Canada's basic (im)balance

You can call it, I guess, Stephen Harper's parting gift to Justin Trudeau, who will be sworn in as Canada's Prime Minister tomorrow (November 4). A study by economists at BofA/Merrill Lynch  has revealed a sharp deterioration in Canada's so-called basic balance -- or as the headline on the linked article soberly expresses it, "money is flooding out of Canada at the fastest pace in the developed world".

The basic balance is an infrequently-used statistic that combines the trade balance and autonomous capital flows. In looking at what's happening to Canada at the moment, it's very easy to see that the deterioration in both of these components, and hence the sharply negative swing in the basic balance, is directly attributable to the collapse in energy prices.

Canada's monthly trade balance has predictably worsened in the past two years as the global oil price has fallen. In fact, the oil sector in Alberta has been hit even harder than most other oil producers because of the lack of pipelines to get the product to market -- of which, more in a moment. What the Merrill Lynch study indicates is that as the Harper government's all-in bet on the resource sector unravels, capital flows have turned sharply negative too. Both individual and corporate investors are redeploying funds not just out of the energy sector, but out of Canada altogether.

Given all this, it's no surprise that the exchange rate has weakened so sharply in the last couple of years. What's more, it's hard to be confident that the decline in the Canadian dollar is over. There are only the most tentative signs that the lower exchange rate is making non-oil sectors of the economy more competitive. Meanwhile, the outlook for energy just gets worse: TransCanada's request to the US government this week to delay a decision on the Keystone XL pipeline may well be the final death-knell for the project. Other pipeline proposals, to take Alberta tar sands crude either west to the Pacific or east to the Atlantic, face severe opposition.

In short, Harper's ten years in office have left the economy in a bit of a mess, even though Canada avoided the worst effects of the global financial crisis. The incoming finance minister, whoever that may be, is going to have a lot on his or her plate, right from day one.