Federal budgets will be in deficit over the next few years but Canadians likely won’t be saddled with the massive debt and interest costs that plagued the country 20 years ago, notes a new report from CIBC World Markets.

“Canada’s fiscal standing is hardly at risk,” say CIBC’s chief economist Avery Shenfeld and senior economist Warren Lovely in the report that questions recent forecasts about the size, duration and impact of budget deficits to come in Canada.

Shenfeld and Lovely note that fiscal projections often understate the potential to tackle deficit challenges, and that relatively small errors in estimating future growth can see medium-term deficit projections careen wildly off the mark. This was the case following the early 1990s recession when “large surpluses seemed like a fairy tale.”

Instead, they say, the $37.5 billion deficit “was erased at a breakneck pace” and transformed into a $3 billion surplus in three years “as the business cycle swung to expansion and a ‘jobless recovery’ eventually gave way to more serious hiring and income growth.

Another vital factor in the current deficit outlook is the temporary nature of today’s high-profile stimulus efforts, including infrastructure programs with fixed termination dates.

“Nearly all of the 2009-2010 deficit was cyclical, reflecting the economic hit to revenues and one-off stimulus efforts that will be gone as the economy moves back to full employment,” say Shenfeld and Lovely.

The large role that corporate profits and rising incomes have had in creating budget surpluses in recent years will also help tackle future deficits. “Pre-recession heights in commodity prices generated huge revenue flows associated with resource royalties, and taxes on soaring corporate profits and capital gains incomes. If, as we expect, commodity prices rebound over the medium term, that could produce another material improvement in federal fortunes, even if real GDP growth is anaemic and tax losses are carried forward in the early years of the expansion.”

The CIBC economists caution that patience will be required before much fiscal progress is seen. “Results for 2010/11 will be restrained by the need to avoid a sharp belt-tightening that puts the recovery at risk.”

Shenfeld and Lovely also argue that any remaining deficit after five years point will be small enough that the debt to GDP ratio will fall, minimizing the government’s need to issue debt. Financing needs will also be reduced as the federal government cashes in on insured mortgages it recently bought.

“As a result, the current spike in Canada issuance should prove temporary even if the deficit hangs around longer than the government expects,” say Shenfeld and Lovely.

IE