Canada details plans to slay deficit once recovery entrenched

Posted at 03/05/10 7:03 AM

OTTAWA – Closing the stimulus tap and cutting spending sharply after the economy recovers will rein in Canada's record budget deficit, the government said on Thursday.

In a stay-the-course budget that contained few surprises and is unlikely to trigger a fresh federal election, the government said the deficit in the year to March 31 will be slightly smaller than expected at C$53.8 billion ($52.2 billion). It previously forecast a gap of C$55.9 billion.

But the government said that is partly because its two-year, C$47.2 billion economic stimulus package was slow to get started, so more spending will be pushed into 2010-11.

It now forecasts a 2010-11 deficit of C$49.2 billion, up from C$45.3 billion predicted earlier and expects that to narrow to C$1.8 billion by 2014-15.

Finance Minister Jim Flaherty said the budget would be in surplus the following year, provided all went according to plan.

"This is a tough budget," he told a news conference. "Some very difficult decisions have been made."

Canada's Conservative government has only a minority of seats in Parliament and needs the support of at least one opposition party to pass this budget and stay in power.

"There isn't enough in the way of surprises, nor any major shift here, that would set the stage for their budget not getting passed, but we'll have to wait and see," said Derek Burleton, economist at TD Securities.

As part of its plan to balance the budget, the government will also shave C$17.6 billion from its expenses over the five years to 2015, a small percentage of the C$238 billion it will spend this year alone.

It had widely telegraphed plans to limit the rate of growth in federal spending, but put more flesh on those plans in projections that analysts said were credible but tough, provided the economy keeps recovering at a healthy clip.

"To me their initial steps are fairly impressive (and) show they can impose very real restraint. But the real test will be whether the economy can withstand the very sudden ending of the stimulus program a year from now," said Doug Porter, deputy chief economist at BMO Capital Markets.

Ottawa is walking a tightrope in this budget.

On the one hand, the government must show Canadians, still shell-shocked from the worst recession in decades, that it is supporting economic recovery and creating jobs.

But it must also address widespread concerns that the budget deficit will become a longer-term, structural problem and must recognize the possibility that economic problems elsewhere will undermine its own upbeat forecasts.

Canada, with strong, well-capitalized banks, was hit less severely than most other industrialized nations during the world recession, and stimulus spending rose less steeply than elsewhere.

In an announcement that was slightly more aggressive than expected, the government said it planned to limit annual spending growth to about 2.5% - less than half the average annual increase of the previous decade.

"They are trying to stay true to their commitment in not taking the tax route to reducing that deficit and to balancing it over the medium term," said Paul Ferley, assistant chief economist at RBC.

"Their projections on program expenditure will put the deficit on a downward trajectory, but 2.5% is tight. Our expectation going into the budget was for about 3%."

About a third of the budget savings will come from a cost crackdown, including a freeze on departmental operating budgets at 2010-11 levels and frozen salaries for the prime minister and lawmakers.

The government will cap the foreign aid budget at 2010-11 levels and take a new look at defense spending once the military mission in Afghanistan ends in 2011.

Defense spending -- about one-fifth of total government direct program spending -- will keep growing after that, but at a slower pace. The government said tougher enforcement of tax laws and other smaller spending cuts also help shrink the budget gap.

The government is under heavy political pressure to balance the books. Canada, in sharp contrast to other rich industrialized nations, ran a budget surplus before the world economy melted down, and there is little political appetite for long-term deficits.

The government said Canada's deficit will peak at about 3.5% of GDP and total net debt - which includes provincial debt as well as public pension assets - as a proportion of GDP is projected to remain the lowest in the G7 at about 29% in 2014.