2009 Federal Budget

January 27, 2009

Long Live Deficits

Economics by Jeff Rubin
& Strategy
Only four months ago, the opposition was provide more stimulus in the future. But at
Jeffrey Rubin
threatening to bring down the minority least for now, Canadians seem content to
(416) 594-7357 government if it dared run a deficit. Now it’s be free-riders, since some of Washington’s
jeff.rubin@cibc.ca threatened to bring the government down if stimulus will spill over the border into our
Avery Shenfeld it doesn’t run a big enough one to fight the economy.
(416) 594-7356 recession. It would appear that the world
avery.shenfeld@cibc.ca has changed. While the Conservative budget’s stimulus
Benjamin Tal package was modest, it seems reasonably
(416) 956-3698 Forget about the past sanctity of budget effective. Leakages through savings and
benjamin.tal@cibc.ca
surpluses. Canadians face the deepest imports are what denude stimulus packages
Peter Buchanan recession since those that followed on the of their ultimate economic punch. This
(416) 594-7354 back of the OPEC oil shocks. After years of budget minimized leakage through savings
peter.buchanan@cibc.ca
retreat, the government is about to make by putting the money in the hands of those
Meny Grauman a triumphant return to a leadership role in most likely to spend it (unemployed workers
(416) 956-6527 the economy. And no where will that return and lower- to middle-income taxpayers)
meny.grauman@cibc.ca
to prominence be more evident than in the unlike President Bush’s tax rebates last year
Krishen Rangasamy polar swing in government budget balances. which was largely saved by upper-income
(416) 956-3219
krishen.rangasamy@cibc.ca
While Ottawa racked up record surpluses, Americans.
Canadian households racked up record
debt. With $64 billion in red ink already Similarly the infrastructure spending in the
announced over the next two years, some of budget, or what Keynes once referred to as
that debt is going to get transferred back on digging ditches, will also get a reasonable
to the government’s broad shoulders. bang for the buck. The advantage of
digging ditches, aside from redressing any
Unfortunately for the economy, roughly half infrastructure deficits that might have arisen
“The aftermath of
of that sum isn’t stimulus but simply the during the days of federal surpluses, is that
past recessions,
like those in 1980
impact of the recession on Ottawa’s revenues most of the spending stays local and doesn’t
/81 or even 1991, and expenditures. The stimulus component leak out from the economy into imports.
saw government while welcome, is modest, amounting to little
deficits two to more than 1% of GDP. The budget will do what ultimately it
four times as was intended to do. The public expected
large in relation That’s pocket change compared to what a modest amount of stimulus and that’s
to the size of the Washington is throwing up against this what it got. But soon facing an 8%-plus
economy. Over recession. As a result of measures announced unemployment rate, the public will likely
the coming years by both President Bush and President Obama, expect the federal government to do much
we may see those
the US deficit will be running north of 10% more to get Canadians back at work.
deficits again.”
of GDP. You’ve got to go back to World War And Finance Minister Flaherty has already
II deficits to see the last time Uncle Sam was pledged to “do more” if things get worse.
this much in hock. That will certainly give The aftermath of past recessions, like those in
Ottawa all the political cover it needs to 1980/81 or even 1991, saw government deficits

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CIBC World Markets Inc. 2009 Canadian Federal Budget—January 27, 2009

two to four times as large in relation to the size of the economy.
Over the coming years we may see those deficits again.
The reign of government surpluses is now officially over.
Long live deficits!
End of an Era
Avery Shenfeld and Meny Grauman
Politics demanded fiscal stimulus, but the end of an era
of surpluses owes at least as much to the end of a gravy
train for federal government revenues. It’s not just that
real GDP is in a slide (Table 1), but that prices for Canada’s
output on global markets have nosedived, even relative to
conservative assumptions built into the 2008 budget. Less
than a year ago, the consensus outlook had nominal GDP
advancing at 3.5% in 2008, and 4.3% in 2009. The fresh
consensus outlook falls miles short of that outcome, with
private sector forecasters seeing a 1.2% drop in nominal
output this year, and the budget allowing for a larger
2.7% decline. That dark picture represents a nearly
$20 bn hit to the federal budget balance in 2009/10
relative to the assumptions made a year ago.
That shock alone would have sent the budget careening
into a deficit. While real GDP is assumed to grow
modestly next year in the consensus projection and our
own forecast, that is still much gloomier than the Bank of
Canada’s call for nearly 4% real GDP growth for 2010.
Even if, as we expect, corporate profits and equities
make a comeback due to greater pricing power in 2010,
companies and their investors may still be carrying over
losses from the earlier bloodbath in profits and share
prices. Recall that the last recession in Canada, that of
1990/91, didn’t see the deficit peak until 1992/93, in part
because the shallow recovery couldn’t withstand fiscal
belt tightening.
Table 1
The Economic Backdrop
Y/Y % chg 2008 2009 2010
Nominal GDP (assumed for budget
planning) 4.4 -2.7 4.3
Ottawa or Obama
Measures outlined in the budget will add $18 bn to the
deficit in 2009/10, and $15.5 bn the subsequent year.
That stimulus is in line with the just-over-1% of GDP scale
that we had already built into our economic forecast for
the coming two years, and we likewise assumed that
provinces would ante up additional funds. Since the
shockwaves hitting Canada’s shores mostly had their
origins abroad, it’s going to take a rebound in global
demand to boost exports and resource prices. Nothing
Ottawa can do will make Americans buy more cars or the
Chinese use more oil. Efforts to boost domestic demand
will merely cushion the severity of the recession.
The stimulus package, and the $34 bn peak deficit
projection, are only moderate in scale. While more muted
in the outgoing year, program spending had already been
growing at a roughly 7% clip in 2006/07 and 2007/08,
and last year got a second GST cut. Thus, while spending
will jump at a double-digit pace (Table 2), in terms of a
boost to growth from the government, what we will see
this year isn’t entirely new. Moreover, relative to some
other jurisdictions and to our own history, Canada is,
at this point, barely tipping a toe into the deficit waters
(Chart 1).
Indeed, given their relative scale, Obama’s fiscal stimulus
bill, worth about 6% of US GDP, could mean as much
to Canada’s economy as Ottawa’s plan. About a quarter
of Canada’s employment is tied to exports, and the US
represents the vast majority of that. So a 6% boost to US
GDP would, on average, lift Canada’s economy by about
a percentage point.
Chart 1
Deficit Still Small vs. Canada's Past and US
fcst
4 Federal budget balance, % of GDP
2
0
-2

Private sector forecasts -4

US
Nominal GDP 4.8 -1.2 4.2
-6
Real GDP 0.7 -0.8 2.4
Jobless Rate (%) 6.1 7.5 7.7 -8 C anada
US Real GDP 1.2 -1.8 2.1
-10
3-month T-Bills (%) 2.3 0.8 1.7 71-72 77-78 83-84 89-90 95-96 01-02 07-08
10-year GoC Bonds (%) 3.6 2.8 3.4


CIBC World Markets Inc. 2009 Canadian Federal Budget—January 27, 2009

Table 2
The Fiscal Plan
$Billions 2007/08 2008/09 2009/10 2010/11
Actual 08 Budget 09 Budget Change 09 Budget 09 Budget
Budgetary Revenues 242.4 241.9 236.4 -5.5 224.9 239.9
% change 2.7 -0.2 -2.5 -2.3 -4.9 6.7

Program Spending 199.5 208.1 206.8 -1.3 229.1 236.5

% change 6.0 4.3 3.7 -0.7 10.8 3.2

Public Debt Charges 33.3 31.5 30.7 -0.8 29.5 33.3

Budget Surplus 9.6 2.3 -1.1 -3.4 -33.7 -29.8
Federal Debt 457.6 454.8 458.7 3.9 492.4 522.2
% of Nominal GDP 29.8 28.4 28.6 0.2 31.6 32.1

Provincial fiscal policy should provide a further boost.
Note that provincial budgetary accounting only includes
the amortization of capital as an expense, allowing
provinces to ramp up infrastructure spending in jointly
funded projects without showing a deficit hit. But even
then, avoiding ballooning deficits will be difficult. The
2001 slowdown, which wasn’t even a technical recession,
sent aggregate provincial balances some $20 bn further
into the red over a two-year period.
Dividing Up the Pie
If the objective is to boost growth in the next two
years, the stimulus package needs to be both timely,
and designed to minimize leakages to either imports
or savings. The design of the budget, for the most
part, appears to meet that test. More than 30% in
new initiatives through 2010/11 has been allocated
to infrastructure spending (Chart 2). Given its heavy
domestic content, such spending tends to have a higher
multiplier impact than tax reductions (Chart 3). Even if
these projects don’t hit the economy until 2010, that
year will likely still be in need of a helping hand from
government.
Tax cuts account for a third of the tally of new measures.
There is a risk that some of this will be saved, given the
household sector’s concerns over job risks and wealth
losses. But that risk appears to have been minimized
by giving the largest percentage reductions to those in
lower tax brackets, through changes in both rates and
income brackets on which they apply, or though greater
low-income credits. One study found that nearly 95%
of savings came from the top income quintile, with little
savings for the lowest three quintiles. Moreover, $2.5 bn
of the tax relief offered in fiscal 2009/10 will go to those
undertaking home renovations. You have to spend to
save. That’s also true for accelerated cost allowances and
tariff reductions for some business purchases, although
the latter leaks out to imports.

Chart 2 Chart 3
Allocation of New Measures: 2008/09 to 10/11 Economic Impact: Infrastructure vs. Tax Cut
Impact of $10 Bn Stimulus (Canada)

GDP Employment

115000

Tax Cuts 33%

Other 36%
1.3%

0.8%

57000
Infrastructure 31%

Infrastructure Personal Tax Cut Infrastructure Personal Tax Cut

CIBCWM based on Informetrica; not specific to Budget's tax cut.


CIBC World Markets Inc. 2009 Canadian Federal Budget—January 27, 2009

Other key steps will enhance the impact of monetary needs (the only ones that count in government debt),
policy easing by freeing up room in the credit market. that will be partially offset by a lower target for buying
Ottawa will add another $50 bn to its purchases of mortgages. Gross issues of domestic Canadas will run
insured mortgages, opening up room in the banking just under $80 bn, assuming a steady level of $2.3 bn in
system for lending growth down the road, and will also RRBs, significantly outweighing maturities and buybacks.
buy up to $12 bn in pools of vehicle and equipment loans All of this will, of course, pale next to the torrent of
and leases. Treasuries coming south of the border, a prospect that
has contributed to a narrowing in spreads.
Buckets of Bonds
Quarterly auctions of 2-, 5- and 10-year bonds will
If investors are still seeking the shelter of government continue in 2009/10, but there will only be two 30-year
bonds, they won’t have to worry about finding them. auctions, dropping the extra one added in 2008/09. For
After ten straight years of declining bond supply, by the first time in over a decade, the government is re-
March 31st, there will be some $40 bn more government introducing a 3-year bond, to be auctioned quarterly,
of Canadas outstanding than a year earlier, and another in an effort to spread out the increased funding
$52 bn is coming in 2009/10 (Table 3). In good times that requirements.
would crowd out other debt, but this year at least, it fills
a void left by reduced private issuance, and indeed, helps Table 3
withdraw other fixed income product (i.e. mortgages) The Financing Plan
from the market.
$Billions 08/09E 09/10F
Borrowing Requirements:
Although the first big deficit will be next year, borrowing
Budgetary Surplus -1.1 -33.7
needs were heavily ramped up in the outgoing fiscal year
Non-Budgetary Transactions -102.6 -67.5
by “non budgetary requirements” that don’t directly
impact government debt. That included $75 bn issued Financial Source/(Requirement) -103.7 -101.2
Maturities & Buybacks 34.0 28.0
to cover the purchases of mortgages from the banking
system, and $25.5 bn in loans to crown corporations that Borrowing Requirement 137.7 129.2
previously borrowed under their own name. As a result, Sources:
gross bond issuance more than doubled, from $35 bn in Cash, Bills & Other 62.7 47.7
2007/08 to $76 bn (including RRBs) in 2008/09. Domestic Canadas1 73.8 79.7
Real Return Bonds (RRBs) 2.2 2.3
Net and gross financing requirements will remain heavy Retail (Net) -1.0 -0.5
in the coming year, but for somewhat different reasons. Total 137.7 129.2
Issuance on behalf of crown corporations (included in Net New Issues
non-budgetary transactions) will be nearly steady. While of Nominal Canadas 39.8 51.7
the ballooning deficit will translate into new financial 1
Nominal bonds; incl. Canadas issued via ‘switch’ buybacks
Source: Federal Budget and CIBC WM projections

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