RaboResearch - Economic Research

Country Report Canada

Country Report


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After a rapid recovery following the Great Recession, Canada’s economic growth slowed down due to the slow recovery of its main trading partner, the US. Strong private consumption and residential investment were the engines of growth but left a legacy of elevated household debt and high house valuations. The transition to more balanced economic growth, with stronger contribution from exports and business investment, has proved elusive, and economic activity  remained modest in 2013. 

Strengths (+) and weaknesses (-)

(+) Strong (public) institutions

The efficiency and transparency of institutions is high.

(+) Solid banking sector

The banking sector is well capitalized, profitable and has low non-performing loans.

(-) High dependence on US economy

Canadian exports are highly concentrated with around 75% of its goods exports are destined for the US.

(-) Housing market fundamentals

Although some macroprudential measures have been taken, houses are still overvalued.

Key developments

1. Economic growth remains modest, subject to downside risks

Canada’s economic growth remained modest in 2013. After a slowdown of growth in 2013 (2%), real GDP is expected to expand by 2.2% in 2014 (figure 1). The uncertain global economic environment and the persistent strength of the Canadian dollar (CAD) have weighed on exports and hence GDP growth leaned heavily on domestic demand, especially private consumption.  The current account which has been negative since 2009, is expected to remain stable the coming years at -3% GDP. Household consumption was stronger than expected, driven by the improvement of consumer confidence, gains in employment, rising wealth and easy financial conditions. Owing to a further pick-up in the US recovery in 2014, exports are expected to strengthen, which should support business investment. The contribution of household consumption and residential investment to growth could weaken as households gradually reduce their debt burden and growth of house prices slows down, which, in turn, weakens construction activity. Fiscal austerity is expected to be a modest headwind. Overall, economic growth will probably in 2014 and 2015 be above potential. It should be noted, though, that risks are tilted to the downside. Lower growth in Canada’s main trading partners (especially US), lower energy prices or a decrease in house prices will lead to lower growth.

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: House prices high in historical perspective
Figure 2: House prices high in historical perspectiveSource: Dallas Fed

2. Imbalances in household finances and housing market remain a concern

Canada’s elevated housing market and the associated domestic imbalances remain a potential vulnerability. In recent years, abundant supply of credit and very low interest rates have fuelled the housing market and led to a significant rise in house prices and household indebtedness (figure 2). By the middle of 2013 households’ debt-to-income ratio reached a new high of 163.4%. Housing market fundamentals point to a significant overvaluation. The Bank of Canada’s house-price-to-disposable income ratio of about 5.0 is way above its long-term average of 3.5 and also the price-to-rent ratio (OECD) is 85% above its historical average. Although a broad downward trend in housing market activity, house price growth and household credit growth has set in since the middle of 2012, in recent months the Canadian housing market experienced a slight rebound. This housing market revival could be temporary though, as it may reflect purchases that have been pulled forward as a response to the recent increase in mortgage rates.[1] However, if the rebound would be more persistent than expected, additional (macro-prudential) measures could be taken to prevent a further growth of imbalances.[2] If, on the other hand, a sharp housing market correction would take place, the economy would be hurt significantly. Not only consumer demand would be depressed, but also residential investment, which accounts for about 7% of GDP.

3. Financing of housing market core risk for public finances and financial sector

The federal government’s fiscal deficit declined at a faster-than-expected pace in 2012-13, but the impact on growth was partly offset by less restraint at other levels of government, with a number of provinces delaying the return to a balanced budget. Further fiscal consolidation is under way, with the aim of achieving a balanced budget on federal level in 2015. Government gross debt is with about 95% GDP rather high, but debt servicing costs are relatively low due to low interest rates. The longer term challenge for government finances will be to get health care spending under control. Canada’s banking sector is well capitalized, profitable and has relatively low non-performing loans. Recent severe stress tests showed that Canadian banks are resilient to almost all shocks. Two additional risks emerge from the institutional setup of the Canadian housing market. First, due to the pervasive government backed insurance of mortgages, the federal government is rather exposed to housing market induced risks. A downturn on the housing market could have a contagion effect on government debt. This mortgage insurance also encouraged financial institutions towards the provision of risk-free mortgages at the expense of loans to more productive uses of capital, especially loans to SMEs. Second, a hike in mortgage interest rates might induce a housing price decline and more nonperforming loans, since about a third of all mortgages is financed with variable interest rate. This interest rate vulnerability might materialize when tapering of the US Fed leads to structurally higher interest rates. 

Factsheet of Canada
Factsheet of CanadaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Canada has one of the most developed economies of the world, with the eighth highest per capita income globally, and the eleventh highest ranking in the Human Development Index. It ranks among the highest in international measurements of education, government transparency, civil liberties, quality of life, and economic freedom. Its economic growth has been primarily driven by domestic demand during the last decades, with a on average slightly negative contribution of international net trade. Although also Canada suffered from the Great Recession, its recovery was faster and more sustained than in most other industrialised countries with unemployment decreasing since 2009. This was mainly due to domestic demand, driven by soaring house prices. In normal times, economic prospects are highly intertwined with those of its neighbour, the US. More than three quarters of exports flow to the US, half of imports coming out of the US. The export sector consists for about a quarter of energy products and has grown considerably the last few years thanks to the rapid development of unconventional oil extraction (oil sands). Prospects for further growth are a little bleak because of increasing US home production. The fiscal stance of the Canadian government is solid, although gross government debt is with about 95% of GDP rather high. Main threat to public finances is the long term sustainability of debt due to increasing health expenditure. The financial sector is well capitalized, profitable and has relatively low non-performing loans. Compared to other Western countries like the US, it fared relatively well during the financial crisis. 

Economic indicators of Canada
Economic indicators of CanadaSource: EIU

[1] The interest rate on a typical 5-year fixed-rate mortgage has increased by about 60 basis points between June 2013 and December 2013 (source: Bank of Canada).

[2] In recent years the government has implemented four rounds of measures to tighten mortgage rules in order to moderate the expansion of mortgage credit.

Hans Stegeman
RaboResearch Netherlands Rabobank KEO
+31 30 21 62666

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