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Canada to Use Revenue Windfall to Eliminate Net Debt (Update8)
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By Theophilos Argitis
Nov. 24 (Bloomberg) -- The Canadian government will seek to become the first Group of Seven nation to bring debt levels in line with assets, as it benefits from revenue windfalls stemming from the largest oil reserves outside of the Middle East.
Finance Minister Jim Flaherty moved the country in that direction by pledging yesterday to buy back C$3 billion ($2.63 billion) in bonds each year, as part of a plan to eliminate the country's ``net debt'' by 2021. He also forecast combined budget surpluses of $50.1 billion over six years, according to a fiscal update released in Ottawa late yesterday.
Flaherty's plan builds on a 10-year effort to improve Canada's competitiveness and prepare for an aging population by balancing its budget and cutting debt. Canada was the only Group of Seven country to post a budget surplus last year as the economy benefited from higher commodity prices and record corporate profits.
``Whatever bragging rights that brings, the fact is the lower debt burden you have, the more maneuverability you have down the road,'' said Tim O'Neill, president of O'Neill Strategic Economics and former chief economist at the Bank of Montreal.
Canada's bonds and the currency rose, with the yield on the 10-year note falling to 3.97 percent. The price of the 4 percent security maturing in June 2016 rose to C$100.24. The dollar rose 0.55 percent to 88.06 U.S. cents, the biggest gain in four weeks.
Canada would join countries including Australia, Norway and Finland that have eliminated their net debt, based on figures from the Organization for Economic Cooperation and Development. The Paris-based economic group defines net debt as total obligations of all levels of government, minus assets such as government pension funds.
Nine Surpluses
Canada has posted nine straight years of budget surpluses, allowing it to reduce debt by C$80 billion since 1997. The government estimates the surplus at C$7.2 billion in the year ending in March.
Canada's net debt has fallen to 30 percent of gross domestic product, less than half the rate a decade ago, and well below the average of 52.7 percent for the G-7 countries.
The country's falling debt level has bolstered investor confidence and helped fuel a 38 percent gain in the Canadian dollar over the past four years, the fifth-best performance against the U.S. dollar over the period. The currency reached a 28-year high on May 31.
Net Debt
The surpluses and rising output from Alberta's oil sands allow Flaherty to set out for the first time a target to eliminate the net debt. Flaherty, whose Conservative Party government has been in power since February, said the net debt would be about zero in 15 years because the assets of the Canada and Quebec pension plans will rise fourfold to about C$427 billion.
That will almost match the combined federal and provincial government debts, which are currently about C$525 billion. The federal government debt alone would decline to about C$280 billion from C$353 billion, he said, assuming the government continues to pay back C$3 billion each year. The target also assumes the provincial governments balance their budgets.
Flaherty was accused by opposition lawmakers of using an obscure net debt measurement. The reduction in net debt stems from an expected increase in pension plan assets, not an acceleration of debt repurchases, said John McCallum, the Liberal Party's finance critic.
``It's a pure gimmick,'' McCallum said. ``It's absolutely misleading to talk about eliminating the debt.''
Dominion Bond Rating Service said today that while the plan is ``optimistic'', it will likely result in further credit improvement.
Bonds Remain
The debt reduction may not have a significant impact on the bond market because the stock of government bonds won't be eliminated, economists said.
``While it was a grand announcement of an objective that perhaps all governments should work toward, it doesn't change anything in terms of the way the government is going to be behaving,'' said Ted Carmichael, an economist with JP Morgan Securities in Toronto. ``The financial markets shouldn't have any reaction at all.''
And some economists said the money reserved for debt payments could have been better used for investments or larger reductions in taxes.
``I am really surprised to see the heavy emphasis on debt elimination,'' said Todd Hirsch, chief economist of the Canada West Foundation, a public policy research group based in Calgary. ``When you're doing it at the expense of every other priority, it's akin to a family taking out a mortgage and not feeding the children until the mortgage is paid off.''
Productivity
Flaherty said he would seek in coming years to boost productivity by reducing taxes on savings, including capital gains. Canada will seek to have the lowest tax rates on new investments in the G-7, he said. He didn't say how much the measures would cost. And any unforeseen surpluses in coming years would be used to reduce personal income taxes, he said.
The government plans to put interest savings toward reducing income taxes, starting with C$800 million worth of tax cuts in next year's budget, and rising to C$1.4 billion in 2011, Flaherty said.
Flaherty also pledged to start slowing spending growth to below the pace of economic expansion. Total expenses are forecast to grow 3.9 percent next year, compared with 6.3 percent for the current fiscal year.