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Finance Minister Jim Flaherty and Prime Minister Stephen Harper make their way to the House of Commons to deliver the budget speech, Monday June 6,2011 in Ottawa. (THE CANADIAN PRESS/Fred Chartrand/THE CANADIAN PRESS/Fred Chartrand)
Finance Minister Jim Flaherty and Prime Minister Stephen Harper make their way to the House of Commons to deliver the budget speech, Monday June 6,2011 in Ottawa. (THE CANADIAN PRESS/Fred Chartrand/THE CANADIAN PRESS/Fred Chartrand)

How financial uncertainties could rain on Flaherty's parade Add to ...

Despite all the talk about slashing government spending, the success of Finance Minister Jim Flaherty's latest budget will ultimately depend on the things he can't control.

There's the fallout from the Japanese earthquake, darkening clouds over the U.S. economy, oil at $100 a barrel, a clutch of near-bankrupt Euro members and the threat of higher interest rates.

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And yet the economic assumptions that underpin the government's path to eliminating the deficit remain virtually unchanged from March 22. In essence, Mr. Flaherty is relying heavily on an economic forecast that is months out of date, and fraught with unknowns.

The greatest worry for Canada is what happens to its southern neighbour. The United States still buys nearly three-quarters of what Canada exports, including oil, cars, lumber and minerals. How well the U.S. performs drives manufacturing in Ontario, mining in Northern Quebec and the Alberta oil sands.

"The bigger issue is how fast can Canada grow when it's dealing with a currency above par and a U.S. that's finally in deficit-cutting mode," said Doug Porter, Bank of Montreal's deputy chief economist.

In the three months since Mr. Flaherty's earlier budget, the prospects for the U.S. have worsened markedly. Job creation is anemic. And Standard & Poor's warned recently that it may downgrade the U.S. debt rating unless Congress and the Obama administration come up with a credible long-term budget plan by next year.

And if the United States isn't spending and growing, Canada could be caught in the downdraft.

Mr. Flaherty thinks near-3-per-cent annual growth is possible in Canada in each of 2011, 2012 and 2013 - despite all the potential pitfalls out there.

The Bank of Canada is somewhat less optimistic. It's forecasting growth of 2.9 per cent in 2011, 2.6 per cent in 2012 and 2.1 in 2013.

While Mr. Flaherty is holding firm to his forecasts, investors have been passing judgment on the Canadian economy daily. The S&P TSX Composite index has lost nearly 700 points, or 5 per cent of its value, since the March 22 budget.

Even a miss of a few percentage points on either side of the forecast would have a major impact on revenues and the Harper government's commitment to eliminate the deficit in 2014-15.

When asked about the reliability of the growth forecasts underpinning his budget, the Finance Minister said private-sector economists assured him the March assumptions remain a "reasonable" base for planning purposes.

He stressed that the March budget accounted for the possibility of a worsening economy. Finance Canada revised the private-sector average downward by $10-billion in nominal GDP each year, representing $1.5-billion less in annual fiscal revenues than would otherwise be anticipated.

"We're building in a significant consideration for risk," Mr. Flaherty explained. "The two biggest risks being the European sovereign debt situation and the danger of contagion in the private sector arising from that, and secondly the debt and deficit situation in the United States."

Getting to zero on the deficit will depend much more significantly on an improving economy than any planned spending cuts.

The budget, for example, forecasts that the economy will grow 2.8 per cent in 2012 and 2.7 per cent in 2013. And the jobless rate will gradually fall - to 6.4 per cent in 2016 from an average of 7.5 per cent this year. The current unemployment rate is 7.6 per cent and job creation has been uneven.

Those forecasts may be too optimistic, according to many economists. Parliamentary budget watchdog Kevin Page, for example, has urged greater prudence in the government forecasts, particularly because of U.S. uncertainty. In a report issued last week, he predicted much weaker growth and higher unemployment for the next several years than Mr. Flaherty sees.

The economic outlook is weighed down by an unusual number of external risks, pointed out Conference Board of Canada economists Glen Hodgson and Pedro Antunes. "This makes it doubly important that the federal government stick with a firm plan to balance the books," they said in a post-budget commentary.

Mr. Flaherty opted to leave his forecast unchanged after a meeting with a group of private-sector economists last week. "The economists agreed that the average forecast from the March survey remained a reasonable basis for fiscal planning," according to Monday's budget. And in his speech, Mr. Flaherty said: "We are on the right track."

But it's a track that will likely depend on what the Obama administration and the U.S. Congress do in 2012 and 2013 - two pivotal years in the Finance Minister's drive to wipe out the deficit.

With a report from Bill Curry

Follow on Twitter: @barriemckenna

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