TORONTO, July 30, 2012 /CNW/ - Ramping up government spending on infrastructure, rather than trimming interest rates, may be Canada's best path should economic growth falter in the next year, notes a new report from CIBC world Markets Inc.

"Canada's Plan B can't depend on monetary policy, given how low rates already are," says Avery Shenfeld, Chief Economist, in CIBC's latest Economic Insights report.  "If the global picture materially sours, borrowing more, particularly at the federal level, and spending more on infrastructure projects" could serve to "reduce future deficits and improve growth in the process."

The math supporting this approach is illustrated in 30-year government bond rates which are now below Canada's long-term economic growth rate. That means the cost of financing longer-term debt will steadily shrink over time as a share of GDP. "Infrastructure spending that adds to the economy's productive capacity will raise tax revenues that will offset the added financing costs," says Mr. Shenfeld.

In other cases, the arithmetic is even simpler, he says. "Some projects — toll roads, power projects — generate a direct revenue stream for governments that can more than cover the risk-adjusted financing costs. Canada has a number of projects under consideration in the power sector, some of which involve publicly owned utilities where government funding is part of the plan. The dive in interest rates makes those projects look ever more attractive, and getting moving would be even more compelling if slack opens up in the economy."

There are other reasons why targeted infrastructure borrowing and spending would be more advantageous than rate trimming in the event of economic shock, the report notes.  "Trying to squeeze more growth out of housing and debt-financed consumer spending" by cutting rates increases longer term risks from excesses on both those fronts, says Mr. Shenfeld.

There's also "notable elbow room" for Canadian governments, particularly at the federal level, to borrow and spend more if needed to spur growth, the report notes. "Governments across Canada are improving their fiscal position by rolling mature debt into new lower coupon bonds," say Mr. Shenfeld and Government Strategist Warren Lovely. The drop in interest rates since 2007 has resulted in $25 billion in savings on debt servicing costs in the current year.

Borrowing costs are once again lower than was expected at budget time. "Today's tamer rate environment could deliver another $2-3 billion of combined interest savings for federal and provincial governments in 2012/13 relative to budget plans," say Mr. Shenfeld and Mr. Lovely. That position combined with additional budget buffers like contingencies in spending and reserves for forecast disappointments, creates additional room for governments relative to their spring budgets.

Mr. Shenfeld cautions however that the benefits of increased borrowing to fund more infrastructure projects would only be realized if we are facing a longer period of economic slack. Otherwise the additional building activity might only accelerate the timetable for Bank of Canada rate hikes and crowd out private construction projects. At this point, Mr. Shenfeld remains hopeful that policy makers in Europe and the U.S. will do enough to improve the global environment so that neither monetary nor fiscal stimulus will be needed here.

That said, growth is unlikely to be so robust that the Bank of Canada has to ramp up interest rates in the coming year. The Bank of Canada is looking to an acceleration in capital spending to push overall growth in 2013, but Peter Buchanan and Emanuella Enenajor, economists at CIBC, note in the report that "the roar of booming business investment has sounded more like a whimper in recent quarters, contributing a mere fraction to GDP of what it did earlier in the recovery."

And they say it "may not be just a temporary blip, as domestic as well as external economic headwinds conspire to discourage firms from beefing up capital at a hearty clip."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eijul12.pdf

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SOURCE: CIBC World Markets