Canada May Have Just Passed Up Its Best Shot to Balance Budget

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(Bloomberg) -- Bill Morneau may have passed up his last chance to balance Canada’s budget.

Prime Minister Justin Trudeau’s finance chief released his third fiscal plan on Tuesday in circumstances that have hardly been better. Canada’s economy is near full capacity, led the Group of Seven in growth last year and unemployment recently hit a four-decade low -- all of which Morneau boasts about. He couldn’t have asked for better conditions to move toward what was once his goal: balance.

And yet Morneau’s budget Tuesday plots no such course. New spending on indigenous peoples, military veterans, scientific research and gender equity have eaten up windfalls. Even with new tax revenues from marijuana, tobacco and private corporations, Morneau wasn’t able to accelerate the deficit-reduction path, totaling C$98 billion ($77 billion) over six years.

The problem, critics say, is Morneau is leaving himself without any ammunition to respond to a crisis -- such as another downturn, or risks posed by U.S. tax cuts and a potential Nafta collapse, which the budget was silent on. Morneau brushed off the criticism and said Canada’s still got room to maneuver, with the annual deficit at a modest 0.9 percent of gross domestic product. Canada is one of only a dozen countries with a top sovereign credit rating, according to Moody’s Investors Service.

“We’ve got a really low level of debt to our economy, we can deal with all eventualities and we’re being fiscally responsible along the way,” he said in a Bloomberg interview Tuesday evening in Ottawa. “It’s important to put these demands in context. We’re looking at it. We’re going to carefully analyze it to make sure that our competitiveness stays strong. What I am happy about though is that our economy is in a good position.”

Key Takeaways from Canada’s 2018-19 Federal Budget

Morneau and Trudeau weren’t always this sanguine about deficits. Trudeau campaigned on balancing the budget by 2019, something he’s nowhere near doing. Two years ago, Morneau said growth would bring him back to balance in about five years. Despite strong growth, that’s not in sight.

“The budget is set against what could quite possibly be the high point for economic and fiscal conditions in Canada,” Bank of Montreal Chief Economist Doug Porter wrote in a research note. “We are observing some tell-tale late-cycle conditions in North America, often a period that governments should build fiscal capacity.”

Instead, Morneau largely spent the additional fiscal space that emerged since an October budget update. “The federal government once again opted to spend those savings rather than banking them,” Paul Ferley, assistant chief economist at Royal Bank of Canada, wrote in a research note. “With the Canadian economy approaching capacity limits, future fiscal savings will likely be harder to come by, and the federal government will have fewer opportunities to rein in persistent deficits.”

The spending measures themselves were largely lauded as worthwhile, though tended to include things that, at best, drive growth slowly. About C$7.2 billion in infrastructure spending -- once hailed as a silver bullet -- is being delayed, in what the government calls “reprofiling.” Morneau said the projects are being built anyway: “What you think is reprofiling is really in many cases just accounting,” with the federal money set to flow only once a road or other project is built.

Silent on Trump

Canada’s foremost business groups had issued widespread calls for Morneau to improve business competitiveness, either by cutting corporate taxes or providing other incentives for business investment. “We’ve been not as competitive for years, and the U.S. just shined a stronger light that we haven’t been reinvesting in our plants,” said Dennis Darby, chief executive officer of the Canadian Manufacturers and Exporters trade group.

And yet the budget was silent on the risks posed by Trump. Morneau said he wouldn’t respond to U.S. measures in an “impetuous way” and that Canada will review its overall competitiveness, and taxes are only part of that. “We need to do our homework,” he said.

The Business Council of Canada, representing some of the country’s top chief executives, said the budget sends an “unfortunate signal to entrepreneurs and companies that are looking to invest and grow,” a sentiment echoed by other groups.

“I am concerned that the government feels it’s possible to spend its way to prosperity,” Perrin Beatty, chief executive officer of the Canadian Chamber of Commerce, said in an interview. “If you can’t balance the books in the good times, what’s going to happen when you get a downturn in the economy?”

Budget Details

Morneau projected a shortfall of C$19.4 billion in 2017-18 and C$18.1 billion in 2018-19 with no return to balance -- all largely in line with what was projected in the October fiscal update. The ratio of debt to the economy is scheduled to fall from 30.4 percent in 2017-18 to 28.4 percent in 2022-23.

Canada’s next election isn’t until 2019, but this budget has plenty of political overtones. Many measures are aimed at voters that may back the left-leaning New Democratic Party. That included launching a council to study the possible creation of a national plan to cover the cost of pharmaceutical drugs, a big-ticket item. Morneau said it’s not acceptable that some Canadians have no drug coverage. “Our goal is to do this in a way that actually deals with that gap.’’

©2018 Bloomberg L.P.

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