Scenario Analysis: COVID-19 Pandemic and Oil Price Shocks

At present, the economic and fiscal outlook is extremely uncertain. Notwithstanding the elevated uncertainty surrounding the outlook, this report provides a scenario analysis to help parliamentarians gauge potential economic and fiscal implications of the COVID-19 pandemic and recent oil market developments.

The scenario under consideration is but one of many possible outcomes. As more data and information become available, PBO will update its scenario analysis as necessary. We stress that this scenario is not a forecast of the most likely outcome. It is an illustrative scenario of one possible outcome.

  • We assume that the current COVID-19 social distancing and self-isolation measures will remain in place through August, lasting roughly 6 months in total.
  • We assume that members of the Organization of the Petroleum Exporting Countries (OPEC) and its partner countries will not limit oil production to target relatively balanced global oil markets.

In our first scenario analysis, we limit the horizon to focus on the near term exclusively, that is, the quarterly profile through 2020 and fiscal years 2019‑20 and 2020-21.

Economic scenario

We develop an economic scenario based on assumptions related to the economic impact of the COVID-19 pandemic and oil market developments that are informed by past events such as the Global Financial Crisis (GFC) in 2008-2009, as well as a bottom-up assessment of affected industries. However, we do not attempt to identify the individual contributions from each of these shocks.

In our economic scenario, real GDP is assumed to decline by 2.5 per cent in the first quarter of 2020 and then again by 25.0 per cent in the second quarter (both at annual rates).

  • For 2020, real GDP growth would be -5.1 per cent, the weakest on record since 1962. Compared to our November 2019 projection, annual real GDP growth would be 6.5 percentage points lower.

Lower commodity prices would also drive GDP inflation lower, resulting in a decline in the aggregate price level of the economy.

  • The decline in real GDP and the GDP price level combine to reduce the level of nominal GDP—the single broadest measure of the Government’s tax base—by $218 billion in 2020 compared to our November 2019 projection.
  • The unemployment rate in our scenario is assumed to rise to 15.0 per cent in the third quarter.

Fiscal scenario

To generate our fiscal scenario, we simulated our projection model using the economic scenario, applying judgement in some cases to better capture the fiscal impact of the economic downturn on certain revenue and spending components.

Our fiscal results include $28.5 billion in direct federal support measures that were announced on March 11 and March 18. The value of these measures is based on Finance Canada’s estimates and assumes that “up to” amounts will be fully spent in 2020-21.

PBO will be providing an independent costing of key support measures in future reports. Additional fiscal policy measures beyond those announced as of March 23 are not included in this scenario—in particular, the un-costed portions of Bill C-13.

  • Based on our economic scenario, the budget deficit would increase to $26.7 billion in 2019-20 and then to $112.7 billion in 2020-21.
  • Relative to the size of the Canadian economy, the deficit would be 1.2 per cent of GDP in 2019-20 and 5.2 per cent of GDP in 2020-21.

To put this in historical perspective, the last time the budgetary deficit was near 5.2 per cent of GDP was in 1993-94. Compared to our November projection, the deficit is $5.5 billion higher in 2019-20 and $89.5 billion higher in 2020‑21.

  • Rising budget deficits and lower nominal GDP push the federal debt-to-GDP ratio to 38.1 per cent in 2020-21, which is 7.5 percentage points higher than we projected in November.
  • The last time the federal debt-to-GDP ratio was above 38.1 per cent was in 2003-04. This level, however, remains well below the peak (since 1966-67) of 66.6 per cent of GDP reached in 1995-96.

While additional fiscal measures will likely be required to support the economy in the coming months, the Government’s balance sheet prior to these shocks was healthy.

However, even after additional support measures are provided, fiscal stimulus measures may be required to ensure that the economy reaches lift-off speed especially if consumer and business behaviour does not quickly revert back to “normal” conditions.

Given credit market access at historically low rates, and looking to historical experience, suggests that the Government could undertake additional significant borrowing if required.