Canada needs to take action on uninsured mortgages and keep up with global regulatory reforms in financial services, says the International Monetary Fund (IMF) in its latest report on Canada.
The IMF report notes that the Canadian economy has performed relatively well over the past year. However, it says that business investment remains tentative, and so a rebalancing of growth away from household consumption and residential investment “remains incomplete”. Nevertheless, the IMF indicates that it expects stronger U.S. growth to support above-potential growth and a broadening recovery.
For 2014, GDP growth is estimated to be about 2.25%, and inflation is expected to remain close to the Bank of Canada’s 2% target “as the remaining slack in the economy is gradually reabsorbed and inflation expectations remain well anchored.”
In terms of risks to the outlook, the IMF report says that the balance is tilted modestly to the downside for the Canadian economy. “A faster-than-expected tightening of global financial conditions and a further decline in global oil prices from weaker demand are the key external downside risks facing Canada,” it says. “Deeper downside risks to growth involve a combination of external shocks that are amplified by high household balance sheet vulnerabilities and a sharper-than-expected correction in house prices.”
On the upside, it notes that U.S. demand may be stronger than expected, and a faster resolution of infrastructure bottlenecks could sustain increased activity in the energy sector.
Domestically, the housing market has regained momentum, it notes, mainly driven by brisk activity in major cities such as Toronto, Vancouver, and Calgary. “Across market segments, single-family homes are a major source of price increases, and there are signs of overvaluation, especially associated with high-end buyers,” it says, adding, “Tighter mortgage insurance rules, reduced affordability, and new construction of multi-family units appear to have contained price growth in other market segments.” The IMF says that it welcomes new guidelines issued by the Office of the Superintendent of Financial Institutions (OSFI) to strengthen residential mortgage insurance underwriting practices.
Against this background, the IMF says that monetary policy “can afford to stay accommodative for now.”
“Given well-anchored inflation expectations and downside risks to export-driven growth, a monetary policy tightening cycle can await firmer signs to emerge of a more balanced and durable recovery with stronger business investment,” it says. “At the same time, rising long-term interest rates driven by the expected U.S. monetary normalization could facilitate a needed moderation in Canada’s housing sector.”
In terms of fiscal policy, the IMF says that consolidation should continue at the general government level, but that the federal government can afford to adopt a more neutral stance due to its soon-to-be-balanced budget. “The recently announced tax cuts and enhanced child benefits to support families go in this direction. The mission sees merit in using available fiscal resources for targeted growth-friendly measures (e.g., aimed at R&D, SMEs, venture capital, and strategic infrastructure projects) in support of business investment and productivity or reducing federal income taxes that could provide more tax space to provinces,” it says. “In terms of the policy mix, a more neutral fiscal stance would help monetary policy rebuild its space faster as the recovery proceeds.”
Financial stability risks have been largely mitigated by low interest rates and macro-prudential measures adopted since 2008, the report says. “They have helped curb growth in insured mortgage credit and strengthen credit standards, in addition to helping dampen house price increases.”
However, it also notes that uninsured mortgages are rising noticeably, and it says these mortgages now comprise the bulk of mortgage originations. “Further action may be needed if household balance sheet and housing market vulnerabilities resume rising. Targeted actions could include tighter standards, such as lower amortization limits for uninsured mortgages,” it says.
The IMF also calls for further action to limit taxpayers’ exposure to the housing market, and to encourage more risk retention by the private sector. “More broadly, re-examining the dimensions of extensive government-backed mortgage insurance should remain on the authorities’ longer-term agenda, including managing a transition from financial market reliance on government-backed instruments as the public sector role recedes,” it says.
The banking system looks to be in good shape, the report notes, as the banks remain highly profitable, with favourable loan quality, low nonperforming loans, and improving capitalization. “However, banks’ increasing exposure to capital markets and risks from foreign operations warrant close attention,” it says.
And, it notes that while policymakers have made good progress on certain reforms, such as the Basel III liquidity and leverage rules, other recommendations on “financial sector oversight, safety nets, and macro-prudential frameworks remain to be addressed,” it says.
In particular, it calls for enhanced coordination between federal and provincial authorities in supervision and stress-testing. “While discussions between federal and some provincial authorities have started, cooperation in supervision should be enhanced within respective mandates, including to reduce possible regulatory fragmentation,” it says.
Additionally, it says that a single entity should have a mandate for macro-prudential oversight, which, the IMF says, “would strengthen transparency and accountability, and reinforce Canada’s ability to identify and respond to future crises.”