Experts see risks from Canada's fixation on balanced budget

OTTAWA Tue Mar 12, 2013 8:21pm GMT

Canada's Finance Minister Jim Flaherty speaks during Question Period in the House of Commons on Parliament Hill in Ottawa March 5, 2013. REUTERS/Chris Wattie

Canada's Finance Minister Jim Flaherty speaks during Question Period in the House of Commons on Parliament Hill in Ottawa March 5, 2013.

Credit: Reuters/Chris Wattie

OTTAWA (Reuters) - The government's steely determination to balance Canada's budget by 2015 could break an economy that is already showing signs of strain, as Ottawa seeks to rebuild a reputation for prudence that made it the envy of the industrialized world.

The 2013-14 federal budget, due later this month, is set to reinforce the government's message that the deficit will be eliminated by 2015, an election year, and it will include what Finance Minister Jim Flaherty called "more sacrifices" from various ministries in the form of spending cuts.

But not everyone agrees that the tough fiscal targets make economic sense, given that Canada just recorded the weakest two quarters of economic growth since the 2008-09 recession.

"I don't think there are any economists that are particularly concerned about the deficit at this point," said David Macdonald, a senior economist at the Canadian Centre for Policy Alternatives (CCPA), an Ottawa-based think tank.

The Parliamentary budget officer, which provides independent analysis of the nation's finances, estimates spending cuts will shave about 0.6 percent from GDP this year, 0.9 percent next year and 1 percent or more in 2015 and beyond.

"This is like the minister standing up and saying: 'my plan for the economy is to cut growth by a third.' That's something no minister would ever say but that's in fact what is happening," said Macdonald.

Canada, once dismissed as a high-debt basket case, spent years between 1994 and 1997 taming its federal budget deficit, and winning a global reputation as prudent fiscal managers with a top-tier rating.

But the Conservative government allowed the surplus to turn to deficit as the recession hit, adding big spending programs to previously announced tax cuts to stimulate the economy.

Ministers now say it's time to turn that pattern round again.

"If you don't set targets like that based on your original processes, you'll never reach a target," Tony Clement, the minister who oversees departmental spending, said in an interview with Reuters on Monday.

Asked if the government was perhaps trying to balance the books too soon, he replied: "We've shown fiscal probity that is all too rare with advanced, industrialized economies, so I think we are the poster child in the G7 and the G20 ... that other countries would do well to emulate."

The renewed penny-pinching push comes as consumers have hit a debt wall, businesses are too scared to invest and exports have yet to recover their pre-crisis levels due to weak global demand. The Bank of Canada has made it clear it will not cut interest rates to stimulate the economy, leaving fiscal policy as the only other tool to boost growth.

Yet one business leader who has met several times with finance officials in pre-budget consultations said he was hearing that the minister won't bend on the 2015 target.

Flaherty has blamed a price discount on Canadian oil for a "significant" hit to federal revenues and said he would have to compensate by focusing "like a laser" on spending and closing some tax loopholes.

The main opposition party, the New Democrats, accuses Prime Minister Stephen Harper of trying to please his small-government, conservative base and make fiscal room to offer new goodies the next time they go to the polls in October 2015.

"Austerity can be a job killer and a growth killer," said NDP legislator Peggy Nash.

In the May 2011 election, Harper promised a tax cut for families with children by allowing the higher earner to split some of his or her income with a spouse, and a higher ceiling on tax-free savings accounts, costly measures that will take effect only after the budget is balanced.

Ottawa expects the 2012-13 federal budget deficit to be C$26 billion, or about 1.5 percent of gross domestic product, falling to C$13.5 billion in 2013-14.

That is trivial compared to the U.S. or U.K. deficits of about 5 and 7 percent of GDP, respectively, although Canada's numbers are less flattering when provincial government debt is included.

Even if the government increased spending substantially and ran a deficit next year twice the amount forecast, as proposed by Macdonald and his colleagues, the debt-to-GDP would decline to 31 percent in 2015-16 from the current 33 percent.

Canada would still have the best debt position in the Group of Seven advanced economies.

Chief economists from Canada's largest commercial banks said last week that bond markets and rating agencies don't mind if the fiscal gap is closed in 2015 or a couple of years later.

"Given the fact that a lot of the provinces are moving into pretty serious restraint, it would probably be unwise for the federal government to step on the brake further than they already have," said Doug Porter, chief economist at Bank of Montreal.

But even as the federal government pushes ahead with plans to cut spending, cities are hoping for extra cash for infrastructure like roads, bridges and public buildings, arguing that Ottawa should take advantage of current low interest rates.

"We've been very encouraged and are hopeful with regards to the outcomes on budget day," said Karen Leibovici, president of the Federation of Canadian Municipalities (FCM), which lobbies on behalf of cities.

The FCM is seeking an additional C$2.75 billion in infrastructure spending, which would bring it in line with investment seen in the 1980s and 1990s in percentage of GDP.

Flaherty says will be revealed on budget day, the date of which is likely to be announced in the coming days.

(Additional reporting by Euan Rocha and Janet Guttsman in Toronto; Editing by Diane Craft)