Trepidation reigns in corporate Canada as 2023 nears
As Canadian businesses begin to close the books on what was a relatively strong 2022 and turn their attention to the new year, the prevailing mood in the nation’s C-suites is one of trepidation.
While corporate balance sheets are solid after a year of record profits, companies are facing a dangerous cocktail of high interest rates and slow growth in 2023.
The implications are difficult to predict.
The higher borrowing costs are not only a major headwind for Canada’s frothy housing market and heavily indebted households, but costs of capital are rising for businesses at a time when the nation is only just starting to embark on a massive investment drive to accelerate its transition to a low carbon economy.
Which is why U.S. President Joe Biden’s Inflation Reduction Act tops the list of major corporate worries in Canada.
Yes, the landmark federal legislation finally breathes some life into our neighbor’s climate transition efforts.
Biden is making available about half a trillion Canadian dollars worth of tax incentives and other measures to fuel spending in renewable energy, clean manufacturing, nuclear power and other sectors.
But for Canada’s executives, the ambitious American plan is also the latest in a string of potentially existential economic threats that have emerged south of the border in recent years. The fear is that the U.S. incentives will siphon Canadian capital south of the border.
In her fiscal update last month, Finance Minister Chrystia Freeland acknowledged her government will need some sort of response.
Without new revenue raising measures, however, Freeland will probably need to make some choices about winners and losers. Many of the country’s executives are working hard to ensure their industries aren’t left on the losers list.
The government’s dilemma is very much akin to the situation in 2018, when Trudeau was pressured to respond to Donald Trump’s corporate tax cuts with Canada’s own investment sweeteners. The governing Liberals at the time moved ahead with a targeted tax break package worth about C$15 billion — a big bill simply just to keep the playing field level.
The cost of responding to Biden’s incentives this time could be even higher, especially if the U.S. plan starts to undermine the future sustainability of Canada’s whole carbon pricing edifice.
Banking regulator’s latest move adds to the anxiety
A few weeks ago, Canada’s banking regulator probably wasn’t on anyone’s bingo card as a source of angst heading into the new year, but its decision this month to raise capital buffers for the nation’s largest lenders is adding a new source of pressure.
The Office of the Superintendent of Financial Institutions (OSFI) announced it would be raising the level of one of its buffers — the so-called Domestic Stability Buffer that applies only to the largest banks — to 3 per cent of total risk weighted assets, from 2.5 per cent.
The regulator characterizes the buffer as a rainy-day fund for banks to be able to cover massive loan defaults and other losses. OSFI also hinted the buffer could increase by more if needed.
The move had an immediate impact, forcing the Bank of Montreal to raise $3.2 billion in capital to help meet the new requirements, sending its shares significantly lower.
The regulator’s intention, of course, is to reduce chances of a major destabilizing event for Canada’s financial system — which this move clearly does. But the higher buffer will also constrain credit at a time when the economy is slowing, and raise the cost of capital at a time when interest rates are already elevated.
The effect will be to amplify the downturn the regulator is worried about. Buffers should be accumulated in good times, not in bad.
Even more important may be the messaging OSFI is sending to investors both domestic and global. The bank regulator is signaling it’s concerned a prolonged downturn is a distinct possibility, which is currently not a best case scenario for the Bank of Canada, the government of Canada or most bank economists.
That will simply add to jitters about 2023.