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P 261307Z JAN 09
FM AMEMBASSY OTTAWA
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UNCLAS SECTION 01 OF 04 OTTAWA 000070 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR E, EB/DCT, WHA/EX, WHA/CAN 
 
STATE PASS USTR (SULLIVAN) 
 
COMMERCE FOR ITA/MAC (WORD) 
 
TREASURY FOR IA (NEPHEW) 
 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV EIND PREL PGOV CA
SUBJECT: Canada's Coming Federal Budget and Stimulus Prospects 
 
REF:  A. 08 OTTAWA 1574 
¶B. 08 OTTAWA 1516 (AND PREVIOUS) 
¶C. 08 OTTAWA 1372 
¶D. 08 OTTAWA 1528 
¶E. TORONTO 20 
¶F. 08 TORONTO 204 (AND PREVIOUS) 
 
SENSTIVE BUT UNCLASSIFIED.  PLEASE PROTECT ACCORDINGLY 
 
¶1. (SBU) Summary:  With the economy dominating the political 
landscape (ref a), Canada's opposition parties have made the January 
27 federal budget a litmus test of PM Harper's ability to make his 
Conservative minority government work.  Ottawa observers estimate 
that the budget will pass with just enough grudging support - or 
abstentions - by the Liberals.  Budget details remain hidden behind 
Canadian secrecy rules until January 27, but the expected 
legislation is the product of cross-country and cross-constituent 
brokerage.  The budget will likely contain considerable 
infrastructure spending, tax cuts and credits aimed at the middle 
class and industry, and a range of social spending initiatives. 
Monetary stimulus - a combination of rate cuts and liquidity 
injections - has been ongoing since November and the Bank of Canada 
reports that there is room for additional monetary stimulus.  End 
Summary 
 
Economic and Political Context 
------------------------------ 
 
¶2. (SBU) Canada entered the world financial crisis with strong 
economic fundamentals - including low unemployment, eleven years of 
budget surpluses, record prices for commodities, and a 
well-regulated banking sector.  Despite these strengths, Canada's 
medium-sized, open economy has little influence on the global stage 
and is vulnerable to external forces.  For example, exports to the 
United States are critical to Canadian GDP, so falling U.S. demand 
has had a quick and negative effect on the Canadian economy.  Given 
Canada's size and outward orientation, government stimulus packages 
can do relatively little to promote recovery, other than make 
competitiveness improvements at the margins and buy time until 
export demand returns. 
 
¶3. (SBU) The confluence of the global financial crisis and a 
domestic parliamentary crisis (ref b) have made federal spending 
debates more volatile than usual (ref d).  On December 4, Prime 
Minister Harper prevailed upon the Governor General to suspend 
Parliament, which avoided the defeat of his minority government in 
the House of Commons.  While other factors played a role, much of 
the parliamentary crisis was blamed on the government's overly 
optimistic assessment of the Canadian economy and lackluster 
proposals for stimulus and recovery.  This provoked criticism that 
the government was not doing enough to help Canadians deal with 
domestic and global economic turmoil. 
 
¶4. (SBU) The January 27 presentation of the FY 2009 budget provides 
the Conservative government with an opportunity to make amends on 
economic stimulus and to re-exert political leadership.  PM Harper 
has announced that his budget will contain significant spending that 
will "sustain economic activity and confidence in Canada," even if 
this means that Canada will once again take on a deficit that the 
government admitted (likely to pre-empt criticism next week) on 
January 23 will run as high as C$34 billion for 2009 and C$30 
billion for 2010.  This will push Canada's debt to GDP ratio from 
23.4 percent in 2007 - the lowest among the G7 countries - to 28 
Q23.4 percent in 2007 - the lowest among the G7 countries - to 28 
percent. (Comment:  Since 1998, running a federal deficit has been 
anathema to Canada's political parties  --ref c.  End comment)  On 
January 22, the Bank of Canada separately predicted that Canada 
would recover from its recession in less than year, with GDP 
shrinking by 1.2 percent in 2009 and growing by 3.8 percent in 
¶2010. 
 
¶5. (SBU) The government stimulus package is expected to total 
between C$20 and C$30 billion and to include a combination of tax 
cuts, infrastructure spending, and assistance for those groups and 
sectors hardest hit by the financial crisis (the last a key demand 
of the opposition Liberal Party).  Distributional decisions about 
 
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the stimulus could present problems because Canada's constitution 
divides federal and provincial responsibility for economic issues. 
Public federal funds are allocated to the provinces through transfer 
payments and also through direct provision of services by federal 
agencies in such areas as industry, natural resources, and the 
environment. 
 
Federal Assistance to the Provinces 
----------------------------------- 
 
 
¶6. (SBU) To preserve the stability of federal-provincial relations, 
Ottawa seeks to treat all provinces equally on issues such as 
infrastructure spending.  Federal officials have been holding 
cross-country meetings with provincial representatives and business 
leaders to prepare the new budget.  Infrastructure spending will 
have to be coordinated with provinces, as will particular types of 
sectoral assistance.  At the same time, federal authorities must 
weigh the costs and benefits of assisting regionally concentrated 
industries, such as the auto sector (Ontario) and forestry (Quebec 
and British Columbia), where longer-term competitive prospects are 
uncertain.  The federal government's early commitment to auto sector 
assistance (ref e) has fuelled sectoral requests from other regions. 
 (A C$4 billion auto sector package was announced in December, with 
more than C$1 billion coming from Ontario province.)  Since 2006, PM 
Harper has made significant monetary and political overtures to 
Quebec in a largely unsuccessful bid to bolster federalism and to 
build a new political base for the Conservatives in the province as 
a key to a future majority victory.  There is speculation that the 
government's disappointing performance in Quebec in the October 2008 
federal election might translate into less money for the province in 
the January 27 budget if the government seeks instead to consolidate 
support elsewhere, notably in Ontario. 
 
Reaching out to the Opposition 
------------------------------ 
 
¶7. (SBU)  Since the December parliamentary crisis, PM Harper has 
made some uncharacteristic efforts to reach out to his political 
opponents, including the new leader of the official opposition, 
Liberal party head Michael Ignatieff.  Liberal economic critics have 
also met at least once with their Conservative counterparts. 
Ignatieff has publicly urged the government to focus on social 
spending, including more generous unemployment and re-training 
benefits and measures aimed at housing and infrastructure.  All 
three opposition parties, however, have complained that the 
government's outreach and willingness to listen to their views have 
been too little.  Meanwhile, the Prime Minister's center-right 
economic advisory panel has urged the government to avoid deep 
deficits -- anathema to many Canadian voters, not only on the 
Conservative side -- and to craft a limited stimulus package that 
focuses on Canada's longer-term competitiveness. Privy Council 
advisers told EMIN on January 23 that they were confident that the 
opposition would approve this budget, albeit with complaints. 
 
 
Prospects for Stimulus Spending 
------------------------------- 
 
¶8. (U) The government has indicated that its main budgetary focus 
will be infrastructure spending and relief for the middle class. 
Total government spending should fall close to the two percent of 
QTotal government spending should fall close to the two percent of 
GDP range endorsed by the IMF in January.  For Canada, this 
represents some C$30 billion, although falling government revenues 
have prompted new spending estimates closer to C$20 billion. 
 
¶9. (U) Infrastructure investment will likely include expanded and 
accelerated spending on highways, bridges, roads, sewer and water 
systems, public transit, and green energy.  With a number of 
infrastructure projects already in train, the total planned spending 
on infrastructure now tops C$50 billion with approximately C$14 
billion in expected new spending.  However, federal cost-sharing 
proposals for infrastructure are drawing criticism from 
less-well-off provinces and municipalities, most notably at meetings 
of provincial and municipal leaders with PM Harper during the week 
 
OTTAWA 00000070  003 OF 004 
 
 
of January 12. 
 
¶10. (SBU) The Canadian Council of Chief Executives and other 
economic think tanks have recommended corporate income tax cuts to 
encourage business investment, research and development, and 
increased competitiveness.  These cuts might be helpful in 
countering deflationary pressures from the current recession.  Tax 
credits to encourage consumer spending are also expected.  If the 
government introduces broad social spending, it will likely want to 
proceed cautiously with tax measures to avoid - by Canadian 
standards - massive deficits. 
 
¶11. (SBU) Stimulus to the manufacturing sector hangs on the question 
of which sectors have the capacity for long-term competitiveness 
once U.S. and global demand return. Canadian Conference Board Chief 
Economist Glen Hodgson has recommended that the government provide 
only minimal assistance to declining sectors and instead to 
facilitate orderly downsizing. 
 
¶12. (U) Commodity exports- especially energy and agriculture - are 
expected to support the recovery of the Canadian economy as global 
prices begin to rebound.  There are few budgetary proposals for 
stimulus in the commodities market except for continued calls for 
green investment in the energy sector.  Also, Alberta has warned the 
federal government that the recent fall in oil prices will 
significantly reduce the more than C$16 billion that the province 
annually transfers to Ottawa. 
 
Monetary Stimulus 
----------------- 
 
¶13. (U) Interventions by the Bank of Canada and the government in 
monetary policy and the financial sector, respectively, have been 
ongoing since October.  The Bank has cut its benchmark lending rate 
from three to one percent - and appears open to additional 
quantitative easing (government purchases of securities and debt). 
The government has already added more than C$100 billion in 
liquidity to Canadian banks and government lenders.  The global 
crisis has served as a catalyst for other improvements in the 
financial sector, including a restructuring plan for non-bank 
sponsored asset-backed commercial paper (ref f and septel) and 
progress toward the formation of a single national securities 
regulator. 
 
¶14. (U) A lingering financial problem that the government may 
attempt to deal with in the budget is the shrinking secondary credit 
market.  Over the past four months, consumers and businesses have 
found it increasingly difficult to lease vehicles and equipment. 
Among the proposals under consideration by the government are loans 
and guarantees for existing credit firms as well as regulatory 
changes to allow more players into the market (e.g., allowing 
chartered banks to offer auto leases). Canadian business 
associations have also urged the government to provide equipment 
loans directly to firms and to suspend tariffs on equipment 
imports. 
 
Comment 
------- 
 
¶15. (SBU) Despite Canada's solid economic fundamentals, the 
government's budgetary stimulus will only work on the margins until 
global demand recovers.  Until then it must walk a fine line between 
delivering "enough" spending to cushion the recession and satisfy 
the opposition parties and reassuring its own Conservative base and 
hesitant voters that the return to deficit is necessary and 
temporary. While PM Harper has been largely unmoved by opposition 
Qtemporary. While PM Harper has been largely unmoved by opposition 
criticism in the past, Michael Ignatieff's promising start as 
Liberal leader and the lingering option of a Liberal-NDP coalition 
supported by the Bloc Quebecois appear to have led the Prime 
Minister to approach the new budget in a more conciliatory way than 
has been his norm, as well as to abandon a long-standing principle 
against deficit spending in the short-run.  End comment. 
BREESE 
 
 
 
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