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Canada’s Deteriorating Federal Finances Face Additional Risks

Thu 19 Dec, 2024 - 12:52 PM ET

ֳ-New York-19 December 2024: Canada’s (AA+/Stable) Fall Economic Statement (FES) highlights the continuing slow deterioration in federal finances, as well as considerable economic and political uncertainty, ֳ says. In addition, the exclusion of certain promised policies suggests that the FES’s deficit and debt forecasts may be optimistic.

Federal deficits decrease annually in the FES’s projection period but exceed the government’s original 2024 budget. They decline from CAD61.9 billion (2.1% of GDP) in fiscal year to end-March 2024 (FY23) to CAD48.3 billion (1.6%) in FY24 and CAD42.2 billion (1.3%) in FY25, compared to CAD40 billion in FY23, CAD39.8 billion in FY24, and CAD38.9 billion in FY25 in the 2024 budget.

Canada’s fiscal balance still remains strong, even when relying on ֳ’s preferred general government metric that includes provinces and other sub-national governments. The general government deficit is forecast to be 1.6% of GDP in 2024 and 1.2% of GDP in 2025, stronger than the ‘AA’ category median of 2.3% and 1.8%, respectively.

Nonetheless, the FES’s revised projections leave little fiscal space within the government’s self-imposed fiscal framework to address the considerable risks that Canada will be exposed to over the coming years. Furthermore, while the federal debt burden remains modest and Canada benefits from a strong asset position, general government debt-to-GDP, at 83.0% is elevated compared to the ‘AA’ category median of 47.7%.



The FES’s baseline fiscal forecasts do not reflect weaker economic dynamics or the potential risks from aggressive U.S. trade policy under the Trump administration. This is partly because the forecasts were constructed in September 2024, prior to the U.S. election and changes in Canadian immigration policy. Accordingly, the FES baseline assumes real GDP growth of 1.7% next year and 2.1% in 2026, considerably stronger than ֳ’s forecasts of 1.0% and 1.3%, respectively in its Global Economic Outlook – December 2024, which incorporate working assumptions of a 25% tariff on dutiable imports. The FES does include a detailed scenario analysis, which considers these dynamics, and is similar to our economic forecast.

In the event of U.S. tariffs on Canadian imports, weaker growth will weigh on revenue, while the government will likely increase expenditures to support the most affected sectors, pushing deficits above the FES baseline.

Canada’s fiscal dynamics will also be complicated by the approach of federal elections, which must occur by October 2025. The incumbent government led by Justin Trudeau has begun rolling out programs to bolster its political support, only some of which are included in the FES. Disagreements within Trudeau’s minority coalition on fiscal policy contributed to Finance Minister Chrystia Freeland’s resignation shortly before the FES was due to be released.



The fiscal deterioration in the FES through FY28 is still meaningful. Forecast deficits are an average of 16.6% higher than in Budget 2024 for each of the next five years, although as a share of GDP deficits increase by an average of 0.2ppts. Over the next six years, the FES outlines CAD24.2 billion in new expenditures, but only CAD3.1 billion in new revenue, mainly from efforts to reduce tax evasion.

New expenditures include CAD17.4 billion for changes to the corporate tax code, including the Accelerated Investment Incentive, CAD1.3 billion for border security and CAD1.1 billion for research tax incentives, among other smaller programs. The FES also incorporates CAD2.3 billion in forgone revenue due to lower immigration and CAD1.6 billion from a two-month sales tax (GST) holiday that is likely to have little long-term economic impact.



However, the FES excludes Prime Minister Trudeau’s promised CAD250 cash handouts for nearly 19 million Canadians earning less than CAD150,000, which will cost a minimum estimated CAD4.7 billion. The FES also excludes an extension of the GST tax holiday past its February 15 expiration, which we think likely given the approaching elections. Defense expenditures may also rise more quickly in response to demands from the Trump administration to meet the 2% of GDP NATO target.

By excluding these potential expenditures and not assuming greater economic risks in baseline growth forecasts, the government met two fiscal targets from last year’s FES. Debt-to-GDP is forecast to decline and deficits are expected to fall below 1% of GDP by FY26. However, the less than CAD40.1 billion FY23 deficit target was missed, with a CAD61.9 billion shortfall due largely to CAD21.0 billion in accounting charges for contingent liabilities for Indigenous claims and provisions for unrecovered pandemic support loans. Revenues also fell short by CAD5.5 billion (around 1.2% of the original revenue forecast), including a CAD6.1 billion drop in income taxes.

ֳ affirmed Canada’s ‘AA+/’Stable rating on 23 July 2024. A renewed rise in the general government debt/GDP ratio in the medium term, for example from a marked widening in the budget deficit or weakening in GDP growth, is a negative rating sensitivity.

Contacts:

Joshua Grundleger
Director, Sovereigns
+1 646 582 4462
joshua.grundleger@fitchratings.com
ֳ, Inc.
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Shelly Shetty
Managing Director, Sovereigns
+1 212 908 0324
shelly.shetty@fitchratings.com

Mark Brown
Senior Director, ֳ Wire
+44 20 3530 1588
mark.brown@fitchratings.com



Media Relations: Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@thefitchgroup.com

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