Press Release No. 15/25

Press Release: IMF Executive Board Concludes 2014 Article IV Consultation with Canada

January 30, 2015

On January 28, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Canada. ¹

Canada’s recent growth performance has been solid, alongside a stronger U.S. recovery. U.S. growth momentum, exchange rate depreciation, and high energy demand in early 2014, all led to a pickup in exports, although it has yet to translate into strong investment and hiring. In particular, the slowdown in business investment has been widespread in recent years. Thus, the composition of growth has not yet shifted away from private consumption and residential investment to generate a broader, more durable recovery. Substantially lower oil prices will be a drag on growth through weaker investment in the energy sector. Private consumption has continued to grow thanks to rising household wealth and exceptionally easy financial conditions. Indeed, after a brief pause, Canada’s housing market rebounded in 2014, fueled by low and declining interest rates although there are some welcome signs of cooling especially in overheated markets. IMF staff analysis suggests a national real house price overvaluation between 7–20 percent although with important regional differences.

Growth momentum is expected to continue this year, despite substantially lower oil prices, and become more balanced with a cooling housing market. The stronger U.S. recovery, which is expected to continue, is leading to higher non-energy exports and supporting investment. These factors should mostly offset a moderation of private consumption and residential and energy investment as U.S. interest rates rise, low oil prices persist and households remain highly indebted. Looking beyond the recent past strength in housing markets, staff continues to expect a “soft-landing” as higher interest rates and weaker terms-of-trade prospects would temper housing demand. Downside risks to the outlook have risen in light of further oil price declines, adding to the risks of weaker global growth and still-unfolding effects from the unusually large fall in oil prices. Domestic vulnerabilities in housing markets and the household sector remain elevated but contained from a financial stability perspective. Given interconnections between external and domestic risks, some risks could occur together.

Public finances continued improving in 2014, reflecting federal and some provincial consolidation efforts. The general government fiscal deficit is expected to narrow from about 2¾ percent of GDP in 2013 to 1½ percent in 2014, with the federal government essentially on track to achieving its balanced budget target in FY2015/16 despite lower oil prices. Federal authorities should consider adopting a neutral stance given past consolidation gains and downside risks to growth. Such a stance would still be consistent with achieving the longer-term goals on public debt reduction. Provinces remain committed to their balanced budget targets, but, for some, fiscal adjustment continues posing challenges. They will need to sustain their efforts to strengthen public finances, especially in light of longer-term aging-related fiscal pressures.

In the wake of substantially lower oil prices and increased uncertainty around an otherwise solid economic outlook, the Bank of Canada cut its policy rate by 25 basis points and revised down its projections for GDP growth and headline inflation, on January 21. The Bank’s policy action is in line with staff advice to use available monetary policy space should adverse shocks intensify given the deeper drop in oil prices. Overall, maintaining monetary accommodation along with gradual fiscal consolidation at the general government level would be conducive to achieving a growth composition with stronger exports and, thereby, investment in the economy, while targeted macro-prudential policies would help address housing sector vulnerabilities as needed.

Canadian banks remain highly profitable, with favorable loan quality, low nonperforming loans, and improving capitalization. Stress tests suggest that banks are resilient to credit, liquidity, and contagion risks due to their strong capital position, stable funding sources, and low exposures to the energy sector, as well as extensive government-guaranteed mortgage insurance. Steady progress has been achieved on key parts of the financial reform agenda, such as on implementing the Basel III Liquidity Coverage Ratio and leverage standards. Enhanced coordination across federal and provincial authorities in supervision and stress-testing will further bolster financial system soundness. Also, strengthening macro-prudential and crisis management frameworks will reinforce the overall resilience of the financial system. 

Executive Board Assessment²

Executive Directors agreed with the thrust of the staff appraisal. They welcomed Canada’s continued solid growth performance, underpinned by the authorities’ sound macroeconomic policy management. Directors noted that while the outlook remains favorable and growth is expected to become more balanced with a cooling housing market, risks are tilted to the downside because of tighter global financial conditions, effects from substantially lower oil prices, and persisting vulnerabilities in housing market and household sector. Directors agreed that continued well-calibrated policies should facilitate the needed rebalancing and sustain the growth momentum. Structural reforms to boost productivity and business investment will also be important to support medium-term growth.

Directors agreed that monetary policy should remain accommodative given well-anchored inflation expectations, sluggish business investment, lower oil prices, and until there are firm signs of durable recovery with stronger business investment. They supported the Bank of Canada’s decision to lower the policy rate as it would help further support the economy in light of the likely adverse effects of the oil price shock. However, they encouraged the authorities to continue monitoring the impact of monetary policy on household debt and house prices.

Directors acknowledged that macro-prudential measures have been effective in containing growth of insured mortgage loans, but noted significant rise in uninsured mortgages alongside still-strong segments of housing markets. They generally agreed that additional macro-prudential policy action may be needed if household balance sheet and housing market vulnerabilities resume rising, in particular tighter standards for uninsured mortgages. Directors welcomed the authorities’ recent initiatives to limit the government’s exposure to the housing sector. They encouraged further action gradually to ensure appropriate risk retention by the private sector and, in the longer run, to re-examine the dimensions of extensive government-backed mortgage insurance.

Directors welcomed the authorities’ commitment to fiscal targets and that the federal government is essentially on track to achieve a balanced budget in 2015. They agreed that fiscal consolidation should continue at the general government level, but the composition of the fiscal adjustment would need to shift from the federal government to the provinces. Most Directors saw scope for the federal government to adopt a neutral stance going forward, given strong adjustment efforts in recent years. They encouraged using the available fiscal resources for growth-friendly measures and strengthening the medium-term fiscal frameworks.

Directors agreed that fiscal adjustment at the provincial level would need to proceed, including through sustained progress in containing aging-related spending and supported by regular spending reviews. They generally noted that long-term fiscal sustainability challenges call for extending long-term fiscal forecasts at the provincial level and publishing consolidated general government fiscal forecasts in consultation with provinces.

Directors noted that Canada’s financial sector continues to be sound and stable and commended the authorities for the progress on the international reform agenda. They welcomed the progress made in implementing several recommendations of the 2013 update of the Financial Sector Assessment Program (FSAP) and generally encouraged the authorities to move forward with the outstanding FSAP recommendations. In general, Directors noted that further enhancing supervisory cooperation across federal and provincial authorities, harmonized stress-testing of systemically-important depository institutions, and strengthening macro-prudential and crisis management frameworks would reinforce the resilience of Canada’s financial system. A few Directors observed that focusing more on outcomes with respect to financial sector performance and allowing greater flexibility as regards frameworks or structures to achieve them could be beneficial.