When Paul Martin stood in the House of Commons to deliver his budget speech last week, Raymond Tighe was listening carefully to every word. Tighe is a 31-year-old currency trader in the Wall Street office of the multinational, Dutchowned ING Bank MV. Even before the new budget was formally tabled, he had wagered heavily in the market against Martin’s ability to win—and sustain—confidence with his long-awaited attack on Canada’s deficit.
Initially, Tighe’s negative position was scuppered by a mild post-budget rally in Canadian equity and currency markets.
Sparks of optimism were also fanned after the Canadian Bond Rating Service of Montreal revised its outlook on the domestic credit rating from negative to stable. But even though Canada was able to sell $25 billion in bonds in an international auction last Wednesday, the Canadian dollar’s rise quickly stalled. Said Tighe, “I’m sticking to my bearish call on Canada because of the fundamentals. This budget was tough, but just not tough enough.”
While the response to Martin’s budget in the domestic business community was generally favorable, Tighe’s reservations were clearly shared by other foreign investors. Even though trade figures released last Wednesday showed that Canada’s average economic growth rate in 1994 was 4.5 per cent—which bodes well for a strong performance in 1995— the Canadian dollar remained limp on international markets. It drifted steadily downward—along with the the U.S. dollar—to close the week at 71.09 cents (U.S.), down 0.86 cents from last Tuesday.
The message from credit rating agencies contributed to the prevailing mood of uncertainty. Just two days after the budget, the influential bond-rating agency, Standard and Poor’s Corp. of New York declared that the country’s high interest rates may soon precipitate a credit downgrade, a move that would skew many of the core economic assumptions contained in the budget. According to Jean Precourt, vice-chairman of the Certified General Accountants Association of Canada, a downgrade could add as much as $5 billion to the national deficit as well as another $2 billion in annual interest charges and an overall decrease of $3 billion in revenue to the government because, within months, corporations would have to pay more to borrow money. Although Standard and Poor’s confirmed the double-A-plus rating on Canada’s foreign currency debt and its triple-A local currency long-term debt rating following the budget, the agency adjusted its outlook for Canada’s foreign currency rating from stable to negative.
At the same time, the Toronto-based Dominion Bond Rating Service Ltd. also sounded a warning when it placed the province of Ontario’s credit rating under review with what it described as “negative implications,” which signals that a downgrade may soon follow. The agency said that it is concerned about the effect on Ontario’s economy of Martin’s plan to reduce the transfer payments from Ottawa to the province by as much as $2.5 billion by 1997. However, Moody’s Investor Service of New York, which placed Canadian debt on credit watch on Feb. 16, had not commented further on the possibility of a downgrade by week’s end. To tout the benefits of the new budget, Ottawa dispatched several key cabinet ministers to international financial centres to field questions and offer assurances. In Tokyo, where Japanese financial institutions own about $40 billion in Canadian debt, International Trade Minister Roy MacLaren denied persistent speculation that Japanese investors are selling their Canadian holdings. And he also downplayed reports about pending credit downgrades from Moody’s and Standard and Poor’s.
Nevertheless, after Canada’s most recent experience with currency market mayhem in January—which was caused in part by the devaluation of Mexico’s peso—Martin was clearly aware of the risk of being blown off-course. As a result, he took the precaution
of creating a deliberate hedge against budget backlash. The finance minister explained after the budget’s release that he had introduced a 1.5-cent a litre tax on gasoline specifically as part of a revenue cushion or “contingency reserve” against a weak dollar and higher interest rates. The gasoline tax is expected to generate about $500 million a year.
While international debt raters and money markets pondered the latest developments in Canada, the call for a harder line from Ottawa was also sounded at home by the Canadian Chamber of Commerce. According to chamber president Tim Reid, the national debt and deficit, which remain the greatest deterrents to domestic business confidence and expansion, should have been targeted for elimination by 19971998. And despite the fact that spending cuts outnumber tax increases in the budget, Reid noted that for the business sector, the budget brought in almost $1 billion in new taxes.
Specifically, the budget introduces a 12.5-per-cent increase in the tax on the capital base of large corporations and boosts the corporate surtax from three per cent to four per cent. That is expected to generate annual revenues of about $260 million. A temporary tax on banks will raise $100 million over the next two years.
Nevertheless, the budget’s stated objective of diminishing the role of government in Canada’s economic and social life was warmly applauded by all business interests. Reid noted that Canadian companies have been lobbying for years to reduce the level of Ottawa’s business subsidies. These are now slated to decline by 60 per cent over the next three years—from $3.8 billion currently to $1.5 billion by 1997-1998. Above all, business leaders welcomed the federal government’s plan for the devolution of some powers to the provinces. This move should eventually eliminate some of the layers of duplication and bureaucracy between the two levels of government.
That same push to reduce the government’s presence in the private sector also led to the plan outlined in the budget to sell off Canadian National railways, commercialize Transport Canada’s air navigation system and several airports and to divest Canada Communications Group, a federally owned printing and communications service. In addition to those initiatives, the budget announced that Ottawa’s remaining 70-per-cent stake in the former Crown corporation, PetroCanada of Calgary, would be sold into the market. At current share prices, that would generate almost $2 billion. Still, even though the measures included in Martin’s budget represent a significant shift in the management of Canada’s economic and social life, the question remains: is it enough for Raymond Tighe? □
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