Challenging times for finance ministers
THE CANADIAN PRESS/Adrian Wyld
Deputy Prime Minister and Minister of Finance Chrystia Freeland responds to a question during a news conference, Monday, September 16, 2024 in Ottawa.
In the past few weeks, there have been several notable developments in fiscal policy internationally that are worth unpacking. The upshot: things are getting increasingly challenging for government finances worldwide amid pressure to continue spending even in the face of rising interest rates.
The U.K.’s new Labour government introduced its first budget since winning elections earlier this year that was marked by sharp increases in spending, taxes, and deficits—the trifecta of fiscal policy.
As noted by Bloomberg, the £40 billion a year increase in taxes was “the largest single hike in 31 years and the second largest since at least 1970, taking the overall tax burden to a record high as a share of GDP.” This included higher capital gains taxes, a move that may sound familiar to a Canadian audience.
The U.K. budget also projects an average annual increase of £70 billion in public spending, along with an additional £142 billion in borrowing over the next five years. Investors responded by dumping U.K. bonds, driving interest rates higher.
Meanwhile, France’s finances were recently assigned a “negative outlook” by Moody’s credit rating agency. In Spain, the governing Socialists agreed to extend a windfall tax on banks for three more years. This followed a similar move by Italy’s Prime Minister Giorgia Meloni, who also recently imposed taxes on banks and insurers.
These strains illustrate the extent to which governments have not only failed to repair their finances from Covid, but continue to damage their fiscal health. They are struggling to fully rein in their pandemic deficit habits. Often, they are looking for new politically acceptable taxes to fill the hole.
According to IMF data, general government deficits for advanced economies will average about 4.4 per cent of GDP over the next four years, versus 2.6 per cent in the four years before the pandemic. This year, global public debt is set to surpass US$100 trillion for the first time - a major headwind and risk to the global economy.
This continued deterioration in government finances is one reason why global bond yields are beginning to march higher again.
Government finances in Canada are in much better shape, but have also shown deterioration. Our general government deficit (which includes provinces) is projected to average about 1.2 per cent of GDP over the next four years, versus a near balance before the pandemic. (This despite bigger increases in government revenue in Canada than elsewhere since the pandemic.)
Canada’s governments are also facing lower interest rates, which eases debt servicing costs. At about 3.3 per cent, the yield on Canadian 10-year government bonds is more than a full percentage point below what the U.S. government pays to borrow.
That reflects two things: the solid creditworthiness of Canadian governments, to be sure, but also a weaker economic outlook here. Investors deem Canada needs the lower rates because its economy is a lot more fragile.
This weaker outlook is also reflected in our depreciating currency. The Canadian dollar lost 3.3 per cent of its value against the U.S. dollar in October, the biggest one-month drop in two years.
