CANADA

A tale of two Canadas: the two-speed economy

AA1

LOW RISK for entreprise

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

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GDP	USD 1736bn (World ranking 10, World Bank 2019)
Population	38mn (World ranking 39, World Bank 2019)
Form of state	Constitutional parliamentary monarchy
Head of government	Justin Trudeau (PM)
Next elections	2023, legislative

Politically stable
High per capita GDP
Robust banking system
High data transparency
Large oil and gas reserves
Diverse GDP

Dependence on exports
High exposure to the U.S. economy
Sensitive to commodity prices
High personal debt
Government revenues dependent on oil

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Covid-19 devastated the economy and the pace of recovery is uncertain

Like the rest of the world, the Canadian economy has been devastated by the Covid-19 pandemic. The pandemic first started in China, causing authorities there to virtually shut down the entire economy, including its massive exporting machine. As a result, the global supply chain was greatly affected and Canadian businesses suddenly could not get the materials they needed for export production - the supply shock. Then most governments, including Canada, shut down their own economies in an attempt to stop the spread of Covid-19, and thus created a demand shock. However, unlike most other countries, Canada was also exposed to a commodities shock as the economy is dependent on oil production. Prices collapsed to as little as USD7/bbl., by far a record low price. And finally, Canada also relies on exports to the U.S. for about 20% of its GDP, and thus was vulnerable to the shutdown of the American economy. The combination resulted in unimaginable damage and destroyed 22 million jobs between February and April, or 15.7% of all jobs. By comparison, 14.5% of all jobs were lost in the U.S.

Government response

However, the government responses to mitigate the situation were swift and massive, both from the fiscal and monetary sides. The federal government implemented a fiscal package of spending and robust support to both businesses and individuals worth 15% of GDP (compared to 13% for the U.S., and even less for European countries). On the monetary policy side, the Bank of Canada (BoC) dropped its normally conservative, careful approach and instead emulated the Fed’s “We are here with as much as it takes, for as long as it takes” posture. The BoC drove up the size of its balance sheet from 5% of GDP to 25% and is poised to leave it elevated indefinitely. The bank also set the overnight rate near 0% at 0.25% and has even signaled that it could in fact use negative interest rates as a part of its policy approach.

A strong start to the recovery, a long way to go

As a result of these fiscal and monetary measures, the economy has made a surprisingly sharp rebound. After the September employment report, the economy had regained a remarkable 76% of the jobs it had lost in just five months. Put another way, during the shutdowns, the economy lost 15.7% of its jobs, and now it’s just down 3.7%. However, there is a long way to go yet. The biggest job gains came in June followed by consecutively slower gains in July and August, followed by an uptick in September. We expect that job gains in coming months will be even slower for three reasons. First, the early job gains were the “low-hanging” fruit where businesses had been temporarily closed and then opened back up, re-hiring former employees. As most provincial and local governments have already eased many restrictions, and in some cases are now re-imposing restrictions, there are fewer cases of those easy gains to be had. In the meantime, there have been many permanent job losses, and unemployed workers will no longer have a position awaiting them. And finally, re-entrants to the job market will find much tougher conditions with fewer job openings available. It will probably take until 2023 for the labor market to return to some semblance of full employment.

In terms of GDP growth, over the past four recessions it has taken the economy on average nine quarters to fully recover. This wouldn’t put the economy back to previous levels of output and business conditions until the end of 2022. Indeed, using the monthly GDP measure, economic output is still down -5.8% since before the pandemic, or an annualized rate of -13%. However we do expect to see continued GDP growth with a massive +40% or more q/q annualized bounce back in Q3, followed by +6% in Q4. For 2021 we expect the economy to grow a very strong +5.2%.

However, as a result of the scars left on the economy, business bankruptcies will surely rise. The increase in bankruptcies in 2020 compared to 2019 is likely to be modest at approximately +4%. This is less than might initially have been thought, but there has been a backlog in the courts due to the shutdowns, and businesses have remained flexible to keep each other afloat, providing as much forbearance in lending as possible. However, next year the courts will catch up, and debt forgiveness and forbearance will start to wear thin. As a result, we expect to see business bankruptcies rise by a very sharp +21% in 2021 vs. 2020.

A long way to go, but with some tailwinds

Not all is lost however. Despite the forecast of a slowing recovery and a large increase in business bankruptcies, there are some strong tailwinds. Two major leading indicators, the Business Barometer from the Canadian Federation of Independent Business and the Ivey Purchasing Managers Index, have both rebounded strongly above 50, indicating economic expansion and forecasting stronger conditions over the next year. The housing market has made a dramatic comeback with unit sales hitting record highs, as people have sought to move out of apartment buildings and cities into their own homes. Retail sales are now higher than they were before the pandemic. New orders for manufactured goods, which are a harbinger of future employment have bounced back sharply. By some measures the economy has “bottomed out”.

Covid-19 could change everything, again

Nonetheless, there is a major risk that this scenario could get completely derailed. If there is a resurgence of COVID in the colder months ahead, and governments choose the same policy of shutting down the economy, the resulting second round of permanent job loss could result in much deeper and longer-lasting damage. Unfortunately, there are already signs of a sharp resurgence in the two most populous, and hardest hit provinces, Ontario and Quebec. It is unclear if the resurgence in cases is due to an increased prevalence of the disease, or to more aggressive testing, particularly in Toronto. And of course Covid-19 cases are now rising sharply in the U.S. as well, and some states are now starting to tighten restrictions again. If the U.S. economy slows down sharply as a result, of course that will put extra downward pressure on Canadian exports. If Covid-19 returns, targeted shutdowns would be optimal since over 80% of all Covid-19 deaths occur in the very small portion of the population over 65, and very few are deaths are in the much larger young population. In addition, deaths are also concentrated in those who are already sick or who are more susceptible to the disease because of pre-existing conditions. Targeting the right populations could help avoid shutting down the entire economy and doing even deeper damage.

Trade structure by destination/origin

(% of total)

Exports	Rank	Imports
United States 75%	1	51% United States
China 4%	3	12% China
United_Kingdom 4%	3	6% Mexico
Japan 2%	4	4% Germany
Mexico 2%	5	3% Japan

Trade structure by product

(% of total)

Exports	Rank	Imports
Cars And Cycles 12%	1	8% Cars And Cycles
Crude Oil 11%	2	5% Engines
Aeronautics 4%	3	5% Vehicles Components
Non Ferrous Metals 4%	4	4% Miscellaneous Hardware
Other Edible Agricultural Prod 4%	5	4% Commercial Vehicles

Although the payment behavior of domestic companies is good, the law provides no standard payment terms and does not facilitate the debt collection process meaning late payment conditions (delays, interest rates, collection costs) are left for the parties to consider contractually.

Low
Medium
Sensitive
High

Payments
Court proceedings
Insolvency proceedings

Payments
Court proceedings
Insolvency proceedings

Canada offers an efficient judiciary system despite being complex insofar as different federal and local rules are applicable. Contractual ownership protection mechanisms, like retention of title, are recognized as a security interest and governed by the Personal Property Security Act (PPSA). However, enforcement is uncommon, difficult, and costly.

Insolvency law provides sophisticated mechanisms, but their efficiency in recovering unsecured debt is very limited, therefore pre-legal action should be considered as the best debt collection opportunity.