Fitch Ratings has affirmed Canada’s foreign and local currency Issuer Default ratings at ‘AAA’ with stable outlooks. However, the ratings agency warns that fragmented markets are impairing productivity, and could hurt the country’s ability to deal with a commodity demand downturn.

The ratings reflect the continued improvement in Canada’s public and external finances, which in turn echo the economy’s healthy growth and decreased output volatility, the firm said. “The ratings are further supported by Canada’s high standards of living, institutional strength and cohesive macro-policy environment,” it added.

“Strong growth, a stable macroeconomic environment and continued downward convergence of public and external debt ratios towards AAA medians have underpinned Canada’s rating” notes Fitch’s Brian Coulton.

The rating agency notes that Canada’s economy has expanded at a sturdy pace since the bursting of the dotcom bubble with average annual output growth during 2000-2006 higher than that of all other G7 nations, except for the United States. The surge in global demand for commodities in the last five years has buoyed the economy and resources exports although the simultaneous rise in competition from Asia has reduced Canada’s share in the market for U.S. manufactured imports, it adds.

Nevertheless, Canada has enjoyed a string of unbroken current account surpluses since 1999, Fitch says. These surpluses have in turn helped to reduce net external debt to 21% of GDP in 2006 from its 46% peak in 1994, which is now close to the 2006 ‘AAA’ median of 18%.

“The improvement in the national savings and investment balance has reflected a rise in the public and the private sector savings, the former via a concerted consolidation effort and the latter on account of the prudent use of the handsome profits that have accrued to the corporate sector. Nevertheless, household indebtedness has risen on the back of mortgage equity withdrawal, helping to fuel robust consumption growth. Consumption has also been supported by increasing wages, employment and household wealth,” it says.

On the downside, Fitch notes that fragmented labour, product and capital markets and high rates of taxation have slowed productivity growth outside the resources sector. “This could hamper the ability of the economy to ride out any sustained fall in global commodity demand. Moreover, enhancing productivity performance will become more important in the face of the impending fall in labour supply as the baby boomer generation retires,” it says.

“While Canada’s relatively high commodity dependence has not resulted in output volatility to date, it will be important to ensure that the broader economy is flexible enough to counteract any future downturn in the global commodity cycle” notes Coulton.

Continued improvements have occurred in public finances in recent years, Fitch says, as public debt has fallen to 67.3% of GDP in 2006 from 72.2% in 2004. All 13 provincial governments registered a surplus for the first time in the fiscal year to end-March 2006, and 10 out of 13 expect to register a surplus in fiscal 2007. “Nevertheless general government debt as a percentage of GDP and interest payments as a proportion of revenue (10.2%), still remain among the highest in the ‘AAA’ category while debt as a proportion of revenue also remains above the ‘AAA’ median,” Fitch notes, however it adds that the general government has accrued sizeable pension fund assets and that net government debt measures are consequently significantly lower.