The International Monetary Fund has issued its latest report on Canada, noting that further rate hikes could be needed. However, the IMF report warns that the central bank should be cautious as various factors could pressure growth.

The IMF report also calls for a national securities regulator, among other structural reforms.

The IMF lauds Canada’s recent economic performance and improved budgetary position. It concludes that the economy is likely to continue to perform solidly in the coming year, supported by robust growth in consumer demand and business investment of 2.9% in 2005 and 3.0% for 2006.

However, the IMF report also notes that there are important risks to the outlook, warning of the possibility of a sharper-than-expected drop in net exports, particularly given the Canadian dollar’s recent appreciation against the U.S. dollar, and a more abrupt softening of consumer spending.

It also observes that the unwinding of global current account imbalances could result in further upward pressure on the Canadian dollar. “The uncertainties surrounding prospects for exchange rates, global commodity prices, and the ongoing process of trade liberalization, place an additional premium on policies to improve fiscal prudence, economic flexibility and productivity,” it notes.

The report finds that monetary tightening in the second half of 2004 was appropriate and that further tightening could eventually be needed. Although, it notes, “there is room for a cautious and pragmatic approach to withdrawing stimulus, consistent with meeting the inflation target, particularly considering the absence of wage pressures, the risks to the outlook, and well-anchored inflation expectations.”

And, it commends the Bank of Canada for further strengthening policy transparency and stepping up its communication activities. There is some suggestion that more background information on policymakers’ views on the distribution of risks and related policy implications would be useful to markets.

The report adds that recent spending commitments, including increased transfers to provinces, have limited the room for fiscal maneuvers, and caution that Equalization payments should not become an entitlement.

“Directors hoped the ongoing expenditure review will serve as the basis for a careful evaluation of the merits of spending programs versus further reducing the relatively high tax burden,” it says.

It also stresses the importance of health care reform including greater focus on improving incentives for cost containment by both health care providers and consumers; continuing structural reforms to maximize productivity; and strengthening incentives to save and invest.

The IMF also stresses that adopting a single national securities regulator would help reduce compliance and administrative costs, and that clarifying the regulatory framework governing bank mergers would reduce uncertainty and possibly allow institutions to reap efficiency gains. “Directors also encouraged the authorities to consider enhancing incentives for firms to fund their defined benefit pension plans, and to use the upcoming review of financial sector regulation as an opportunity to reduce regulatory overlap,” it reports.

Minister of Finance Ralph Goodale welcomed the report. “This annual appraisal recognizes that our country’s recent economic performance has been ‘enviable’—reflecting the benefits of sound institutions, a strong monetary and fiscal policy framework, and structural reforms,” said Goodale.

Goodale notes that the study also provides a positive assessment of Canada’s budgeting practices. “I want to thank the IMF for undertaking this very useful study at our request,” said Goodale. “It will be an important tool to help us make sure that the Government of Canada continues to use the most up-to-date economic and fiscal forecasting methods, and to benchmark Canadian practices against the best in the world.”

Finance reports that the IMF study has been forwarded to Tim O’Neill, chief economist of BMO Financial Group, who has been commissioned by the government to assess the Department of Finance’s economic and fiscal forecasting methodologies. His report is expected later this spring.