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Canada's Covid-19 Response Is to Spend Heavily and Ignore the Deficit -- for Now -- Update

12/01/2020 | 01:02pm EST

By Paul Vieira and Kim Mackrael

OTTAWA -- Canada's deficit is growing at the fastest rate among developed nations as it seeks to prop up its economy during the Covid-19 pandemic.

Canadian officials are betting the aggressive approach will pay off, pointing to the number of jobs already recovered, and argue that the country can afford to pour money into the economy while borrowing costs are historically low. But some economists warn the heavy spending could lead to a fiscal crisis, and one major ratings firm has already stripped the country of its triple-A rating.

Canada isn't alone in its spending spree: The International Monetary Fund estimates governments around the world have doled out $12 trillion to minimize the economic damage from restrictions in place to halt transmission of Covid-19. Canada's virus-related spending, the bulk of which originates with the federal government, has totaled about 382 billion Canadian dollars, the equivalent of $294 billion, and accounts for roughly 19% of Canada's total economic output.

Yet data from the IMF indicate Canada's fiscal position during the pandemic -- incorporating all levels of government -- has deteriorated at the fastest pace among the major economies in the Group of 20 industrialized countries as it seeks to keep the economy pumping.

"Canada could come off as heroic if this spending is done right," said Jimmy Jean, a strategist at Desjardins Securities in Montreal. "If Canada fails, all the emergency spending might have been done in vain because we won't have the capacity to power the post-vaccine recovery."

The Canadian government said Monday that it projected a budget deficit in the current fiscal year, ending March 30, to jump to at least C$381.6 billion or 17.5% of gross domestic product, versus a deficit of C$39.39 billion, or 1.7% of GDP, in the previous 12-month period. The U.S. budget deficit tripled during the fiscal year that ended Sept. 30, to reach $3.1 trillion, or the equivalent of 14.9% of economic output.

The deficit could swell to near C$400 billion because of deteriorating economic conditions related to a second wave of Covid-19 infections. Canada anticipates the deficit to narrow next fiscal year to between C$121 billion and C$166 billion, depending on how much new spending is deployed.

So far, Canada has recovered about 80% of the jobs lost in March and April because of the virus, whereas the U.S. has regained just over half of employees shed. Canada's economy grew by a record 40.5% annual rate in the third quarter, Statistics Canada said Tuesday. However, growth is expected to grind to a halt in the final three months of 2020 as restrictions re-emerged to deal with a rise in Covid-19 infections.

The federal government's debt is also set to surpass C$1 trillion for the first time this year, or 50% of GDP, and debt from all levels of Canadian government will surge to roughly 115% of GDP this year from 89% in 2019, the IMF said. The debt-to-GDP ratio this year in the U.S. is forecast to reach 131%; 108% in the U.K.; and 73% in Germany, according to the IMF.

When downgrading the country's rating from triple-A to double-A-plus in late June, Fitch Ratings cited a steep rise in the country's total government debt, and skepticism about the ability among political leaders to stabilize debt growth after the pandemic passes.

Carolyn Wilkins, the second-highest-ranking official at the Bank of Canada, said fiscal policy is a powerful tool with interest rates already near zero and business activity constrained. Without massive fiscal outlays, "you wouldn't be seeing the recovery we're seeing now," Ms. Wilkins said in an interview.

Canadian Deputy Prime Minister and Finance Minister Chrystia Freeland said Monday that the fiscal taps will remain wide open for the foreseeable future. She said in an annual fall economic update that the government is set to spend up to C$100 billion over a three-year period starting in 2021 to help fortify the recovery from the pandemic. Stimulus spending would cease only when benchmarks related to employment data were met, she said.

"Canadians understand that this crisis demands targeted, time-limited support to keep people and businesses afloat and to build our way out of the Covid-19 recession," she said.

Ms. Freeland said the government would eventually introduce rules to stabilize debt growth but only after the recovery is complete.

She said Canada can afford this wave of spending because of historically low borrowing costs, and that the government is adjusting its debt-management strategy to lock in the low rates by issuing more long-term debt. Even with the rapid growth in debt, Canada said debt-financing charges are projected to fall below 1% of GDP this year and rise to 1.2% by 2025-26.

While Fitch downgraded Canada, S&P Global Ratings and Moody's Investors Service are maintaining their triple-A rating.

Ryan Goulding, fixed-income analyst at Leith Wheeler Investment Counsel, a Vancouver-based asset manager, said there are relatively few downsides to Canada's current borrowing -- so long as it is focused on rebuilding capacity wiped out by the pandemic. He said credit-rating downgrades shouldn't be a concern.

"There's a lot of more capital in the world than there was 10 years ago. It is trying desperately to find a home, and the safe ports for capital are getting fewer and fewer," he said.

Mr. Jean, of Desjardins Securities, said the government is betting the massive fiscal outlays will prevent a catastrophe in household and corporate bankruptcies.

Yet David Rosenberg, economist and head of Toronto-based consulting firm Rosenberg Research, pointed out that combining mounting government debt and what households and nonfinancial corporations owe puts Canada's total debt-to-GDP ratio at more than 400% -- ahead of the Americans and Chinese, but on par with Italy and Greece. The latter two countries dealt with fiscal crises last decade.

"The only way that Canada's aggregate debt ratio is sustainable is if we just have interest rates close to zero in perpetuity," he said.

Write to Paul Vieira at paul.vieira@wsj.com and Kim Mackrael at kim.mackrael@wsj.com

Corrections and Amplifications

This article was corrected on Dec. 3, 2020 because it misstated that the U.S. deficit was the equivalent of 16.1% of economic output, a figure that was based on an earlier projection. The U.S. budget deficit was the equivalent of 14.9% of economic output.

(END) Dow Jones Newswires

12-01-20 1302ET

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