Canada needs to stay on the right fiscal track or risk the bond market's wrath

David Jones: Ottawa must hold firm to fiscal projections laid out in fall economic statement

Article content

A wise man once said: “Beauty is in the eye of the bondholder.”

That’s valuable wisdom as the federal government gears up for this year’s budget. When judging the sustainability of Canada’s fiscal plans, the perspective of the financial markets matters the most, because they finance deficit spending and determine government borrowing costs.

Article content

In the 2023 Fall Economic Statement, released in November, the federal government repeated a recent habit of further postponing the return to fiscal balance. When compared with Budget 2023, the deficit trajectory is now projected to fall more slowly in future years.

Advertisement 2

Article content

The government might feel this is manageable or politically appealing. Recent polls suggest that Canadians are more concerned with affordability, housing and healthcare than fiscal sustainability.

But further postponing deficit reduction means that Canada’s fiscal forecasts will be viewed less credibly by the markets and rating agencies. If Canada wants to maintain its ‘triple-A’ rating, financial markets need to believe the government’s fiscal plans.

There is still just enough time to sneak in a fiscal New Year’s resolution. The government should seek to re-enforce its credibility with financial markets by ensuring that fiscal plans in Budget 2024 hold firm to the trajectories set out in the fall statement.

The 2023 Fall Economic Statement

There were several positives in the statement. The federal government’s fiscal forecast for 2023/24 remains in line with the forecast at Budget 2023 (a deficit of $40 billion. Net debt remains favourable compared to other G7 countries and Canada has a ‘triple-A’ rating from two of the main agencies.

However, not all is rosy. Current federal government public interest charges are roughly double pre-pandemic levels (as a percentage of GDP), yet the fall statement added $20 billion in spending. From 2024/25 onwards, it forecasts a fiscal deterioration relative to previous projections — including higher deficits, rising debt and higher debt-servicing costs. As per Budget 2023, no time frame is given for achieving a balanced budget.

Article content

Advertisement 3

Article content

Admittedly, the federal government faced an exceptional challenge to support the economy and Canadian households through the post-pandemic period. But much recent spending growth is not pandemic-related. Canada needs the markets and rating agencies onside, so now is the time to reset financial rigour.

The market perspective matters

Some expert debate on Canada’s fiscal position is beneficial to understand its true strength and sustainability, but the true arbiters are financial markets, which effectively set the price of Canada’s debt and therefore determine the cost of deficit spending.

A recent example — albeit an extreme one — is the United Kingdom. Under Liz Truss’ government, the U.K. issued a fiscal plan with unfunded tax cuts that drastically misread the financial markets, causing government bond yields to spike.

Canada’s current fiscal plans are much less radical. However, there are some signs of nerves. A recent assessment by Fitch, one of the Big Three rating agencies, was titled: “Canada’s Medium-Term Fiscal Challenges to Increase.”

If a rating downgrade (and higher Canadian risk premium) were to occur, it would have a material adverse fiscal impact, given that federal public interest charges are currently already elevated.

Advertisement 4

Article content

Navigating challenges in 2024

There may be economic downsides in 2024 that the federal government cannot fully control, as indicated through the fiscal ranges in the fall statement’s projections.

But slow economic growth in 2024 does not mean that fiscal projections go out of the window.

The statement’s projections already bake in relatively low economic growth for 2024 (0.4 per cent real GDP growth). Moreover, the government has a responsibility to manage potential future cost pressures or revenue shortfalls, and re-prioritize accordingly.

Related Stories

The year ahead likely holds many challenges for the federal government. When it comes to Budget 2024, it should hold the line on its current fiscal trajectories.

David Jones is a policy analyst and economist. He is a fellow at the Canadian Centre for Health Economics and is studying public policy at the Munk School of Global Affairs and Public Policy, University of Toronto.

Article content