BUSINESS

A FOREIGN AFFAIR

CANADA’S CREDITORS AERO AD KEEP A CLOSE EYE ON THE POLITICAL AND ECONOMIC SCENE AS THE FEDERAL ELECTION APPROACHES

DEIRDRE McMURDY October 25 1993
BUSINESS

A FOREIGN AFFAIR

CANADA’S CREDITORS AERO AD KEEP A CLOSE EYE ON THE POLITICAL AND ECONOMIC SCENE AS THE FEDERAL ELECTION APPROACHES

DEIRDRE McMURDY October 25 1993

A FOREIGN AFFAIR

CANADA’S CREDITORS AERO AD KEEP A CLOSE EYE ON THE POLITICAL AND ECONOMIC SCENE AS THE FEDERAL ELECTION APPROACHES

BUSINESS

They are not registered to vote in the approaching federal election. Neither do they reside in Canada or directly own Canadian assets. But Canada has a critical new political constituency— foreign creditors who are owed about

$84.6 billion by Ottawa. Any government that neglects the interests of that group does so at its peril: by dumping their Canadian debt holdings, foreign creditors can force down the Canadian dollar and push up domestic interest rates. Indeed, the clout of nervous offshore investors has already been acutely felt in Canadian markets over the past two months. Until the Liberal party recently pulled into a clear lead in public opinion polls, uncertainty about the outcome of the election depressed the Canadian dollar in currency markets. From early August, the dollar depreciated by 4.2 per cent

and the interest rate spreads between Canadian and U.S. bonds widened significantly, making it more costly for Canada to compete for global capital. External pressure was also apparent following remarks by Liberal Leader Jean Chrétien about his plans to review the role of the Bank of Canada and its governor, John Crow. That notion was quickly dropped after a flurry of negative

foreign commentary. “No matter what the outcome of the election, the deficit ensures that no party has any room to get fancy,” says Karim Basta, a vice-president of Merrill Lynch Inc. in New York City.

The announcement last week that Ottawa’s revenues for the first five months of the year lagged behind those recorded a year earlier heightened the foreign scrutiny of Canada’s shifting political landscape. Despite reduced spending levels, the deficit in federal government operations from April 1 to Aug. 31 was $18.6 billion, up $2 billion from the same period in 1992. Concern about Ottawa’s ability to generate higher revenues to repay the deficit also surfaced last week, along with signs that Canada’s export-led economic recovery may be flagging. Statistics Canada reported record imports of $14.3 billion and a $47-million or 3.7-per-cent decline in exports for August to $14.9 billion. As a result, Canada’s trade surplus fell to $596 million—the lowest since July, 1992. “Canada’s deficit is the number 1

WHERE OTTAWA OWES ITS DEBT Total: $374.8 billion (The federal debt, in bonds and short-term money market borrowing)

issue for foreign money,” notes Paul Thursby, director of fixed income investments at Baring Asset Management in London. “People are paying very close attention to it and to what the politicians—and the numbers— are saying.”

Still, the higher deficit figures caused relatively little stir and the Canadian dollar remained strong enough for the Bank of Canada to lower its benchmark interest rate to 4.87 per cent from 4.95 per cent. According to observers, that calm is partly attributable to the fact that after weeks of drifting voter opinion, a poll released by Angus Reid on Oct. 8 finally showed that

the Liberal party had enough popular support to form a majority government.

Although the Liberal party is dogged by a history of relatively aggressive public-sector spending, Chretien’s emphasis on deficit reduction is sufficiently close to the existing Conservative party line to quell any serious misgivings. Says one currency trader based in Chicago by a major chartered bank: “New government means new policy and new players. Everyone is anxious to avoid surprises and to stick with the existing script.” But, he adds, a minority government is “always considered to be the worst-case scenario” by financial markets.

The major risk with minority governments is that, in the past, they have tended to buy support for their policies with spending on programs demanded by their political allies. In Pierre Trudeau’s Liberal minority government of 1972-1974, for one, Ottawa under-

took significant spending to sustain the support of the New Democratic Party. As a result, according to Robert Bothwell, a Canadian history professor at the University of Toronto, that period was “absolutely dreadful for economic policy.” Anita Lauria, an economist with Salomon Brothers Inc. in New York City, notes that another concern is that minority governments can be short-lived and economic policy disrupted by back-toback election campaigns. Lauria adds that the alliances formed by a minority government are also critical. “If the two allied parties are on the same wavelength ideologically, the risks do diminish somewhat,” she says.

For many foreign investors, the recent fragmentation of the Canadian political scene, marked by the emergence of strong alternative contenders in the Reform Party of Canada and the Bloc Québécois, has complicated the task of predicting the election outcome. But the Chicago currency trader noted that most European money managers are already accustomed to splinter party politics in their own markets. Because of the Reform party’s strong anti-deficit stance, it has readily found favor with foreign investors. The Reform party also has the advantage of a precedent: Preston Manning is widely viewed outside Canada as a northern version of Ross Perot. Perot managed to impose a deficit reduction agenda on the Democratic party in the 1992 U.S. election without actually making significant political gains. Notes Merrill Lynch’s Basta: “American investors in particular relate to the Reform thing.”

The Bloc Québécois, however, is more of an enigma to foreign observers. It is also a cause of concern, according to Baring’s Thursby, because it recalls last fall’s constitutional crisis and reminds investors that Canadian federalism can be fragile. “The breakup of Canada’s federal structure is still a worry out there,” he says. “That kind of nagging doubt can always lead to volatility.”

One of the key components in projecting a positive image—especially in the eyes of European investors—is the constant hand of John Crow at the Bank of Canada. In Europe, currency speculators have wrought havoc over the past year and money managers now place an especially high premium on stability. Dolph van den Brink, executive vice-president of Amsterdam-based ABN Amro Bank says: “Many central banks are losing control of their markets to speculators. Once you yield that grip, it is hard to recover it.” He adds: ‘There is no bottom to the currency market any more.” For his part, Crow has a solid reputation based on his consistent anti-inflation policy and his defence of the Canadian dollar in global markets. And with Canada’s creditors casting a stern eye over his domain, Crow can continue to bank on strong support—whatever the election outcome.

DEIRDRE McMURDY