February 27, 2008 / 12:02 AM / in 10 years

Canada economy to slow, risks to downside - IMF

OTTAWA (Reuters) - Canadian economic growth will slow to 1.8 percent this year and there is a risk of an even sharper downturn as weakness in the U.S. economy spreads beyond the housing sector, the International Monetary Fund said in a report on Monday.

After growing about 2.5 percent in 2007, Canada’s healthy economy and fiscal standing will help it withstand the global turbulence but external risks will pose a challenge.

“The balance of risks to growth is tilted to the downside,” the Washington-based lender said in its annual report on Canada.

“With U.S. weakness through the third quarter (of 2007) primarily reflecting a housing downturn, spillovers have continued to be limited,” the report said. “As the U.S. slowdown broadens to consumption, it is likely to generate more general trade effects.”

The IMF said the Canadian dollar at near parity with the U.S. dollar was an appropriate market value, reflecting the strong economy and high commodity prices. Some measures suggest it is slightly overvalued, it noted.

“The Canadian dollar has fallen from November’s record high against the U.S. dollar, when it was modestly overvalued by most measures,” it said.

The Canadian dollar has appreciated 45 percent since 2002. It hit parity with the U.S. dollar last September for the first time in three decades, and continued to climb to a modern-day high of about US$1.10 in November before easing.

The currency has moved within a range close to parity for the past several weeks.

Canada’s adjustment to the currency’s rise has been “remarkably smooth” due to its flexible labor market, it said.

The Bank of Canada has appropriately cut interest rates to respond to the growing risk from the U.S. housing crisis and subprime mortgage debacle, the IMF said. Further monetary action would likely depend on incoming data, it said.

And in the day before Ottawa’s Conservative government brings down its third budget, the IMF praised the government for maintaining surpluses, cutting taxes and committing to debt reduction.

However, it sided with most economists in saying the reduction of the federal sales tax, or GST, by one percentage point to 5 percent -- at a cost of C$6 billion annually - was not the most efficient measure.

“To foster efficiency, the fiscal room should be used to reduce high marginal effective tax rates on capital, saving and labor (in that order),” the IMF said.

It warned that the revenue gains that led to higher-than-expected surplus in the current fiscal year may be temporary and therefore Ottawa should restrain spending in the medium term.

Reporting by Louise Egan; Editing by Renato Andrade

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