Canada may need to take further policy steps to curb growing household debt that makes the country vulnerable to economic shocks, the International Monetary Fund said.
The ratio of Canadian household debt to disposable income rose to a record last quarter, even after Finance Minister Jim Flaherty and the country’s banking regulator tightened mortgage rules. The housing sector is an “important source of vulnerability” and “additional measures may be needed” if debt levels continue to climb, the IMF said in its annual report on Canada, released today.
“High household debt and an exuberant housing market make Canada more vulnerable to adverse macroeconomic shocks,” especially if export demand weakens, commodity prices fall and global financial conditions tighten, IMF staff said.
Bank of Canada Governor Mark Carney has warned that mounting household debt poses the greatest domestic threat to the country’s financial system and economy, which probably had its worst six-month performance since the end of the 2009 recession in the second half of 2012.
“If something bad happens to the Canadian economy, the ability to respond simply by borrowing, which was used at the time of the Great Recession, is simply not going to be there,” Roberto Cardarelli, IMF mission chief for Canada, told reporters in Ottawa.
While economic growth should pick up later this year, downside risks remain “elevated” from a potential U.S. slowdown, a worsening of Europe’s debt troubles or a slump in commodity prices due to weak demand from emerging markets, the IMF said in its so-called Article IV report.
The Washington-based lender forecasts the Canadian economy will grow 1.8 percent in 2013, followed by a 2.3 percent expansion in 2014. That compares with the Bank of Canada’s forecast of 2.0 percent this year and 2.7 percent next year.
Most directors on the IMF’s executive board agreed the Bank of Canada has “scope for further monetary policy easing” if economic conditions were to worsen, according to the report. Still, a “few” directors believe a cut in the bank’s policy interest rate probably wouldn’t be effective and would worsen the financial risks of low borrowing costs, according to the IMF report.
Carney said Jan. 23 the need to raise the central bank’s benchmark rate had become “less imminent,” a position he repeated this week in testimony to a parliamentary committee.
Flaherty introduced stricter rules on mortgages insured by the government in July, while the Office of the Superintendent of Financial Institutions recommended tougher standards on home loans in June.
Canada’s housing agency reported Feb. 8 the annual pace of home starts dropped 19 percent in January from a month earlier. The average resale price rose 0.3 percent nationally in 2012 to C$363,740, according to the Canadian Real Estate Association.
Housing prices will probably drop 11.5 percent on an inflation-adjusted basis over the next five years, IMF staff said in the report released today. Still, if employment doesn’t grow from its 2012 level, home prices may fall 18 percent by 2017, they said.
Canada’s banks are “largely protected” from a housing downturn, due to conservative lending practices and the support of government-backed insurance, IMF staff said.
“However, pressure on margins from low interest rates and lower growth in household loans may induce banks to increase their exposure to more volatile capital market operations and expand more aggressively abroad,” they said in the report.
IMF staff also expressed concern about the increasing exposure of the country’s economy to swings in prices of commodities, in particular energy.
Canada recorded its ninth straight trade deficit in December. While weak U.S. demand has been a factor, Canada’s export position is also being eroded by a strong currency, according to IMF staff. Part of the dollar’s rise over the last decade can be attributed to rising commodity prices, they said.
To blunt the impact of swings in commodity prices, the federal government and its provincial counterparts should consider setting aside savings during resources booms, said IMF staff.
Flaherty said in November he planned to balance the federal budget by 2015 by clamping down on spending. While the federal government will probably eliminate its deficit by 2016, some provinces may have difficulty cutting spending as planned, IMF staff said in their report.
Flaherty said in a statement today that the IMF staff report “confirms Canada’s sound approach to economic management.”