Canada Economists Gush With Pride While People Feel The Strain

Sue Cox, director of Toronto's Daily Bread food bank, estimates that demand for food parcels is 50 per cent higher than a year ago. It looks pretty dismal, Cox says.

Her agency alone hands out 90,000 hampers a month. This gloomy picture has been underlined in recent days by Statistics Canada, which reported that real domestic product grew at an annual rate of only 1.3 per cent in the second quarter, well below forecasters' expectations.

Consumer spending was flat and business investment, especially in inventories, fell markedly. But economists see recent trends in a different light. Richardson Greenshields, a Toronto-based securities firm, responded to last Friday's data with a gushing report titled: Canada: New G7 leader. ..Resurrection and Redemption. Its upbeat assessment was spurred by news of a record merchandise trade surplus in the second quarter and the first current account surplus in 12 years.

 

The strong balance of payments performance is partly because of a significant improvement in Canada's competitiveness. Canadian business is in the throes of a far-reaching and at times painful -restructuring caused by the pressures of the North American free trade agreement (Nafta), diminishing government intervention in the economy, and the protracted slump in domestic demand.

Comparisons with the US economy put Canada in an increasingly favourable light. Canada's inflation rate in June was 1.2 per cent, compared with 2.8 per cent south of the border. Unit labour costs in Canada have grown more slowly than any other G7 country for the past six years.

The economy still has a good deal of spare capacity, encouraging forecasts that inflation will remain muted for some time. Ottawa has also been more successful in putting its fiscal house in order. Government budget deficits as a percentage of GDP have contracted by 4.5 percentage points in Canada over the past four years, compared to only 2.5 points in the US.

The Liberal federal government has moved to the right since it was elected in 1993, renewing privatisation, clamping down on government spending and putting a lid on transfers to the provinces for health, education and welfare. It has pledged to eliminate its borrowing requirement by the 1998-99 fiscal year.

Paul Martin, finance minister, said last week he had no intention of being distracted from the attack on the deficit by offering tax reductions, as some of his conservative opponents have urged. Seven out of 10 provinces produced budget surpluses this year.

The two biggest provinces, Ontario and Quebec, are chopping spending with the aim of balancing their books within the next five and four years, respectively. These trends have not gone unnoticed in financial markets.

Domestic short-term interest rates fell below US levels in February, and the discount has steadily widened. The Bank of Canada has lowered interest rates five times this year without waiting for a lead from the Federal Reserve in Washington.

Canadian banks now charge a prime lending rate of 5.75 per cent, compared to 8.25 per cent in the US. Andrew Spence, chief economist at Citibank Canada, says Canada is starting to benefit from a virtuous circle, with falling debt-to-GDP ratios leading to improved credit ratings and lower interest rates. The overall government deficit to C$20.9 billion (9.8 billion) in the second quarter from a C$58 billion peak in mid-1993.

On the rare occasions that the central bank has tried to pursue an independent monetary policy in the past, it has quickly been brought to heel by a run on the Canadian dollar. Not this year. The currency has hovered around 73 US cents for most of 1996. Economists are almost unanimous in forecasting a stronger currency over the next few years. Some also predict a further narrowing in the spread between long-term US and Canadian interest rates. ScotiaMcLeod, a securities firm, said in a recent commentary that the Canadian dollar has the best set of fundamentals we have seen in 20 years. It expects the dollar to rise to just above 75 cents at the end of 1997. A number of developments could upset this rosy scenario.

With the ratio of exports climbing over the past decade from 25 per cent to 43 per cent of gross domestic product, Canada's economic health has become increasingly dependent on the big market to the south. The improved balance of payments has coincided with strong US demand for Canadian industrial products. A US downturn would provide the real test of Canada's competitive edge.