Canadian economic recovery could take longer than US, says RSM

23 April 2020 Consulting.ca

Canada’s economic recovery from the Covid-19 pandemic will likely take longer than in the US, due to a number of pre-existing conditions. RSM Canada’s first quarterly economic report of 2020 focused on the coronavirus headwinds battering the Canadian economy.

Covid-19 initially caused an unprecedented supply shock, disrupting the global supply chain in Asia. Those supply chain disruptions spread to the West alongside the virus, while quickly turning into demand shocks as shelter-in-place and social distancing policies were enacted.

Thankfully, monetary authorities prevented the subsequent financial system shock from turning into a broader financial and banking crisis through the enactment of activist and globally coordinated monetary policy.

The Bank of Canada set interest rates to 0.25%, injected liquidity into money markets to maintain short-term funding, and purchased government securities to force lower long-term interest rates and encourage investment.

As a result, the recovery will not be L-shaped like the Great Depression, according to the RSM analysis. However, the Canadian economic recovery is likelier to be a U-shaped recovery than the V-shaped recovery of the US, due to a number of factors.

Real business investment growth and Household debt-to-GDP ratio

The Canadian economy was already showing weakness before the pandemic, with GDP growth underwhelming and slowing down. Meanwhile, the US-China trade war had negatively impacted Canada due to its close integration with the US – with uncertainty driving lower business investment. Outside of residential structures, business investment decreased significantly in the past couple of years.

The oil price crash will also lower Canadian exports. Energy products, including petroleum, accounted for 21% ($124 billion) of Canadian exports in 2019, while automobiles and auto parts were 14% ($86 billion). Both category exports are expected to decline significantly.

Household debt levels in Canada are also the highest in the G-7, buoyed by a housing market that has refused to cool down. Household debt as a proportion of GDP was 102% in Canada as of Q3 2019, compared to 76% in the US. Debt levels could increase further because of the economic fallout of the pandemic.

Finally, Canadian fiscal policy has been more reserved relative to the US, where the initial stimulus package is 10% of GDP. In Canada, the initial economic stimulus package plus the emergency wage subsidy amount to 3% of GDP.

"Measures being taken to stem the spread of COVID-19 have ravaged Canada's economy," said Alex Kotsopoulos, vice president, projects and economics with RSM Canada. "As we look ahead to recovery, we expect it will be more tepid than originally thought and, unfortunately, for a variety of reasons it will take longer for us to rebound in Canada than the U.S."

The report also noted that the RSM Canada Financial Conditions Index dropped by four to seven standard deviations because of the Covid shock. The index is a composite measure of risk being priced into financial assets, and would normally fluctuate within two standard deviations above or below normal stress levels. Four standard deviations below normal conditions suggests “disturbing circumstances,” and seven suggests the country is on the verge of a financial crisis rivaling 2007-2009.

As of March 31, the equity market was 9.7 standard deviations below normal levels, the money market was 2.1 below, and the bond market was 4.2 below.


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