Business sector to lead growth

As government consider restraint and consumers curb spending, Canada’s business sector will take charge as the leading source of growth in the Canadian economy, says a report from CIBC World Markets Inc.

Canadian businesses, says the report, are set to invest in productivity gains and explore export opportunities in emerging markets.

“By any measure, the current recovery in capital spending is impressive,” says Avery Shenfeld, chief economist at CIBC. “The real return on capital employed is rising and is now currently at just under 6%—a full point above its long term average, and return on equity is now above 12%.”

The oil sands, utilities and the manufacturing sectors, could add significantly to capacity to ensure business investment continues to support the domestic economy, not just in 2011 but beyond.

Shenfeld says that the stronger loonie helps investment in the manufacturing sector, even if its strength is hurting exports.

“There has been a lot of discussion regarding the disappointing productivity numbers, but the reality is that we are seeing a much tighter correlation between the value of the dollar and purchases of machinery and equipment from abroad,” says Shenfeld. “The surge in imports of machinery and equipment has clearly been facilitated by a strengthening Canadian dollar. We expect the loonie’s strength to persist over the longer term, which should help boost investments going forward in sectors that can remain competitive.”

The capacity utilization in the manufacturing sector is fast approaching pre-recession levels and currently stands at 81%, six points above that of the rest of the economy. With improving capacity use and rates of return on capital employed in the sector approaching a 10-year high, Shenfeld expects business investment in manufacturing to rise strongly in 2011.

“Canada’s exports will tap into some of the resulting improvement in the U.S. economy, particularly for companies that can hitch themselves to the U.S. supply chains for products ultimately destined for higher growth economies overseas,” he says. “A strong Canadian dollar will remain a challenge for exporters, but we expect the improving global economy to generate increased opportunities over the next few years.”

Shenfeld believes many of Canada’s small and medium-sized enterprises (SMEs) will have to think more globally to grow. Recent trends in SMEs’ trade activity and international comparisons suggest that Canadian SMEs have not responded to globalization in a way that significantly contributes to the Canadian economy as a whole.

Strong growth in emerging markets and increased opportunities to participate in global supply chains due to the growing export focus of the U.S. economy provide Canadian SMEs with an opportunity to reverse this trend, notes the report.

“Given the rising number of new immigrants from emerging markets in general, and China and South Asia in particular, there is a clear opportunity to capitalize on this trend.”