Federal deficit will melt away faster than other nations as economy
    recoversTORONTO, July 23 /CNW/ - CIBC (CM: TSX; NYSE) - Federal budgets will be
in deficit over the next few years but Canadians likely won't be saddled with
the massive debt and interest costs that plagued the country 20 years ago,
notes a new report from CIBC World Markets.
    "Canada's fiscal standing is hardly at risk," say CIBC's Chief Economist
Avery Shenfeld and Senior Economist Warren Lovely in the report that questions
recent gloomy forecasts about the size, duration and impact of budget deficits
to come in Canada.
    Pointing first to history, Mr. Shenfeld and Mr. Lovely note that fiscal
projections often understate the potential to tackle deficit challenges, and
that relatively small errors in estimating future growth can see medium-term
deficit projections careen wildly off the mark. This was the case following
the early 1990s recession when "large surpluses seemed like a fairy tale."
Instead, they say, the $37.5 billion deficit "was erased at a breakneck pace"
and transformed into a $3 billion surplus in three years "as the business
cycle swung to expansion and a 'jobless recovery' eventually gave way to more
serious hiring and income growth.
    "Almost overnight, Canada rewrote its fiscal credentials, shedding the
'honourary member of the Third World' mantle The Wall Street Journal had
slapped the country with in 1993."
    Another vital factor in the current deficit outlook is the temporary
nature of today's high-profile stimulus efforts, including infrastructure
programs with fixed termination dates. "Nearly all of the 2009-2010 deficit
was cyclical, reflecting the economic hit to revenues and one-off stimulus
efforts that will be gone as the economy moves back to full employment," say
Mr. Shenfeld and Mr. Lovely.
    The large role that corporate profits and rising incomes have had in
creating budget surpluses in recent years will also help tackle future
deficits. "Pre-recession heights in commodity prices generated huge revenue
flows associated with resource royalties, and taxes on soaring corporate
profits and capital gains incomes. If, as we expect, commodity prices rebound
over the medium term, that could produce another material improvement in
federal fortunes, even if real GDP growth is anaemic and tax losses are
carried forward in the early years of the expansion."
    But even if fiscal progress is slow and deficits prove hard to erase,
Ottawa has more room and time to act than it has had in past recessions. The
policy tools for a fiscal tightening are today more readily available than in
earlier periods, when the debt servicing burden ate up a larger share of
Ottawa's revenue dollar.
    "Over a 15-year period from 1982 to 1997, debt service was equivalent to
fully one-third of federal revenue. Today that interest burden has fallen to
just 13 per cent versus total revenue," note Mr. Shenfeld and Mr. Lovely.
    The CIBC economists caution that patience will be required before much
fiscal progress is seen. "Results for 2010/11 will be restrained by the need
to avoid a sharp belt-tightening that puts the recovery at risk."
    Mr. Shenfeld and Mr. Lovely also argue that any remaining deficit after
five years will be small enough that the debt to GDP ratio will fall,
minimizing the government's need to issue debt. Financing needs will also be
reduced as the federal government cashes in on insured mortgages it recently
bought.
    "As a result, the current spike in Canada issuance should prove temporary
even if the deficit hangs around longer than the government expects," say Mr.
Shenfeld and Mr. Lovely, adding that "this time, The Wall Street Journal will
be comparing the U.S., not Canada, to banana republic debtor nations.

    The complete CIBC World Markets report is available at:
http://research.cibcwm.com/economic_public/download/sjul09.pdf

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