Original article published in The Chronicle Herald, May 4, 2020.
The effect of COVID-19 on the Canadian economy has been swift and dramatic. Before COVID-19, the economy was expected to grow at a 1.6 per cent to 1.7 per cent rate in 2020. The Bank of Canada now expects economic activity to slow by as much as 30 per cent from the end of 2019; one estimate by Bloomberg projects a slump as high as 40 per cent. Just by looking at the number of unique applicants for the $2,000 Canada Emergency Response Benefit (CERB), it appears that the pandemic has effectively wiped out all job gains made in the Canadian economy over the last 30 years.
How prepared are Canadians to weather such an unprecedented and virulent economic storm? To begin with, Canadian household and business insolvencies spiked dramatically even before COVID-19. Every single day in 2019, a whopping 375 people filed for insolvency proposals, a number that hasn’t been seen since the recession of 2008-2009. To add insult to the injury, the collapse in oil and gas prices led to a sky-high number of business insolvencies in 2019, the first such increase since 2001. On top of that, Canadian households owe $1.76 for every dollar in disposable income, one of the highest rates in the developed world. In places like Vancouver and Toronto, that spikes to about $2.40, at a level only seen in Iceland before the global financial crisis. The insolvency accounting firm MNP Consumer Debt Index, released recently, found that about half of Canadians (49 per cent) surveyed are now on the brink of insolvency, saying they are $200 or less away from not being able to meet their monthly debt obligations. It is therefore fair to say that Canadians entered the COVID-19 episode quite ill-prepared.
Why aren’t we seeing bankruptcies piling up? Because we are now witnessing the calm before the storm. Right now, every Canadian consumer and business are essentially creditor-proof due to the federal and provincial income, wage and rent support system and, of course, courts are closed. The trouble is the government does not know whose credit is good and whose is bad, but the bank knows. When the economy starts to reopen, the fault line will emerge, and some businesses will likely fall through the crack. Being accountable to their shareholders, banks are unlikely to pick up the slack when the government safety net ends.
In the next few months, we will witness not only the unfolding of the COVID-19 global pandemic but also a likely surge in Canadian consumer and small business insolvencies. Worse, things may take a dreadful turn if the broader post-COVID economic misery spills into the housing market. Real estate, including residential construction, is Canada’s largest sector, accounting for 15 per cent of the economy. If the housing market flops, in addition to liquidity-driven insolvencies, we will see a spike in strategic insolvencies, where homeowners walk away from their mortgages if the market values of properties fall well below mortgage amounts, a phenomenon reminiscent of the 2008-2009 financial crisis.
The severity of this frightful post-COVID scenario, however, will hinge on three factors: the length of the pandemic until a cure or vaccine is found, whether we have a V-shaped, U-shaped, W-shaped or L-shaped recovery; and the mightiness of the fiscal power of our governments.
While a vaccine is months away, one thing we know for sure is that recession tends to be deeper and longer lasting when households are mired in debt. This is not an encouraging prospect for Canadians, given the $2.3 trillion in household debt in Canada, more than our GDP and a higher ratio than the U.S. had before the recent great recession. All this means that we are likely to see a U-shaped recovery instead of a V-shaped one, as the recent surge in the equity market seems to suggest.
More importantly, COVID-19 will test the limits of fiscal prowess of our governments. You cannot “lend” your way out of an economic crisis; you need to “spend.” That is why fiscal policy would be way more effective in combating the COVID-19 downturn than the near-zero interest rate.
The trouble is, provincial governments’ finances were already stretched going into this situation. Canada’s provinces had $853 billion of debt securities outstanding, more than the federal government, and collectively making them the largest sub-sovereign debt issuers in the world. This means that the federal government will have to do the bulk of the heavy lifting on the fiscal front, as it is doing right now. This is rightly so, given the historically low borrowing cost of the fed. Despite the enormity of our federal spending power, it may not be enough to save all Canadian consumers and businesses.
The storm after the calm is inevitable. If we get lucky and can grow our economy slightly faster than the rate of increase in debt for a sustained period, we can pull this through as we did when the fed unleashed its mighty spending power during the aftermath of the Second World War.
Mohammad M. Rahaman is PhD Canada Research Chair (CRC) in International Finance & Competitiveness, associate dean, strategic partnerships & sommunity engagement, associate professor of finance & co-ordinator for the Global Business Management Program, Sobey School of Business, Saint Mary's University.
