The International Monetary Fund (IMF) says that it expects economic growth to pick up in Canada over the next year, it also lauds the latest progress on a national securities regulator, and suggests that the current mortgage insurance scheme should be re-evaluated.
The IMF released its latest preliminary assessment on Canada, noting that growth has been modest so far in 2013, but that stronger external demand is expected to push growth above its potential rate in 2014. The IMF sees growth accelerating to 2.25% next year from 1.6% this year. However, it notes that the balance of risks is tilted on the downside.
It says that the significant downside risks surround the projected acceleration of the U.S. recovery next year, which is seen as the main source of Canada’s accelerated growth. Additionally, protracted weakness in the euro-area economic recovery and lower-than-anticipated growth in emerging markets would also hurt the prospects for Canada’s exports through lower commodity prices, among other effects, it notes.
Additionally, it warns that high house prices and household leverage could amplify the impact of any external shocks, “potentially triggering a less friendly unwinding of domestic imbalances and further weakening of household spending.”
The energy sector is a source of both upside and downside risks to the outlook, the IMF says. “A more rapid growth in U.S. production of unconventional energy and/or delays in the expansion of transportation capacity would limit the demand for Canadian energy, put downward pressure on Canadian energy prices, and adversely affect exports and investment. At the same time, faster progress in solving the infrastructure bottlenecks would allow to increase Canadian energy producers’ access to international (non U.S.) markets and Canadian eastern provinces, boost production, and raise the price of Canadian energy,” it explains.
In terms of monetary policy, the IMF says that the gradual absorption of the existing economic slack is expected to drive inflation back to 2% by the end of 2015, and interest rates are projected to increase starting in early 2015. For now, it says that monetary policy needs to remain accommodative “until there are firmer signs that a sustainable transition from household spending to exports and investment is taking hold.”
On the fiscal side, the IMF suggests that “there is room to delay the adjustment needed to return to a balanced budget in 2015 if there is no meaningful pick-up in economic growth.”
In terms of the financial industry, the IMF says that the sector is healthy overall, but that it is essential to remain vigilant against the potential risks from the prolonged period of low interest rates. “Pension funds and life insurance companies appear to have coped well with a prolonged period of low interest rates, although their increased reliance on non-traditional investment strategies continues to deserve close scrutiny from regulators. Continued expansion abroad of both Canadian banks and life insurance companies, while contributing to diversification, also calls for enhanced monitoring,” it advises.
The IMF lauds policymakers’ progress on reform over the past year, however, it says “Over the long run, the need for extensive government backed mortgage insurance should be re-examined.” It notes that, while the current system has its advantages, “it exposes the fiscal budget to financial system risks and might distort the allocation of resources in favour of mortgages and away from more productive uses of capital.”
It endorses the government’s recent initiatives to impose limits on government-backed mortgage insurance, but says that “further measures should be considered to encourage appropriate risk retention by the private sector and increase the market share of private mortgage insurers.”
Additionally, the IMF notes that the recent agreement between B.C., Ontario, and the federal government to establish a cooperative capital markets regulator “could prove a useful step in further harmonizing securities market regulation and oversight nationally.”
There are also a few other areas where the resilience of Canadian financial sector could be strengthened further, the IMF says. It suggests that more clarity around the legal independence of the Office of the Superintendent of Financial Institutions (OSFI) is necessary, as is stronger prudential responsibilities for the regulator. It also says that there’s room for stronger coordination between federal and provincial authorities in both the supervision and stress-testing of all large depository institutions; and, that “a clear mandate could be given to an entity to carry out macro-prudential oversight, with participation broad enough to allow a complete view of systemic risks across all financial institutions and markets, and with powers to collect the data required for the analysis of systemic risks.”