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Trade deficit drops 'for all the wrong reasons' Add to ...

Canada's trade deficit narrowed sharply at the end of 2010 and a return to surplus is expected later this year.

But beneath the surface, Canada's trade picture is more worrying.

The main driver of the shrinking deficit was an unexpectedly large (3.2 per cent) drop in imports - an indication that Canada's domestic economy was slowing rapidly as the year ended. The overall deficit fell to $81-million, down from $1.5-billion in October.

"Canada's merchandise trade balance was better in November, but for all the wrong reasons," CIBC World Markets economist Emanuella Enenajor said.

Equally significant, the composition and destination of exports highlights a more troubling long-term trend in the Canada's trade position. The country appears to be working its way down the valued-added chain, exporting fewer manufactured goods to the United States and more resource-based goods to the rest of the world.

"We're exporting inputs to production to the rest of the world so they can produce the goods the U.S. wants," Toronto-Dominion Bank economist Diana Petramala said.

"We're diversifying trade away from the United States, which is a plus, but we're not diversifying it with value-added goods, which isn't the way to achieve long-term success in trade."

Measured in dollars, energy exports shot up 3.2 per cent in November. Exports of industrial goods and materials rose 6.6 per cent.

Canada's exports still go mainly to the U.S., but that share - at 70 per cent - is now the lowest since the early 1980s and before the Canada-U.S. free-trade agreement. It's also down from more than 80 per cent just as the United States tumbled into recession.

Blame Canada's faltering export position on the strong dollar and relatively weak Canadian productivity. Manufacturers in particular are struggling to compete in the U.S. market with the dollar at par.

Not surprisingly, exporters are feeling gloomier about their near-term prospects, according to Export Development Canada's semi-annual trade confidence index. The index, released this week, fell in the fall to 74.1 from a reading of 78.8 in the spring, reversing three consecutive increases.

"Optimism cooled at the tail end of 2010 as perceptions of Canada's economy weakened and doubts about the international situation grew," said EDC chief economist Peter Hall.

And most economists expect the dollar to remain high for an extended period, due to the strength of global commodity prices. Also, foreign investors are attracted to Canada because government finances here are better than in many other developed countries.

Canada's share of U.S. imports is "strongly correlated" to the value of the dollar, according to the TD's Ms. Petramala. When the dollar surges, Canada's share of U.S. imports falls. "We lost a lot of that share as the Canadian dollar appreciated," she said.

Canada, which has traditionally had a trade surplus with the world, has been in the red since the spring of last year. Ms. Petramala predicted the trade balance would return to "positive territory sometime in 2011," although it's likely to remain volatile in the coming months.

The U.S. economy is picking up and the Canadian economy is slowing. And that, she said, will tend to boost exports and constrain imports.

Follow on Twitter: @barriemckenna

 

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