Exports to resurgent U.S. could add billions to government books over next two years

TORONTO, Sept. 17, 2014 /CNW/ - Ontario's economy is poised to be the single biggest beneficiary of sturdy U.S. growth and a weaker Canadian dollar in the next two years, likely boosting provincial government coffers by $4-5 billion, finds a new report from CIBC World Markets.

The report calls for Ontario's economy to grow by 2.8 per cent next year, behind only that of Alberta. In 2016, real GDP growth is forecast at 2.4 per cent, but still above the national average.

"From manufacturing shipments, to domestically driven signposts in retailing, wholesaling and homebuilding, Ontario has seen a notable resurgence, shifting from a perennial trailer to among the better performing regions of the country," says Avery Shenfeld, Chief Economist at CIBC, who coauthored the report with senior economist, Warren Lovely. "Employment hasn't caught fire, but should respond at some point to firming output."

Mr. Shenfeld notes that historically, Ontario's real GDP has had the tightest correlation to U.S. economic activity, but after years of plant exits, capacity use has actually tightened in the face of demand gains. "Ontario needs to cultivate growth sectors, rebuild capacity and win the battle for new facilities.

"Our call for the Bank of Canada to significantly lag the U.S. Federal Reserve in rates hikes next year, and a resulting depreciation of the loonie to roughly 85 cents U.S., should reposition the province as a more cost-competitive location. Lower federal/provincial corporate tax rates, the shift to the HST, and a $2.5 billion fund set up by the province to court direct investment, could be further enticements."

The report notes that Ontario's economy has underperformed the national average dating all the way back to the 2002-2007 pre-economic crisis period. The CIBC economists are calling for Ontario to match national growth in 2014 at 2.3 percent and move slightly ahead in each of the next two years. This forecast would top estimates and improve the provincial government's bottom line.

"All told, Ontario could have an additional $4-5 billion accumulated over two years that could be used to either exceed targets for deficit reduction or avoid the full burden of what rating agencies have judged to be tough-to-meet spending constraints," says Mr. Shenfeld. "The extra room captures published budget sensitivities to nominal GDP divergences, and obviates the need to dip into the $1 billion in reserves and $0.5 billion in contingencies set aside this year, and the $1.2 billion reserved for 2015/16."

He notes that despite the fact that the province has been running ahead of budget targets, the province's bond performance has been hurt recently by earlier downgrades in the economic outlook and risks of a corresponding move by rating agencies. As well, a softer outlook implied even tighter spending plans or the further use of tax-hike room in order for the province to meet the targeted date for a balanced budget.

"Having avoided a credit downgrade, Ontario bought itself some time, and the revenues associated with a better-than-expected nominal GDP outlook should be of value in protecting its rating," adds Mr. Shenfeld. He says that the rebound in the U.S. and a more favourable exchange rate have the province better positioned to rise to its fiscal challenges.

"We see conditions a year from now as comparable to late-2010 and early-2011. As was the case back then, Ontario real growth will be topping 2.5 per cent and 10-year Canada bonds will be near 3 per cent. If that analogy extends to spreads, a year from now, 10-year Ontario bonds could tighten in to that earlier period's 70 basis point spread over Canadas. So bond investors have reason to cheer "grow Ontario grow" as gains in nominal GDP support some bond outperformance against Canadas."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eisep14.pdf

CIBC's wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.

SOURCE CIBC World Markets