This is the last in a series of reports on what to expect in Wednesday’s federal budget and how the financial services sector may be affected. On Wednesday, Investment Executive will provide full coverage of the budget beginning as soon as Finance Minister Ralph Goodale begins speaking in the House of Commons, around 4 p.m. ET.


As Finance Minister Ralph Goodale prepares to hand down his budget Wednesday, he does so knowing that the economic outlook has deteriorated since his economic update in November, thanks in large part to the strength of the Canadian dollar.

Economists have scaled back their estimates for growth for this year and upped their forecasts of where the C$ will be at the end of the year. TD Economics and Bank of Montreal Economics have lowered their forecasts for growth this year to 2.7%-2.8% vs the 3.5% they were expecting in the fall, while CIBC World Markets now is predicting growth of 2.6% vs 3% a few months ago.

On the C$, TD predicts it will finish at US84¢ at yearend vs an earlier call of US$79¢, while BMO now forecasts the dollar at US80.7¢ vs US77.7¢ earlier; CIBC WM continues to predict the dollar at US76.9¢. TD now expects the three-month treasury bill rate will be 3% by the end of this year vs 4%, while BMO is predicting 2.8% vs 3.5%, and CIBC WM is forecasting 2.25% vs 2.85%.

Finance’s economic assumptions are based on the average predictions of 20 private sector forecasters. If TD, BMO and CIBC WM are typical, the budget will be based on real gross domestic product rising this year by between 2.6% and 2.8% rather than the 3.2% assumed in Ottawa’s November update. Similarly, the forecast for the three-month T-bill rates average has dropped to between 2.5% and 2.7% vs 3.2%.

The impact of a one percentage point change in the growth assumption is greater than that of a sustained 100 basis-point change in interest rate assumptions — $2.5 billion in the first year vs $1.1 billion, and $2.6 billion vs $1.5 billion in the second year.

Once the economic assumptions have been established, Finance gets four forecasting groups to develop detailed fiscal projections, which it then uses to generate its budgetary projections. The four groups are Global Insight, University of Toronto and the Centre for Spatial Economics, all based in Toronto, and Ottawa-based Conference Board of Canada.

Finance sets aside $3 billion a year as a contingency reserve to cover unexpected expenditures. Funds are also kept back for economic prudence for unanticipated revenue shortfalls due to slower growth; the amount rises from $1 billion in Year One to $4 billion in Year Five. The economic prudence disappears by the fall of the fiscal year in question. Any unused contingency reserve at the end of the year is supposed to be put to deficit reduction rather than used to cover spending in future years.

This budget process tends to underestimate the surplus that actually occurs, but it is also responsible for the rapid decline in public debt as a percentage of GDP.

In its November update, Finance said it estimates public debt will have declined to 38.6% for March 31, 2005, down from a peak of 68.4% at March 31, 1996. The government has a target of 25% within 10 years, a goal most experts think can be met as long as the government of the day avoids deficit financing and continues to put aside funds for contingency reserves and economic prudence.

Finance continues to try to improve the budget process. Tim O’Neill, retiring chief economist at Bank of Montreal, is leading an independent review to “identify and access the source of differences between the budget and the fall update fiscal projections and the outcome.” The review will make recommendations for “improving the accuracy of economic projections, improving the preparation and accuracy of fiscal projections and addressing ways of dealing with uncertainties in economic and fiscal forecasting.”

The report and recommendations are expected shortly.