The Government of Canada's current fiscal plan may not tell the full story of the country's financial path.
The purpose of this paper is to explore the way two fiscal anchors, the debt/GDP ratio and the interest cost revenue ratio, are likely to evolve over the decade ahead (2032-33) under five plausible economic scenarios and thus to assess the implications of these two anchors as a guide to sustainable fiscal policy actions.
In Budget 2022 and the November economic statement the federal government laid out a fiscal plan against a plausible but optimistic set of assumptions about the economic and interest rate context in which it would be operating through 2027. In our base scenario, we incorporate these assumptions and extend the fiscal plan through to 2032. In this base scenario, the net debt/GDP ratio continues to decline to pre-COVID level by 2032 and interest cost/revenue ratio stays below 10%. Thus, if the federal government were to limit spending and borrowing to levels set out in the Fall Economic Statement (FES) 2022, these two ratios indicate that the federal government would be able to continue to access capital markets without paying a higher risk premium, although at interest rates higher than in the pre-COVID period as global interest rates are permanently higher.
But there are three big risks to this base scenario even assuming that real potential growth of 1.8% per annum and inflation of 2% are achieved and the current tax structure remains in place:
- planned spending is unlikely to be adequate to deliver the policy goals set out by the government;
- there is a high likelihood of a more severe recession in 2023; and
- medium-run inflation pressures are highly likely to continue and interest rates to remain well above pre-COVID levels.
When each of these risks is modelled individually, the debt/GDP ratio does decline somewhat but remains at or above 40% every year to 2032 and the interest cost/revenue ratio rises somewhat above 10% by or before fiscal year (FY) 2027-28.
As these three risks are likely to occur simultaneously at least to some degree, in a fifth scenario the two ratios are calculated taking account of all three risks combined. In this case the debt/ GDP ratio would remain near 50% throughout the whole period and the interest cost/revenue ratio would steadily rise well above 10% especially beyond 2026-27. Were this to be the case, continued federal government access to capital markets on current favourable terms would be seriously threatened and the 10-year rate on Canada bonds could well be higher than 3.7% toward the end of the 2020’s. Moreover, as the knock-on effect of higher rates and fiscal deterioration could permanently impair the private (and public) investments needed to secure the 1.8% potential real growth assumed in our analysis, our conclusion is that there is a significant risk in the fiscal plan as laid out in Budget 2022 and the fall FES may not be sustainable in the decade ahead.
Prepared in collaboration with Robert Asselin, Senior Vice President of Policy at the Business Council of Canada.
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