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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.

Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Associate Editor: Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin,
Jonathan Lemco, Jean-Marc F. Blanchard, Barry Metzger, Russell Smith,
Ilissa A. Kabak, Andrew Novo, Jonathan Hopfner, C. H. Kwan, Dominic Scriven and Andrew Thorson

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