[R-G] Canada set for record current account deficit

[Anthony Fenton]

Financial Post

Wednesday, February 13, 2008
Canada set for record current account deficit

http://www.financialpost.com/story.html?id=303871
Strength of loonie and domestic economy will drive shift, Merrill  
Lynch forecasts

Jacqueline Thorpe,  Financial Post  Published: Wednesday, February  
13, 2008

Andy Clark/Reuters

Canada is heading for a record current account deficit of $36-billion  
in 2009, a lighting speed transformation from a decade of surpluses  
as the economy realigns itself towards imports from exports.

Merrill Lynch forecasts the switch will occur this year as Canada  
moves to a $20-billion deficit from a surplus of $12-billion in 2007.  
The deficit will continue to swell in 2009.

Although the change will ultimately put pressure on the Canadian  
dollar, it is very much a function of the loonie's recent strength --  
and a strong domestic economy -- which will continue to fuel imports.  
Flattening commodity prices and less dramatic gains from income  
abroad will also be major drivers said David Wolf, Canadian economist  
at Merrill.

"Canadian demand is a lot more relative to the world than it was five  
years ago," Mr. Wolf said. "Canadians are richer and they are buying  
more goods and services from abroad."

The switch may be abrupt for a country used to crowing about its  
triple surpluses -- fiscal, trade and current account -- but will be  
a reflection of strength, Mr. Wolf said.

The current account numbers are the broadest measure of a country's  
international trade, including goods, services, investment gains,  
travel and pretty much everything else. A big deficit would mean  
Canadians are consuming far more of the world's wares then they are  
exporting and would put Canada in a position that the U.S. has been  
criticized over for years.

Still, a $36-billion deficit would be a record in nominal terms but  
at 2.2% of GDP it will still be below the 4.8% recorded in 1975, the  
year of Canada's largest prior deficit. It will also be lower than  
the United States' deficit which is forecast at 3.9% in 2009 and well  
below their peak of 6.2% in 2006.

More importantly will be the source of the deficit. The current  
account deficit days of the early 1990s were driven by large  
government borrowings abroad. This time it will be a reflection of  
strong domestic demand and higher relative rates of return at home.

Mr. Wolf had already been forecasting a swing to deficit in 2008 as a  
stronger dollar spurs imports and compresses the merchandise trade  
surplus to nearly a deficit toward 2010. Services have been in  
deficit since 2005. Flattening commodity prices also suggest an  
improving terms of trade will no longer provide an offset.

But he dramatically raised his deficit projection from a previous  
forecast of $2.0-billion in 2008 and $13-billion in 2009 on the view  
that Canadian net indebtedness will no longer be able to improve so  
dramatically.

Lower U.S. interest rates and profits will reduce income receipts  
while Canadian rates are unlikely to go down in lock-step.

A lower Canadian dollar is the "natural implication" of a swing into  
deficit, Mr. Wolf said. Mr. Wolf also expects GDP to take a hit as  
more demand is satisfied from foreign factories.

The switch will also highlight how important the Canadian-U.S. trade  
relationship is, even in a world where the United States sucks in  
record imports from China and other emerging markets.

As Canada swings to deficits, the U.S. deficit will improve. Merrill  
Lynch forecasts a U.S. current account deficit of about US$189- 
billion between 2007 and 2009. Canada's deterioration will represent  
about one-quarter of the U.S. adjustment, roughly the same as  
Canada's share of trade.

A new surge in commodity prices and loonie, however, could throw the  
forecast askew as could a major domestic retrenchment in Canada.