Short recession in North America but Canada will have to meet certain challenges

The National Bank of Canada today published its economic projections. Economic growth in the U.S. and Canada will start to pick up again in 2002, after a short recession in 2001. The downturn will affect the economies of Quebec and Ontario rather similarly in the second half of 2001, with growth projected to pick up progressively in 2002.

According to Dominique Vachon, the National Bank's Vice-President and Chief Economist, not all the economic forces that made the past decade one of strong growth for North America have lost their strength, despite the uncertainty over the current geopolitical climate. "Low inflation has given the central banks considerable maneuvering room. The impact of the interest rate cuts, starting at the beginning of the year, will be felt in the coming months. The major efforts made by most of the governments of the industrialized countries to clean up their finances this past decade have made them much less vulnerable to the economic slowdown they face today."

This will allow the U.S. economy to start growing again in 2002, after contracting about 1.5% in the fourth quarter of 2001. The Fed Funds rate has been cut ten times since the beginning of the year, from 6.5% to just 2.0%. In addition, tax stimulation measures could total almost $200 billion in fiscal 2002 alone, or about 2% of GDP. However, increased spending on security and defence, as well as the difficult task of improving the climate of uncertainty created by fears of new attacks or an uncontrolled spill-over of the current war, will limit the growth potential of the U.S. economy to around 3%.

Canada, for its part, will have to juggle several factors that will conspire against it. It will be difficult for the Canadian dollar to appreciate given the persistently weak commodity prices. The pause in investment spending will defer hope for new productivity gains. Up to now, tax cuts have been minimal and the next scheduled cuts may be compromised. However, if Canada is to retain its ranking among the top industrialized countries, it must meet a number of challenges.

In terms of production, the technology sector is in a deep depression. After posting more than 60% annualized growth in 2000, production of computers, communications equipment and semi-conductors has plummeted 41% in Canada and 11% in the U.S. over the past year. Ms. Vachon noted that the drop in output in this sector is more pronounced in Canada and started earlier than in the U.S., which suggests that our technology sector trails the U.S. in terms of value added. It is as though Canada were a back-up producer for the Americans.

Ms. Vachon went on to add that the restructuring in this industry has been brutal and will continue to be so. In fact, in the days when stock markets were beating record after record, almost 90% of corporate activities were financed through share issues, with loans from affiliated companies making up the rest. The crash in stock prices has obviously dried up the main source of corporate financing, as companies try to find the liquidity they need to face declining activity levels. They have little choice but to maintain only their most profitable operations or those best positioned for the future.

Quebec's computer and electronic equipment industry exports 70% of its products to the U.S. This dependence on the American market constitutes the main stumbling block for the Quebec economy in 2001. In fact, telecommunications equipment exports to the U.S., which had grown by leaps and bounds in recent years, are now just a shadow of their former selves. By August 2001, they had fallen to just 21% of their August 2000 level. Further production cuts are expected in the months to come. Employment has held steady in Quebec since the beginning of 2001, despite the severe slowdown. Moreover, the Quebec budget tabled on November 1st included a number of initiatives to stimulate economic growth. Despite the government's reduced maneuvering room, this budget will improve the fundamentals of the Quebec economy, notably in terms of infrastructure, education and health. The tax measures granted to SMBs are very good news and one can only applaud the government's decision to respect its tax cut schedule despite the economic situation.

Summary of principal projections:
(Annual % growth, unless otherwise stated)

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