The federal and provincial governments have announced massive emergency expenditure measures to alleviate the financial difficulties faced by many Canadians due to the COVID-19 pandemic.
Fast and significant expenses are needed. However, both levels of government must borrow heavily to pay for this financial support.
Figures from independent parties Parliamentary Budget Office point to a 2021 federal budget deficit of $ 90 billion more than initially estimated, while the three largest provinces will provide an additional $ 25 billion in aid.
Prime Minister Justin Trudeau recently offered assurances to Canadians that the federal government is physically ready to help people and businesses affected by the pandemic.
Trudeau said “we are in an enviable position to have a significant fiscal firepower to support you. “He then stated that”we are a G7 country with the lowest debt to GDP ratio, “It shows that Canada can borrow according to plan without emphasizing our future fiscal position.
Two critical questions
There are two key questions that must be answered regarding the fiscal sustainability of our country in dealing with this black swan, which is defined as an unexpected event with potentially large consequences.
What is our ability to provide meaningful short-term financial support for Canadians in need? And how quickly will our economy recover when strong economic activity continues, which allows people to be employed and profits to be taxed?
Using 2018 data from International Monetary Fund, we can compare how Canada ranks in terms of the federal government’s debt to GDP ratio. The graph shows that the federal government’s debt in proportion to the size of our economy is the lowest of the G7, though not Australia, which is comparable in size but not in the G7. At first glance, this shows that Canada has a relatively greater loan capacity when needed.
However, the data above only explains the burden of state debt at the federal level. The provincial government also borrows to cover their spending needs. Although each province is responsible for covering its own debt and interest, the fact is that the federal government is likely to have to assume responsibility if there are provinces that cannot fulfill their financial obligations.
Therefore, to get a better picture of how much our government debt is, and how much loan capacity we have relative to others, we also need to take into account provincial debt.
An unsettling image
And here the picture is more disturbing. Government loans, at the provincial (and city) level, are by far the highest of the G7 plus Australia.
If the federal government is seen as the final guarantor for provincial debt, then our fiscal position is not as strong as our prime minister’s suggestion. Fitch, the main credit rating agency, considers provincial and federal debt in their credit ratings. Based on pre-pandemic economic forecasts, Fitch wrote that Canada’s federal and sub-national (especially provincial) debt “is higher than other AAA-ranked countries … and remains close to levels not in accordance with AAA status.”
The third element that we must consider is household debt. If households have their own “fiscal power”, they can be independent in difficult times without large government spending.
The chart below compares the amount of debt incurred by Canadian households compared to G7 and Australian households. We have the highest level of household debt after Australia. Unfortunately, high household loans result in high fixed loan costs. When combined with sudden job losses, this can cause financial ruin.
To complete the picture, let’s compare Canadian, provincial and federal loan rates to G7 plus Australia. Canada places the second highest, behind Japan, for overall debt relative to economic size. In fact, Canada’s ranking is worse than Italy’s overall debt. The data shows that the level of loans, both by the government and households, is currently high.
Some might argue that the federal government is technically not responsible for provincial debt. Maybe that’s the problem. However, history seems to have supported the federal government which provided assistance to the province in the past.
Around the same time, Ottawa also saved Saskatchewan right before they defaulted. Saskatchewan returned default in 1993 before the federal government rushed to provide financial support to the province.
In a paper on provincial and municipal loans, economics professors Richard Bird and Almos Tassonyi writes that “… the federal government seems to be implicitly responsible for all provincial debt.”
Recently, Walter Schroeder, founder of the credit rating agency Dominion Bond Rating Service, reflected that “the easiest call I have ever made as a debt collector is the bankruptcy of Newfoundland. That’s a sure thing. ”
In fact, on March 20, Newfoundland and Labrador Premier Dwight Ball wrote in a letter to Trudeau that “… efforts to complete our loan program, both short term and long term, were unsuccessful.” The Canadian bank then agreed to buy provincial bonds so they could continue to borrow.
The need to leave money in the hands of people due to large job losses is real and necessary.
While Canada currently has a loan capacity to reduce financial difficulties from COVID-19, our fiscal calculation day will come, sooner than later. A critical point will be reached and governments and individuals will be forced to take steps that are personally and politically unattractive.
Our future can consist of a credit rating downgrade by rating agencies that will result in us having to pay higher interest rates on our debts. Canadians will also face higher taxes and reduced government programs to reduce our overestimation.
Planning a black swan event
Unfortunately, if economic recovery takes time, the government’s ability to provide further support programs to affected Canadians will be very limited.
When the pandemic passes, financial officials at the federal, provincial and municipal levels must all objectively reconsider our debt policies, including budget and program deficits and spending according to law. Regular budget planning should include the possibility of black swan events.
Just as the government maintains national medical stockpiles for use in emergencies, Canada must build reserve loan capacity – meaning the ability to borrow in times of crisis while avoiding painful, post-crisis debt hangovers.
All three levels of government must prioritize reducing the level of state debt.
Canada will face economic shocks in the future, either through pandemics, natural disasters or economic recession. While such events can incur inevitable human costs, the government will be in a position to offer significant economic support to those most affected while still allowing the economy to recover as quickly as possible.
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