October 18, 2023

Fall update to show Ottawa faces fiscal squeeze, growing deficit projections in coming years, economists say

Finance Minister Chrystia Freeland’s fall update will show worsening projections for the federal debt and deficits over the coming years, economists say, leaving the Liberals with less fiscal room to deliver on spending promises, including responding to concerns over the cost of housing and prescription drugs.

Parliamentary Budget Officer Yves Giroux is set to release his office’s fall economic and fiscal forecast on Friday, which will give a strong indication of how Ottawa’s bottom line has changed since the March budget. Mr. Giroux provided a preview to The Globe and Mail. He said in an e-mail that the economic forecast will be lower for the rest of 2023 and 2024 in comparison with the PBO’s March report.

“On the fiscal front, new spending measures and higher interest rates are increasing the federal deficit,” he said.

The date for the government’s update has not been announced but it is typically released in November. Ms. Freeland has scheduled an advance meeting with private-sector economists for next week.

The economic update is being prepared at a precarious moment for the Canadian economy. After a year and a half of monetary policy tightening by the Bank of Canada, higher interest rates have brought economic growth to a standstill and unemployment is rising. At the same time, inflation remains stubbornly high, and bond markets don’t expect the central bank to cut interest rates any time soon.

This means government finances could be squeezed by a combination of slowing growth and more costly debt servicing, as outstanding bonds mature and need to be refinanced at higher interest rates. In recent months, long-term interest rates have risen dramatically amid a global bond market rout. The yield on 10-year Government of Canada bonds is just shy of 4 per cent, from around 2.8 per cent six months ago.

A recent Bank of Montreal research note said that if interest rates settle at a higher level than before the pandemic, something a growing number of economists predict, it could mean an eventual impact of about $10-billion to the annual deficit.

Bank of Montreal chief economist Doug Porter said the recent bond market shift is a significant development that all governments must now take into account.

“Something fundamental has changed,” he said in an interview. “It’s not the free money, or the zero real interest rates that we have been looking at for a number of years up to and including the pandemic. ... Some tough decisions are going to have to be made in the coming months and years on government finances.”

A new Nanos survey for The Globe on economic matters provides a sense of the public mood as the government finalizes the update.

The survey shows an overwhelming number of Canadians lack confidence that housing affordability will improve over the next five years. More than eight in 10 Canadians say they are either not confident (57 per cent) or somewhat not confident (24 per cent) that in five years housing in Canada will be more affordable than it is today.

The survey also shows the NDP (26 per cent) and the Conservatives (25 per cent) are more trusted than the Liberals (16 per cent) on housing affordability. Further, the Conservatives (34 per cent) are more trusted than the Liberals (27 per cent) on managing inflation. Only 8 per cent of respondents said they trusted the NDP the most to manage inflation.

The Nanos hybrid telephone and online random survey of 1,058 Canadian adults was conducted between Oct. 1 and Oct. 4. The margin of error is plus or minus three percentage points, 19 times out of 20.

The fall update is an opportunity for the Liberals to recast their economic plans amid high concern over housing and escalating global uncertainty as violence in Israel risks spreading into a wider regional conflict.

Economic and fiscal updates can include new policy announcements, but they are primarily an accounting of how economic events and recent spending announcements have changed federal projections for deficits and debt.

When Ms. Freeland last released a fiscal forecast in the March, 2023, federal budget, the deficit for the current fiscal year was projected to be $40.1-billion, declining each year after that. The federal debt as a percentage of GDP was projected to be 43.5 per cent this year, with slight declines to follow. The budget figures, which are based on an average forecast from private sector economists, said inflation would be 3.5 per cent in 2023 before falling back to right around the Bank of Canada’s target of 2 per cent over the next four years.

Since then, growth for 2023 has exceeded expectations. But this has contributed to inflation remaining above the Bank of Canada’s earlier projections and leading to assumptions that interest rates will remain higher for longer. This translates into higher lending rates for mortgage holders, which is driving public concern about affordability.

It also means higher borrowing costs for federal and provincial governments.

Randall Bartlett, senior director of economics at Desjardins, recently released a report on federal finances that warned they are “on a precarious path” owing to recent spending announcements and higher interest rates.

“The souring of the economic outlook doesn’t bode well for the Government of Canada,” he wrote, projecting that annual budget deficits could be about $5-billion larger a year.

“Obviously the economic outlook has changed since the budget,” Mr. Bartlett said in an interview.

The larger deficits are driven by higher debt financing costs and a series of federal spending announcements in recent months, he said, including substantial industrial subsidies for the electric vehicle sector and a promise to waive the federal sales tax on new purpose-built rentals.

Mr. Bartlett said those factors leave Ottawa with less room to announce major new spending in areas such as housing or pharmacare, which is a priority for the NDP in the minority Parliament.

“It’s difficult to see in the current fiscal environment that there’s the room to roll out a full pharmacare program nationally,” he said.

Robert Asselin, senior vice-president of policy with the Business Council of Canada and a former economic adviser to the Liberal government, agrees.

He said he finds it “worrisome” that the government is considering large new permanent spending programs like pharmacare when the fiscal outlook is weakening. He said the situation warrants a prudent approach to budgeting.

“The big factor is we’ve seen in the last few weeks, our yields have gone up. So that tells me that financial markets are becoming a bit more wary of the amount of debt that governments are taking on, and that’s an important development. I think that’s very significant going forward,” he said. “Is it at the level it was in the nineties? No. But it’s not going in the right direction.”