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A wise man once said, “Beauty is in the eye of the bondholder.”
That's valuable wisdom as the federal government prepares for this year's budget. When assessing the sustainability of Canada's budget plans, the perspective of financial markets is particularly important, as they finance deficit spending and determine the government's borrowing costs.
In the Autumn 2023 Economic Statement published in November, the federal government repeated its recent habit of further delaying the return to fiscal balance. Compared to the 2023 budget, the deficit is now expected to decline more slowly in the coming years.
The government might find this manageable or politically attractive. Recent polls suggest Canadians care more about affordability, housing and health care than financial sustainability.
However, a further delay in deficit reduction means Canada's fiscal forecasts will be viewed as less credible by markets and ratings agencies. If Canada wants to maintain its triple-A rating, financial markets must believe the government's financial plans.
There's just enough time left to make a business-like New Year's resolution. The government should seek to strengthen its credibility with financial markets by ensuring that budget plans in the 2024 budget stick to the paths set out in the autumn statement.
The Fall Economic Statement 2023
The statement contained several positive aspects. The federal government's budget forecast for 2023/24 remains in line with the forecast for the 2023 budget (a deficit of $40 billion). Net debt remains cheap compared to other G7 countries and Canada has a “triple-A” rating from two of the major agencies.
However, not everything is rosy. The federal government's current interest expenses are roughly double pre-pandemic levels (as a percentage of GDP), but the fall statement increased spending by $20 billion. From 2024/25, it forecasts fiscal conditions to deteriorate compared to previous forecasts – including higher deficits, rising debt and higher debt servicing costs. The 2023 budget does not provide a time frame for achieving a balanced budget.
The story goes on
Admittedly, the federal government has faced the extraordinary challenge of supporting the economy and Canadian households in the post-pandemic period. However, much of the recent spending growth is not pandemic-related. Canada needs the markets and ratings agencies on its side, so now is the time to change financial stringency.
The market perspective is important
An expert debate on Canada's fiscal position is helpful in understanding its true strength and sustainability, but the real arbiters are the financial markets, which effectively set the price of Canada's debt and thus determine the cost of deficit spending.
A recent example – albeit an extreme one – is the United Kingdom. Under Liz Truss' government, the UK released a financial plan with unfunded tax cuts that drastically misjudged financial markets and led to a rise in government bond yields.
Canada's current financial plans are significantly less radical. However, there are some signs of nervousness. A recent assessment from Fitch, one of the three major credit rating agencies, was titled: “Canada’s medium-term fiscal challenges are increasing.”
Should there be a rating downgrade (and a higher Canadian risk premium), this would have a significant negative impact on finances, as federal government interest expenses are currently already elevated.
Mastering the challenges of 2024
In 2024, there could be economic disadvantages that the federal government cannot fully control, as shown by the budget ranges in the autumn statement forecasts.
However, slow economic growth in 2024 doesn't mean fiscal forecasts are out the window.
The statement's forecasts already assume relatively low economic growth for 2024 (0.4 percent real GDP growth). In addition, it is the government's responsibility to manage potential future cost pressures or revenue shortfalls and re-prioritize accordingly.
The coming year is likely to hold many challenges for the federal government. When it comes to the 2024 budget, the country should stick to its current budget development.
David Jones is a political analyst and economist. He is a fellow at the Canadian Center for Health Economics and studies public policy at the Munk School of Global Affairs and Public Policy at the University of Toronto.
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