Finance Committee on April 28th, 2015

[Carolyn Wilkins]

Yes, you're correct. These are underlying improvements. But, because of the oil price shock, the situation may deteriorate in the short term. In the second quarter and throughout the rest of the year, however, we will see more significant improvements.

[Pierre Dionne Labelle, NDP, Rivière-du-Nord, QC]

I'd like to pick up on the investment rate.

We talked about the 30% drop in oil sector investment. Where do things stand in the non-oil sector, the manufacturing sector, specifically? When the dollar was quite high, we know that companies invested very little in production capacity, robotics, IT and so forth. Where does the sector stand now, versus four months ago? Has investment in the manufacturing sector picked up or is it still flat?

[Stephen S. Poloz]

That's another very complex question.

We compiled the figures, and they show that the unemployment rate will clearly rise in the oil sector and perhaps in other sectors of the supply chain, as well. These examples come from the manufacturing sector, given that we're dealing with the supply chain.

During the first month of the year, we saw mainly a negative impact. At the same time, we observed positive things. Two parallel economies exist, one that is affected by the shock and another that is picking up speed because of the shock. And both of those elements have a push and pull effect when it comes to the figures.

In the second quarter, the positive effects will be clearer, but not 100%. They will be much more visible in the third and fourth quarters.

[Pierre Dionne Labelle, NDP, Rivière-du-Nord, QC]

I'd like to raise another point, regarding the level of household debt, which has reached record highs. You are still expecting the debt to income ratio to increase.

In your view, are banks assuming too much risk by lending people money so easily? Right now, is there a risk that banks are going too far in supporting household credit?

[Stephen S. Poloz]

Households are certainly vulnerable to changes of that nature. We're talking about a vulnerability, which is not the same thing as a risk. In order to have a risk, you need a catalyst. In certain regions of the country, the oil shock is providing the catalyst. As for banks and other financial institutions, we believe the system is functioning properly. It worked well during and after the crisis, and continues to work well today.

Carolyn, did you have anything to add about household debt?

[Carolyn Wilkins]

Yes.

Clearly, banks have ways to verify the loans they grant. More tangibly speaking, the IMF reviewed our banks as part of its FSAP work. The review simulated extreme pressure on the banks, caused by a recession similar to the one in the U.S. during the economic crisis. That had never before been seen in Canada. It showed that the funds are strong enough to withstand that kind of pressure.

[The Chair, Conservative, James Rajotte]

Fine. Thank you.

Thank you, Mr. Dionne Labelle.

We'll go to Mr. Van Kesteren, please.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

Thank you, Chair.

Thank you, Governor and Deputy Governor, for being with us. We always enjoy your visits, and they are always informative.

We have spoken about what I would think we all agree are solid fiscal policies that have been carried out in Canada and that have resulted in a strong position, relatively speaking, compared to so many of the other countries in the world, specifically the G-8 and most G-20 countries.

You touched upon some of the policies. We remember our former finance minister, the late Jim Flaherty, who used to talk about the conversations within the inner circles about what was necessary, and governments participated in a program that certainly saved us in 2009 from fiscal ruin. I am hearing cautious optimism as your approach to how you see the Canadian economy. What are the things on a global scale that keep you awake at night, things you see as something that we, as a government here in Canada, can do very little about but that will affect our economy? Is there anything particular in Europe at present? I wonder if you could just elaborate on that.

[Stephen S. Poloz]

That's fertile ground. There are a lot of unknowns in the world. I began with the premise that in the post-crisis period, the global economy has continually disappointed us. The forecasts from such organizations as the IMF looked for recovery, and then it was delayed a year, and it was delayed another year, and each year there's a series of downgrades for the outlook. It's precisely because we're in an environment that we've never really been in before.

There have been crises, or what we call balance sheet recessions, in the past. What that means is that it's not just a typical recession where there's a shock, and interest rates move, and we're down for six months, nine months a year, and then we go back. It's one in which people go bankrupt, or banks must rebuild balance sheets, or companies must rebuild balance sheets before they're back to where they can behave normally again. That process takes an undefined amount of time. By the way, it applies to governments, too.

The good news is that, as you allude, everybody got in gear in 2008-09. The G-20 acted in concert, and that really made a big difference. Certainly the policies in the U.S. made a big difference.

This is what concerns me: is the job done? Have we done everything? In Europe we can see they've made some very positive steps this past year, so that's good, but we're not sure yet if it's working or how well it's working. So Europe remains an area that concerns us, but with something to watch, if you like.

China is decelerating. It's a very natural process as they restructure their economy. They're even bigger than they were five years ago, so 7% growth is a lot of growth, yet every time a new number comes out, someone will say, “I think it's slowing more”. That makes you concerned about commodity markets, what matters for Canada, and so on.

Brazil is having a slow growth period. Then there's India, the bright light.

All those uncertainties come up. We want to make sure that you understand that what we try to offer is a balanced risk forecast. We have to be able to tell you that there's something on the upside that we're worried about, too, as a forecaster. That would be the U.S. economy. The U.S. economy appears to be firing on all cylinders. It's had a questionable first quarter but it has a very good momentum. So it has the potential to surprise us on the upside.

Yes, there are negatives, but there are always positives, too, and that's why we can offer it up and say that we think we've balanced the judgment around these numbers we give you.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

You mentioned China, and I'm glad you pointed that out, because one of your remarks talked about the impact that demographics have on an economy. Of course, China has a one-child policy that was enacted probably 20 or 30 years ago. When most of us visit China, this is something that they point out. Is that going to become more of an issue in China as well, their slowing birth rate, and the drag that would result on their economy?

[Stephen S. Poloz]

Yes, it is gradually slowing its potential growth rate. But that, as I said, is a natural process. We've seen it happen in previous economies such as South Korea. You start off way below the standard of living that's perhaps 15% or 20% of the leader, and over time you make your way up there. The same thing happened in Japan. If you go back to the early 1970s, say around 1970, Japan had a much lower standard of living than the U.S., and it caught up in about 20 years' time.

Those things happen at the same time that these demographics are working their way out. It has to do with technology, productivity, and what upgrading your economy does. Think what agricultural reform could do in a place like China where you amalgamate a lot of smaller farms. It's the same thing in India. You get these kinds of reforms that can unleash a lot more potential capacity in terms of GDP, even with the same number of people. These things are highly unpredictable.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

There's another point I guess I want to touch on. There have been a number of measures that we've enacted as a government that have proven positive. I wonder if you can maybe share with the committee how you feel the push for free trade agreements around the world will impact our economy in the future.

[Stephen S. Poloz]

Well, without commenting on specifics or on policies themselves, I mean, most economists would agree that freer trade is unambiguously good for a trading nation such as Canada. We have observed, over this past cycle, a significant amount of diversification of Canadian companies to non-U.S. markets, which is exactly that kind of mentality in motion. That's made an important difference as we've come to rely less on the U.S. economy for the growth of the Canadian economy. We still rely, and always will rely very much, on the U.S. economy, but adding more markets can of course help us in times of volatility and can also increase the total market size that we can see.

If we look farther out into the future, we know that economies such as China and Brazil and India will be truly massive economies, and massive amounts of trade will be happening between them and their neighbours. Canada's challenge in this space is to find the entry points to participate in that very big phenomenon. Those things will bear fruit, long term. As I said, it's more like an upgrade to your growth prospects in the long term.

[The Chair, Conservative, James Rajotte]

Thank you very much.

We'll go to Mr. Adler, please.

[Mark Adler, Conservative, York Centre, ON]

Thank you very much, Chair.

Thank you, Governor and Deputy Governor, for being here today.

Governor, I first want to talk to you about something that you have some experience in, and that's the export sector. As you know, the performance of our export sector is critical to our sustained economic performance. Can you talk a bit about some of the competitive challenges our exporters currently face?

[Stephen S. Poloz]

Certainly.

I guess we should begin with a little bit of history. We've mentioned a couple of times here this morning that in fact a number of Canadian companies were forced to exit the export sector over the course of the post-crisis cycle. Those who stayed, of course, did so by being very careful on their costs and actually becoming more efficient.

One of the byproducts we're seeing of this is quite a good increase in productivity. In the Canadian economy, this is a very positive sign. What it means is that our competitiveness is not just about a lower Canadian dollar but better cost performance among those companies that survived this very difficult period. Of course, now we're laying the groundwork for whole new kinds of sectors, high-tech things like environmental technologies—windmill blades, new jet engines, smokestack emission scrubbers, or robots that inspect metal parts. I mean, ten years ago we didn't even imagine these things, and now they're part of our exports. That is the phase of the cycle that we call the rebuilding cycle, which we believe is just in progress. It's not just about expanding companies who are now up at their capacity; it's brand new companies. We'll be watching those signs very closely.

There are challenges that we're facing, of course. Where are you going to sell? You have to have that kind of global perspective, because it's not just about the U.S. That costs real money; it's hard. There are language barriers, and all kinds of rules and regulations that one has to understand. We have people to help companies do that. It's also about the cost of capital equipment, which came up before. A lot of that comes from other economies.

So you have to take those costs into account, but I'm very optimistic that we have all of the ingredients there for a very successful phase in our cycle.

[Mark Adler, Conservative, York Centre, ON]

I think about a year ago now Economist magazine had a cover story on the growing strength of diasporas in various countries, and what they would mean to a country's export potential. Canada, I think, is very well positioned on that front, given that people from all over the world come to this country and are in very large diasporas, in a lot of instances.

What advantages do you see in Canada's various diaspora communities in helping grow and sustain our export sector?

[Stephen S. Poloz]

I would agree with your premise. In my time with EDC I was continually meeting with various institutions or associations and there would be a very big community around that. Some of the barriers to trade are those kinds of softer barriers, cultural or language. A very active facilitation goes on. You can see the difference in areas where we have a diaspora and others where we don't where you just show up with a suitcase in a country to show people your stuff. People don't buy that way. They need to get to know you and they want to sit at the Chamber of Commerce lunch with you, those kinds of things because it's people-to-people. We think of it as country-to-country but it's not, it's a person-to-person business.

I think you're right that those diasporas serve us very well, and we're not alone in that. Other countries have that too. But I'm glad we have it.

[Mark Adler, Conservative, York Centre, ON]

In terms of our lower dollar right now, we've heard a lot from people. Some members of the opposition are in favour of the lower dollar. Is there a risk that pinning an industrial strategy on a lower dollar could be a problem going forward?

[Stephen S. Poloz]

I would say that the dollar is what it is. No one, certainly not us, pins an industrial strategy on a weak currency. We know historically that countries that have tried to purposely depreciate their currency end up with a higher inflation rate. It doesn't pay off. As a company, if you have a lower currency, that sounds like a good deal until your costs are rising in the background and it just offsets it. It doesn't help you.

For us, the dollar is driven by markets. I just remind you of my favourite chart. There is no doubt at all about the main actor in this story: there’s just zero doubt in this. What we have to do is take it as it is. No one around here can influence the global price of oil. For about 25 years or thereabouts oil has been significant enough in our economy that this becomes a key driver of our currency.

So what we have to do is take that as a given. That means there may at times be adjustments within the Canadian economy that are costly, slow us down for a while, but when they're over then we pick up again. Sometimes, like now, we expect they're going to speed us up, especially in sectors that have been in difficult times since the dollar started to rise so much due to the oil price.

[Mark Adler, Conservative, York Centre, ON]

[Inaudible--Editor]...in your estimation—

[The Chair, Conservative, James Rajotte]

This is your last question.

[Mark Adler, Conservative, York Centre, ON]

—any potential inflationary risks on the horizon that we need to keep an eye on?

[Stephen S. Poloz]

No, we're not seeing those. Because the economy has excess capacity our predominant concern is downward pressure on inflation. Yes, when the dollar goes down it causes some prices to rise and that gets built into our inflation number, but our inflation expectations are extremely well anchored at 2%, so that too is a temporary effect. It lasts about one year or a little longer and then it falls out of the numbers, which is why we talk sometimes about underlying inflation. That's an important concept.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Adler.

Governor, I wanted to follow up on a couple of points. First of all, with respect to the housing market your financial system review in December 2014 said overvaluation of the housing market was between 10% to 30%. But you said at that time and you said today it's not a bubble, so how do you define a bubble? What percent overvaluation would be a bubble?