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Flaherty to Keep Canada on 2015 Budget Surplus Path

Canadian Finance Minister Jim Flaherty
Canadian Finance Minister Jim Flaherty has consistently stressed the need to return to surpluses even in the face of a weakening revenue outlook as the country’s expansion has fallen short of forecasts. Photographer: Patrick Doyle/Bloomberg

Canadian Finance Minister Jim Flaherty will release a budget today that will keep the country on path for surpluses starting next year, and set the stage for a political battle over how to use the coming fiscal room.

Flaherty’s last update on Nov. 12 forecast a surplus of C$3.7 billion ($3.3 billion) starting in the fiscal year beginning April 2015, and producing surpluses of as much C$36 billion over four years if growth forecasts bear out. At a Jan. 27 press conference, Flaherty said his budget was on track for a surplus of just under C$4 billion next year.

Prime Minister Stephen Harper and Flaherty have made balancing the budget a key part of preparations before the next election in 2015, touting it as a symbol of Canada’s strength relative to other Group of Seven countries and fulfilling a key pledge from elections three years ago.

“In the past, it was how quickly you get back to balance, what do you have to cut,” said Craig Wright, chief economist at Royal Bank of Canada, the country’s second largest bank by assets. “Going forward, it will be how do you spend this dividend.”

The surpluses will allow the government to enact tax breaks that Harper promised during the 2011 federal election, including the ability of families to split their incomes for tax purposes. Flaherty’s last fiscal update projected surpluses of about C$24 billion in the four years beginning in 2015. The government also has built in a cushion of C$3 billion annually in case growth fails to meet expectations, giving it as much as C$36 billion in fiscal room.

Surplus Need

Flaherty has consistently stressed the need to return to surpluses even in the face of a weakening revenue outlook as the country’s expansion has fallen short of forecasts.

In his November update, Flaherty revised down estimates for nominal growth, which includes the impact of inflation and directly affects the government’s revenue base. He pledged to make up the shortfall by reducing spending, including freezing operating budgets.

Since then, economists have lowered their forecasts for inflation, suggesting the government’s revenue outlook may weaken further. Canada’s finance department uses forecasts from private sector economists to generate its economic outlook.

Direct program spending, which excludes transfers to provincial governments and people, has been the focus of Flaherty’s cutting. It was projected in November to decline 4.4 percent to C$115.4 billion in the fiscal year that starts April 1. As a share of GDP, direct program expenses was forecast to drop to 5.4 percent by 2017, the lowest since at least 1967, from 6.5 percent this year.

Undermining Growth

That pace has led opposition leaders to say the government may be undermining growth at a time when job gains have slowed and consumer confidence may be waning. Canada’s economy created 99,000 net new jobs jobs in 2013, the smallest gain outside of a recession year since 2001.

Canadian consumer confidence fell last week to the lowest since May, as the worst-performing currency in the Group of 10 this year chips away at the perception Canada’s economy is robust, according to the Bloomberg Nanos Canadian Confidence Index.

The Canadian dollar has lost 9.3 percent against the U.S. dollar in the past 12 months, ranking it 12th among 16 major currencies tracked by Bloomberg. Canada’s benchmark Standard & Poor’s/TSX Composite Index has underperformed the Standard & Poor’s 500 Index, with its 8.2 percent gain trailing the 18.6 percent gain in the U.S. benchmark.

Flaherty is seeking to safeguard Canada’s status as the only Group of Seven country with a stable AAA credit rating, which is helping keep down interest costs for companies such as Bank of Nova Scotia, Royal Bank of Canada and BCE Inc. that were among the country’s largest borrowers last year.

Bond Yields

Yields on Canadian corporate bonds, at 2.88 percent on Feb. 10, have been below those in the U.S. since May, according to Bank of America Merrill Lynch indexes. Canadian companies issued C$109 billion in bonds last year, according to data compiled by Bloomberg.

Fiscal policy will be a “modest headwind to growth” that is already threatened by the risk of another year of weak global demand for Canada’s exports, the IMF said in a report last week.

“It’s important to strike the right balance,” between growth and curbing spending, Roberto Cardarelli, the IMF’s chief of mission to Canada, said on a Feb. 3 conference call. “There is room to delay the adjustment needed to return the budget to balance in 2015 if there is no meaningful pickup in growth.”

Artificial Timetable

Both main opposition parties, the New Democrats and Liberals, say the government is artificially setting a balanced budget date to coincide with the election year.

“They’ll do anything they can to create a surplus next year then in next year’s budget they will treat that as an election platform,” said Scott Brison, the Liberal Party lawmaker responsible for finance issues. Balancing the budget next year “is a political objective they have set for themselves that has very little to do with the economic aspirations or challenges faced by middle class Canadian families.”

The NDP, which has said it would reverse corporate tax cuts implemented by Flaherty that have helped to fuel deficits, last week proposed a tax credit for small businesses that create jobs, at a cost of just over C$100 million. They’ve also proposed a tax credit for hiring youth.

“What we would like to see in the budget are some things that recognize that far too many Canadian families, middle class Canadian families are stretched,” said Peggy Nash, NDP lawmaker responsible for finance issues. “Their incomes are not increasing and yet their costs are going up.”

Youth Unemployment

Flaherty has acknowledged more can be done on the jobs front. In an interview with CBC broadcast Feb. 9, Flaherty said he will introduce measures to help reduce youth unemployment, which was at 14.1 percent in January, compared with a national average of 7 percent.

The budget will also tackle consumer issues, Flaherty told the CBC. In a separate interview with CTV, he said there will be funding for major infrastructure projects.

Flaherty’s budget could include a consultation paper on rules that govern how bondholders will share a greater burden for bailing out banks in a crisis. Barclay’s Capital analyst Phillip Huang said in a research note that the budget could amend legislation to cap wholesale rates for wireless telephone companies.

The government is likely to remain upbeat about Canada’s outlook. In a Jan. 16 interview, Harper said a weaker economy “is not our read” and the government is “pretty optimistic about the prospects for the year to come.”

“Messaging related to the budget and government finances can have a dampening or encouraging effect on consumer sentiment,” Nik Nanos, an Ottawa-based pollster at Nanos Research Group.

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