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Economist to Canada: In case of emergency, blow the budget

These are stories Report on Business is following Wednesday, June 26, 2013.

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Economist to Canada: In case of emergency, blow the budget
Capital Economics raises the question today of whether Canadian governments might have to pump more stimulus into the economy.

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"While we take some comfort from the recent improvement in U.S. economic activity, the global economy remains fragile and commodity prices volatile," economist David Madani said today in a report titled "In case of emergency: Blow the budget."

"In addition, overvalued housing, high household debt, low saving rate and little scope for lower interest rates all point to sub-par growth in domestic demand," he added.

"Under the circumstances, we suspect that a debate will eventually emerge over whether or not federal and provincial governments should scale back the size and speed of planned fiscal consolidation."

Mr. Madani's report came as the U.S. Commerce Department revised its look at first-quarter growth, revising it down to an annual pace of 1.8 per cent, though the Federal Reserve said last week that things were looking up.

The report also comes ahead of a Statistics Canada report on Friday that analysts expect will show the economy effectively stalled in April.

That, economists say, could mean the second quarter as a whole could see gross domestic product expand by less than 2 per cent.

"On the one hand, pressing ahead with existing consolidation plans might endanger economic growth," Mr. Madani said.

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"On the other, not pressing ahead might endanger future financial stability."

That, of course, is the conundrum all governments face, particularly in Europe, where austerity measures have hobbled some of its economies and driven unemployment to intolerable heights.

Fortunately, Canadian governments are largely in decent enough shape should severe trouble arise.

"Canada is one of the few countries that can boast healthy public finances and can afford to run sizeable fiscal deficits for an extended period," added Mr. Madani.

"Should its economy struggle this year and next, then there is still scope for policy makers to ease the pace of budget consolidation, or, in the case of an economic emergency, reverse course altogether by providing significant new fiscal stimulus."

U.S. revises growth reading
The U.S. government today took a knife to its original reading of how the economy performed in the first quarter of the year.

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According to the Commerce Department, gross domestic product expanded at an annual pace of 1.8 per cent in the first three months of 2013, down from an earlier measure of 2.4 per cent.

That's primarily because of a revision to consumer spending.

The overall revision is already causing market players to question anew the timing of when the Federal Reserve will begin to pull back from its $85-billion-a month quantitative easing program, a timeline that has caused market upheaval.

Investors don't want the bond-buying scheme to end before the economy can handle it, and the suggestion is that the central bank will begin to withdraw in the fall, and end the program completely next year.

That, however, was before today's report.

"Depending how Q2 comes in (we had a slower pace of 2 per cent penciled in ... we may take out the erasers ... if we end up with three consecutive quarter of sub-2-per-cent growth, the Fed won't taper under those conditions," said senior economist Jennifer Lee of BMO Nesbitt Burns.

"They need convincing signs of a pickup before they turn the taps."

Economist Andrew Grantham of CIBC World Markets, however, isn't so sure. He's waiting for next week's reports on manufacturing from the Institute for Supply Management and the U.S. Labor Department's reading of the labour market.

"The weaker start to the year may have some people downgrading the chances of an early tapering by the Fed, particularly if consumer spending in Q2 looks softer as a result," he said.

"However, with Q1 now well in the rear-view mirror, next week's data from the ISM and non-farm payrolls may still be more important in determining when and by how much the Fed tapers QE."

Telecom shares slip
Shares of Canada's major phone companies slumped today as analysts warned a potential entry into Canada by Verizon Communications Inc. could "disrupt the Canadian wireless market."

In their exclusive report today, The Globe and Mail's Boyd Erman, Rita Trichur and Steven Chase write that the U.S. giant is pushing ahead with plans to expand into Canada, with an initial offer for upstart carrier Wind Mobile and talks with Wind rival Mobilicity.

Verizon's initial bid for Wind values the carrier at about $700-million.

Shares of Telus Corp., Rogers Communications Inc., BCE Inc. and Quebecor Inc. fell today after the report was published.

"We believe Verizon has several advantages it could use to become successful in the marketplace, such as its advantage with U.S. roaming, capital strength and, importantly, its handset-buying power," said Desjardins analyst Maher Yaghi, also noting recent changes by the country's telecom regulator, the Canadian Radio-television and Telecommunications Commission.

"Given the recent change by the CRTC to limit postpaid contracts to two years, the handset subsidy has become a more important factor in the consumer's decision framework and Verizon's handset-buying power allows it to be more aggressive in subsidizing handsets."

BCE, Quebecor and Bell Aliant are "best positioned to weather the storm," he added.

Bombardier delays launch
Bombardier Inc. has pushed the first flight of its new C Series plane out to the end of July from the scheduled end of June date, The Globe and Mail's Greg Keenan reports.

"Based on the latest program review, the first flight will occur by the end of July," Bombardier said in a statement today.

"In order to enhance the effectiveness of the flight program, Bombardier extended the timeline slightly to allow for additional software upgrades for improved system maturity and functionality."

It's the second time, the Montreal-based transportation giant has missed the first flight deadline it set for itself.

Canada moves up
Canada has shot up in an annual ranking of countries favoured as a destination for foreign investors as our energy sparks "a wave of interest."

Canada now ranks No. 4, rising 16 spots in the A.T. Kearney ranking released today.

Ahead of Canada in the survey of senior executives in 27 countries are the United States, in top spot, China in second place and Brazil in third.

Behind Canada in the top 10 are India, Australia, Britain, Mexico and Singapore.

The United States moved up three spots to displace China at the top, where it stood last year. Canada climbed at the fastest pace among the top 25 seen as the most attractive countries for foreign direct investment.

"It is the only G7 country to recoup all of its output and employment losses since the recession," the A.T. Kearney report said, noting that foreign direct investment in Canada surged in 2011 to almost $41-billion (U.S.) from $23.4-billion a year earlier.

"Manufacturing remains a primary target, attracting about one-third of FDI," the report said.

"Canada is the first G20 country to offer a tariff-free zone for manufacturers, and by 2015 all industrial tariffs have been eliminated across the country."

The report also cited recent takeover, partial investments and joint ventures in Canada's oil patch, where American, Chinese and Malaysian companies have invested billions.

"The country's oil and gas boom is attracting a wave of interest, as Canada boasts the largest reserves in the world in which private companies can invest," A.T. Kearney said, though rules covering the oil sands have now changed.

More questions than answers?
Observers are trying to figure out just what President Barack Obama is signalling when it comes to the Keystone XL pipeline, but some still expect it will get the go-ahead.

What the president said yesterday is that the massive project will be approved only if it "does not significantly exacerbate the problem of carbon pollution."

What he meant depends on who you listen to, given that supporters and opponents alike said they were buoyed by his comments on the proposed pipeline, which would carry some one million barrels a day of Alberta crude to the Gulf coast.

Which suggests, of course, that the situation remains as confused as it ever was.

"In short, the speech raised more questions than it answered about a piece of infrastructure that is undoubtedly of tremendous importance to the Canadian economy and to ongoing U.S. energy policy - and one whose future is still a matter of public policy debate in the U.S.," said economists Derek Holt and Dov Zigler of Bank of Nova Scotia.

As The Globe and Mail's Paul Koring and Steven Chase report, Keystone XL figured prominently as the president unveiled his climate change policy in Washington.

A decision on the TransCanada Corp. project is expected later this year. It has already been rejected once, forcing the Canadian company to change the planned route to skirt an environmentally sensitive region in Nebraska.

Analysts say the project is crucial for Canada amid stubborn pipeline constraints. Economists at CIBC World Markets calculate that Canada would lose out on a potential $50-billion over a three-year period because of those troubles.

Scotiabank's Mr. Holt and Mr. Zigler pointed to two of the president's comments in particular:

  • “Our energy strategy … [has] certainly got to be about more than just building one pipeline.”
  • “Allowing the Keystone pipeline to be built requires a finding that doing so would be in our nation’s interest. And our national interest will be served, only if this project does not significantly exacerbate the problem of carbon pollution. The net effects of the pipeline’s impact on our climate will be absolutely critical to determining whether this project is allowed to go forward.”

"The nuance of the language is important: The speech referred to the fact that the State Department is evaluating whether or not Keystone 'exacerbates the problem of carbon pollution,'" the Scotiabank economists said.

"Preliminary findings by the State Department indicated that global carbon pollution is less of a concern with respect to Keystone XL as oil sands development would happen without the pipeline - the exact language reads 'approval or denial of the proposed project is unlikely to have a substantial impact on the rate of development in the oil sands, or on the amount of heavy crude oil refined in the Gulf Coast area' … That text is taken from the 'Draft Supplementary Environmental Impact Statement' – but is that the final word?"

Analyst Robert Kwan of RBC Dominion Securities believes there was little in the president's speech to move the ball, citing the finding of the Draft Supplementary Environmental Impact Statement that greenhouse gas emissions from the pipeline are projected at 31.9 million metric tons annually, or the equivalent of the electricity used by about 398,000 homes.

"Over all, our initial thought is that there was little said that changes our 75-per-cent probability that the Keystone XL project will receive its presidential permit by the end of the year," he said in a research note.

"It is our opinion that the electricity consumption of 398,000 households is not an amount of carbon emissions that would 'significantly exacerbate' carbon pollution," he added.

Patricia Mohr, one of Canada's leading commodities analysts, is in China and so did not hear the president's speech, but she believes the project will win approval at the end of the day.

"The decision on Keystone XL will be made on wider grounds – economic as well as based on international relations," said Ms. Mohr, also of Scotiabank.

"I believe Keystone XL will be approved because of the long-term trade relationship with Canada."

The final decision, whatever it may be, will have a marked impact that goes beyond the energy industry, to the point of possibly moving the Canadian dollar.

"The approval of Keystone XL would suggest that it would be viewed as being positive economically for Canada, and that in turn would be positive for CAD," said chief currency strategist Camilla Sutton, a colleague of the other Scotiabank analysts, referring to the currency by its symbol.

"If it went the other way, it would be viewed the other way … because it would fail to ease the bottlenecks."

Gold, silver slip
Gold and silver prices slumped again today, bullion heading ever closer to the $1,200-an-ounce level.

Gold is now at its lowest in some three years as precious metals come under "heavy assault," as Robert Kavcic of BMO Nesbitt Burns put it.

"Note that prices have now plunged more than 30 per cent from their October 2012 high, with losses accelerating in recent weeks as the U.S. dollar has firmed and Fed tapering approaches," Mr. Kavcic said of gold, referring to the U.S. central bank's plan to begin pulling back from its aggressive bond-buying stimulus later this year, probably in the fall.

Italy faces losses
Italy is facing the possibility of billions in losses on derivatives contracts, The Financial Times reports today.

The report cites Italy's restructuring of eight contracts with foreign financial institutions, valued at almost €32-billion.

The news organization says it has a confidential Treasury report that highlights the "financial tactics" used by Rome to allow it to join the euro zone in 1999.

No banks are named, but The Financial Times says the Italian government was "flattering its accounts" via bank payments up front that let Italy meet deficit goals.

Contracts were restructured during the depths of the crisis in the euro zone.

There are suggestions that the restructuring could mean up to €8-billion in losses Italy spread out payments, meaning more onerous terms at times.

Italy responded, saying the contracts were hedges.

"Italian spreads are tighter on the day, largely ignoring the derivatives story in favour of the short-covering mood," said senior currency strategist Elsa Lignos of RBC Europe.

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More


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