June 2018

The International Monetary Fund has given a warning saying Canada’s economy may face significant risks due to trade sanctions with the U.S. In an annual review of Canada’s economy, IMF has come out and said that Canada should have a “careful rethink of corporate taxation to improve efficiency and preserve Canada’s position in a rapidly changing international tax environment.” This would enable them to remain competitive after the U.S. decision to reduce corporate tax.

“The impact of lower corporate tax rates in the U.S. could make Canada a less attractive destination for investment,” said Cheng Hoon Lim, the IMF’s assistant director, Western Hemisphere Department.

The Canadian government is evaluating the impact of the tax cuts on Canada, but Prime Minister Justin Trudeau insists Canada remains competitive.

Although Canada has had a ‘robust’ 3% GDP growth in 2017, the current strength will not sustain. Growth is predicted to fall to 2.1% this year. Moreover, several factors will limit population growth; this along with loss in competitiveness will affect medium-term growth, limiting it to just 1.75%. This number is significantly lower than historical averages.

This warning comes after tension between Canada and its neighbor, with the U.S. placing tariffs on Canadian steel and aluminum exports. The Canadian government responded with surtaxes of its own, on 16.6 billion dollars worth of U.S. products. However, the tax on Canada could prove to be a big blow to the country’s economy, especially if the U.S. and Canada are unable to reach a new NAFTA agreement, as output would be reduced by another 0.4% if the two countries revert to World Trade Organization rules. Lim also said that if the new NAFTA agreement is not met within a reasonable time frame, then Canadian investment and growth could be hurt for an extended period.

Internal risks
In the internal context, the IMF has also flagged the housing market as being a key risk to the domestic economy. A potential “sharp correction” in the housing market may occur, being potentially caused by a faster than expected rise in mortgage interest rates.

“If housing vulnerabilities continue to rise, new lending by banks should be subject to loan-to-income limits,” reports the IMF.

Despite the IMF reporting that this vulnerability has somewhat moderated due to Canada’s housing market cool down, “It will remain a vulnerability for some time given the large stock of household debt,” Lim said.

Bank of Canada’s report
This IMF report came before the Bank of Canada report released on the 7th of June. In the report, Bank of Canada shares the IMF concerns on the housing market. Although the amount Canadians owe has begun to decline, "the total amount of debt carried by Canadian households is so large, we know that it will be with us for a long time," reports the Bank of Canada governor Stephen Poloz.

The Bank of Canada report suggests Canada has several vulnerabilities that may result in key risks including severe recession, a house price correction, and long term high interest rates.