Canada is showing symptoms of Dutch Disease, a major U.S. bank warns. But help is here, or at least on the way.
The issue has been a hot one for Canadian politicians. And many observers have rejected the idea of Dutch Disease in Canada, including former Bank of Canada Governor Mark Carney.
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But in a report this week, Bank of America Merrill Lynch says the evidence points to a Canadian case of Dutch Disease, a phenomenon of foreign money flooding into a country in the case of, say, a huge energy find, and damaging an economy by driving up the currency and, thus, hurting trade.
In Canadas case, this would, if true, mean the oil boom pushes up the Canadian dollar, in turn whacking the export manufacturing base.
The boom in oil production is a plus for GDP and national income, Bank of America economist Emanuella Enenajor and foreign exchange strategist Ian Gordon said in the new report.
But this sea-change also has meaningful ramifications on the currency and trade, they added, pointing out that the energy sector was but a blip in the economy in the 1990s, accounting for less than 4 per cent of Canadian exports.
We find a heightened relationship between the currency and oil prices in the past decade, suggesting the C$ is increasingly trading as a petrocurrency, the researchers said.
Moreover, a persistent current account deficit on weak non-energy trade suggests Canada is suffering from a Dutch Disease, as the outsized appreciation in the currency has been out of line with broader trade fundamentals.
The loonie, as Canadas dollar coin is known, has gained over the years, trading at par with the U.S. greenback early last year. It has most recently weakened, helping along what the central bank hopes is a rebound in non-energy exports.
According to Ms. Enenajor and Mr. Gordon, 10-per-cent rise in oil prices is linked to a persistent 1.2-per-cent strengthening of the currency.
And according to their calculations in the report titled Canadas Dutch Disease, crude will account for 27 per cent of all Canadian goods exports by 2025, as the biggest single component.
In turn, a 10-per-cent jump in the loonie cuts export revenues by 5 per cent, when converted back into Canadian currency, given that half of the countrys factory sales are export-bound.
Keep in mind that the currency has gained nearly 45 per cent since 2002, and since then, factory production has fallen by 11 per cent, with jobs down by 24 per cent a key symptom of Canadas Dutch disease.
Many observers believe the loonie should be lower than the 91-cent level of today, and expect it will be. And the flow of capital into Canada has eased.
With a gaping current account deficit, all it takes is a slowing in capital flows for the currency to depreciate, said Ms. Enenajor and Mr. Gordon, projecting that the dollar will end the year at just shy of 88 cents U.S.
In our view, that risk is significant in an environment where the Fed is likely to hike before the Bank of Canada, and where energy prices risk stagnation.
Theyre not alone in their currency projections.
Just yesterday, chief economist Douglas Porter of BMO Nesbitt Burns noted that the recent softening in the price of oil seems to be another negative for the loonie.
He added, however, that the currency depreciation of the last year and one-half appears to have gotten well ahead of the easing in oil prices.
Having said that, we still look for the Canadian dollar to weaken further over the next year, undercut in part by a broadly strengthening U.S. dollar, Mr. Porter said.
A further slide in oil would just grease the wheels.
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