Bank of Canada's projections suggest Ottawa deficit forecast is too low

FILE PHOTO: People are silhouetted in front of the Canadian national flag at the Palais des Congres in Montreal, Quebec, Canada October 21, 2019. REUTERS/Stephane Mahe/File Photo

TORONTO (Reuters) - Canada’s historic budget deficit for this year, projected just over a week ago to top C$340 billion ($251.4 billion), may be even higher if the more pessimistic central bank growth forecast delivered on Wednesday turns out to be right, analysts said.

The Bank of Canada (BoC) projected that Canada’s GDP will fall 7.8% in 2020. That compares with an estimated 6.8% contraction used by Ottawa in its fiscal outlook.

The additional decline in economic activity would add C$8 billion to the deficit, according to an estimate by Stephen Brown, senior Canada economist at Capital Economics, while an analysis in the 2019 federal budget estimated that a 1% decrease in GDP growth would impact the budgetary balance by nearly C$5 billion.

Ottawa’s fiscal outlook is based on forecasts in May from private-sector economists. The more pessimistic forecast from the BoC comes as coronavirus infections rapidly climb in the United States, Canada’s largest trading partner by far, making economic recovery more uncertain.

Last month, Canada lost one of its coveted triple-A ratings when Fitch downgraded it for the first time, citing the billions of dollars in emergency aid Ottawa has spent to help bridge the downturn caused by COVID-19 pandemic shutdowns. Standard & Poor’s, Moody’s and DBRS still give Canadian debt the highest rating.

Canada’s budget deficit is expected to hit C$343.2 billion in the 2020-2021 fiscal year, the largest shortfall since World War Two.

While an C$8 billion increase in the shortfall would be proportionally small, slower-than-expected growth could encourage Ottawa to spend more on stimulus after already rolling out about C$212 billion in direct aid.

“If the government chose to react to that more pessimistic economic projection by introducing new spending, then the deficit could end up being materially wider,” said Royce Mendes, a senior economist at CIBC Capital Markets.

The finance minister’s office did not immediately respond to a request for comment.

Reporting by Fergal Smith in Toronto; Editing by Steve Scherer and Matthew Lewis