Weak real gross domestic product (GDP) growth — forecast to end 2013 at just 1.7% — will make it difficult for Canada’s federal and provincial governments to meet their deficit-cutting targets in the short term. That’s according to a report published yesterday by TD Economics. “Some provinces are just not going to be able to meet their deficit-reduction timetables,” said the report’s author Sonya Gulati in an interview with me yesterday. She’s a senior economist with the firm. “They may have to cut more spending in order to make their books balance. Or they may push back their deficit-reduction timetable a year or two.”

Canada’s federal and provincial government deficits total $45.8 billion. That’s about $6 billion more than was anticipated in last year’s budgets. Government finances worsened during the 2012-13 fiscal year as a result of a softening economy.

That adds complexity to this new round of budgeting. Policymakers have to balance fiscal discipline with the need to avoid decisions that squash economic growth. “It’ll be a very careful balancing act,” said Gulati. “It is a risk-filled environment and a lot of the risks that are out there are [global].”

Seven themes to watch, according to Gulati:

• Government revenues will rise in 2013, but just slightly. TD Economics predicts nominal GDP growth of 3.6%. (Nominal GDP is a measure of the value of goods and services produced in current prices, whereas real GDP measures economic output in terms of a base year’s prices.) While the prices of most major commodities are expected to rise in the second half of 2013, don’t count on big government revenue gains as a result.
• Half the provinces will see black ink before the fiscal year is out. There’s good news forecast in British Columbia, Alberta, Nova Scotia and Quebec, all of which are expected to balance their budgets in the coming fiscal year. Look for Saskatchewan to maintain its surplus too. Still, these governments will have to remain vigilant about spending.
• Don’t expect big moves on taxes. There simply isn’t the political appetite. Sin taxes are always easy to bump up. And we could see increases in sales taxes, health taxes or user fees, according to the report. Income taxes, which have a more negative impact on economic growth, are unlikely. (Alberta may buck this trend, though.)
• Governments are more likely to hold the line on spending. Weak GDP growth will make it tougher for governments to stay on track with their deficit-cutting goals. Some will delay their plans. “When the 2013 budget season is done, we would not be surprised to see two or three provincial governments set their original timetables back one year,” wrote Gulati.
• Healthcare and education spending will take hits. Both are major priorities for governments across the country. According to TD Economics, they account for about 70% of total spending for most of the provinces. So they’re going to need to be creative.
• The credit rating agencies want to see a plan. “We saw three moves last year on the credit rating front,” Gulati told me. Standard & Poor’s downgraded New Brunswick and slapped Ontario with a negative outlook. Moody’s gave British Columbia a negative outlook, too. “What they’re going to look at is the medium-term plan, whether that continues to look credible or not. I don’t think they’re going to be worried if there’s a significant deterioration in one year. But they want to look at what the plan is to get back to budgetary balance.”
• Watch for more infrastructure spending in Ottawa. This played a key role in the stimulus program that followed the 2008 financial crisis. The feds may restart the Building Canada program, which is set to expire in 2014.

Clearly, the news is not all bad. “When you look at yields, when you look at spreads of provincial bonds over federal bonds, you’re seeing that Canadian governments in general are in pretty good shape when compared to some of the other players in the world,” said Gulati.

What’s fascinating is how complex the austerity vs. stimulus debate continues to be among policymakers. In that sense, Canadians are facing the same tough decisions their counterparts are throughout the developed world.

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