The increased difficulty achieving political consensus after the elections and the challenging foreign trade environment are enough to make investors cautious, despite the country’s top sovereign credit ratings.
Canada looks to be sitting pretty near the top of the global rankings, but the path ahead is slippery underfoot
Canada is one of the world’s safer investments, commanding triple-A sovereign credit ratings for the past five years without a hint of equivocation from Fitch, Moody’s or Standard & Poor’s.
Or is it?
Euromoney’s risk survey shows Canada sliding to 15th out of 174 countries this year.
It is still a low risk, admittedly, but Canada has fallen more than any other of the world’s top-30 safest investments in the global rankings. It is now considered to be more in line with Chile and Ireland, both of which are A-rated, but are not among the safest, gold-plated credits:
Part of the problem stems from political uncertainty, which led to analysts downgrading Canada ahead of the federal elections in October and saw Justin Trudeau’s governing Liberal Party endure a decline in vote share, with a loss of 20 seats and its majority in parliament.
Johan Krijgsman, of Krijgsman & Associates and one of Euromoney’s analysts, has been chipping away at Canada’s political risk rating for several quarters, and he does not expect to reverse these moves in the short term. Neither do many others.
“The biggest surprise of the elections was the re-emergence of Bloc Québécois [BQ, led by Yves-François Blanchet], which gained 22 seats, to total 32,” says Krijgsman.
“Other parties shied away from dealing with Quebec Bill 21 [restricting religious symbols], while the BQ embraced it, as well as moving closer to the conservative policies of the popular provincial government.”
He adds: “This suggests that greater provincial autonomy is back on the political agenda.”
Rumblings of ‘Western exit’ from Canada have been heard, but seem unlikely to be acted on, unless the federal government badly mishandles the situation- Johan Krijgsman, Krijgsman & Associates
The Liberals will need to reach agreements with other parties to govern as a minority, which seem possible – on social and environmental issues at least – with BQ, the New Democratic Party (NDP) led by Jagmeet Singh and/or the Greens.
An exclusive arrangement with NDP would provide a governing majority, but the growing desires for greater provincial autonomy will likely make governing difficult.
“It would not sit very well with Ontario or most western provincial governments,” says Krijgsman.
“Issues relating to pipelines and carbon taxes have not been resolved. Rumblings of ‘Western exit’ from Canada have been heard, but seem unlikely to be acted on, unless the federal government badly mishandles the situation.”
He adds: “Given that the NDP lost 15 seats in Quebec, its base is now mainly in the west [15 of 24 seats], which may cause conflict between ideological preferences and economic ones.”
Another problem relates to global and regional trade issues slowing GDP growth.
As with other countries facing a weakened trade environment, and a slower tempo across the US border, Canada is seen growing by just 1.5% on a real-terms basis this year, according to the IMF, after having already decelerated from 3% in 2017 to 1.9% in 2018.
Next year, growth may improve a little to 1.8%, the IMF suggests, and unemployment is currently quite low at 5.5% of the labour force.
However, the labour force is declining mainly due to an ageing population, making low unemployment a gradually unreliable barometer of economic vitality.
GDP growth will also likely be constrained by weak investment and low commodity prices, Mexico’s cost advantages, and reduced corporate tax in the US making Canada’s southerly neighbour more competitive.
These are features that Krijgsman and other Canadian country risk experts are concerned about.
The Bank of Canada’s forecast range for GDP growth in 2020 is 1.3% to 2.1%, while Craig Alexander, at Deloitte Canada, has recently tried to dampen enthusiasm raised by a strong second-quarter growth figure by arguing it is mostly a rebound from two prior quarters of virtually no growth.
“Abstracting from the quarterly volatility reveals a more subdued picture, with the trend pace of growth three times slower,” he says.
Risks may abate, of course, not least if China and the US patch up their differences and agree to dismantle trade tariffs.
However, Alexander also states that “a scenario where politics further damages the world economy, sparking a global downturn and dragging Canada into recession, is not implausible”.
Most of Euromoney’s contributing experts would agree, which is why few are prepared to upgrade their risk scores and stop Canada from sliding in the global risk rankings.
A bigger economic slowdown or recession, bearing in mind the government’s fiscal spending plans, could cause a rapid deterioration in the federal finances.
Canada’s Globe and Mail states: “The re-elected Liberals promised to raise the deficit to more than C$27 billion – a 37% jump – to finance new spending. Their likely partner in passing the next federal budget, the NDP, campaigned on increasing the deficit to C$32.7 billion.”
Canada is still safe, but it is sliding – and that means it’s not as secure as the credit rating agencies claim.