The federal government is pinning its new “fiscal anchor” to a rapid postpandemic recovery, with economic growth expected to put the government’s debt-to-GDP ratio on a downward trajectory over the next few years, despite continuing deficits.
Ottawa added more than $350-billion to its accumulated debt last year, and expects to run another deficit of $154.7-billion this year. Federal debt now stands at $1.08-trillion or 49 per cent of GDP, up from $721-billion or 31.2 per cent before the pandemic.
Heading into Monday’s budget, economists and business groups were calling for the government to adopt a fiscal anchor – that is a target, such as a debt-to-GDP ratio, to moderate deficit spending and debt accumulation. The government responded with a loosely defined commitment to unwind its emergency spending and reduce the size of its debt relative to the size of the economy “over the medium term.”
The budget projects the federal debt-to-GDP ratio peaking at 51.2 per cent next year, then falling gradually to 49.2 per cent by the 2025-26 fiscal year, when debt will stand at around $1.4-trillion. (This is net debt: total government liabilities minus total assets.)
The deficit, meanwhile, is projected to fall from $354-billion last year to $154.7-billion this year and $59.7-billion the following year. The government is projecting a $30.7-billion deficit by 2025-26.
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Underpinning the debt management strategy is the expectation that the economy will grow out of the COVID-19 pandemic at a blistering pace, as vaccination becomes widespread and businesses reopen.
The budget is based on consensus estimates from private-sector economists that put real GDP growth at 5.8 per cent this year and 4 per cent next year. By 2023, the rate of growth is expected to normalize at around 2 per cent, then remain slightly below 2 per cent for the next few years.
Bank of Montreal chief economist Douglas Porter said these economic projections are reasonable over the medium term. But the outlook, he said, “relies heavily on the economy managing to recover from the pandemic over the next 12 to 18 months.”
“The risk is that we could be surprised over the next year if the recovery disappoints,” he said.
The other risk is that interest rates move much higher than projected. The government was able to finance its massive deficit over the past year at record low interest rates, which brought down debt servicing costs even as the total amount of debt soared. If interest rates move sharply higher, it would increase the cost of issuing new debt and refinancing outstanding debt.
The budget takes a relatively benign view of this, again relying on private-sector consensus estimates. It sees the interest rate on 10-year Government of Canada bonds rising to 2.7 per cent by 2025 from 1.5 per cent (which is close to where these bonds currently trade). Based on these rate projections, the government expects its debt servicing costs to rise to $39.3-billion or 1.4 per cent of GDP by 2025 from $22.1-billion or 0.9 per cent in this fiscal year.
“This is still substantially lower than the average cost of financing debt over the last two decades, even with a significantly higher public debt load because of COVID-19,” the budget notes.
In a move to lock in lower interest rates, the government is adjusting its debt management program to focus on longer-term bonds.
It plans to issue 42 per cent of its bonds as long-term debt with maturities of 10 years or greater. Before the pandemic, only 15 per cent of its bonds were issued at maturities of 10 years or greater. The government is also planning to reintroduce an ultralong 50-year bond.
“What we’re seeing is a bond program that is transformational relative to what we’ve ever seen before in Canada,” said Ian Pollick, global head of fixed-income, currency and commodities strategy at CIBC Capital Markets. “Remember, Canada was notorious for having a chronically undersupplied long end of the market.
“What I get concerned about when I see this type of bond program is the potential for a crowding out effect,” he added, noting that provincial and municipal issuers have traditionally issued bonds in the longer end of the market.
The government also announced plans to issue $5-billion worth of green bonds, which will be used to finance clean energy infrastructure and technology.
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Mark Rendell