Oct. 16 (Bloomberg) -- Canadian Prime Minister Stephen Harper framed his re-election campaign around promises to avoid deficits and a costly rescue of the country's banks.

While his Oct. 14 victory left him with more Conservative Party seats in Parliament, the deepening global financial crisis may force him to backpedal on both pledges.

Harper yesterday said his first move may be a taxpayer- funded package to keep financial institutions competitive amid bailouts in the U.S. and Europe. With the budget surplus shrinking and Harper lacking a parliamentary majority, he'll also probably end up spending more than he wants because he'll need help passing legislation from opposition parties that want to expand social programs.

``We are probably in for some weak economic times,'' said John Shields, a political science professor at Ryerson University in Toronto. ``It's hard to deliver on your promises.''

Harper's Conservative Party, which went into elections with 127 seats, won 143 districts, short of the 155 needed for a parliamentary majority, according to preliminary results from Elections Canada. Throughout the 37-day race, he boasted that Canada's financial system was still sound as other countries bailed out their banks and said a rescue wouldn't be necessary.

``The Americans are bailing out their banks and financial institutions,'' Harper, 49, said Oct. 11 at a rally in the Montreal suburb of Longueuil. ``We are investing in jobs right here in Canada.''

Harper Reversal

Yesterday, Harper reversed course, indicating taxpayers will probably need to cover the cost of ensuring that Canadian banks stay solid. Finance Minister Jim Flaherty, 58, may increase deposit insurance beyond the current C$100,000 ($83,900) per person and guarantee short-term bank debt, the Globe and Mail reported on Oct. 14, citing people it didn't identify by name.

The Bank of Canada may let mutual funds and pension funds take part in its short-term debt purchases aimed at shoring up liquidity in credit markets, the Globe also said. The central bank confirmed it will release details tomorrow.

Harper, speaking in Calgary, pledged in his first press conference after the election to ``take appropriate actions to support our financial system, including whatever steps are necessary to ensure that Canada's financial system is not put at a competitive disadvantage. The options we are looking at don't involve significant outlays of taxpayers' money.''

European Subsidies

Last week Harper complained that support packages offered by some other countries were subsidizing their banks. The U.S., France, Germany, Spain, the Netherlands and Austria have committed more than $2 trillion to guarantee bank loans and take stakes in lenders.

While Harper isn't likely to pump capital into Canada's banks, he'll need to match those guarantees, according to Michael Gregory, senior economist at BMO Capital Markets in Toronto.

``We could see Canadian banks put at some form of disadvantage,'' Gregory said in an interview. ``I suspect that we will see some kind of program that mimics what, in terms of expanding kind of a guarantee or insurance,'' is happening elsewhere.

Harper, Canada's prime minister since 2006, will need to decide whether to allow a budget deficit as falling commodity prices and a slowing economy erode revenue. Current projections of a C$2.3 billion surplus this year and C$1.3 billion in 2009 were based on growth forecasts of 1.7 percent this year and 2.4 percent in 2009.

Slashed Forecasts

Economists have since slashed their forecasts, with Bank of Nova Scotia and BMO Capital Markets now predicting a recession. If the slowdown deepens, the government will need to cut spending, raise taxes or let the budget move into deficit.

``Canada, too, is headed for recession and our government will awaken to the need for deficit spending,'' Sherry Cooper, chief economist of BMO Capital Markets, said in a note to investors.

All major party leaders, including Harper, ruled out running a deficit and ending the country's record of 11 consecutive surpluses. Harper also ruled out raising taxes.

``It may not be sensible to balance the budget at all costs,'' said David Wolf, chief strategist at Merrill Lynch & Co. Canada in Toronto. ``The government is going to have to face a hard choice, a choice federal governments haven't had to make in a number of years.''

Legislative Leeway

Wolf said Canada may post a C$10 billion deficit in the next fiscal year unless the government scales back spending or raises taxes. Harper hinted yesterday that he would focus on restraining spending, saying it was ``essential to keep government spending focused and under control.''

Harper's improved showing in the election will give him some leeway to overcome legislative gridlock even as economic realities limit his options.

All of the major party leaders pledged to cooperate in the next parliamentary session, while the opposition Liberals -- short of cash and facing the prospect of a campaign to replace leader Stephane Dion -- are unlikely to oppose initiatives that could trigger an election.

Canada's last three elections failed to generate a majority government, starting with a Liberal minority in 2004.

``It's the third campaign in four years. People are tired,'' Denis Coderre, one of 13 Liberal lawmakers from Montreal who won re-election, told reporters. ``We have to rebuild our associations, our finances.''

Harper's Conservatives lasted longer than 10 of 11 previous minority governments because the Liberals opted not to oust them. Harper pulled the plug himself on Sept. 7.

To contact the reporters on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net; Greg Quinn in Ottawa at gquinn1@bloomberg.net.

Last Updated: October 16, 2008 14:36 EDT