Canada is keeping its coveted membership in the shrinking club of countries with a stable triple-A credit rating.
But in its annual report on Canada, Moody's Investors Service Inc. warned Thursday that the country’s heavy reliance on now-falling crude prices is likely to be a drag on the economy.
“The drop in prices that has taken place in 2012, combined with lower demand in the U.S., could potentially have a significant impact on the growth performance of the economy,” Moody’s said in its report, reaffirming Canada’s stable triple-A rating.
Sixteen of the 113 countries rated by Moody’s have triple-A scores. Many of those, including the United States, Britain, France and Germany, are under negative ratings warnings because of deteriorating government finances.
Moody’s cited Canada’s “very high degree of economic resiliency, its very high government financial strength, and its low susceptibility to event risk” for confirming the rating.
“Although the recession caused a reversal of the improvement in the debt ratios, they did not deteriorate as much as in most other triple-A-rated countries, are now on an improving trend, and remain compatible with the country’s Aaa rating,” Moody’s said.
Canada’s growing dependence on oil – for investment and to drive exports – is a double-edged sword. Oil and gas activity accounted for roughly a fifth of Canada’s economic growth in 2010 and 2011, according to Moody’s.
Normally, a fluctuating currency would help the economy adjust to changed commodity prices. But Moody’s senior vice-president Steven Hess said that isn’t happening this time because of the turmoil in the rest of the world. What makes Canada a low credit risk is also what makes the country an attractive place to invest and park money.
“Canada has a haven status in financial markets,” Mr. Hess said in an interview.
“There is some chance that the exchange rate remains high even if commodities prices fall because Canada’s government finances are good enough and investors are looking for Canadian dollar assets. So the adjustment from a free-floating exchange rate is not working as it would in the past,” he said.
Lower oil prices mean that Canada is likely to continue to have a current account deficit, the broadest measure of trade and investment flows, Moody’s said. A current account deficit acts as a drag on economic growth.
The rating agency said Canada’s lack of exposure to fast-growing emerging economies, the high dollar and competition from low-cost Asian countries will “cause the manufacturing sector to continue struggling.”
The Harper government has made Asia a key focus of its trade expansion efforts. It’s engaged in free trade talks with India, Japan, South Korea and the 10-member Trans Pacific Partnership.
Moody’s identified a housing collapse and Quebec separation as the main risks facing Canada’s economy. But the agency pointed out that the likelihood of either event is low.
On housing, the rating agency acknowledged “at some point” the housing market will cool off, taking a bite out of consumption and economic growth. But Moody’s characterized the housing market risk as “manageable,” even if Canada Mortgage and Housing Corp.’s mortgage portfolio takes a hit.
“Our baseline is that there is a soft landing, that housing prices will decline modestly,” Mr. Hess explained. “We don’t expect a collapse in housing prices.”
And on the other major risk, Quebec separation, Moody’s pointed that sovereignty is “not high on the agenda” in the province and opinion polls have consistently shown support for the status quo.