Resurgent growth could see deficit reduction accelerated or spending cuts curtailed

TORONTO, June 6, 2013 /CNW/ - A rebounding global economy could see Canadian governments back in the black a lot earlier than forecast, finds a new report from CIBC World Markets Inc.

"Canadian governments are selling themselves short," write CIBC economists Warren Lovely and Emanuella Enenajor. "With ample insulation against today's still-tepid economic climate and prospects of a more forceful 2014/15 global expansion, federal and provincial governments will enjoy some important fiscal breathing room. In response, deficit elimination timelines could be accelerated, recovering ground given up in the past year.

"Alternatively, some governments will be in a position to ease up on spending restraint without jeopardizing budget targets, hinting at a less onerous medium-term fiscal drag. Incremental wiggle room also creates scope for new fiscal initiatives that could hold the key to re-election for some."

The economists note that while a weak global economy and debt conscious Canadian households have seen GDP disappoint, government budget targets are likely still well protected. Federal and provincial governments set aside $5 billion in explicit reserves/forecast allowances in 2013/14, enough to absorb at least a full percentage point miss on nominal growth.

The report adds that government bottom lines will also be helped by another year of low interest rates and resulting lower-than-planned debt service charges. In addition, some high-profile headaches in the energy sector—transportation bottlenecks and a discount between Alberta and international crudes—have been less painful of late.

"At this stage, it's hard for us to see 2013/14 fiscal results being thrown off track," say Mr. Lovely and Ms. Enenajor. "Further out, Canadian governments clearly expect better things for 2014/15 and 2015/16, as resurgent growth lops some $30 billion from the combined federal-provincial deficit over those two years.

"That already sounds impressive enough. But if anything, Canada's finance ministers could end up being even more pleasantly surprised. Powered by external markets, we see Canadian nominal GDP growth topping five per cent in both 2014 and 2015, comfortably north of the weighted average growth forecast built into current fiscal plans."

They note that, all told, the combination of above-plan growth and budgetary prudence is equivalent to roughly $10 billion in federal-provincial fiscal cushioning for 2014/15 and an even greater $15 billion the year after. "Add that to the insurance built into the current fiscal year and the cumulative leeway exceeds $30 billion.

That's $30 billion in deficits that theoretically need not materialize, suggesting that in some cases, deficit elimination timelines could be accelerated."

Mr. Lovely and Ms. Enenajor think a more likely scenario would see "take a less aggressive stance on spending restraint relative to current thinking. If all their fiscal upside was applied to spending, Canada's provinces would have room to grow their spending by roughly an extra 1.5 percentage points per year (on average) through 2015/16—a near doubling relative to the ultra-lean 1.8 per cent average annual gain now officially projected."

Canada's commodity rich regions will once again be the primary beneficiaries of accelerated global expansion. While a shrinking fiscal drag stateside means better times ahead for U.S.-levered regions like Ontario, an elevated loonie will hurt the factory sector's ability to fully capitalize on America's resurgence. These trends could re-ignite the relative economic, fiscal and spread outperformance of Canada's Western provinces starting next year.

A return to deficit reduction would further curb the government bond market. Currently, Canada is the only sovereign in the G7 where the stock of central government bonds is effectively topping out. Net provincial issuance is also on the wane, likely to amount to roughly $30 billion this fiscal year, off notably from $40 billion-plus digested in 2012/13. By the time 2015/16 rolls around, combined federal-provincial net bond issuance—once so plentiful—could be virtually non-existent.

"The likelihood of better-than-expected fiscal results should ultimately defuse a lingering threat to select provincial credit ratings," add the CIBC economists. They note this will "result in an even scarcer supply of bonds, supporting Government of Canada yields and provincial credit spreads alike."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eijun13.pdf.

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SOURCE: CIBC World Markets