The official estimate of the federal deficit has soared by 38 per cent over Finance Minister Jim Flaherty's previous forecast, a downgrade that underscores the deep link between commodity prices and Canada's fortunes.
Mr. Flaherty released a fall economic update Tuesday that – for the second time in two years – pushed back Ottawa's timeline for erasing the federal deficit. That is now expected in 2016-17.
Mr. Flaherty also acknowledged that further stress could come from a major economic risk that will play out over the coming weeks: discussions in Washington over the "fiscal cliff."
If a bipartisan deal is not reached by Jan. 1 in Washington, a mix of spending cuts and tax hikes could drive the U.S. into recession, likely dragging Canada along with it.
Canada's federal deficit is now expected to reach $25-billion, a jump of nearly $7-billion from the budget delivered in March. One bank economist said the government's financial credibility could be in jeopardy if the target is pushed back yet again.
"I can assure you, we have contingency plans," Mr. Flaherty said Tuesday when asked about this possibility. His department's fiscal update document makes clear, however, that the government is assuming this scenario is unlikely and that a political outcome will produce a plan that does affect growth, but not drastically.
A common theme from the federal Finance Minister is that his Conservative government is controlling what it can, because there are a lot of factors affecting federal finances that are beyond its control.
While Ottawa is clamping down on spending, several factors contributed to higher forecast deficits this year and through to 2015-16. One of the biggest factors is a 7-per-cent reduction in commodity prices since the March, 2012, budget. Prices for commodities, such as oil, base metals and grains, have a big impact on government revenues. Finance Canada pointed out that crude oil prices, for example, are down 18 per cent in that same period.
Larger deficits ultimately mean more federal debt, which is considered to be manageable now but could squeeze out spending in other areas if interest rates rise. Many bank economists note that Canada's debt as a percentage of the economy remains small by international standards, yet the Canadian Taxpayers' Federation accused the government of allowing "runaway borrowing" that Canadians can't afford.
This year's federal deficit is on track to be $25-billion (before adding a $1-billion adjustment for risk), which is nearly $7-billion larger than the comparable projection from Mr. Flaherty's March budget.
As for the return to balance, the 2012 March budget had forecast this would happen in 2015-16, when Ottawa would post a $3.4-billion surplus. The November update now expects a $1.8-billion deficit for that year, though that includes a $3-billion adjustment for risk. If those risks do not materialize, the books could still be balanced that year.
The government's fiscal cushions for risk would still fall well short of absorbing the worst-case "fiscal cliff" scenario in the United States.
The search for a solution is dominating the political news agenda in Washington. President Barack Obama is spending the week meeting with business and labour groups – as well as senior members of the Senate and the Republican-led House of Representatives – in an effort to find a solution. Unless a new plan is reached, automatic tax hikes and spending cuts worth about $600-billion will take effect Jan. 1. The President does not want to continue tax cuts for those making more than $250,000 and this is a major point of disagreement with the Republicans in Congress.
Mr. Flaherty's budget numbers are based on an average of the most recent private-sector forecasts. Bank economists largely gave the minister a pass for keeping deficits small as a percentage of the economy. But one Bay Street economist suggested Ottawa's credibility will be on the line if it pushed back its balanced budget target one more time.
"The fiscal slippage reflects the government's judgment that it has found the optimal balance between austerity and growth, while maintaining its policy credibility," said BMO senior economist Michael Gregory in a note. "We concur, but if there's a third consecutive year of slippage without any offsetting policy response, the government's credibility could be called into question."
The Conservatives' 2011 platform included pledges – like allowing income splitting for families with dependent children – that were contingent on a balanced budget.
Mr. Flaherty, who delivered his update at a business luncheon in Fredericton, was later asked whether he would push to post a surplus before the next election, currently scheduled for Oct. 19, 2015.
"I'll be frank with you. I don't play with numbers, the numbers are the numbers," the minister bristled. He said the projected 2015-16 deficit of $1.8-billion was not a "significant" amount and "a little more than half a per cent of the federal budget."
By coincidence, former prime minister Paul Martin and former Canadian Ambassador to the U.S. Frank McKenna were also in Fredericton Tuesday at a separate event.
Both men told The Globe they are optimistic Washington will avoid the worst-case scenarios regarding the fiscal cliff.
Mr. McKenna – who was also premier of New Brunswick for 10 years until 1997 – said he's concerned about the effect of political "drama" and "hostage-taking" playing out in Washington.
"If the U.S. does something stupid and spirals into a recession, it will definitely bring Canada with it," he said.
Erasing the deficit: Then and Now
April 11, 2011, Conservative election platform
"A re-elected Stephen Harper government will eliminate the deficit by 2014-15." Platform promises a $3.7-billion surplus in 2014-15 and $8.2-billion surplus in 2015-16.
June 6, 2011, federal budget
"The Strategic and Operating Review will build on the first cycle of strategic reviews to support the return to balanced budgets by 2014-15."
March 29, 2012, federal budget
"The government's plan to return to balanced budgets over the medium term is on track." (Forecasts $1.3-billion deficit in 2014-15 and $3.4-billion surplus in 2015-16.)
Nov. 13, 2012, fiscal update
"The government remains on track to return to balanced budgets over the medium term." (Forecasts $8.6-billion deficit in 2014-15, $1.8-billion deficit in 2015-16 and a $1.7-billion surplus in 2016-17.)