2021 Federal Budget: Spending to Immunity and Beyond
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The federal government unveiled its first budget in two years on April 19. I’ve been covering budgets for more than 30 years, and this one was truly like no other.
In terms of scope, the 700-page document touched almost every facet of the economy and included more than 100 new measures. The proposed budget will need to win approval of the majority of Parliament to take effect.
Regardless of what the budget contained, we expected a relatively robust recovery as the economy reopened. But we believe it further reinforces what should be a strong growth pattern in the summer and fall.
Budget Highlights
The budget includes an aggressive $101.4 billion in new spending over three years aimed at supporting the country through the third wave of the COVID-19 pandemic while laying the groundwork for a longer-term recovery.
One of the key takeaways was that the budget did not include any major tax increases, such as a wealth tax. It does call for several targeted tax increases, notably on certain luxury items, digital services and vacant homes owned by non-Canadian nonresidents. But the good news is that this signals the government’s belief that it can stabilize public finances over the next couple of years without resorting to broad-based tax measures.
Among the other highlights:
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Debt is expected to stabilize at around 50% of GDP. For prior years, Ottawa had maintained a debt-to-GDP ratio of around 30%. The expectation is that the debt will peak this year and begin to drift lower over the medium term.
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After reaching a record $350 billion in 2020, the deficit should drop to about $155 billion in fiscal 2021—still historically large, but its 6% share of GDP is more in line with what we’ve previously experienced during recessions.
State of the Economy
We expect the economy to begin fully reopening through the summer. The federal government does too—the budget indicates that much of the special spending could be rolled off after September. Accelerating the pace in vaccinations will be the key to getting the recovery on track.
Ottawa’s forecast of 5.8% GDP growth is essentially in line with our expectation of 6%. The caveat here is that the tough restrictions currently in effect in Ontario, British Columbia and Alberta will adversely affect the economy in April. Our view is that this will delay, though not derail, the start of the recovery. While we’re still confident in a robust rebound in 2021 and 2022, we can’t ignore the impact the third wave will likely have on this year’s growth rate.
In light of the proposed budget, here’s what we expect in various aspects of the economy.
Spending. What’s clear is that the spike in government spending in 2020 was a historical outlier, largely due to the special measures that were rolled out to backstop the economy and provide support to individuals and small businesses. But as the economy reopens, those one-time spending measures should roll off quickly. Even with some of the new spending measures in the new budget, such as the $30 billion set aside over the next five years to create a national child care system, total spending is expected to return to about 15% of GDP, close to where it was before the pandemic.
Interest rates. Short-term rates will likely remain near zero until the economy achieves a full recovery in 2023. Long-term rates, however, are expected to move higher over the next couple of years. It’s worth noting that the budget relies on the combination of a strong recovery over the next year and the persistence of low interest rates. While we believe that’s correct, there is a risk to both of those assumptions.
Inflation. We can expect to see a fairly meaty 3% inflation rate in the next couple of months, partly because of comparisons with the extraordinary conditions from a year ago. But we expect that to ease back to around 2% later this year, where they should remain in the medium term. The risk to this forecast, however, is on the high side.
Housing. The budget only paid nominal attention to the housing market, but this is the one area where there’s been a lot of inflation. What Canada’s housing market has experienced is beyond a v-shaped recovery. In many respects, this is the hottest national housing market I’ve ever seen. Past housing booms have been focused in the large metropolitan areas; this time, it’s sweeping the country. There were some modest measures in the budget—such as the tax on nonresident ownership of vacant property—but until policymakers get serious about trying to dampen the market, it’s likely to remain strong until buyers start to express exhaustion with soaring prices.
Unemployment. While the unemployment rate recovered from the double-digit levels we saw last spring, the recovery in Canada has been a bit choppier than in the U.S. due to the on-again-off-again restrictions. The unemployment rate will likely rise in April and May before beginning to drop off. By mid- to late 2022, unemployment rates should return to pre-pandemic levels.
Currency. Our view is that the Canadian dollar is likely to strengthen over the next year. A powerful global recovery is always good news for the dollar, and we’ve been impressed by the strength in oil prices. Looking further out to the next three to five years, we expect the Canadian dollar to trade in the 75 cents to 80 cents range against the U.S. dollar.
Signs of Hope
This has been an extraordinary recession and recovery. While the current wave and the resulting lockdowns in parts of the country are creating a lot of uncertainty, we can see the light at the end of this long, dark tunnel. And the proposed federal budget gives us reasons to be optimistic that the country is well-positioned for a rebound while setting the stage for long-term economic growth.
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Speaker 1: Welcome and thank you for joining us for today's live webcast and discussion. We invite you to be a part of the conversation. You'll see a chat box located near the video window. Click chat as a guest and enter your name. Feel free to enter your questions, and our moderators will forward them to the panel. We'll repeat these instructions later in the show as a reminder. It is now time to begin and I will invite your host to take the stage.
Nadim Hirji: Good morning, everyone. I'm Nadim Hirji, Executive Vice President and Head at BMO Commercial Banking business in Canada. Thank you for starting your day with us today, especially for those of you on the West Coast and the Prairie's where it's 5:00 or even 6:00 AM. With the federal government tabling the budget yesterday, the first issued in two years, we felt it was important to have this call to hopefully provide you with some insight and some clarity.
Doug Porter, BMO's chief economist has analyzed the budget and he's here to unpack what it could tell us about the years ahead. The current third wave and the challenges that come with it especially with full lockdown in Ontario and parts of Quebec, and the great challenges across all of Canada creates a lot of uncertainty. I think we all still see a light at the end of this long dark time.
Hopefully, the budget gives us all a reason to be optimistic that the country will be well-positioned for a rebounding from the pandemic and that it sets the stage for prosperous economic growth. We'll start this morning with Doug's analysis followed by Q&A. We received many questions in advance on our registration site. Many of which will be answered through the information that Doug will provide in his presentation.
You can also submit a question for Doug through the chat feature you see on the screen. Let's get going. Good morning, Doug. I will turn the floor over to you and hope that you can provide us with your views on the state of the country's finances. What are some of the important pieces of the budget that we should understand better, its impacts, and what lies ahead? With that, over to you, Doug.
Douglas Porter: Thank you, Nadim. Good morning everyone, it's a pleasure to join you here. I have to tell you I've been covering budgets for a little bit more than 30 years and this one was truly like no other, and this budget breakfast is like no other as well. This was an enormous document, it was a very ambitious effort. I think in some sense, as Nadim said, we did not have a budget last year.
In some sense, this almost made up for the fact that we didn't have one in just the scope. It really did touch on almost every imaginable portion of the economy. It even had things like a tax on vaping products, for instance. I can't possibly do it justice the 700 pages, there's literally more than 100 new measures in the budget. I can't do it with full justice in terms of each and every one of those measures over the next 20 minutes or so, but what I plan on doing is basically walking through some of the major financial aspects of the budget.
Then I'm going to turn around and talk about what it might mean for the economic outlook over the next year. Just to get started, let's begin with the very big picture. There were two main themes in the budget. One was basically getting us through the last stage, hopefully, the last stage of the pandemic. There's still quite a tremendous cost to that over the next six months or so. Then laying the groundwork for the recovery, in the government's view, their so-called building back better. The main plank of that was the new national childcare, the proposed childcare arrangement. That was just one of many, many measures.
Now, in terms of the big deficit number, last year's deficit, which was a record, did come in a bit smaller than what was initially pegged late last year. Instead of the $380 billion that was widely talked about, because of a better economic performance around the turn of the year, it now looks like it'll be about $350 billion. That's for the fiscal year that would have ended at the end of March.
Now, the year that's just begun this month, it does look like the deficit will come down and come down a lot. It'll drop by about $200 billion, but it will still be historically large. It is expected to drop to a bit more than $150 billion. That's about 6% of the economy. That's back in the range of things we've seen before. We have never seen a deficit like last year's deficit, but as a share of the economy, a deficit that's about 6% of the economy is something we have dealt with before. I would just stress that does include a lot of the spending related to the pandemic that will still be in place in this fiscal year.
Things like the extension of the CUES program, more CRB which used to be served, payments that will wind down as we get later into this year. That's largely why the deficit is still as large as it is expected to be this year. When we get into the next fiscal year, it's then expected to drop again to much, much more manageable levels below $60 billion. That's still twice where we were before the pandemic began.
I would regard the budget deficit forecast for next year and the year after, while still large, a bit larger than I'd like to see, I'm much more comfortable and in the zone of what we've seen before. As I said, there were literally more than 100 measures, just a few of the other ones I would point to besides childcare. One thing a lot of people were watching for was would there be big tax increases?
There were a number of smaller targeted tax measures but I think the good news for most people probably on this line is that there were no broad-based tax increases. We weren't expecting any but it's still a relief to see that the The government does believe that it can get the budget down to much more manageable levels over the next couple of years without resorting to too big tax increases. And I think that's one of the major messages that I'd like to leave you with here today.
This, there's a lot of information on this chart. There's a lot of information in the budget, but the one thing I would like to point two on the left-hand side is this looks at spending and revenues as a share of the economy and it goes back all the way to the 1960s. You can see just what an outlier spending was over the last year compared to any kind of historical precedent.
It really was not a revenue story. Revenues, actually, they did get a bit dented, but they held up remarkably well, they did drop as a share of the economy to the lowest level we've seen in a great number of decades, but as you can see, the expectation is that revenues will come back and come back relatively quickly, and are really not that abnormal in a historic context, but take a look at that light green line. Program spending had basically been drifting sideways for a number of years, had been grinding up somewhat in the last couple of years, and then it just absolutely spiked.
What that reflects is all the very special measures that were wheeled out over the last year to essentially backstart the economy through the shutdown supporting comes for individual support to small businesses and then a number of other special programs that were brought out last year. As you can see, as the economy reopens, the expectation is that a lot of those one-time spending measures will prove to be one-time and that they will roll off and roll off quickly.
Even with things like the new childcare program, you can see that total spending as a share of the economy is expected to be back around 15% of GDP within a couple of years close to where it was before the pandemic began. Of course, the other thing everyone's focused on, I talked about the budget deficit numbers is that federal debt line at the bottom. Yes, the federal debt did go above a trillion dollars, last year is expected to rise further over the next few years, essentially, in the space of about five years, going back to pre-pandemic levels, it will have doubled over that that five year period of time.
So, when we look at the debt figures as a share of the economy, this is ultimately how we will quote pay for the pandemic is through a one-time big step up in debt to GDP. For years before the pandemic, Ottawa had basically been maintaining a very stable debt to GDP ratio of around 30% through thick and thin, we had seen the debt to GDP ratio, as I say, quite stable on it close to 30%. Then we had that enormous pickup last year where we essentially went to 30 from 30% to 50% overnight.
Now, the expectation is in this fiscal plan that was laid out yesterday, is that the debt will peak this year as a share of the economy and actually begin to drift down over the medium term because the economy will be growing faster than the debt will be in the years ahead. Effectively, the government will now be targeting a 50% debt to GDP ratio. It's very unfortunate that it's taken this one big step up from what had been a very stable level for years and years. I guess if there's any good news it's the fact that it's still below where we were back in the battle days in the mid-1990s.
In the mid-1990s the debt to GDP peaked at a little bit more than 70% of GDP. We're still below those levels that we saw a little bit more than two decades ago. Just as if we took the chart way back on the left-hand side, if we went back to the pre-war days or, I'm sorry, the immediate post-war years, we would have actually seen the debt get closer to 100% of GDP very temporarily, and then it came down quickly in the post-war boom.
The level of debt wall in dollar terms it's not a record high it's nowhere close to being a record as a share of the economy. The other good news, of course, is that this has all taken place at a time of very very low-interest rates. Now, I wouldn't want to bank on that forever where there's no guarantees that interest rates are going to remain anywhere close to where they are. We suspect they are not likely going far in the next couple of years and I'll get into that in a minute.
The overall interest costs of this debt still remain very low. In fact, even with the big run-up that we've seen in debt over the last year, the actual interest costs on Ottawa's debt have dropped in the last year, just because interest rates plunged so much over the past year. Now, this won't last forever, we will see the interest costs begin to creep up over the next few years but effectively we expect them to remain quite manageable. Again, I would stress that does not give Ottawa an open checkbook to freely spend as they like this low level of interest rates is by no means guaranteed.
It's also not guaranteed that we're going to have a robust economic recovery to fuel revenues in the years ahead. That brings me to the next topic and that's the economic forecast that this budget was based upon. Just as a reminder, Ottawa really since the mid-1990s has been basing its economic projections on the private sector consensus. They've basically taken their hands off, and almost depoliticizing the economic forecast which I think is appropriate.
I'm not going to tell you the consensus always gets it right. We're certainly part of that consensus, I'd like to think we're a big part of that consensus. We don't always get it right but I do believe that over time that consensus is one of the single best forecasters for the economy. What this budget is based on is frankly a very strong economic recovery. If you can see the numbers there what the budget is based on is 5.8% real growth this year and 4% growth next year. We think those are actually fairly reasonable assumptions, where if anything, that's slightly more optimistic both this year and next than the consensus is on the forecast. However, by no means is that strong recovery absolutely baked in the cake.
We've seen some of the much tougher restrictions, whether it's in Ontario or BC or even Alberta in recent days in recent weeks that is going to ding the economy pretty seriously in the month of April. Our view is that this is only going to delay the point at which the economy recovers. It's not going to derail it but it will take a little bit of a bite out of this year's growth rate.
We can't completely be comfortable in the assumption that the economy will see a very strong recovery this year and next, but we do think it's a reasonable assumption. The other thing the budget is based on, as I mentioned is the continuation of relatively low interest rates. We did have a big bump up in long-term interest rates to start the year. They have since stabilized and even come down a little bit.
Again, it just so happens that our projection for interest rates for this year and next, whether it's short-term interest rates close to zero or longer-term interest rates have a little bit more than 1% over the next year. It's very close to what the budget is based on. I would just point out that the budget does rely on the nice combination of a strong recovery over the next year and the persistence of relatively low interest rates.
We do think that's correct but there is clearly a risk to both those relatively positive assumptions. Now, the other thing I would point out is I talked a little bit about Ottawa's still very significant budget deficit. As I said, 16% of GDP last year expected to fall to 6% this year. Of course, when you look at Canadian fiscal landscape, you also have to take the provinces into account as well. They are very significant borrowers in addition to Ottawa.
Now, the good news is, and I would say appropriately so, is that Ottawa really did shoulder the burden of the pandemic costs over the past year and even again this year. Yes, the budget deficits did widen in most provinces. You can see New Brunswick actually managed to almost balance its budget over the last year, but they were the outlier. Most provinces did run fairly significant budget deficits.
It was much smaller than what we saw at the federal level. If you combine all the provincial budget deficits together, there were about 4% of the national economy, which is about a quarter of the size of the federal government deficit. If we add everybody together, Ottawa plus all the 10 provinces, you do end up with a budget deficit that was close to $450 billion or about 20% of the economy. That is enormous. That is one of the larger budget deficits in the world.
Canada really takes a back seat to no one, I would say, in terms of how much support we saw right across the country, whether it was from the federal government, or from the provincial governments. Just to wrap up the specifics of the deficit, I'm sorry, of the budget, I think the main point is before this began, Ottawa talked about spending an extra $70 to $100 billion, in their words, to jumpstart the economy. They did that one better. They're actually planning on spending $101 billion over the next three fiscal years with the bulk of it, landing in this year to, again, really support the economy through, hopefully, the last stages of the pandemic and to help foster the recovery.
Now, our view is that the recovery was likely to be relatively robust in any event, as the economy reopened, this will just further reinforce what we expect to be a relatively strong growth pattern as the economy gets through the initial stages of reopening, hopefully, this summer and into the fall. With this extra spending, though, the deficit will not completely come down quickly, we do expect it to drop pretty sharply, but it will remain relatively large at over $150 billion dollars this year. Largely because of that extra dose of spending that Ottawa is talking about bringing in.
Even with that extra spending, we are looking for the debt to GDP ratio to stabilize, it will peak this year, just a little bit more than 50%. It will stabilize in the next couple of years and then we think it will slowly drift down as that deficit recedes further and the economic recovery is more complete. As I said, to me, one of the key takeaways is, many fiscal conservatives, I consider myself mildly fiscally conservative, might be concerned about this wave of spending.
I will point to the fact that even with this relatively aggressive backdrop for spending the new childcare program, we are looking at an environment with no major tax increases, there was a lot of concern about things like the capital gains inclusion rate going up, not just on principal residences, but capital gains more broadly, and there was no talk of that whatsoever.
The tax increases were much more targeted. Things like luxury tax on high-end boats, planes, and vehicles above $100,000. There was a Digital Services Tax, but there were really no major broad-based tax increases. The budget plan really does see a pretty [unintelligible 00:17:29] narrowing in the deficit in the years ahead without resorting to tax increases.
Now, with that, I'm going to briefly talk about what this means for economic forecasts. This is where I get into the more traditional aspects of my presentation. Certainly, the dominant feature remains the pandemic, especially here in Canada. I talk about a third wave, this chart looks at the number of new COVID cases in Canada, the big five European economies in the US and you can see stands out there is really for the first time in the pandemic, and this is pretty close to being on a per capita basis.
Canada is really seeing as many new cases as any of the major economies at this point. I guess the good news is, is in places like Europe and the US, partly because of the aggressive vaccination processes, especially in the US and the UK, we're not seeing a full-fledged third wave such as we're seeing at this point in Canada. The vaccine is getting rolled out in a much more expeditious fashion.
We suspect that after this wave does crest, we are expecting the economy to much more fully reopen through the summer, especially in the last four months of the year. Looking at the budget document, for instance, yesterday, there did seem to be the assumption that a lot of the special spending could be rolled off after September when I would presume the government too, is assuming because of a much more rapid pace of vaccinations, that we will have a much more full opening of the economy when we get into September and beyond.
Globally, we are expecting a very robust recovery. This is not just a Canadian story by any means, after seeing the worst downturn in the post-war era globally last year when the global economy fell by about 3%, we are looking for the global economy to bounce back at a 6% growth rate this year. Then maintain some of that strength into 2022, when things like the travel industry open much more fully. We're expecting the global economy to grow by 5% when we get out into next year.
Turning to North America, it's actually a roughly similar story. I mentioned earlier what our projection was for Canada. If anything, we see somewhat stronger growth in the US this year. There's a couple of reasons for that. One is frankly, and I think we're all aware of that is how much more quickly the US economy has been able to reopen because of their faster vaccination program. Also, President Biden brought in that massive stimulus proposal of his own at the start of the year, $1.9 trillion. That's equal to 9% of the US economy. That has already started to juice things like retail sales and housing starts in the US.
We're looking for the strongest performance of the US economy and the strongest growth rate since 1984, at 6.5%. If anything, we may even be a little bit conservative, cautious in that view. I actually see the risks to our forecast on the US economy this year to be the upside. Then some of that strength carrying through, into next year, when we see the US economy still growing by better than 4%, when we get out into 2022.
As you can see, we see Canada largely growing in line. There'll be a bit of a delay, a bit of a stalling out in the second quarter because of the new restrictions, but then we think we'll play catch up through the second half of the year and into 2022 when we think the Canadian economy can basically grow in line, if not even a little bit faster for some quarters than the US economy over the next year.
Now, after that terrible performance or terrible event last year last spring, when we saw unemployment rates shoot up to the double-digit pace in both the US and Canada last April and we've seen them come down and come down pretty aggressively. We've seen a bit more choppiness in Canada because of the on-off restrictions that we've seen. We actually do believe the unemployment rate will likely rise in April and May before beginning to drop again.
We are looking for some further, pretty dramatic improvement in the unemployment rates in both Canada and the US over the next year. We think that by the middle part of next year, or even late next year the unemployment rates will be almost all the way back to where they were before the pandemic began and that the employment market will be fairly close to what we would consider to be normal by late next year, as the economy reopens.
I talked a little bit about the interest rate environment earlier, and the budget being based on a still low-interest rate environment. If we look at the short-term interest rates on the left, these are things that drive prime rates, your variable mortgage rates. These are the so-called overnight rates that the central banks can directly control. We think that central banks in Canada and the US cannot be clearer that they are going to be extraordinarily patient before they raise interest rates.
Our view is that it's likely not until 2023 before either the fed or the Bank of Canada raises the short-term interest rates. They're very close to zero in both Canada and the US. We think that they will wait until we have a full recovery and a full recovery, especially in the labor market before they start raising interest rates. We see the short-term interest rates really going nowhere over the next two years. It's slightly different story for longer-term interest rates.
As I mentioned, we did see these longer-term interest rates burst out of the gates at the start of the year. That's almost a perfect V-shape pattern you see on the right-hand side in the last 12 months or so, but they have stabilized in recent weeks. While we do see some further modest, upward pressure on these long-term interest rates over the next 18 months, I think in some respects, the big move is already behind us. There is a slight chance that there's any disappointment on the recovery that we'll actually see these rates recede temporarily before grinding higher later this year and into 2022.
There again, I think the big story is that after a very sharp move in the first couple months of the year, we see interest longer-term interest rates only grinding higher over the next couple of years. Effectively much like other financial markets, the bond market really did build in a very robust recovery right at the start of the year. Essentially, the market will no longer be surprised by those kinds of strong growth rates that I talked about just a few slides ago. Now, one other concern that is definitely out there in the market and among our clients is given all the stimulus that we've seen given just this unprecedented bond-buying we're seeing by central banks, this persistence of very large budget deficits, is this going to lead to much higher inflation?
We are going to see some pretty meaty inflation numbers in the next couple of months, partly because we're comparing ourselves to extraordinary conditions of a year ago. Temporarily the headline inflation number in Canada in the US will get around 3% or even a little bit higher from what's current readings, just around 1%. We think these high readings will not last long and that inflation will ease back close to 2% by the end of this year.
We expect over the medium-term inflation to settle back at around 2% or so. When you're doing your planning over the next five years or so, I still think it's very reasonable to base that plan on an average inflation rate of about 2%, even though we're going to see some pretty meaty numbers, as I said, in the next couple of months or so. Now, I will tell you that the risk to this forecast, or a little bit on the high side and not on the low side. I think that's an important message.
A year ago in the early stages of the recession. The concern was that we were looking at possibly a situation of deflation, an extended period of declining prices, and really no one's talking about that anymore. The concern now is more that there is this outside risk that we could be left with a real inflation problem over the medium term. I still give the risks of that. I assigned the odds of that as being relatively low, but I think it's an important message that there's probably more upside risks rather than downside risks to inflation to look at this point.
Now, one area, just a couple more items I'd like to talk about, one area where we have seen a lot of inflation and frankly, it definitely got second billing in the budget yesterday, is in the housing market. I just cannot exaggerate how strong the Canadian housing market is, and this is not just a Canadian story, by the way, we're seeing strong housing markets right around the world, but again, Canada takes a backseat to no one on this front.
We've not just seen a V-shape recovery, we've seen something well beyond that. In many respects, this is the hottest housing market I have seen nationally. That's the key here in past housing booms, it's been mostly focused in the large cities, especially Toronto, Vancouver, perhaps Montreal, this time it's pretty much national. We are seeing strong housing markets almost across the country, especially in smaller cities, in Ontario, in particular, and just a lesser extent come back in Atlantic Canada.
This is something that is really sweeping the country. We did see some modest measures in the budget, including the tax on non-residents who have vacant homes in the country, but that's modest stacked up against the tidal wave of demand that we're seeing. Our view is that unless and until policymakers get very serious about trying to dampen the market, it is likely to remain very strong for a period of time.
Now, there is some point at which buyers are just going to express the exhaustion. Some people talk about the fear of missing out, there's also the fear of overpaying. I think at some point that will tend to dampen the market a little bit, but at this point, we remain very constructive on the market and believe that it is likely to strengthen further rather than going to reverse anytime soon.
The last thing we'll talk about is just the Canadian dollar, much like almost every other financial market out there it seemed a very nice recovery from the depths that it hit just a little bit more than a year ago. Our underlying view is that the Canadian dollar is more likely to strengthen rather than weaken over the next year. A powerful global recovery is always good news for the Canadian dollar. We've also been very impressed by the strength in oil prices and the discipline that OPEC is showing at this point.
Those are two very big positive factors for the Canadian dollar. I will say that the dollar barely blinked at the budget yesterday, there was almost no reaction whatsoever in currency markets to the budget. That's largely because the deficit mostly came in and the measures in the budget were no big surprise to financial markets. Looking out over the next year, we see the Canadian dollar modestly strengthening. We think it's more likely to strengthen than weaken.
Longer term when we get out three to five years, I would regard 80 cents as being close to a ceiling over the medium term for the Canadian dollar. I would hazard to guess that a fair value for the Canadian dollar is more in the 75 to 80 cents range when we look out, say three to five years down the road. That's it for the formal part of the presentation, I'd now like to invite Nadim back into to join me for a spell of a Q&A. Thank you very much.
Nadim: Okay. Thank you very much, Doug, let me start by reminding our guests they can use the chat feature shown on their screen if they'd like to ask a question this morning. I will start with some several questions that we did receive from clients during registration, as I mentioned at the beginning. First one, Doug, that came in is what do you think we should expect for future corporate tax rates based on this budget?
Douglas: Yes, and it's interesting because as I mentioned, revenues have actually held up relatively well. They have not been the story and the deterioration in the deficit that we've seen in the last couple of years, it really was mostly because of all of the specific spending to deal with the pandemic. I think perhaps the big wildcard here for Canadian corporate tax rates is what happens in the US.
With Biden's big infrastructure proposal, partly to pay for that was the proposal to raise corporate income taxes in the US, reversing about half of the tax cut that we saw under Mr. Trump. There's been some pushback on that from moderate Democrats. I suspect that ultimately we're going to land at a smaller, corporate tax increase in the US. If and when that does happen, I think that's when Ottawa might take a longer look at possibly moving on corporate tax rates.
It's foregone conclusion whatsoever that, Ottawa is going to follow in the wake of the US. I think that does give Ottawa a little bit of room to maneuver if the US corporate taxes ultimately do edge back up. To me, it's not at all obvious that Ottawa's going to fall in their wake, it does give them the option. In terms of the bigger picture, in terms of not just corporate tax increases, but tax increases more broadly. My view all along has been the best way to cure the deficit, the best way to get finances under repair and back to where they were before the pandemic began is to ensure that we get a full economic recovery, and anything that can possibly frustrate that economic recovery or forward it is counterproductive.
I view broad-based tax increases as being a threat to the economic recovery. If I was finance minister, or if I was in charge, I would not even be considering broad-based tax increases until the pandemic is completely in the rear view mirror, and we know exactly how the dust is settled on government finances. Bottom line is, first we have to wait to see what happens in the US and then I think we have to wait to see how exactly how the Canadian fiscal landscape sorts itself out after the pandemic is over.
Nadim: Okay. A question actually just came in online, which ties into what you just said is, with the lack of new taxes, or at least lack of increase in taxes, is there a concern that this is an election budget and that then a new government will come in with massive taxes after the fact?
Douglas: There's two parts of that question. One is, is this an election budget? I would certainly assume that there's a very good possibility that it can serve as a platform. Given the fact that the average minority government, historically has lasted about 18 months or so. We're getting basically almost at that date. I'm almost operating under the assumption that after the worst of the pandemic is over, we've got a very high probability of looking at an election later this year.
I would it as regard as a pre-election budget. Could we be looking at tax increases after the election? Well, I guess that really depends on who wins the election and whether we're faced with another minority government again. I would just very briefly repeat what I said. I think, first of all, we have to see what the fiscal picture does look like after the pandemic. Do we even need tax increases to really stabilize, government finances? Again, significant tax increases could frustrate the recovery. I just think that would be completely counterproductive until we've got a complete economic recovery at this point.
Nadim: Okay, thanks, Doug. Another one just came in online. Is there any money in the budget for infrastructure spending?
Douglas: The short answer is, well, first of all, I would suggest that there was money for almost everything in this budget. I'm not being facetious on that front, but it's interesting. Typically, a normal quote recovery budget or post-recession budget would go very, very heavy on infrastructure. There was some money allocated to infrastructure, but it wasn't built as one infrastructure budget bucket, I should say it was put into a variety of areas.
There was for instance, $6 billion set aside for infrastructure aimed at indigenous communities. There was a lot of money aimed at green energy infrastructure. It wasn't [unintelligible 00:34:10] into a single file of infrastructure, it was basically sprinkled throughout the budget, but I will say to me, one of the key messages is it didn't really rely that heavily on infrastructure.
That may well be appropriate given the situation that we're in. When you think about this recession and recovery, it's a very, very different from every other one we've seen. In the past, typically what we see is the the interest sensitive, heavy industries, things like manufacturing, construction are the ones that hit or hit hardest. They were not hit hard in this time relative to say the service sector.
In fact, of course, the residential construction industry is absolutely on wheels. Just what happens, we saw the strongest housing start number for the month of March. This figure just came over yesterday that we've ever seen before, over 300,000 units were begun in the month of March on an annual rate. We've never seen numbers like that before in a single month. The construction sector is actually, at least on the residential side, is actually quite robust.
I believe that the thinking in Ottawa was that the construction sector didn't need extra support in these circumstances. Really what they focus more on is the sectors that have been directly effected by the pandemic and do need a lot more help. Things like the tourism sector and the small business sector is where the real pain has been and that ultimately does need the support in construction, wasn't particularly in need of a lot of support. That's why the spending did not rely particularly heavily on what would traditionally be seen as a typical area to focus on in a recover and that would be infrastructure spending.
Nadim: Okay, thanks. We're going to flip to a different industry. What do you see as the outlook for the automotive industry and its supply chain?
Douglas: Of course, the auto sector has faced all kinds of challenges in this episode. It's interesting, on the demand side, this has again, not been a typical recession and recovery at all. Yes, auto sales and production almost went to zero last April, but it's impressive how quickly sales have almost completely recovered in both Canada and the US. In fact, in the month of March, US Auto Sales had one of their best months ever in the US.
The demand is certainly there. The auto sector is facing all kinds of different challenges though. First of all, they're facing the short-term challenge of this chip shortage, which is leading to a variety of production cutbacks that we're seeing, especially here in Canada. We do think that is going to ding our production in a pretty meaningful way in both Canada and the US this year.
I guess from the automaker standpoint, the positive news is they’re going to have a lot of pricing power this year. I think there actually are going to be shortages in particular mix this year in North America. Longer term, of course, we're obviously looking at this profound transition to much more emphasis on electric vehicles in the years ahead. Of course, that carries incredible implications right up and down the supply chain. Significant changes.
Of course, the parts industry is facing a major transformation in the years ahead. Fortunately, for Canada, we do have a lot of mandates now to build electric vehicles in the years ahead. It is going to be a real challenge for the parts industry in particular. Of course, the other issue we're dealing with, and I think the questioner is really hitting on that is, we do face a fundamental review of supply chains right across the board.
I think, industries manufacturing in particular, have come face-to-face with a lot of significant challenges with lengthy supply chains through the pandemic. I think there's going to be a wholesale review and potentially a reordering in many industries of supply chains. I think, ultimately, supply chains in a variety of industries will be shortened. I suspect that does include the auto industry as well. That doesn't mean that it's going to be the case for every manufacturer, for every auto maker.
I do think whether it's the transition to electric vehicles, I should say, the short-term chip shortage or this overview of supply chains, the auto industry faces an incredible transformation over the next 5 and 10 years, I believe.
Nadim: Okay, thank you. I'm going to ask you put a bit of a fortune-teller hat on here, but what is your assumption or forecast regarding timing of the opening of the US Canada Border?
Douglas: That that is a tough one and of course, that's one we've been dealing with, really, really since the pandemic began. Obviously, there's pressure on both sides to open the border as soon as safely possible. I suspect that will be the day when governments on both sides have determined that we have reached something akin to herd immunity, my best guess is that's when both economies can pretty much fully or close to fully safely reopened. My best guess would be something like September or October that we'd be looking at. It's likely after the summer tourism season. Again, I have no particular insight information on that or, special insight that would be our best assumption, though at this point.
Nadim: Okay, thank you, Doug, we all saw after this was tabled the reaction to the budget from the other political parties for the NDP, the Conservative, interesting words that they both chose to speak of, when you think of their reaction, do you think there's a serious possibility that the budget will fail to pass?
Douglas: I don't. I actually, of course, the government really only needs one party to support it. I thought Mr. Singh was incredibly clear. He effectively said he thought it would be irresponsible to have an election in the middle of a pandemic. Frankly, I thought the budget probably ticked a lot of boxes for the NDP. I would be surprised if the NDP would not support the budget? I think the question is whether the sitting government, ultimately wants to once they call an election, I suspect they will not be forced into calling an election, I think it will be the government's choice. Ultimately, I'm under the assumption that the budget will pass.
Nadim: Okay, thank you. Question that just came in online. What concerns do you have with bankruptcies, both personal and corporate, once the government programs, and I know some of them were extended in the budget to the fall of this year, but I think the concern is around, it's not a never never plan, we all get that. What are the concerns once the merry-go-round stops so to speak?
Douglas: First of all, just taking a step back, this has been an extraordinary recession and recovery historically. I think one of the most extraordinary features of it was the fact that we saw a collapse and personal bankruptcies in the last year. There's no mystery what's going on here. It was due to the incredible level of government support. It was also the fact that people were able to defer their mortgages if need be, and it was because of the steep drop in interest rates too that made debts more affordable.
I believe that we are not going to see a significant run-up in personal bankruptcies or over the next year even when supports do fade away.
Frankly, if the government is going to air on this front, it's that if they need to keep these support programs running longer, they will, if they're going to make a mistake, it's that the air on the side of being too generous. I think that we are not going to see significant run-up in personal bankruptcies. Business bankruptcies are a different story. They too collapsed over the last year but I don't think there's a guarantee that they're going to stay low when we're on the other side of this.
I think a lot of businesses are just hanging on especially in sectors that are directly affected, some have just shut their doors, haven't necessarily declared bankruptcy. I do believe that does not give us the full story. The drop in business bankruptcies over the last year. I am concerned that when we're on the other side of this that when the economy is reopened and businesses can completely reassess where they stand. I think we could get an echo of business bankruptcies on the other side of this.
Nadim: Okay. In the budget, were there anything more for the heavily hit industries, travel, tourism, hospitality?
Douglas: There was a little bit. There was in this day and age of billion-dollar sounds like a little. There was a billion dollars aimed at rejuvenating the travel and tourism industry. There was a fair bit of money spent into, essentially, I would say making people more comfortable traveling by airplanes as more of us get vaccinated. There was all kinds of money set aside on that front. Most of it was just the extension of programs that are already in place.
There was an attempt to target it a little bit better at sectors that have been more directly affected, but there was not say an overwhelming large package aimed at supporting the travel and tourism industry. It was I would say more of the same of general levels of business support and support to help firms reemploy people as they're able to reopen again. It was almost a cuse on steroid. I'm sorry, I actually do not remember the name of that program off the top of my head, but basically it was almost subsidizing half of the pay of workers as they reopened in the initial month over the summer and into the early fall. Industry specific stuff there was not a huge new program. No.
Nadim: Doug, is there anything in this budget that, you expected to see or hope to have seen? That's not in there?
Douglas: The one thing we were angling for at least in the economics department is we were hoping for something along the lines to try to cool demand a bit, in the housing sector. It wasn't there, not in a significant way. I'm really not surprised though. Frankly, the housing story has really dominated the airways for weeks. I believe the government didn't want the housing industry to soak up all the oxygen when there were so many other different, important announcements that at this point.
Frankly, I was relieved not to see any significant tax increases. I was somewhat comforted by the expectation that the budget deficit would come down back to around the 30 billion limited in the years ahead. Frankly, as I said, at the outset there were more than over 100 measures here. I almost would've hoped for less rather than more, my view is that the government's role really is to get the economy through as I said. hopefully, this last stage of the pandemic to get us through to the other side.
I really think that should be the job number one is really accelerating and supporting the vaccination program as much as possible, because really that does hold the key to getting the economy on the other side of this. Short answer is no, there was nothing significant that I was really looking for that wasn't there in this budget.
adim: Okay, thanks. Just on that note, you mentioned getting to the other side, a question came in and saying, is the budget built to withstand another wave of COVID?
Douglas: I would say it is built to withstand the wave that we're going through now. I would say the assumption is that a lot of the special programs like the CUES and [unintelligible 00:47:16] or CRB that's now in place are-- the expectation is that, they will be able to be wound down by the fall. This budget is not prepared for, yet another, if it comes to that, and yet another big wave say later this year, and another round of restrictions that might be needed later or later than that.
I guess the good news is while that would dent finances, certainly, I think it's fairly clear that the economy has largely learned to deal with restrictions. It's certainly, not an ideal world by any means, but it does seem much of the economy has been able to at least grind through the restrictions at least temporarily and I don't think the fiscal costs would be particularly huge if there was a fourth wave, so it would deteriorate government finances further, but I don't think it would completely alter the picture.
By the way just as a quick reminder if you go back to November, really the budget wasn't assuming a huge, significant second wave at that point. The ultimate-- the end deficit figures really weren't that different from late last year or even with the second and the third wave restrictions that we've seen.
Nadim: Thanks, Doug. We talked a little bit, a couple of times about the housing market, the strength of it being across Canada, and that not much was in the budget. That's going to really cool it down. You mentioned that something that perhaps is one thing that you thought would have been in there, but is not, the question is, what do you think is an appropriate and efficient measure that could have been in there to cool down the real estate market?
Douglas: Just to reiterate, I really wasn't expecting them to really do anything in the budget. Measures that could cool the housing market do not necessarily have to be in a budget. They can come at any time and just because they didn't do anything yesterday, it doesn't mean otherwise is going to completely stand aside over the next year, especially if the market remains anything close to as hot as what we saw in the month of, really through the first three months of the year, we actually put out a piece in the economics department a few weeks ago that list of 10 potential measures.
I wouldn't say we ranked them in order of feasibility and worthiness, but it was pretty close. Frankly, right at the top of the list is ultimately is lies at the feet of the Bank of Canada. I think one thing the Bank of Canada could do without raising interest rates is just stop talking about interest rates remaining low forever. Maybe just the opposite, start reminding people that interest rates can move up to at some point.
In terms of what the federal or even the provincial governments can do, we had a whole list, a variety of topics. The reality is though almost anything they do will have side effects and are not going to please everybody by any means. One thing provincial governments could do though, we've seen a non-resident tax in the golden horseshoe in Ontario, but it doesn't apply to a lot of smaller centers in Ontario, and that's where the real heat is these days.
Places like, Sarnia, Windsor, London, Ontario which don't have a non-residents tax. It may not be that effective, but it really doesn't have that many negative side effects either. Even if it just acts as a signal that the provincial government is uncomfortable with the pace of price gains that can have an important effect on the market just by signaling that the-- it can break the psychology that we're seeing right now. This is a fear of missing out, which we think is fanning the flames. The other thing we talked about was doing away with blind debting, which we think is really ballooning housing markets.
Doing away with that would have few side effects on the rest of the economy. We would actually rank that as one of the top things that can be done to at least throw a little bit of a wet blanket on the market.
Nadim: Thank you, Doug. I could probably keep you here all day. We received a lot of great questions, but we are unfortunately out of time now this morning. Thank you, Doug, for sharing your insights with us this morning, as always, they were very informative and extremely insightful. Thank you to everyone who joined us today. We will have a replay and a recap on our website soon at bmo.com/commercial.
We thank you for your time, your partnerships, and your business, and hope that we've been able to provide some added value here for you today. If you have any questions that we weren't able to address today, please don't hesitate to reach out to your people representative and we will, of course, get you an answer. Thank you again for joining us today. Please stay safe and, of course, stay healthy and have a great rest of your day. Thank you.
Douglas: Bye, everyone.
Douglas Porter
Chief Economist and Managing Director
Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Economist at BMO Financial Group and author of the popular…(..)
View Full Profile >The federal government unveiled its first budget in two years on April 19. I’ve been covering budgets for more than 30 years, and this one was truly like no other.
In terms of scope, the 700-page document touched almost every facet of the economy and included more than 100 new measures. The proposed budget will need to win approval of the majority of Parliament to take effect.
Regardless of what the budget contained, we expected a relatively robust recovery as the economy reopened. But we believe it further reinforces what should be a strong growth pattern in the summer and fall.
Budget Highlights
The budget includes an aggressive $101.4 billion in new spending over three years aimed at supporting the country through the third wave of the COVID-19 pandemic while laying the groundwork for a longer-term recovery.
One of the key takeaways was that the budget did not include any major tax increases, such as a wealth tax. It does call for several targeted tax increases, notably on certain luxury items, digital services and vacant homes owned by non-Canadian nonresidents. But the good news is that this signals the government’s belief that it can stabilize public finances over the next couple of years without resorting to broad-based tax measures.
Among the other highlights:
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Debt is expected to stabilize at around 50% of GDP. For prior years, Ottawa had maintained a debt-to-GDP ratio of around 30%. The expectation is that the debt will peak this year and begin to drift lower over the medium term.
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After reaching a record $350 billion in 2020, the deficit should drop to about $155 billion in fiscal 2021—still historically large, but its 6% share of GDP is more in line with what we’ve previously experienced during recessions.
State of the Economy
We expect the economy to begin fully reopening through the summer. The federal government does too—the budget indicates that much of the special spending could be rolled off after September. Accelerating the pace in vaccinations will be the key to getting the recovery on track.
Ottawa’s forecast of 5.8% GDP growth is essentially in line with our expectation of 6%. The caveat here is that the tough restrictions currently in effect in Ontario, British Columbia and Alberta will adversely affect the economy in April. Our view is that this will delay, though not derail, the start of the recovery. While we’re still confident in a robust rebound in 2021 and 2022, we can’t ignore the impact the third wave will likely have on this year’s growth rate.
In light of the proposed budget, here’s what we expect in various aspects of the economy.
Spending. What’s clear is that the spike in government spending in 2020 was a historical outlier, largely due to the special measures that were rolled out to backstop the economy and provide support to individuals and small businesses. But as the economy reopens, those one-time spending measures should roll off quickly. Even with some of the new spending measures in the new budget, such as the $30 billion set aside over the next five years to create a national child care system, total spending is expected to return to about 15% of GDP, close to where it was before the pandemic.
Interest rates. Short-term rates will likely remain near zero until the economy achieves a full recovery in 2023. Long-term rates, however, are expected to move higher over the next couple of years. It’s worth noting that the budget relies on the combination of a strong recovery over the next year and the persistence of low interest rates. While we believe that’s correct, there is a risk to both of those assumptions.
Inflation. We can expect to see a fairly meaty 3% inflation rate in the next couple of months, partly because of comparisons with the extraordinary conditions from a year ago. But we expect that to ease back to around 2% later this year, where they should remain in the medium term. The risk to this forecast, however, is on the high side.
Housing. The budget only paid nominal attention to the housing market, but this is the one area where there’s been a lot of inflation. What Canada’s housing market has experienced is beyond a v-shaped recovery. In many respects, this is the hottest national housing market I’ve ever seen. Past housing booms have been focused in the large metropolitan areas; this time, it’s sweeping the country. There were some modest measures in the budget—such as the tax on nonresident ownership of vacant property—but until policymakers get serious about trying to dampen the market, it’s likely to remain strong until buyers start to express exhaustion with soaring prices.
Unemployment. While the unemployment rate recovered from the double-digit levels we saw last spring, the recovery in Canada has been a bit choppier than in the U.S. due to the on-again-off-again restrictions. The unemployment rate will likely rise in April and May before beginning to drop off. By mid- to late 2022, unemployment rates should return to pre-pandemic levels.
Currency. Our view is that the Canadian dollar is likely to strengthen over the next year. A powerful global recovery is always good news for the dollar, and we’ve been impressed by the strength in oil prices. Looking further out to the next three to five years, we expect the Canadian dollar to trade in the 75 cents to 80 cents range against the U.S. dollar.
Signs of Hope
This has been an extraordinary recession and recovery. While the current wave and the resulting lockdowns in parts of the country are creating a lot of uncertainty, we can see the light at the end of this long, dark tunnel. And the proposed federal budget gives us reasons to be optimistic that the country is well-positioned for a rebound while setting the stage for long-term economic growth.
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