Analysis: Canada’s Trudeau Should ‘Trim the Sails’ on Spending, Economists Advise

By Fergal Smith, Steve Scherer

OTTAWA – As Canada faces the possibility of a recession and grapples with the highest debt servicing costs in over two decades, economists are urging Prime Minister Justin Trudeau to rein in government spending. They stress the need for fiscal responsibility to avoid future policy constraints.

Trudeau’s Liberal government has built a reputation for ambitious spending, initially pledging to run deficits in 2015 to improve public infrastructure, which helped secure their election victory. The government then experienced an unprecedented rise in borrowing during the pandemic, resulting in the largest deficit in Canadian history.

Currently, the cost of servicing debt is approaching a significant threshold of 10% of revenue, a level deemed critical by some economists to prevent future generations from bearing an undue burden or risking cuts to essential government services. Analysts warn that these costs could escalate further due to recent increases in global bond yields.

Doug Porter, chief economist at BMO Capital Markets, noted that failing to control spending risks allowing market forces to dictate fiscal policy. "I do think they have to trim the sails a bit," he remarked, highlighting the need for caution in financial management.

Anticipating future expenditures, Finance Minister Chrystia Freeland plans to announce new measures in an upcoming Fall Economic Statement, expected soon. These measures may focus on assisting Canadians with housing and affordability challenges.

In its defense, the finance ministry pointed to data from the International Monetary Fund, asserting that Canada maintains the lowest deficit and net debt-to-GDP ratio among G7 nations. Katherine Cuplinskas, a spokesperson for the ministry, declared, "Canada’s economic plan is sound, sustainable, and fiscally responsible."

However, Trudeau is currently facing plummeting poll numbers, and unlike in 2015, increased deficit spending could exacerbate his popularity issues while undermining the Bank of Canada’s efforts to control inflation. The central bank governor has indicated that under current spending plans, both federal and provincial governments are likely to contribute to inflation in the coming year. Macklem emphasized the importance of aligning monetary and fiscal policy to effectively reduce inflation.

The Trudeau administration claims to be committed to maintaining a downward trajectory for the debt-to-GDP ratio over the medium term. Nevertheless, analysts stress that there is limited room for additional spending, especially given that the economy may already be in a shallow recession.

While Canada has the lowest general government net debt among G7 countries, its gross debt is estimated to be around 106.4% of GDP in 2023—higher than that of Germany and the UK.

This year, the government has continued to invest in various initiatives, including subsidies for the electric vehicle supply chain and tax exemptions for new rental apartment construction. Desjardins economist Randall Bartlett warns that the government is quickly depleting its fiscal space, noting that previous estimates of sustainable spending may no longer hold true.

High issuance of treasury bills in recent months also suggests potential challenges in government finances, according to Simon Deeley, director of Canada rates strategy at RBC Dominion Securities.

If the opposition New Democrats continue to support his minority government, Trudeau could govern for another two years before facing elections. However, their support comes with substantial demands, such as implementing a national prescription drug program, which is estimated to cost C$11.2 billion in its first year.

Robert Asselin, senior vice president of policy at the Business Council of Canada, warned that if the government pursues aggressive spending initiatives like pharmacare or housing support, it could attract scrutiny from credit rating agencies.

Fitch Ratings downgraded Canada’s credit rating to below triple-A in June 2020, citing pandemic-related expenditures. However, other major agencies still maintain the highest ratings for Canada.

S&P Global Ratings’ lead analyst for Canada, Julia Smith, noted that rising debt servicing costs, combined with slowing growth, will necessitate careful considerations regarding future policy initiatives.