Canada is well on the way to slashing its fiscal deficits in half, but getting them all the way to zero is likely going to involve some hard work ahead, TD Economics says in a new report.

TD says that the latest G20 commitments to halve budget deficits by 2013 and stabilize debt-to-GDP ratios by 2016 appear to be well within reach for Canadian governments. It notes that federal and provincial budget plans project that combined deficits will fall by about 60%, to $35 billion, by fiscal year 2012-13.

“But as longer-term budget plans highlight, the more difficult challenge is likely to be the second phase of fiscal consolidation – that is, moving from the intermediate targets to zero deficits,” TD says.

“Over this longer-term time frame, a number of headwinds are expected to intensify,” TD says, noting that long-term economic growth, and government revenue growth, is expected to be relatively lacklustre; and debt-service costs are projected to rise steadily over the next five years. These dual forces are pushing governments to budget for program spending growth of about 2% on average after fiscal 2011-2012. “Even then, the pace of deficit reduction slows dramatically,” TD notes.

“Meanwhile, it remains unclear how provinces in particular will meet these longer term spending targets in view of underlying age-related (e.g. health care) funding pressures,” it adds.

“While governments in Canada have been at the forefront of laying down deficit elimination targets, much of the hard work is just beginning,” TD cautions.

Moreover, while there are short-term risks to the upside, the withdrawal of fiscal stimulus over the next couple of years is expected to impact growth on the downside. TD estimates that current fiscal policy plans will shave an average of 0.2 to 0.4 percentage points from annualized real GDP growth. “In other words, after aiding through the recession and initial stages of the recovery, fiscal policy will turn into a modest headwind,” it says.

“For the longer-term, we remain concerned that economic growth might prove disappointing and/or debt-service costs rise more than expected,” it says. “Another long-term risk surrounds health care. Past experience shows that savings without fundamental reform just delays cost pressures into the future.”

Nevertheless, it notes that deficit elimination remains an iterative process “where markets will continue to watch for clear and credible fiscal adjustment measures to eliminate deficits as soon as reasonably possible once the economic recovery is self-sustaining.”

“The degree of fiscal austerity needed will continue to vary depending on the specific economic outlook, overall indebtedness levels, civil service buy-in, and political choices,” it concludes. “Canada’s federal and provincial governments have ample opportunity to show resolve and results to further distinguish themselves on the international stage.”

IE