The International Monetary Fund (IMF) Mission on Canada report released today credits the government and the central bank with keeping Canada’s economy in fighting shape.

The report points out that Canada’s economy has outpaced those of many of the major industrialized countries.

“The IMF report confirms that we are on the right track with our long-term economic plan, Advantage Canada,” said Jim Flaherty, minister of finance, in a release. “Our economic fundamentals are as strong as the Canadian Shield due in large part to our commitment to ongoing debt reduction, tax cuts and focused spending.”

But the report also forecasts that the economy will slow in the next few quarters. “The drag from external factors should intensify with a weakening U.S. economy and recent currency appreciation,” states the IMF. “Domestic demand is expected to moderate as financial conditions tighten and real income growth normalizes.”

“While the IMF report overall is very positive, it highlights the fact that we still have work to do to improve our productivity and competitiveness,” said Flaherty.

This year’s IMF report card notes that the government’s October Economic Statement should have allocated the budget surplus to reducing high marginal effective tax rates on capital, saving, and labors to foster efficiency. “Instead, the main tax relief measure in the Statement is a one percentage point cut in the federal GST rate to 5 percent.”

The IMF lays out what it views as the major policy challenges facing the Canadian government: managing conflicting risks from domestic demand and external/ financial conditions; adjusting to the high dollar and promoting rapid productivity growth; safeguarding financial stability given the strains while fostering innovation; and further improving the tax system’s efficiency while maintaining a sound fiscal position.

“Domestic demand could remain stronger than expected, given the recent boost to real incomes from oil prices and currency appreciation,” predicts the IMF. “Nevertheless, large downside risks to growth increasingly outweigh the significant upside potential, given a possible U.S. recession and risks that global financial conditions could tighten further.”

The IMF report goes on to say that Canada’s adjustment to the volatile dollar has been “remarkably smooth” thanks in part to flexible labour markets. “Employment gains in services, construction, and mining as well as interprovincial migration have more than offset manufacturing job losses in the central provinces,” the report says.

The report looks favourably on the Bank of Canada’s response to risk in financial markets, its success in keeping the overnight rate close to target and its framework for assessing exchange rate fluctuations.

The asset-backed commercial paper (ABCP) situation still remains a major risk to investor confidence, according to the IMF. It blames the market standstill that started in August on weak investor due diligence, ratings that neglected liquidity risks, and a lack of transparency. The IMF welcomes the federal government’s efforts to support an restructuring of third-party ABCPs, in order to reinforce investor confidence and avoid further strains on already illiquid markets for structured credit products.

Overall, the report concludes that the Canadian financial system appears to be in a position to weather financial turbulence.