Astonishing Fiscal Red Ink Announced Today
Finance Minister Bill Morneau presented his fiscal snapshot this afternoon. Most economists were expecting a budget deficit of roughly $260 billion. Instead, the government announced a deficit for the fiscal year 2020-21 of $343.2 billion–close to 16% of GDP. That compares to the $34.4 billion deficit projected before the pandemic.
A big chunk of that additional deficit can be attributed to the $212 billion in direct support measures the federal government is providing to individuals and businesses. The deficit was initially estimated at C$256.2 billion by the Parliamentary Budget Officer, the country’s budget watchdog. The discrepancy reflects lower tax revenue, an eight-week extension of CERB and the wage subsidy increase.
Aside from the pandemic program spending, the economic slowdown is estimated to have added another $81.3 billion to the deficit in 2020-21, driving spending levels to their highest since 1945. The recession has also taken a toll on revenue, which will drop as a share of the economy to the lowest since 1929.
The prime minister argued the economy would be in much worse shape were it not for the government’s response, in part to thwart the need for households to take on more debt. “We made a very specific and deliberate choice throughout this pandemic to help Canadians, to recognize that overnight people had lost their jobs,” Trudeau told reporters in Ottawa. “We decided to take on that debt to prevent Canadians from having to do it.”
To be sure, the government can finance the debt at a much lower cost than households. Long-term interest rates for the government of Canada are at record lows–below the rate of inflation. The ten-year GOC yield is 0.56% and the 30-year bond yield is just a tad over 1.0%. In consequence, the interest cost to the government of the rising debt burden is very modest.
In addition, the vast majority of the temporary surge in Ottawa’s new debt is being absorbed by the Bank of Canada in its bond purchases. While the BoC’s holdings of federal government debt as a share of its total securities holdings has risen abruptly from less than 14% at the start of the year to around 27% now, that’s still below the share of domestic government debt held by central banks in Japan, Germany and Sweden, for example. Canada’s overall public sector net debt remains moderate among major economies, and especially when compared to the U.S., Britain, or the Euro Area.
The Canadian economy is projected in the report to shrink by 6.8% this year before bouncing back by 5.5% next year, making this crisis the worst economic contraction since the Great Depression. The economy is expected to decline in FY2020-21 more than twice as much as it did in FY2009-10 in response to the global financial crisis.
Between February and April, 5.5 million Canadians either lost their jobs or saw their work hours significantly reduced. Those losses pushed the unemployment rate to 13.7% in May — the highest rise on record — from a pre-crisis low of 5.5% in January.
Finance Minister Bill Morneau said that without government pandemic programs, the GDP would have contracted by more than 10% and unemployment would have risen by another 2 percentage points.
The government now projects debt will rise to 49.1% of GDP in the fiscal year that started April 1, up from 31.1% last year. In his speech, Morneau didn’t provide any forecasts beyond 2020 or provide any indication of future fiscal plans other than to say Canada will continue to hold its low-debt advantage relative to other major economies. That status is facilitated by historically low interest rates, with public debt charges actually declining as borrowing costs fell.
“We, the collective we, will have to face up to our borrowing and ensure it is sustainable for future generations. Canada’s debt structure is prudent, it’s spread out over the long term, and it compares well to our G-7 peers,” the finance minister said. “And we will continue to make sure this is the case in the months and years to come.”
Federal government spending, along with the deficit, is poised to hit all-time highs as a share of GDP outside of World War II. Program expenses will surge 69% to C$592.6 billion, or 27.5% of GDP. That figure has averaged about 15% in the past half-century.
That includes a cost of C$80 billion for the main income support program — the Canada Emergency Response Benefit, or CERB. One change in Wednesday’s documents is a top-up of almost C$40 billion in the government’s wage subsidy program to C$82.3 billion. The numbers suggest the government anticipates transition Canadians from the C$2,000-per-month cash support beginning in September.
The government has asserted bragging rights as having the most comprehensive fiscal response to the pandemic in the G20 (see chart below).
The fiscal snapshot states, “Canada’s strong fiscal position going into the pandemic has allowed the government to implement an ambitious economic response plan by international standards. Direct fiscal support measures alone represented over 10% of Canada’s GDP, relative to 6.7% on average for G7 countries, with the bulk of support directed at individuals and households. In comparison, the U.S. plan also devotes a large share of direct support to individuals and households but to a lesser extent than Canada. Beyond its total size, which is among the most significant in the G7 and the G20, Canada’s plan is also among the most comprehensive, covering a broader range of measures than most plans announced in peer countries. Canada is notably one of the few countries that has announced both a national program to provide commercial rent assistance for small businesses and forgivable credit to SMEs.”
Let us hope that the government does not consider restraint measures until it is certain that the pandemic has been contained and the economic recovery is on firm ground. The last thing we need right now is tax increases, which many people fear will be the outcome of all of this red ink. Much of the one-time fiscal costs will roll off as the economy recovers. it is essential, however, that we avoid supporting businesses that are no longer viable in a post-pandemic world. We also want to assure that the CERB and other income supports do not discourage people from returning to work that is available.
The government did not forecast beyond the current fiscal year. Given the uncertainty surrounding a possible second wave of the virus and the timing of a vaccine, that forecast would be highly unreliable. Morneau will get back to us with an update in the fall.