Housing market cool-down, spending cuts and tax rises to be the heated issues of 2015?

This modest-looking house on Vancouver’s east side was sold for $774,900. Overvalued, a bargain, or priced just right? (Click for source.)

When the analysts at the International Monetary Fund (IMF) speak, the world’s governments listen — or at least they should. Several IMF staff arrived in Canada recently to give our country a thorough economic check-up, and today they released their findings.

Thankfully, there were some positive comments in their report. The IMF noted that Canada’s economic performance “has been solid in recent quarters”, “economic slack has been gradually declining” and that the country has “an improving labor market”.

The IMF was also particularly pleased with the strength of the Canadian banking system, which they described as being “highly profitable, with favorable loan quality, low nonperforming loans, and improving capitalization.”

But the IMF also saw some creeping problems that they felt Canada should make an effort to fix before they get out of hand.

One such area was the housing market, which the IMF suggested was showing signs of being over-priced. While some of this was driven by normal supply-and-demand factors, such as a growing number of households and land scarcity in larger cities like Toronto, Vancouver and Calgary, fast growth in the number of uninsured mortgages was seen as a troubling sign.

The IMF’s openly expressed worries about “overvaluation” and “vulnerabilities” in the housing market increases the probability that the federal Finance department will push for even tighter rules in 2015 to prevent higher-risk mortgages from ever being approved — a sound move, but one that wouldn’t necessarily be popular with rejected applicants or the real estate industry.

Even more controversial changes in 2015 could come from the IMF’s displeasure with the provincial governments’ difficulties in balancing their budgets — a task complicated by the growing number of older people who both pay less in tax and are more reliant on government services.

The most controversial proposal of all is cleverly concealed in what might appear to the reader as bureaucratese:

Consolidation plans at the provincial level should proceed, especially in provinces with higher levels of public debt. While adjustment plans rely on ambitious expenditure restraint, raising concerns about their durability, it would be essential for provinces to successfully pursue strategic spending reviews. Still, the adjustment plans may need to be complemented with revenue measures to meet balanced budget targets.

A rough translation into Plain English would go something like this: “Governments are naïve if they think they’re going to balance their budgets by ‘getting rid of waste’ and ‘finding efficiencies’. They are going to have to say ‘no’ to some spending requests, including indirect spending such as tax credits, even if this makes them unpopular. If that doesn’t cover the shortfall — and it likely won’t — they’re going to have to find ways to pull in more money, such as through fees, fines, taxes, and ‘unbundling’ some of their services.”

 

Canada’s strengths heading into 2015:

• The IMF notes that the job market has been heading in the right direction during most of 2014, and that inflation, while inching upward, remains under control.
• Household debt has stabilized — though it is still high, at more than 150 percent of disposable income.
• The U.S. economic recovery and a lower Canadian dollar should be good for Canadian exports and business investment in 2015.
• A profitable, stable banking system “resilient to credit, liquidity, and contagion risks”. Yet the IMF cautions that Canadian banks face risks from capital markets and their own foreign operations, which should be kept an eye on so that problems are fixed early on.
• The federal government’s expected return to a balanced budget in 2015-16  should make it easier for Ottawa to pursue useful goals such as increasing the amount of research and development that takes place in Canada, encouraging businesses to invest more and to improve their productivity, or reducing federal income taxes.

 

Canada’s weaknesses heading into 2015:

• The IMF notes that Canadian businesses have been slow to invest in recent years, and much of their job-creation has been of the part-time and temporary variety.
• Overvalued housing, driven in part by normal supply-and-demand, but complicated by high-end buyers and a growing use of poorly insured mortgages. Reforms to prevent buyers from taking on mortgages that might later turn out to be unaffordable would be a good idea, even if controversial.
• If oil prices continue to drop, the economies of the oil-rich provinces (particularly Alberta) will begin to slow down. The IMF notes, however, that this might be partially offset by better growth opportunities in manufacturing and services.
• More could be done to improve oversight of the financial services industry in Canada, with this job now being split between federal and provincial regulators. While progress has been made in closing these gaps, federal and provincial regulators need to work more closely together.
• The provinces remain prone to running deficits, and the growing number of older people in the population adds to the financial pressure. They will sooner or later have to make tough choices that could include both cutting spending and getting their hands on more money.
• Productivity could be better. Contrary to popular belief, this doesn’t mean spending more evenings and weekends at the office; but it might mean making some controversial choices such as entering into more international trade deals, opening protected industries to more competition (which could include scrapping foreign ownership limits) and getting energy exports to market more quickly (think Keystone XL Pipeline).