Canada seen facing stiff global competition

(March 4, 2005) The Canadian economy is facing tough competition from developing nations, which could trim investment gains over the next two years, according to the latest Global Outlook report from Scotia Economics, entitled “What’s Hot and What’s Not.”

The report predicts growth in Canada will be tepid, with strong commodity prices benefiting the resources rich western provinces as well as Newfoundland and Labrador. Real estate markets are expected to remain hot, as the Bank of Canada is seen holding the line on low interest rates.

Provinces which rely more heavily on manufacturing may struggle due to continued competition from developing economies like China and Mexico.

“Within the NAFTA zone, Mexico is relatively hot and Canada is not,” says Warren Jestin, chief economist at Scotiabank. “While energy sales to the United States have helped growth in both nations, our currencies have moved in opposite directions against the U.S. dollar. Since 2002, the loonie has risen 30% and the peso has fallen 20% — a big shift in competitive advantage since over 85% of exports in both nations go to U.S. markets.”

As a result, overall Canadian economic growth is expected to reach just 2.5% this year, while Mexico could top 4%.

“In this environment, don’t expect inflation, interest rates or equity markets to go anywhere fast,” the report says.

In the U.S., economic growth should slow from 4.5% to a more sustainable 3% through 2005 and 2006, as consumers run out of options on financing their long-running shopping spree. The U.S. government has little room to offer further tax cuts, since it faces a budget deficit of between $412 billion and $600 billion US.

Scotia looks to corporate America to pick up some of the slack with increased capital spending on equipment and software to enhance productivity. U.S. firms are reportedly sitting on a mountain of cash as earnings have outpaced expenditures since the market bottomed.

The U.S. dollar is expected to continue to weaken, as the Federal Reserve follows the Bank of Canada’s lead, maintaining low interest rates, a move welcome in Washington as it would avoid increasing debt service charges. The lower dollar could also help reduce the U.S. trade deficit, as imports become pricier and American exports become more competitive abroad. The Scotia report predicts the Canadian dollar could test the 90 cent US level in 2005.

“Our trade and fiscal surpluses and buoyant commodity markets will help the loonie gain altitude, but the major thrust comes from increasing investor nervousness about the ability of the United States to control its massive twin deficits,” Jestin says. “Reversing the trade imbalance requires a substantial downshifting of domestic demand, which is not imminent.”

With the exception of Japan, Asia is expected to remain strong despite the damage done by December’s tsunami. Chinese growth is expected to moderate, but at 8.5% should still impress. India’s economic growth rate is expected to ring in at about 6.5%.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com