Provincial bond market purchases are a start, but may show too much restraint: economist

The Bank of Canada introduced one of the most drastic provincial funding measures the country has ever seen, doubling its balance sheet and outgrowing any strategy taken in 2008 – and it might not be enough.

Dr. Marc-Andre Pigeon, an economics professor at the University of Saskatchewan, explained that while the central bank’s $50 billion program cap may seem like a steep figure, it presents a limit to what the bank is willing to do to help the provinces during the crisis.

“I think that sends a signal to the market that there’s still this kind of effort by the federal government to not go full-board on supporting the provinces,” Pigeon said.

Provinces have been struggling with providing benefits to their financially ailing businesses and recently jobless citizens. Responding to this need, the Bank of Canada introduced a provincial bond purchase program to provide liquidity and enhance the provincial government funding market. This latest measure is expected to roll out in May and follows an announcement in late March of a provincial money market purchase program.

Because of the uncertainty surrounding the crisis, Pigeon believes this commitment is too limited.

“[With] the crisis and what the markets are telling us about bonds and provincial interest in bonds right now... I think that we need to be more courageous as far as our stepping up for the provinces.”

COVID-19’s economic impacts were widespread across all of the provinces, leaving as many as 3.1 million Canadians either out of work or with drastically reduced hours.

Western provinces have been struck particularly had with a double-crisis: COVID-19 labour market impacts and the swift downturn in oil it brought when it caused a global drop in demand. These challenges push the need for a fiscal response that will help provinces develop emergency funds and emergency benefits for its businesses and citizens, Pigeon said.

Provincial bonds have often been an overlooked segment in the market. Brian Romanchuk, an economic research consultant who writes extensively about bond markets, said provincial bonds tend to sit in between high-risk, high-reward corporate bonds and virtually risk-free, low-paying government of Canada’s bonds. Because they fall between these categories, they’ve been less attractive in general: “There’s going to be mechanical pressure on them,” explained Romanchuk, “They’re stuck in the middle, they’re not attractive enough.”

These purchasing programs have brought a smorgasbord of concerns from analysts, ranging from market insufficiencies and wider credit spreads to rampant inflation and currency devaluation.

Romanchuk believes these measures, despite popular opinion, don’t immediately translate to higher inflation levels.

“It can happen, but from a fundamental point of view, the quantitative easing by itself is just swapping around financial assets and it’s not really going to cause inflation,” he said.

Canada’s provinces have had accelerating debt obligations over the past ten years. Heading into the last recession in 2007/2008, the combined provinces had a net debt as a share of the GDP ratio of 20.3 per cent compared to the federal rate of 32.7 per cent, according to a report by the Fraser Institute.

In the fiscal year of 2019/2020, the provincial rate of 29.9 per cent nearly caught up to the 34.4 per cent federal rate. With provincial debt loads already at all-time highs, these quantitative easing measures from the Bank of Canada prompted concerns from economists that provincial and federal deficits would deepen.

A self-described modern monetary theorist, Pigeon doesn’t consider these to be top-priority concerns, instead advocating that these fiscal tools should be used to face the economic wolf at the door.

“The deficit is kind of a residual, it should adjust based on our real needs. I would not prioritize it at the federal level as a policy measure unless we’re nearing inflation,” he said. Pigeon suggested that a more conservative fiscal approach at this stage would run the risk of hitting the brakes too early, and the provinces would suffer deeper economic impacts.

Pigeon anticipates a slower recovery once the crisis subsides, though he expects that it will come from fiscal restraints and cut spending that impacts regular people and businesses. His biggest concern is that the policies will be too squeamish and fall short of keeping the real economy afloat.

“I think there’s a lot of solutions the Bank of Canada could be offering, a more kind of unconditional support,” Pigeon said.

“There’s going to be challenges after this, but for now, we have to get through this.”