IMF concerned Canadians may be piling on too much debt

The Canadian government may need to take further steps to curb the country’s still robust housing market in order to discourage growth in household debt, the International Monetary Fund says.

In its latest Western Hemisphere outlook, the Washington-based financial institution finds Canada’s overall economic situation relatively sound, but said it was concerned that Canadians may be piling on too much debt.

“Developments on the housing front require increased vigilance, and consideration may need to be given to additional prudential measures to prevent a further buildup in household debt,” it says in a section called “Canada Policy Options.”

It adds that a combination of households strapped by debt and falling home prices have the potential to damage the domestic Canadian economy by curtailing spending.

Given that the federal government is withdrawing fiscal stimulus, the Bank of Canada should and likely will retain its low interest rate policy, which encourages borrowing, the IMF said.

In fact, it suggests the central bank may actually be cutting its one per cent policy rate and, at the very least, is not expected to hike rates until well into 2013.

The IMF report acknowledges that federal Finance Minister Jim Flaherty tightened mortgage eligibility rules earlier in the year, the third such action by the government in as many years. But it says Flaherty may need to act a fourth time.

The IMF warning comes a few weeks after Statistics Canada reported that Canadian household debt had reached a record 149% of disposable income in the second quarter.

But most analysts also note that both debt accumulation and the housing market have slowed in recent months.

During a speech to a New York business audience earlier in the day, Flaherty presented Canada’s “strong and stable housing market” as a source of economic strength.

Later, he told reporters that it would take “clear evidence of a bubble” in Canada’s housing, which he said outside Vancouver’s hot market, doesn’t exist, for him to tighten rules further. In fact, he said Canada’s housing market has softened this year.

In a coincidental report, Royal LePage said Canadian home prices unexpectedly spiked by as much as 7.8% in the most recent quarter, but noted most of the gains were isolated in Vancouver and Toronto.

CIBC economist Benjamin Tal called the IMF recommendation premature at best and at worst potentially damaging to an already fragile economy.

That’s because the relatively robust housing market is one of the few remaining engines of growth in the country, he said.

“This is much premature. We are seeing very clear signs that previous measures are already working and that the mortgage market is slowing,” he said.

“If, in six months, we see marginal borrowing is starting to rise and we see (home) prices rising in a very significant way, then I would suggest (the IMF) is right. Today there is no evidence to support this kind of recommendation, because remember when you change policy it’s very difficult to reverse.”

The IMF’s report is generally positive about Canada’s economy and its fiscal policies, although it repeats the assessment it made last month that growth will be limited by the weaker U.S. economy.

As such, it downgraded prospects for Canada to 2.1% growth this year and 1.9% in 2012, half a point lower than its spring outlook. It notes that global factors are contributing to an economic divide between resource-rich regions, mostly in the West, and weakness in Central Canada more tied to manufacturing and exports.

“Significant risks,” remain, it adds, stemming from “the uncertain global environment, as well as potential fragilities in domestic consumption” as households trying to cope with large debts hold back on purchases.