expected to decline to 86½ percent in 2014, after peaking at about 88 percent in 2012, and continue declining to 80 percent in 2019. Canada’s effective interest rate is expected to reach a historical low just below 4 percent in 2014 and then rise towards its historical average of 6 percent by 2018. Net debt stands currently at 37 percent of GDP—or at 67 percent if only highly-liquid asset are used, and is expected decline over the medium term after peaking in 2015.

  • Primary balance shock. A scenario involving a deterioration of the structural primary balance of about 1 percent of GDP raises the gross debt-to-GDP ratio by about 3 percentage points over the projection period. The risk premium on sovereigns is assumed to increase by 25 basis points (bps) for each 1 percent of GDP deterioration in primary balance, with little effects on the debt path.

  • Growth shock. A lower real output growth by 1 standard deviation for 2 years starting in 2015 would have a significant impact on the level of gross debt, which will reach 91½ percent of GDP in 2016, but would revert to a downward path over the projection period.

A01ufig17

Fan Chart: Debt Outlook

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

A01ufig18

General Government: Gross and Net Debt 1/

(Percent of GDP, 2013)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: Finance Canada1/ Net debt includes all financial assets
  • Interest rate shock. An increase in sovereign risk premia by 200 bps for two years would raise the government’s interest bill by about ½ percent by 2016 (about 95 percent of outstanding marketable debt is in fixed coupon bonds). Higher borrowing costs would slow the decrease in the debt-to-GDP ratio, which ends up 1½ percentage points higher than in the baseline in 2019, at about 81½ percent.

  • Exchange rate shock. If the exchange rate depreciates by about 15 percent, the fiscal impact is minimal—almost 90 percent of Canada’s outstanding marketable debt instruments are in Canadian dollar, and both federal and sub-national governments usually hedge their FX exposures.

  • Commodity price shock. Lower than expected commodity prices, by 10 percent on average over the forecasting horizon would increase the gross debt to 91 percent of GDP in 2016 and decline to 85 percent by 2019.

The sizable general government liquid financial assets represent a mitigating factor for Canada’s high gross debt and financing needs. In at least two of the above scenarios, Canada’s gross debt rises above 90 percent of GDP and the gross financing needs go above 25 percent of GDP in at least one of the following years (see the heat map below). However, general government’s financial assets stood at about 50 percent of GDP in 2013, of which 40 percent (20 percent of GDP) is highly-liquid assets (deposits, short-term papers, and bonds) (Chart).

A01ufig19

Canada: Financial Assets Composition

(Percent share of total financial assets, 2013)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: Finance Canada

In addition, Canada’s gross and net public debt have increased in recent years due to Canadian government policy to fund public sector employee pension plans by raising market debt. Unfunded pension liabilities of the public sector are excluded here from Canada’s general government debt, to improve consistency with other countries that do not report these liabilities. However, because Canada has funded part of its pension liabilities since 2000, those liabilities are reflected in its public debt.

A01ufig20

Canada Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 85% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.In the case of Canada, staff estimate that liquid financial asset represent about 25% of GDP, in which case the 85% benchmark will not be exceeded2/ The cell is highlighted in green if gross financing needs benchmark of 20% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.In the case of Canada, staff estimate that gross financing will pass below the 20% benchmark by 2015.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white.Lower and upper risk-assessment benchmarks are:400 and 600 basis points for bond spreads; 17 and 25 percent of GDP for external financing requirement; 1 and 1.5 percent for change in the share of short-term debt; 30 and 45 percent for the public debt held by non-residents.4/ An average over the last 3 months, 14-Oct-14 through 12-Jan-15.
A01ufig21

Canada Public Sector Debt Sustainability Analysis (DSA) - Baseline Scenario

(in percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff.1/ Public sector is defined as general government.2/ Based on available data.3/ Bond Spread over U.S. Bonds.4/ Defined as interest payments divided by debt stock at the end of previous year.5/ Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the denominator in footnote 4 as r - π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).8/ Includes asset changes and interest revenues; the latter explains most of the projected residuals. For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
A01ufig22

Canada Public DSA - Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff.
A01ufig23

Canada Public DSA - Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF Staff.1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Not applicable for Canada.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
A01ufig24

Canada Public DSA - Stress Tests

Citation: IMF Staff Country Reports 2015, 022; 10.5089/9781498396325.002.A001

Source: IMF staff.

1

Staff analysis suggests that about one-third of non-energy exports (including passenger cars) outperformed their model benchmarks over 2009–2013. However, large sectors such as industrial machinery/equipment and intermediate metal products grew slower and/or remained below their model-predicted levels by end-2013 (Selected Issues). The analysis suggests that the recent pick-up in non-energy exports is predominantly driven by U.S. business investment, with some industries (like passenger cars) benefiting also from recent Canadian dollar depreciation.

2

For energy exports, despite declining U.S. oil imports, Canadian crude oil exports to the U.S. continued steadily rising (reaching about 2.8 million barrels per day on average in January–October 2014 and recording all-time highs in recent months), reflecting gains in U.S. market share (from 22 percent in 2009 to about 40 percent in 2014).

3

Regionally, Calgary and Toronto recorded the fastest price gains followed by Vancouver, while Montreal and Ottawa registered near zero growth over the last four quarters. Housing starts though appear to have settled down close to their 2013 average and below 2012 levels. Home sales have not been particularly strong suggesting that price increases may be due to supply constraints rather than demand factors (Figure 4).

4

Research by the Bank of Canada staff suggests estimates for overvaluation in Canadian housing markets range from 10–30 percent (Financial System Review, December 2014).

5

On October 30, 2014, a number of fiscal measures were announced, including (i) the Family Tax Cut, a federal tax credit (capped at Can$2,000) that will allow a transfer of up to Can$50,000 of taxable income to a spouse in a lower tax bracket, for couples with children under the age of 18, effective for the 2014 tax year; (ii) increasing the Child Care Expense Deduction limits effective for the 2015 tax year; (iii) increasing the Universal Child Care Benefit (UCCB) for children under the age of 6, from Can$100 to Can$160 per month starting from January 1, 2015; and (iv) expanding the UCCB by introducing a new benefit of Can$60 per month for children aged 6–17 from January 1, 2015, while repealing the existing Child Tax Credit for children under the age of 18 years. These measures have been incorporated in the fall budget update, and are estimated to cost about 0.2 percent of GDP per year in FY2014/15 and over the medium term. A further significant decline in oil prices relative to staff’s baseline may keep the fiscal balance in a slightly negative territory in CY2015.

6

For Alberta, non-renewable resource revenue, mostly from bitumen and crude oil royalties, represents about 20 percent of total provincial revenue.

7

The real effective exchange rate (REER) assessment refers to its average level over January–October 2014.

8

Real energy prices fell by an estimated about 30 percent in November–December 2014. Staff estimates of a longrun equilibrium relationship between the Canadian REER and commodity prices suggest that a one-percent decrease in the real price of energy would lead to about 0.1 percent real depreciation (see, IMF Country Report 13/41). This is broadly consistent with the EBA methodology on the relation between real exchange rates and the terms of trade.

9

Compared to the October 2014 WEO, in the January 2015 WEO baseline, the projected oil prices are about 43 percent lower in 2015 (down from US$100 per barrel to below US$ 57 per barrel) and 30 percent lower over 2015–19. Projections for partner-country demand growth remain largely unchanged, however, mainly reflecting stronger U.S. growth.

10

Cyclical conditions (both domestic and external) may make the short-term neutral rate deviate from the longer-term neutral rate. The short-term neutral rate is useful to help assess the appropriateness of the current policy rate as well as the adjustment path to the neutral rate over the medium term. Specifically, the interest rate gap provides a measure of policy accommodation (tightness).

11

These measures have been used by many jurisdictions to address risks stemming from housing and mortgage credit markets. While some countries have used a single instrument to deal with the risks (e.g., India and Indonesia used LTVs), many other countries have used them in combination (e.g., Israel used amortization periods and LTVs; Korea, Malaysia, Netherlands used LTVs in combination with DSTI ratios whereas Hong Kong and Singapore used all three instruments).

12

In past consultations, staff raised the issue of considering differentiated macro-prudential measures across provinces to target areas with more buoyant housing sectors (see, IMF Country Report 13/40), however such policies come under the jurisdiction of provincial or municipal authorities (e.g., property taxes and transaction fees).

13

This is broadly in line with recommendations of the Basel Committee on Banking Supervision.

14

The federal government guarantees 100 percent of CMHC’s insured loans and 90 percent of those insured by private companies.

15

NHA MBSs are securities that are backed by distinct pools of insured mortgages. The timely payment of NHA MBS principal and interest is guaranteed by the CMHC backed by the Government of Canada. The CMHC also guarantees non-amortizing CMBs issued by a special-purpose trust, the Canada Housing Trust (CHT). CHT uses the proceeds of its bond issuance to finance the purchase of NHA MBSs.

16

According to the BOC’s activity-based definition (different from the Financial Stability Board’s entity-based definition), “shadow-banking” is estimated at 40 percent of GDP and includes government-insured mortgage securitization, private-label securitization (ABCP and ABS), repos (predominantly in government securities), money market mutual funds (MMMFs), bankers’ acceptances, and commercial paper (IMF Country Report No. 14/29).

17

Canadian banks have already adopted Basel III capital adequacy standards in 2013. For the 6 designated D-SIBs, a capital surcharge will also be coming into effect from January 2016. The minimum LCR requirement for Canadian institutions is set at 100% beginning January 1, 2015, without any phase-in period. While there is a deterioration in the share of liquid assets to total assets since 2011 (Table 4), the LCR numbers for D-SIBs remain robust and above the supervisory threshold that came into force on January 1, 2015. Federally regulated deposit-taking institutions will be expected to have Basel III leverage ratios that exceed three per cent. The capital measure used for the leverage ratio is the all-in Tier 1 capital of the institution. OSFI will continue to set authorized leverage ratios on an institution-by-institution basis and will update their guideline on liquidity adequacy requirements with Basel III regulations on Net Stable Funding Ratios based on the final guidance issued by the Basel Committee for Banking Stability.

18

For a discussion of long-term fiscal sustainability and aging-related challenges, see Annex III of IMF Country Report No. 14/27.

19

Relative to current policies, maintaining a cyclically-adjusted primary surplus (at the federal level) broadly constant at its 2014 level would amount to some 0.3 percent of GDP fiscal impulse over 2015–17, but would still be consistent with the authorities’ debt reduction target of 25 percent debt-to-GDP ratio by 2021.

20

Discussions center on a federal balanced budget legislation that will “require balanced budgets during normal economic times and concrete timelines for returning to balance in the event of an economic crisis.”

21

Recent reforms to move away from global budgeting (based on historical levels) toward more patient- or activity-based funding models for hospitals, increasing out-of-hospital care, and consolidating purchases of drugs, medical supplies, and equipment are helping contain health care costs and increasing efficiency on a sustainable basis, but further effort would be needed to ensure long-term fiscal sustainability of provincial debt (see, IMF Country Report, No. 14/27).