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Economic and Fiscal Outlook - April 2017.pdf
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This report responds to the 4 February 2016 Standing Committee on Finance motion. It incorporates data available up to and including 21 April 2017.
We expect real GDP growth to rebound from 1.4 per cent in 2016 to 2.5 per cent in 2017 and 2.1 per cent in 2018. We assume that delayed federal fiscal measures will boost economic activity in 2017 and 2018 while growth in exports and business investment picks up.
Overall, real GDP is expected to grow, on average, at 2.0 per cent annually over 2017 to 2021, essentially the same as projected in October. We continue to anticipate a recovery in non‑residential business investment and non‑energy exports as well as a significant decline in residential construction activity.
GDP inflation (a measure of economy-wide price increases) is projected to rise from 0.6 per cent in 2016 to 2.7 per cent in 2017 and then average 2.0 per cent annually over the remainder of the projection horizon. Nominal GDP—the broadest single measure of the tax base—is projected to grow at 4.1 per cent annually, on average, over 2017 to 2021.
Average annual nominal GDP growth of 4.1 per cent over 2017 to 2021 is the same as we projected in October. Adjusted for historical revisions, the level of nominal GDP is, on average, $10 billion (0.4 per cent) higher per year over 2017 to 2021 compared to October. This is due to stronger‑than‑anticipated nominal GDP growth in the second half of 2016. We have also revised upward our outlook for Canadian long-term interest rates, reflecting higher-than-anticipated U.S. long-term rates.
PBO’s economic outlook reflects the view that possible upside and downside outcomes are, broadly speaking, equally likely. In terms of downside risks, we believe that the most important risk is weaker business investment. In terms of upside risks, we believe that the most important risk is stronger household spending. To illustrate the uncertainty surrounding PBO’s nominal GDP projection, we have constructed confidence intervals around our projection. Relative to our baseline nominal GDP growth projection, 30, 50 and 70 per cent confidence intervals are consistent with average nominal GDP growth of ±0.5, ±0.8 and ±1.3 percentage points respectively.
We expect that the budgetary deficit will be $20.7 billion (1.0 per cent of GDP) in 2016-17. This is $1.6 billion lower than we projected in October. The smaller deficit is mainly attributable to higher estimated income tax revenues, especially from corporations.
However, we are projecting budgetary deficits that are $2.2 billion larger, on average, over 2017-18 to 2021-22 compared to October. This is primarily due to higher program spending. More than half of the projected spending increase reflects new policy decisions, such as the indexation of children’s benefits as well as higher transfers to subnational governments for infrastructure and health care. In addition, higher interest rates contribute to increased public debt interest costs over the medium term.
In Budget 2016, the Government committed to returning to balanced budgets and to reducing the federal debt‑to-GDP ratio to a lower level over a five-year period ending in 2020-21. The debt target translates into a federal debt-to-GDP ratio of 31.0 per cent (or lower) in 2020‑21. Under current tax and spending plans, we project that the federal debt-to-GDP ratio will be 29.6 per cent in 2020-21, 1.4 percentage points of GDP lower than the Government’s targeted level. As such, the Government has flexibility within its current fiscal plan to reach its medium-term debt-to-GDP target.
To illustrate the fiscal implications of the uncertainty surrounding our economic outlook, we mapped the distributions of alternative economic scenarios into budgetary components. Given the possible scenarios surrounding our economic outlook, and on a status quo basis, it is unlikely that the budget will be balanced, or in a surplus position, over the medium term. We estimate that in 2019-20 there is, approximately, a 15 per cent chance that the budget will be balanced or in a surplus position. The probability of budgetary balance/surplus rises to 20 per cent in 2020-21 and to 30 per cent in 2021-22.
However, it is likely that the federal debt-to-GDP ratio will fall below its 2015‑16 level of 31.0 per cent over the period 2017-18 to 2021‑22. We estimate that in 2020-21 there is, approximately, a two-thirds chance that the federal debt-to-GDP ratio will be below its 2015‑16 level.
Budget 2017: Key Issues for Parliamentarians
The presentation of the fiscal plan
The Government continues to improve the transparency and accessibility of its fiscal plan. However, there remain further opportunities for improvement. For instance, the budget continues to lack detail regarding the sources of reallocated funding and the consequential impacts on programs. In addition, there continues to be a misalignment between the budget and departmental plans for 2017-18.
Budget 2017 economic outlook
Notwithstanding the uncertainty and downside risks that continue to weigh on the domestic and global economy, PBO judges that there is upside risk to the private sector outlook for nominal GDP in Budget 2017. This risk stems from using an outdated survey from December 2016 that did not incorporate the stronger-than-expected economic releases prior to Budget 2017.
Budget 2017 fiscal outlook
PBO projects budgetary deficits that are $5.9 billion lower, on average, than Budget 2017 over 2016-17 to 2021-22. This difference reflects the Government's $3 billion annual risk adjustment and PBO's stronger economic outlook.
Given the Government’s judgement that risks to the private sector economic outlook are broadly balanced, this risk adjustment suggests that the Government is taking a “prudent” approach to fiscal planning. That is, it is understating its fiscal outlook with the expectation that fiscal outcomes will exceed its projections. This approach contrasts with adjusting the private sector economic outlook to account for the balance of risks either to the upside or downside.
PBO believes that the Government’s outlook for the budgetary balance over 2017-18 to 2021-22 is overly prudent. This results from using an outdated economic outlook and from incorporating a risk adjustment despite judging that risks to the economic outlook are broadly balanced.
Federal infrastructure spending
Data from the Government’s accounting system, provincial spending and Statistics Canada all indicate that federal spending on infrastructure has lagged the timing originally set out in Budget 2016. As a result, we expect that roughly half of the proposed infrastructure money will be spent as planned in 2016-17.
PBO expects that spending will pick up in 2017-18 to above the level originally projected in Budget 2016 (112 per cent). This would result in overall infrastructure spending being close to 90 per cent of originally projected levels. Remaining money would be spent in subsequent fiscal years.
Budget 2017 provisions for 1 per cent annual growth over the medium term, implying steady declines in operating spending relative to GDP. Collective agreements promise annual wage growth in excess of 1 per cent, so other sources of savings must underpin the projection. Parliamentarians may wish to seek further detail on the Government’s strategy to manage operating expenses.