Press Release No. 16/273

Press Release: IMF Executive Board Concludes 2016 Article IV Consultation with Canada

June 13, 2016

On June 6, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Canada. The consultation was focused on assessing the macro-financial impact of the oil shock and policies to bolster near-term domestic demand, mitigate downside risks, and position Canada for long-term growth.

The persistent oil shock remains a major test of Canada’s economic and financial resilience since the 2008 global financial crisis. After several years of solid performance, Canada’s growth decelerated in 2015, as energy companies slashed investment spending in response to the decline in oil prices. With rising slack in the economy, the negative output gap widened and financial vulnerabilities have become more apparent, as reflected in rising loan delinquencies, albeit from low levels. More broadly, the weaker economy has reignited concerns about the elevated level of household debt and divergent trends in house prices, which are rapidly rising in Vancouver and Toronto and falling in Alberta. The slowdown in the economy has also weakened public finances, with performance at the provincial level diverging along the lines of their resource dependence.

Growth is expected to rebound in 2016, supported by exchange rate depreciation and accommodative monetary and fiscal policies, but uncertainty about oil prices, challenges in sustaining the global recovery, and elevated domestic vulnerabilities suggest risks to the outlook are tilted to the downside. Therefore, the near-term policy challenge is to pursue an appropriate policy mix that is supportive of growth while containing vulnerabilities in the housing market, while in the longer run, the aim should be to make the best use of the available fiscal space to accelerate structural reform and diversify Canada’s future sources of growth.

Pursuing greater balance in the policy mix will also help reduce risk taking in a low interest rate environment and discourage households from taking on more debt. Macroprudential policy can be further tightened if imbalances in the housing market threaten to intensify. Enhancing financial sector resilience is critical given considerable macro-financial linkages and housing market vulnerabilities.

Executive Board Assessment²

Executive Directors commended the authorities for responding proactively to cushion the impact of the oil shock on the economy and the financial system. Although growth has slowed significantly, and the external position weakened moderately in response to lower oil prices, the Canadian economy has coped well and is projected to recover gradually, with strong fundamentals and a flexible exchange rate facilitating the adjustment. At the same time, Directors cautioned that the macro-financial effects of the oil shock have yet to fully play out, and the balance of risks is tilted to the downside, requiring continued vigilance and a supportive policy mix.

Directors agreed that monetary and fiscal policy should work together to support the economy. They concurred on the need to maintain an accommodative monetary stance and for an active role for fiscal policy. In this context, they welcomed the authorities’ pro-growth budget, and noted that additional fiscal easing should be considered if risks materialize. They also recommended that provinces with high debt or a deficit should undertake fiscal consolidation at a gradual pace so as not to offset federal government stimulus.

Directors highlighted the importance of strengthening the medium-term framework to bolster credibility. They welcomed the authorities’ commitment to putting the debt-to-GDP ratio on a downward path. Directors noted that a new rule that is transparent, easy to communicate, and sufficiently flexible to avoid pro-cyclicality would help anchor fiscal sustainability and sustain market confidence. A few Directors cautioned against premature introduction of a fiscal rule until growth is forecast to remain on a sustainably high track.

Directors agreed that the long-term policy challenge is to make the best use of fiscal space to accelerate structural reform, catalyze private investment, and diversify Canada’s future sources of growth. Close collaboration between the federal and provincial governments is needed to push the agenda forward and ensure efficient implementation. A nationwide infrastructure plan would help raise the quality of infrastructure investment. More broadly, a multi-pronged approach with emphasis on innovation and investment in the labor force is needed to improve productivity and external competitiveness.

Directors noted that Canada’s financial sector continues to be sound and stable. They agreed that macroprudential measures have been broadly effective in containing the growth of mortgage credit and suggested that these could be further tightened if imbalances in the housing market threaten to intensify. Directors also acknowledged that prudential policies have strengthened banks’ balance sheets and helped ensure system stability. They welcomed the progress made in implementing several recommendations of the 2014 Financial Sector Assessment Program Update, including the establishment of the new Capital Markets Authority, and encouraged the authorities to make further improvements where needed. They took note of the authorities’ assessment that the framework for macroprudential oversight achieves the objective of safeguarding financial sector stability, and looked forward to the planned financial sector review. Directors welcomed the authorities’ commitment to remain actively engaged in discussions with international partners related to correspondent banking relationships in the Caribbean.