The Canadian Tiger
is Still Roaring
By
Jonathan Lemco
In 2002, the Canadian economy
was the best performer within the G-7 group of industrialized
nations. Despite the global downturn, Canada was the only major
industrialized nation with a budget surplus, and it registered
a decent GDP growth level of 3.3%. In 2003, the Canadian dollar
has improved relative to its US counterpart from 63 cents in January
2002 to 67 cents in March 2003, a 30 month high. In fact, Canada’s
GDP growth will again average over 3% to outperform its rivals.
The reasons for this success are easily identified. Canada’s
industrial structure has been less exposed to the bursting of
the technology bubble. Also, Canada has benefited from its status
as a net exporter of energy. In addition, the 67-cent dollar (in
US terms) is still attractive to international investors and tourists
alike. In addition, there is some evidence to suggest that Canadian
productivity levels have improved. Policy makers have also played
an important positive role in addressing Canada’s fiscal
and monetary policy challenges.
In February 2003, the Canadian Federal government introduced its
2003 fiscal budget, which calls again for a balanced budget. There
will be increased spending on health care, defense and other items,
but the ethic of fiscal prudence has taken firm hold. Also, the
balanced budget is backed by a Can $3 billion contingency reserve.
The fiscal consolidation and debt reduction undertaken since the
mid-1990s have provided room to further ease tax burdens and introduce
modest discretionary spending stimulus. We think that tax cuts
should be a priority, for the array of taxes imposed on Canadians,
which despite the health and social services that are available
to them as a consequence, is far greater than those imposed on
their US counterparts. Tax cuts could be a vehicle to boost employment
and economic production.
Canada’s flexible exchange rate regime has served the country
well, as it has been effective in cushioning the economy from
external shocks. Also, since the early 1990s, Canada has been
one of the world’s strongest advocates for liberalized trade.
Canada has been a substantial economic beneficiary of the North
American Free Trade Agreement and its predecessor, the Canada-US
Free Trade Agreement. The agreements have resulted in investment
and job creation and have contributed to a falling national unemployment
rate from 9.6% in 1996 to 7.4% in February 2003. This compares
favorably to the United States where unemployment is increasing.
Further, Canada is virtually unique among industrialized nations
with a 2002 current account surplus of 2.8%.
On the monetary policy side, the Bank of Canada has implemented
a successful inflation-targeting framework that has anchored expectations
and permitted timely monetary policy responses. Going forward,
we expect the Central Bank to increase interest rates in 2003
to reduce the inflation risk, which was 4.5% in January 2003.
Thus far in 2003, Canada is the only G-7 nations to increase borrowing
costs at all -- by 25 basis points in March 2003.
There are built-in constraints on this success story however.
The most important of these are the uncertainties associated with
the strength of the US economic recovery. Over 85% of Canada’s
trade is with the United States, and its financial and economic
health is intimately tied to the prospects of the US. In addition,
uncertainty associated with a potential war in Iraq could reduce
investment and diminish national growth prospects.
But we think these risks will be outweighed by the fundamental
strengths of the economy. In March 2004, Prime Minister Jean Chretien
will retire and federal elections will be held. At the moment,
former Finance Minister Paul Martin is the strong favorite to
be elected Prime Minister. Should that occur, investors should
expect continued market-friendly policies from the government
of Canada.
