Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 1 - Evidence - February 4, 2016

OTTAWA, Thursday, February 4, 2016

The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:30 a.m. to study the present state of the domestic and international financial system (topic: The causes and effects of the recent decline in the Canadian dollar exchange rate).

Senator David Tkachuk (Chair) in the chair.


The Chair: This is the second meeting of the standing committee on the issue of the dollar. My name is David Tkachuk, and I'm the chair.

As we talked about yesterday and as I mentioned yesterday, the dollar has been down considerably for some time now, and it has risen moderately lately, opening today at 72.56 cents and now a little bit over 73 cents. So maybe we should just keep on talking.

Today, we have a panel of fabulous witnesses from the financial institutions, who are going to give their perspective. I'd like as much discussion as possible. We're asking that all of them participate for five minutes so that we have lots of time for talk and discussion. Witnesses, if you want to intercede when someone is giving an answer and someone else wants to add to it, I appreciate that as well.

From BMO Financial Group, we have Doug Porter, Chief Economist. From the Canadian Imperial Bank of Commerce, we have Royce Mendes, Director and Senior Economist. From the Desjardins Group, we have Jimmy Jean, Senior Economist. From the Royal Bank of Canada, we have Dawn Desjardins, Vice President and Deputy Chief Economist. From Scotiabank, we have Jean-François Perrault, Senior Vice President and Chief Economist. And from the TD Bank Financial Group, we have Derek Burleton, Vice President and Deputy Chief Economist.

We'll proceed with the opening statements and then move to senators' questions.

I have to vacate the chair at maybe quarter after 12 or thereabouts. I know we're slated to go to 12, but, if we have to go to 12:30, that would be great. So I'll ask a member of the steering committee to do that if the deputy chair is not here. Anyway, we'll leave that with you.

I'm going to call on the first witness: from BMO, Doug Porter, Chief Economist.

Doug Porter, Chief Economist, BMO Financial Group: I'm very pleased to be here with you and the members of the committee and my economist colleagues for the discussion on the causes and effects of the recent decline in the Canadian dollar.

As a little bit of a backdrop, 2015 was the Canadian dollar's second-worst year on record, when it fell by 16 percent in the calendar year. Earlier this year, it was down further to a 13-year low, hit by financial market volatility globally, disappointing economic data, another deep dive in oil prices, and geopolitical surprises, before it rebounded in recent days.

We believe that there have been three primary factors behind the steep decline in the past few years. The biggest weight, in our view, has been the relentless plunge in oil prices, which have plummeted to multi-year lows. Our estimate is that for every $10 move in oil prices, the Canadian dollar tends to move in the same direction by 3 to 5 cents, so, arguably, this plunge in oil prices alone explains the lion's share in the drop of the currency in the past few years.

The second factor is that there has also been direct divergence in monetary policy between the U.S. and Canada, with the U.S. Federal Reserve raising rates last year, at the end of the year, and the Bank of Canada cutting rates twice. Suffice it to say, it is exceptionally unusual to have the two central banks travelling in opposite directions. The closest parallel that we can find in recent decades was in 2002 and 2003, when the shoes were on the opposite feet. That episode was also characterized by a violent reset in the exchange rate; 2003, in fact, saw the Canadian dollar have its best year on record, when it rose by more than 22 percent in a single year.

The third factor is that there has been underlying broad-based strength in the U.S. dollar. The U.S. dollar has risen against every major currency in the world in each of the past two years, and we still believe that there's reason to believe that 2016 will make it three years in a row where the U.S. dollar will be the strongest currency in the world. This does imply that the Canadian dollar is not alone in its plight, with almost all major currencies dropping deeply against the greenback in the last two years.

Those are the three biggest factors driving the currency. However, we would submit that another factor chipping away at it could also be a little bit of concern over Canada's fiscal outlook. It's now almost conventional wisdom that the coming budget will reveal a deficit target considerably larger than the previously pledged limit of $10 billion. After all, if the government's medium-term goal is to keep debt to GDP stable or falling, that allows room for deficits of as much as $20 billion annually, assuming that nominal GDP growth is around 3.5 percent.

On top of that turnabout in federal finances, many provinces remain under fiscal pressure, with even Alberta losing its triple-A credit rating late last year.

Looking through the rest of this year for the currency, it appears that most of these underlying factors are not going to go away, so we believe that that leaves stabilization or potential stabilization in oil and other resource prices as the last line of possible defence for the loonie. Given that we don't expect oil prices to meaningfully stabilize until later this year, we think that the currency is likely to remain under pressure and end the year not terribly different from where we find ourselves today. Based on our projection for oil prices, we then look for the dollar to return to the mid 70-cent level by the end of 2017.

There are several implications to this lower level of the dollar. For domestic businesses, we believe it is a double- edged sword. It's a common refrain to say that the weaker loonie is an economic positive, given that it provides a lift to exporters and really anyone who has to compete internationally, and it definitely strongly benefits the tourism industry.

Manufacturing does generally benefit from the drop in the currency, as its products become more competitive and/ or profit margins expand, but it's questionable whether Canada still has the export capacity to fully take advantage of the more competitive currency.

Certainly, a weaker loonie helps existing firms, but the currency probably isn't quite low enough for long enough yet to attract significant new investment. Moreover, there are some downsides for businesses from the weaker currency, most notably higher import costs, and even manufacturers that would seemingly gain from the lower currency can see negative side effects as many domestic products have quite high import content.

Meanwhile, for consumers, the lower currency is clearly bad news. The low value of the currency is clipping Canadian consumer buying power, especially in the form of higher import prices, most notably for fruit and vegetables so far. In fact, over the past year, Canadian prices for fresh vegetables are up by more than 13 percent as of mid- November. Just to put that in perspective, U.S. fresh vegetable prices, over the same period, have risen by just 0.4 percent, so that entire 13 percent rise can be put down to the weakness in the currency alone. All in, the hit to consumer buying power points to a period of slower real consumer spending growth versus the U.S. and versus the rest of the economy. In fact, we would argue that a weak currency is probably a bigger risk to Canadian consumers at this point than record household debt.

On the investor side, meanwhile, for those choosing to remain in or come back to Canada, it's useful to note that the energy sector is one of the larger beneficiaries of a lower currency, at least from an earnings perspective, although weak commodity prices are dominating that effect.

Export-intensive industries with costs predominantly in Canada, as well as banks with U.S. operations, stand to see a small earnings boost. Those sectors with a large share of imported costs could struggle before accounting for any hedging activity.

Mr. Chair, thank you for the opportunity to be here today. I look forward to answering committee members' questions.

The Chair: Thank you, Mr. Porter.

Royce Mendes, Director and Senior Economist, Canadian Imperial Bank of Commerce (CIBC): Good morning, Mr. Chair and honourable senators. I would like to thank you for inviting me to share my analysis of the causes and effects of the recent decline in the value of the Canadian dollar.

Let me begin my opening remarks by making two brief points that summarize my views. First, the cause of the decline in the exchange rate has largely been the result of the sharp fall in global oil prices. While the divergence in monetary policy between Canada and the U.S. has also been blamed for the depreciation, that deviation occurred only as a result of the fall in oil prices.

Second, the only brief statement I can make about the effects of the decline in the Canadian dollar is that I simply cannot make a brief statement. The effects will be complex and wide-ranging. As a result, I will spend much of my opening remarks discussing these dynamics.

To be clear, while the fall in oil prices is a negative for Canada's economy, the decline in the exchange rate will mitigate the effects. It will act as a shock absorber and spur necessary adjustments within the economy. The weaker Canadian dollar will cause both labour and capital to migrate towards industries that will benefit from the depreciation in the exchange rate. That being said, the process will not be smooth, and the gains will not be evenly distributed.

Moreover, the negative aspects of the depreciation are front-loaded. Weakness in the Canadian dollar has already added more than half a percentage point to inflation, notably in the prices of imported goods. Indeed, the prices of certain imported food items have made headlines recently given that they are placing a disproportionate burden on lower income households.

But, it's important to keep in mind that this is part of the adjustment process; and, over time, the net result of the depreciation will prove beneficial for Canadians by supporting the labour market and increasing global demand for our exports. Indeed the depreciation in the currency has already made our exports more competitive on the global stage. Although it will take more time for capacity to be built to fully take advantage of this new environment, the seeds of growth have been sewn.

That said, it should be noted that external headwinds will cause this adjustment process to take even longer than in past cycles. Weak global growth combined with the depreciation of other currencies is making it more difficult for Canada to fully take advantage of the decline in the exchange rate. Moreover, while the U.S. has been one of the lone bright spots in the global economy, its manufacturing sector has been suffering from the effects of a strong dollar. With a large portion of Canada's manufactured goods feeding into U.S. supply chains, that weakness has also been felt north of the border. Over time, these headwinds should fade; but it's important to keep in mind that absent a weaker Canadian dollar, our nation's exporters would be in even worse shape.

While goods exports often take the spotlight, our analysis at CIBC suggests that more focus should be given to Canada's exportable services. Economics 101 textbooks suggest that services are difficult to export; as the old saying goes, you can't export a haircut. But technological advances combined with Canada's highly educated labour force have put the country in a unique situation to increase service exports. To be sure, after taking into account the exchange rate with the U.S., the services of Canadian Web developers, aerospace engineers and architects cost roughly half of what they do in the U.S. While those are some of the most extreme cases, they are useful illustrations of how competitive Canadian services have become on the global stage. As a result, the rebuilding of capacity in tradeable goods sectors should not be the sole barometer of the effects of the weak Canadian dollar.

To sum up, the negative shock from oil prices and the associated decline in the Canadian dollar have set in motion an adjustment process that will take time to make its way through the economy. Areas of growth in Canada are shifting across industries and regions. While it's proving to be a bumpy road to recovery, it is a necessary process, given the shock the economy has sustained.

This concludes my opening remarks. I look forward to the ensuing discussion.

The Chair: Thank you, Mr. Mendes.

Jimmy Jean, Senior Economist, Desjardins Group: I will make my introductory remarks in French, but I will be able to take questions in both languages.


It is a pleasure and an honour to be part of the conversation today about the depreciation of the Canadian dollar. Clearly it is a subject at the heart of the economic debate, given the implications of a weak dollar on a variety of macroeconomic parameters, be it inflation, regional growth dynamics in the country, sectoral dynamics, or the overall purchasing power of the Canadian consumer. Several of these dynamics were discussed by my colleagues. We will probably have an opportunity to expand on these topics, but for now I will make the following preliminary remarks.

First off, it is very difficult to talk about the Canadian dollar without mentioning oil. There is now talk of an oil supply shock, but how did we get here? There are a variety of factors I could list, but I want to draw your attention to the impact of worldwide prolonged and accommodative monetary policies that have contributed (and still contribute) to reducing the cost of credit and stimulating demand for capital. When you put this together with significant productivity gains in the energy sector, particularly in the U.S., and with what many have called — rightly or wrongly — a commodity price "super cycle,'' we see more and more what is beginning to look like a speculative bubble, characterized by the classic symptoms of overestimating profitability outlooks and underestimating risks, and therefore by overinvestment. So to make link with monetary policies, the irony is that the policies that were implemented in response to previous bubbles may well have sown the seeds of today's environment.

From there, to get to our question of the Canadian dollar, it is simply a story of correlation. Historically, oil and North American rate differentials explain most of the trends in the exchange rate. The depreciation of the Canadian dollar therefore reflects nothing more than the fulfillment of an almost immutable law. Oil dictates our terms of trade, and therefore our currency's fluctuations.

With respect to impacts, we know them pretty well. Based on the past, we can say that there will be some upward impact on inflation as the prices of imported goods cost more. This makes intuitive sense and, besides, we have seen it happen. But the uniqueness of our economic situation is that the vast majority of our economic agents are also net consumers of energy products, so the same products that are the source of the weaker dollar. So we must also take note of the fact that what we are currently losing in purchasing power for food, for example, we get back in the form of lower energy costs. In the first three quarters of 2015, households spent $6.7 billion less on fuel compared with the same period in 2014, equivalent to savings of $470 per household. That is not insignificant.

And that brings us to the question of regional differences. In the producing provinces, revenues are highly dependent on oil and unemployment is currently rising. So the positive effects of the dollar's depreciation pale in comparison to the headwinds caused by adjustments in the petroleum industry. However, in other provinces like Quebec, the impact is clearly positive. According to the results of our research, Quebec is one of the best-positioned provinces to take advantage of the dollar's depreciation, because of the structure of its exports. What we are seeing at this time is that there is a positive response from Quebec exports, but there are capacity constraints that have capped exports in this most recent period. Still, 10,000 manufacturing jobs were created in Quebec between December 2014 and December 2015, and if optimism holds, we may see renewed investment.

We are also not just talking about Quebec. In fact, 2015 was the best year for employment in the Canadian manufacturing sector since 2012, with 37,400 jobs created. This is a rather rare phenomenon. Since 2000, there have been only five years that the net employment change was positive in manufacturing. That is a point that must be taken into consideration. Various polls and surveys from manufacturers confirm that what we are seeing is not due to chance. For example, the Bank of Canada's latest business outlook survey, released last month, says:

Exporters not linked to commodity production anticipate significantly stronger sales growth than other firms.

So we are seeing some ambivalence in terms of impacts. Whether it is a question of inflation, regions or industries, there are pros and cons, winners and losers. The great uncertainty that we must acknowledge is the degree of the various impacts and the time horizon over which these effects will occur. It is a difficult forecast, especially since it requires a lot of assumptions about key parameters, and slight changes in these assumptions can fundamentally alter the conclusions. So even though at Desjardins we remain cautiously optimistic about the ultimate impact of the weaker Canadian dollar, we recognize that the range of risk with which we must now deal is wider than usual.

So, in the end, and I will conclude on this, it is natural to wonder how we got here with the Canadian dollar. Canada had high-value assets that it managed perfectly rationally according to the information it had during the raw materials boom. However, in my view, the global context, the cyclical and geopolitical characteristics inherent in oil prices, and the effect of policies put in place to overcome the 2008-09 crisis are among the factors behind the current volatility of oil prices and therefore the Canadian dollar. That said, the drop in the Canadian dollar could well mark an important turning point for our economy because it is happening at the same time that our economy has a crying need for rebalanced sources of growth. The weaker currency should, in many ways, facilitate this shift, but the results will likely be measured in years, not quarters. Thank you.


The Chair: Thank you, Mr. Jean.

Dawn Desjardins, Vice President and Deputy Chief Economist, Royal Bank of Canada: Thank you, senators, for inviting me here today.

When we look at the Canadian dollar, we certainly see, since the beginning of this century, some really discernible patterns in terms of its direction. We saw it hit an all-time low in 2002, and after that we had a very steady period of Canadian dollar appreciation interrupted by the great recession. Then we did see the currency move back towards parity until about late 2013, and that's when we started to see some deterioration. But it really took hold in June of 2014, and since that point we've seen the Canadian dollar lose about 25 percent of its value against the U.S. dollar. It's not coincidence that, in fact, that is exactly the point when we started to see a sharp drop in oil prices. As we know, oil prices had a recent high of about $108 in June 2014, and today they stand at about $32 per barrel. That same period saw the currency move from about 92 cents to today's rate, which is around what you said, 72.5 cents U.S.

So we look overall at the relationship between the Canadian dollar and oil, and I think that when you just look at a simple chart, you see that in fact it is a very close relationship. When we look at the future for the Canadian dollar, then of course we have to take into account what is likely to occur to oil prices and what that might mean for our currency.

At RBC, we tend to think that oil prices will begin to rise as we go through the latter half of 2016. Global growth, in terms of demand, will continue at about a 1 percent pace per annum, but we think that this oversupply that is continually coming to the market will diminish over time. In fact, supply and demand will become more closely aligned. This will give a lift to oil prices, which we expect to end this year at around $50 per barrel, so there's a fairly significant lift. We think this will be one factor that supports an appreciation in our currency as we go through the course of this year.

It begs the question: Why is oil having such a disproportionate effect on the Canadian currency? Of course, as a large exporter of energy products, accounting for about 22 percent of the volumes of Canadian exports and, more recently, about 12 percent of their value because of the sharp price decline, we have seen a significant reduction in the revenue we're getting from that production. Profits have fallen, and, of course, this is putting stress on government revenues.

Additionally, we're seeing downward pressure on the economy because producers are pulling back in terms of investment, and they're shedding jobs. So, overall, we do see why this is so important, and why investors would be looking at the Canadian dollar in the context of what's happening in one of our key export areas.

Now the Bank of Canada, I think, refers to this as a negative terms-of-trade shock. The price of what we're exporting has fallen relative to the price of our imports, meaning we have generally less income in the economy, and of course this is taking its toll on economic growth.

Now, when we look at the value of the currency and what the main drivers are, our model, which I think is similar to many others, as my colleagues have been discussing — we look at energy prices. We look at short-term interest rate differentials, and we try to determine what the value should be, given where we see prices today.

So our models suggested that three quarters of the decline that we've seen in the Canadian dollar reflects this drop we've seen in energy prices. About 14 percent of that drop we can attribute to non-energy commodities and only about 2 percent to that interest rate differential. We have seen interest rates in Canada shift relative to the U.S. In June 2014, we were issuing two-year bonds with a gain of 60 basis points vis-à-vis the U.S. We're now at about minus 30. So even that 100-basis point move really only accounted, by our calculation, for 2 percent of that move.

That doesn't capture everything. We know that risk, appetite and sentiment toward Canada's currency are also at play, not to mention the independent strength of the U.S. dollar, which has appreciated against most currencies.

Now, when we look at the future, we do think, as I said, that oil prices will move up and that we will, in fact, see the Canadian dollar appreciate along with it. Currently what our model suggests is that the fair value of the Canadian dollar, with oil prices around $31, will be about 76 cents U.S., so a little bit of an overshoot recently, when we saw the Canadian dollar plummet to 68 cents, and even compared to today's level. As we go through the year, we think we'll see a further upward move toward that 76-cent rate by the end of this year.

As my colleagues have discussed, there are several different channels by which this affects Canada's economy. In some ways, it is a help having this weaker currency because the weaker currency helps energy and all commodity producers when they repatriate their U.S-dollar revenues into Canadian-dollar funds.

Additionally, for those that are non-commodity exporters, they also have this opportunity to get a little bit of a buffer in terms of their revenues. A pickup in exports, we think, really is going to be forthcoming because, of course, Canadian companies that are exporting to the U.S. have a little more room in terms of their pricing ability and can in fact reduce their prices because they know that, when they convert them to Canadian dollars, they are getting that pickup.

We think that we will see this competitiveness advantage actually increase a demand for Canadian exports. Over time, this will result in a pickup in investment and employment, so that's the upside from the weak Canadian dollar.

The downside, of course, is that the price of imported machinery and equipment has moved up, and Canadian companies rely on investing in this machinery and equipment from abroad in U.S. dollars. So those costs have risen. When we look at the prices of imported machinery and equipment, they're up 20 percent relative to a year ago. That's a pretty big disincentive for some companies in terms of investment.

Recently I was visiting a client, and they were talking about the types of machinery they buy. They buy massive machinery, and they said that three years ago $1 million bought them a piece of machinery. Now they're paying $1.4 million for that same piece of machinery, and they aren't going to be getting any more productivity out of it. It's difficult for them to pass on those costs to their clients. So it definitely causes some trouble in terms of this chain of investment as we go forward.

The Bank of Canada, in their recent survey, said that these higher costs of imported machinery and other items saw some Canadian companies report that they are going to switch from foreign-produced equipment to Canadian suppliers. Additionally, a few firms said that they're going to move their production back into Canada. So, again, that is the bright side, I guess, of that particular development.

Finally, the impact on consumer prices has already been discussed. We have seen prices for fruits and vegetables, furniture, appliances and reading material all move higher. This does take its toll on Canada's consumer. On the opposite side of that, the decline in energy prices means we're paying a little less at the pump.

On net, it seems that the Bank of Canada believes that the exchange rate pass-through to consumer prices has boosted our inflation rate about one percentage point. If we see a change in the direction of the Canadian dollar affirming, we think we will see the easing of these pressures as we go forward and, therefore, a little less pressure in terms of the consumer outlook as we go through 2016.

The Chair: Thank you Ms. Desjardins.

Jean-François Perrault, Senior Vice President & Chief Economist, Scotiabank: It's a pleasure to be here and to help the committee develop its understanding of the impact of the Canadian dollar on the economy. As I think most of you know and probably have heard, I suspect yesterday from some of the folks you talked to, the dollar is the single most important price in the economy. It's a shock absorber whose value has a large influence on just about every facet of our lives. It determines in part the competitiveness of our exports and has a large impact on the price of imports. Because of this, it affects the value of our firms, household balance sheets and, fundamentally, our standard of living.

It's tempting to think of the impact of the dollar in isolation from other economic and financial developments. That's a mistake. By and large, the dollar reflects fundamental economic and financial forces, and it moves to help the economy adapt to these forces. That's why we call it a shock absorber. These underlying forces have an impact on the Canadian economy and the dollar, making it difficult at times to separate the impact of the drivers of the currency movements on the economy from the impact of currency itself.


So when asking questions about the impact of the dollar on the Canadian economy, you are really asking what is driving the dollar, and what are those factors doing to the economy. Generally speaking, the dollar only really has an independent impact on the economy when it moves beyond what would be suggested by economic fundamentals.


You've heard this a number of times, but our dollar is typically driven by three key factors: commodity prices, both energy and non-energy prices; interest rate differentials; and, over a longer period of time, productivity differentials. The relative importance of these factors changes over time. Add to this shifts in market sentiment and risk appetite, and you can see that movements in the dollar can be hard to explain at times. That's why you have us all here.

Nevertheless, the dollar is usually driven by the fundamental factors I mentioned. There has been a clear correlation between the dollar movements and oil but also other commodities more broadly. Also, a divergence in expectation to growth and monetary policy in the United States and much of the rest of the world has caused investors to invest in U.S. dollar assets, putting downward pressure on the Canadian dollar and other currencies. At times, this has been amplified by what are called "risk-on risk-off sentiments,'' triggered most recently by developments in China.

Despite being perceived as a commodity play, the Canadian dollar seems to have been affected more than other commodity currencies. Quite honestly, this is a bit of puzzle. For instance, our dollar had depreciated against the Australian dollar, which is just as heavily exposed to commodities, in fact more exposed to China than we are. Short positions against our currency were roughly four times as large as those against the Australian dollar, once we adjust for turnover in the foreign exchange market.


It is unclear why the sentiment was so negative, but this negativity is being unwound rapidly. Since its low of just above 68 cents two weeks ago, the dollar has appreciated by about 7 percent to about 73 cents. Though volatile, oil prices are roughly where they were two weeks ago. Part of the change in the dollar reflects altered expectations for the path of monetary policy in Canada and the United States. It is too early to tell, but this does suggest that the dollar had undershot somewhat the level one would consider in line with economic fundamentals.


Where do we see the dollar going from here? Obviously, it depends on what happens in the global economy and commodity prices and, to some extent, the nature of the shocks that will affect us, which are by nature unpredictable. Our view is that the dollar will remain roughly at current levels throughout the remainder of the year and appreciate to best 79 cents by the end of next year. This view is based on a forecast of relatively stable commodity prices this year followed by modest pickup next year. We think there will be a sizable fiscal stimulus package in Canada, which will remove the need for further monetary easing in Canada. We expect the bank's next move to be to raise rates, but only well into 2017. These factors in combination with the strengthening global economy from mid-2016 should lead to an appreciation in the Canadian dollar. In fact, we are already seeing this.

I will turn quickly to the economic impacts of the dollar, and I will remain at a fairly high level. Movements in the dollar create winners and losers. It is a relative price, after all, and that's why folks worry about currency wars. By and large, a weaker currency implies a lower standard of living for Canadians. It has the obvious impact of raising the cost of imported products, like food, raising inflation and making foreign travel more expensive. These are just a few examples. There is a range of impacts, as you have heard, but its impacts are much more fundamental than that. For instance, well over 60 percent of the machinery and equipment used by Canadian firms is imported. A lower dollar raises the costs of these investment goods. Given the importance of business involvement to the economy and the headwinds faced by firms nationally and globally, higher costs for investment goods represent a real drag on activity. That being said, the dollar is a boon to exporters, and we're seeing strength in non-resource exports despite the higher cost of investment.

It's also great news for the Canadian travel industry, and, it seems somewhat unexpectedly, it's a boon to housing markets. The average price in U.S. dollars of a house in Canada is nearly 6 percent lower than levels one year ago, whereas about 12 percent higher in Canadian dollar terms. These kinds of positive effects are what we mean when we say that the dollar is a shock absorber. It offsets a portion of negative shock to the economy. The magnitude of the dollar's impact on the economy is heavily dependent on the length of time that it stays at a particular level. A significant portion of firms with foreign exposure hedges or foreign currency exposure — so variations in the currency have a modest impact on their financial plan if moves in the dollar are short-lived. As hedges run off, so does the financial impact of the depreciating dollar. Smaller companies are less able to protect themselves against foreign currency risks and are more affected by movements in the dollar. This is a pretty straightforward argument to make.

Extended weakness or strength in the dollar also impacts firms' pricing decisions. Firms may not pass through short-term movements in currencies to clients, such as households, but they eventually do if the change in the value of the currency is long-lasting. This is in part why food prices have risen so much in Canada. This can have an impact on monetary policy to the extent that this pass-through affects inflation, and inflation, expectations.


Over a longer period of time, a weak dollar reduces competitive pressure and can allow less competitive firms to remain profitable. This is of course an important political and economic issue.


With that, I look forward to your questions.

The Chair: Thank you, Mr. Perrault.

Derek Burleton, Vice President and Deputy Chief Economist, TD Bank Financial Group: I am happy to be with you today talking about this all-important subject. I think about how history repeats itself. In the 1990s we went through a similar discussion in Canada as the dollar fell from the nineties into the eighties, the seventies, and the sixties. At the time, there were calls that it would go as low as 50 cents. Recently, I heard a 59-cent call, not that it's a mainstream view. But we're starting to hear similar refrains: Will we get into discussions about fixing our exchange rate with the United States? It has not gone that far yet, but that was some of the discussion we had back then.

I dug back into the research from the 1990s to see what was talked about. Back then, a list of a number of factors driving the Canadian dollar were all kind of negative at the time. We are talking about 10 or so. Some of the ones we've heard and also some of the more structural factors like productivity growth differences, taxation differences, fiscal differences, and government finances. These are inherent longer-term structural drivers of growth. As well, you get into the commodity prices, which were drivers back then, too.

This time, you look at the landscape and compare Canada with the United States and many of the competitors. Governments have done a lot to fix a lot of these challenges, at least do a good job. I would argue that the government fiscal position federally is not bringing down the Canadian dollar at all. The debt levels are low, so that's not an issue; and our tax situation is much better than it was, particularly on the business side. It really comes down to what we have heard about time and time again: This is an oil price story. It's delivering a big shock to Canada. We heard from the Bank of Canada governor that this is creating a multi-year adjustment. The Canadian dollar is a shock absorber to help transition to more export-led growth away from consumer — that rotational story we need as an economy. From that perspective, it's a good thing.

One of the factors as well back in the 1990s was a large capital outflow from foreigners. I don't get the sense based on the data we see monthly that it's been a huge issue this time. I would argue that in the last few months, it has picked up. We've seen less foreign demand for Canadian dollar securities; but it has not been a stampede out. There is still a strong demand for government securities and corporate securities, even if it has come off its peaks.

That leads me to the outlook, that to the extent that this is not a full-blown competitive challenge with Canada's structural issues across the board — yes, with some structural issues at play with the transition away from resources over time — I am hopeful we will see stabilization of the Canadian dollar.

Again, it comes down to oil prices, and I think most of us are of the mind that oil prices are not going to keep falling and falling over time, but there are prospects for a bit of a bounce. I do think the Canadian dollar will be helped by that, and also it will lead to fewer concerns about the cyclical gap in economic performance more than anything between Canada and the United States, which I think is key.

Much like my colleagues here, I do see scope for the Canadian dollar to stabilize and perhaps bounce up a bit over the next six months to a year.

In terms of effects, I won't go through all of them. I think two of the effects I'm watching are more the positive effects. We've heard of some of the negative effects in the short term. Because people want a low dollar they don't want to see a falling dollar, and I think it does impede confidence, it leads to more uncertainty, but the benefits will increasingly play out as we go through this year going forward.

It's really partly a manufacturing story. I think there is about a six-quarter lag. We're still seeing those benefits of a more competitive currency playout. That said, we've done our research, and I'm a little less optimistic than I was. Mr. Mendes talked about some of the structural challenges in manufacturing, like lack of capacity and some of the supply chain issues with the U.S. manufacturing sector hurting. That's going to limit the upside. The other observation we've seen in terms of those areas within manufacturing that are most sensitive to a lower dollar, they tend to be the smaller ones and not the big auto sector, such as the rubber, plastics and lumber. They are not insignificant, but they may account for 20 percent to 25 percent of manufacturing. That said, we still see improvement there.

Another positive effect that we're hearing more is that we tend to think of trade being more about goods, but what about service trade? I think tourism is quietly giving a nice boost to the economy. It's two ways; it's not only that Americans are finally coming back to Canada, and we expect about a $1-billion to $2-billion boost in American spending in Canada relative to 2014 levels over the next year, so that's playing though, but we also know Canadians are visiting the U.S. less, and some of that money will be redeployed in Canada, and that I think will provide an even bigger boost. The numbers of Canadians going to the States is declining a lot quicker in terms of the sheer size of spending volumes relative to Americans coming up to Canada. It's just a very much bigger magnitude. Together that double benefit is probably going to deliver a boost to the Canadian economy in the order of $4 billion to $5 billion. It doesn't completely change the picture, but it will provide a nice boost to the economy where growth is sorely needed.

I will wrap it up there. I look forward to your questions. I am happy we're not into this discussion of whether to fix our exchange rate to the United States, because I just don't think, given the different economic structures, that it would benefit us. I will stop there. Thank you.

The Chair: It's not that we haven't had that discussion before.

Mr. Burleton: You may have had it, but it's not in the media mainstream.

The Chair: That's right.

We have a great panel here, senators, and we have until 12:30. Let's try to elicit as much information and allow as many of them to speak as possible. So keep your questions short and crisp and let them talk to us.

I'll start with the first speaker I have on the list, Senator Bellemare.


Senator Bellemare: Thank you, Mr. Chair. My question is brief and is addressed to all of you. You all discussed this in your own words, but I am very concerned by how the Canadian economy will adapt to the new reality of the under par value of the Canadian dollar.

Your message was quite clear with regard to the fact that the value of the Canadian dollar will increase, but we should not expect it to be higher in value than the American dollar or at par over the next few years. Governor Poloz has even told us that we are going to have to restructure our economy.

When we examine that reality from one province to the other, we see that despite the fact that Quebec is in a good position, the maritime provinces, according to data from 1999, have current account imbalances and export more than they import, which gives rise to negative growth in terms of exports.

Yesterday at the committee, representatives from the Bank of Canada and Export and Development Canada also alluded to adjustment problems. Mr. Hall, vice-president and chief economist at Export and Development Canada, told us some interesting things when he answered a question from Senator Tannas, such as the fact that the adjustment was complicated.

Everyone said that with the lower Canadian dollar, people would be able to buy machinery, but 60 percent of machinery is imported. And when the Canadian dollar was high, businesses did not buy machinery, but built up liquidity.

I am going to read Mr. Hall's reply in order to make my question more specific:


To answer another of your questions on hedging activity, I believe that is part of the reason that we haven't actually seen some of the positive effects of a lower currency get into the marketplace at the moment, because contracts, hedging and different instruments that just-in-time global supply chains have to employ in order to maintain stability have put an additional rigidity into the market that hasn't permitted the full benefits of a lower currency to the extent that we anticipate ....


So, this is my question: Do you believe that the financialization of the economy has allowed the real economy to adapt in Canada, or has it prevented it from doing so? We note that things are not going too badly, but that they could be much better, in particular in certain provinces. Economic development is not even, and it seems that the real economy is having trouble increasing productivity and adjusting to international competition. As financial institutions, what is your role in this issue?


Mr. Mendes: There were a few good questions there, and I'll answer two of them and then pass it on to my colleagues here.

With regard to hedging activity, I agree it could delay some of the positive effects and some of the positive rebalancing that is going on in Canada, but the idea of hedging gives companies more certainty with regard to their revenue streams and their costs, which actually allows them to operate in a more efficient way. I think that it would be appropriate to say that in this case it was maybe a negative, but overall, if you look at the long term, it is a net positive for companies.

On your other question or comment with regard to machinery and the purchasing of machinery, and how, when the Canadian dollar loses value, it costs more to purchase machinery, I will make one comment that I think could be helpful. When companies need to purchase machinery in U.S. dollars and they are exporters to the U.S. and they're competing with U.S. firms, they're competing with firms that need to purchase that same machinery and have the same revenue stream in U.S. dollars. So actually it's not necessarily a huge negative in their competitiveness because the U.S. firm is getting their revenue in U.S. dollars and has to buy the machinery, and the Canadian firm is getting their revenue in U.S. dollars and has to buy that same machinery. So it's not actually as bad as maybe you might think at first blush.


Mr. Jean: My thoughts are similar to what Mr. Mendes has just explained regarding the cost of investment. In fact, if we are exposed abroad, at this time we will experience a positive inflation in income. I am talking here about inflation in the cost of capital because of the currency, but if that same inflation acts on the income, then you would have perfect coverage in a perfect world, and the impact would be minimal.

We are competitive on the American market, and that is not really a negative factor. Everything is not perfect, however. Clearly, certain businesses have capital costs abroad, and are subject to that inflation and do not see it in their income. This means that there are businesses that will target the domestic market.

In that case, there will of course be a very negative impact. How can this be remedied? There is one way of doing so, and that is to generate that inflation, that is to say to simply increase prices. In certain sectors, we see businesses passing on these higher costs in higher prices, but not all sectors have the capacity to do that.

In fact, certain sectors have very little capacity to increase prices in order to offset higher costs. In the case of investment, this has the effect of a tax on capital that may curb investment.

We cannot put all Canadian businesses in the same basket. Some businesses will feel a very positive impact, others will not. In the work we did for Quebec, we determined that a large number of businesses benefit from this depreciation at this time, and at a certain point, we should see capital being deployed.

Mr. Perrault: I would have a few additional comments. Clearly, hedging activities, as some of you have explained, interfere with adjustment. We must not forget that that is an insurance policy. Although it may have some negative effects, seen from a certain angle at this time, this also has a positive impact, as some of you have mentioned, as it guarantees a payment flow at a certain proportion of the currency. When that insurance was acquired, it protected against downward or upward fluctuations. So the business had an important advantage. Businesses do that, because it gives them an advantage. In this case some of them lost a little, but basically, this is a positive factor for them.

What we also see, at least in my area, is that businesses protect themselves or purchase coverage at the current rate. Since we anticipate an increase in the value of the Canadian dollar, these businesses were able to purchase coverage from 68 cents to 72 cents, which will allow them to make more money if the dollar appreciates.

Adjustment is a complex process, as some of you mentioned. The governor of the Bank of Canada referred to this often. This is an even more complex process because of the global economic situation. We know that financing costs are very low for businesses. They generally have a lot of money and are profitable. They have a lot of money in the bank but they do not invest all that much. It is not necessarily that financial costs are inhibiting investment. It is simply that they are concerned about the economic perspectives, both in Canada and abroad. We see this on a global scale; there are surplus savings as compared to investment, because businesses are conservative. They are worried about the global outlook, and that is constraining investment internationally. Canada had a slight advantage as compared to other countries, to the extent that investment was stronger here than elsewhere. In the provinces that will have to make considerable structural adjustments, such as the maritime provinces, these factors weigh even more heavily.

That is a partial reply, but it is important to have some perspective and take global conditions into account.

Senator Massicotte: My question will be very brief, and I would ask you for a very brief answer, which would allow me to ask several questions. You are all in agreement that this is the wrong time to suggest that we freeze our dollar as compared to the American dollar. That is out of the question. You are all in agreement on that? Nobody disagrees? Very well.

When you do forecasts, it is easy to talk about the past. You talk about the past with certainty, as does a sports analyst or a stock analyst. When you talk about the future, it is always more difficult. Several of you made projections — Ms. Desjardins, in particular — regarding the price of oil, as did Mr. Porter. How would you quantify your projections in percentage terms? Are you 90 percent sure? Or 50 percent sure? I would like to obtain a figure from each of you. Mr. Porter?


Mr. Porter: I would say about 30 percent sure. A little bit more seriously, it does depend so critically on what you assume about oil prices, and, quite frankly —


Senator Massicotte: So what is your percentage?

Senator Ringuette: He said 30 percent.

Senator Massicotte: No, 30 percent was —


Mr. Porter: Thirtypercent; I'm not kidding.

Mr. Mendes: I would say I'd be very certain. If you could tell me where oil prices are, I could tell you where the loonie would be. With greater than 50 percent odds, I would say that the oil prices end the year higher than they are today and that the loonie ends the year stronger than it was.


Senator Massicotte: So 50 percent.

Mr. Jean: I would say that, at the same time last year, we were 75 percent confident that the price of oil would be sitting at $60 today.

Senator Massicotte: That was in the past.

Mr. Jean: I say that to draw a parallel. Today, the price of oil is just above $30, so we're telling you that it will hit $46. But can we have the same level of confidence? Can we be 75 percent confident in that projection, as we were last year? Of course not, because the situation has obviously been difficult.

Senator Massicotte: What is your percentage?

Mr. Jean: If I had to give a percentage, I would probably say 40 percent. But I do think the lower the price of oil, the greater our opportunity to bounce back.

Senator Massicotte: Ms. Desjardins?


Ms. Desjardins: I have to say, I think I'm reasonably confident that oil prices will rise, so I would say 50 percent.


Senator Massicotte: Mr. Perrault?

Mr. Perrault: I would peg the probability of correctly predicting that the price of oil will rise within a year and a half at somewhere around 50 percent.


Mr. Burleton: I'm on the same page. There are a lot of uncertainties for oil.

Senator Massicotte: What's your percentage?

Mr. Burleton: Oh, okay. I'd say 50.


Senator Massicotte: I'd like to make a comment, if I may. You're in Ottawa; you're accustomed to not answering questions, having learned well from our politicians. When you say 50 percent, you are working with a major bank or financial institution. You have capital market departments engaged in the management and speculation of billions of dollars every day. Do your capital market departments listen to you? Are the risks they take in line with your presumptions of certainty, or are those presumptions simply for public consumption and discussion?

Mr. Porter, are the investments made by your capital market department in line with your expectations? It's a simple question, and I'd like a simple answer.


Mr. Porter: My own, no; they take that as one voice. I'm certainly part of the consensus view out there. On financial markets, I believe that economists are wrong as often as they are right. On other economic variables, like the unemployment rate or growth or inflation, economists have a much better track record, but, essentially, financial markets have all current information priced into them already. So, pretty much by definition, anything from here on out is a surprise.

Mr. Mendes: I would agree with Mr. Porter; he took the words out of my mouth. By definition, financial markets are pricing everything that we know at this current point, so, if we had great certainty, it would almost be rigged. So it's most fair this way.


Senator Massicotte: Mr. Jean?

Mr. Jean: Whether it's the media or our clients, people are always looking to us to talk and hear our views on the value of the dollar and financial variables. If our opinion didn't carry any weight, we wouldn't be so sought after. What matters is not so much being right, but more so, and above all, making projections based on appropriate reasoning and being able to articulate the various dynamics at play. I will tell you that our views are used and they are important.

Senator Massicotte: Ms. Desjardins?


Ms. Desjardins: I agree with Jimmy inasmuch as we build a view based on our best assessment of what we believe are the underpinnings of a movement in the Canadian dollar. So, to that extent, I think it does add value because we do have differing opinions, as you can hear, and differing opinions vis-à-vis the market.

I think, all in all, it does add value. Certainly, if you see developments evolving as we anticipate, you have that same intuition based on economic fundamentals, then I think it does certainly add value to our clients.


Senator Massicotte: Mr. Perrault?

Mr. Perrault: Our projections, in terms of both the dollar and commodities, are used for tax and financial planning purposes.

Senator Massicotte: Mr. Burleton?


Mr. Burleton: If futures markets are any indication, they are a little bit less optimistic than the mainstream forecasters, and it's the same thing with a lot of variables these days — U.S. Federal Reserve Fed funds rate.

There's certainly caution in the markets relative to some of the pundits, but that doesn't mean they'll be right and we'll be wrong, for sure.


Senator Ringuette: I have a simple question, but the answer may be complex. It's for all of you.

For a number of years now, not a week has gone by when we haven't heard about Canadians' level of household debt in the news. What impact do you think the value of the loonie will have on household debt in the short and medium terms?


Mr. Porter: There's not necessarily a direct impact immediately. I think in fact at the margin, one thing that's happened over the last year is because of the weakness in oil prices, the weakness in the Canadian economy, we've actually seen the Bank of Canada cut interest rates twice, we've seen long-term interest rates fall to all-time lows in recent weeks, and if anything, that has actually made it more affordable to manage the debt levels we do have.

When we look ahead, I think how this ultimately will be resolved or will affect the economy — and this is part of the adjustment process when we talk about the lower Canadian dollar — I think we will see a shift in emphasis of growth in the Canadian economy away from consumer spending, away from housing and more towards exports in particular, and the weaker Canadian dollar will help us make that shift.

I've always tried to push back against the doomsday scenario about household debt, seeing it as a clear and present danger to the economy. The one thing I always like to point out is that Canada's household debt levels are not out of the ordinary when we look around the world. There are a number of very successful economies that have higher household debt levels than we do, such as Switzerland, Norway, Netherlands or Denmark. Sweden is very similar to us. The U.K. is very similar to us. Australia is also very similar. Yes, we are higher than the U.S., but the U.S. consumer has reformed. It found religion during the financial crisis and brought its debt down to much more manageable levels. So Canada is not that unusual when we look around the world.

The way I look at our record levels of household debt is that we really can't count on the consumer to continue to drive the economy in the years ahead, but I don't see it as a near-term danger to the economy.

The Chair: Anybody else?

Mr. Mendes: I have just one comment on that. I think what we understand is that the weaker Canadian dollar is going to affect consumers by increasing inflation, but inflation is still very low and contained in this country.

What it will also do is support the labour market, which is more important, so that people can still service that high level of household debt. I think the Bank of Canada's cutting of interest rates as well will support the labour market, and that's where we see support will come from for that debt.

Mr. Burleton: I think that's an important point. We often directly link a lower Canadian dollar with reduced purchasing power of consumers, and all things being equal, that's a negative for the household balance sheet.

The important distinction is not the decline in the dollar; it's what's happening underlying inflation, so you need to look at a broader picture. Inflation is the key from a purchasing power perspective when you look at the Canadian household. By that, you're getting the offset from lower gas prices to some extent. Most feel that the pass-through of the lower loonie to the general consumer prices tends to be a short-term impact rather than something long-lasting.

Senator Ringuette: And the uptake on the job market will enable Canadians to reduce that debt load?

Mr. Burleton: Absolutely. To the extent that the lower dollar helps the job market grow, we get growth in these sectors — some of them I spoke of — and that is really the key when it comes back to the consumer.

That's the thing. It's not the Canadian dollar; it's what it's implying about the underlying economy. To the extent that the falling dollar is due to the Canadian economy really weakening, then that doesn't bode well from a household debt, household financial perspective.

Senator Tannas: Thank you all for being here. Yesterday — Senator Bellemare referred to it a little bit — we tried to have a discussion with the Bank of Canada around sentiment and how, when you add it onto speculation, the short- selling of the dollar, hedging activities by nervous exporters or importers to try to protect themselves, which further plays into sentiment, what kind of an impact that has, and we got nowhere. It's obviously not something they like to talk about.

You all did, or a number of you did. One of you mentioned some of the evidence towards sentiment in your short sale of the Canadian dollar being four times larger than in comparison with Australia, which leads me to believe from your comments that we have been through a period of negative sentiment and that the dollar has been oversold, and perhaps we are somewhere at the bottom or maybe starting to move up as sentiment improves. If I'm wrong with that, maybe you can correct me.

I guess what I'd like from you, being inspired by Senator Massicotte's way of questioning, is could you from your models or from your experience give us a number on neutral sentiment and what your model would drive out for a Canadian-U.S. exchange rate today. We'll start with Mr. Porter.

Mr. Porter: It just so happens that we've been fine-tuning our model recently, and what we're coming up with, based on today's commodity prices, is actually not much different from Desjardins. We come up with 74 cents as a point estimate. That's based on today's oil prices.

I'll give you a longer-term view quickly. I think when we try to look at what is a fair value for the currency over the long sweep of history, something in the low 80-cent range, based on more normal oil prices, is —

Senator Tannas: I get that, and we saw that in a number of years. I'm just looking at the sentiment.

So 74 cents would be neutral. We're still at a discount. For all Canadians watching who patriotically want to go out and short the American dollar today, that's the number we're looking for: 74 cents is where we should be today based on oil prices and all your other factors. Mr. Mendes?

Mr. Mendes: I have a few comments. I will give you the number. I would say it's very close to Mr. Porter's number, 73 cents. But it's well known in the economics profession that currencies often overshoot. I would say that this is a classic case of that right here, what we saw in Canada recently.

The risk with the currency overshooting — and what I calculated was one of the deepest and quickest depreciations of the Canadian dollar in its history outside of the great recession and outside of a few other cases — is that when it moves so far and so quick that it hits consumer confidence. Not even the market's negative sentiment — it hits consumer confidence. That's where I would be worried.

I agree that the markets have been negative. There is that "short Canada'' mentality around the world. What I see in fixed income prices and bond prices is that it's not very heavily priced in with regards to risk premiums.

So I would say that there is a negative sentiment towards Canada. The currency did overshoot. We're moving back to more appropriate levels, and that's a good thing, because if the move had been exacerbated, we would have risked hitting consumer confidence.

Senator Tannas: Good point.

Mr. Jean: On the topic of confidence, I think confidence or market sentiment has been downright toxic in January, not just in Canada but everything in the whole realm of financial markets. It has obviously hit the Canadian dollar significantly, but why? Because of oil prices. I think oil prices are also oversold, given the fundamentals and what we see going forward.

I think what is really problematic right now is the speed of the decline and the sense of instability that can be tracked to sentiment. When we crossed over the 70-cent level, then the general press was alerted and the loonie was making the prime-time news on a daily basis. That hurts how the average consumer and business owner feels about the economy.

Yes, it does get into a period where it can be problematic. I think it's important because the Bank of Canada on January 20 walked into the meeting with the mindset that they should cut interest rates, but then the argument was made that there's fiscal stimulus coming up and, secondly, cutting rates further would exacerbate that instability in the currency. They ultimately chose to hold back and wait a little bit so as not to have that counterproductive effect happen. It is a fair point.

Today we're at 73 cents, so perhaps it acts the other way.

Senator Tannas: Are you 73 in your model, or are you saying—

Mr. Jean: No. I'm saying the currency right now is at 73 cents —

Senator Tannas: What is your number? What is your neutral number?

Mr. Jean: The value of currency is at 75.

Ms. Desjardins: We are at 76 in terms of what our model would say with current economic conditions. I guess one of the factors that have played significantly in this move of currency is of course oil prices but also the U.S. dollar. The U.S. dollar has been powering along against everyone. There was a sentiment that the Fed would be gradually raising interest rates while the rest of the world is either cutting or holding still. We have to put that in the context as well. Yes, we have some negative sentiment, but I think positive sentiment to the U.S. dollar.

Mr. Perrault: We basically all use the same kinds of models for the Canadian dollar. We may end up in a different spot, 74, 75 or 73 cents. We're at 73 cents right now, but that's heavily a function of what happens to commodity prices.

Senator Tannas: You also mentioned that you are watching short positions. You have a way of quantifying that. Are you seeing in the short term an unwinding of those positions as a reflection that we've troughed out on negative sentiment and that we're headed the other way?

Mr. Perrault: The data are weekly. The last data we have don't suggest that. Clearly what's happened with the dollar over the last week suggests there has been a sharp referral in positioning against it. I suspect that when the next data are available, we will see some reversal in short positions.

As Mr. Mendes indicated, there clearly was negative sentiment. At the same time, the way exchange markets work in general is that there needs to be some degree of overshooting before markets reverse and investors start to say, "Okay, this has gone down far enough; it's time to take a bet in the other direction.'' It looks like that's happening now for Canada. There's a large aspect of this which is a kind of movement against the U.S. dollar. The U.S. dollar has been strong for a long period of time. People are re-evaluating whether that strength will be as long-lasting as they thought given what some of the Fed governors have been saying. There is a move away from the U.S. dollar into other kinds of currencies, including our own; but ours had been more aggressively sold than others, so it is normal to expect that ours would pick up and rebound a little more than others.

Mr. Burleton: My gut sense is that the Canadian dollar has oversold but largely because the U.S. dollar has been overbought; and it probably will come down.

Our models may be a little different. We're not far off where our models are pointing. They are largely driven by interest rates as we find that to be a very good indicator. Ten-year spreads between Canada and the U.S. are at historic highs in terms of width; and five-year spreads aren't far off that. Unless that changes dramatically, we see a bit of that narrowing going forward.

Senator Black: I have a question around exports. If it has been asked, please tell me.

The Chair: Mr. Porter, next time you get nailed to go first, you can defer to another witness.

Senator Black: I am very interested generally in whether Canada has the ability to compete in manufacturing. That's the overarching question that I have for you. I observe a falling dollar. I observe that our export numbers, as you have really aligned today, haven't picked up perhaps as quickly as we would have hoped. I would draw your attention to increasing free trade agreements, which have taken me to a place where I'm a little bit worried about Canada's ability to compete as an export nation. Maybe it's just on the products that we're currently exporting, but I'm going to leave that to you. Would you be good enough to comment on that, please?

Mr. Burleton: I guess I'm cautiously optimistic. One thing the Canadian dollar falling to these levels has done is eliminate the gap in unit labour costs between Canada and the United States that had really opened up. That, of course, is an average statistic that really depends on the industries as some are more competitive than others.

On the flip side, we're competitive against U.S. firms, while Mexico is still a very big challenge within the North American market. We've seen our Canadian dollar and the Mexican peso fall by almost the same amount. They've been almost right on top of each other over the past year or two. That's a longer-term challenge that we are continuing to adjust to — the idea being that our strength will be in the higher-value end of the curve. It's taking time, but I think it will happen, hence the focus on innovation. We're going to hear a lot about this clearly in the upcoming federal budget and provincial budgets. That's really going to be the trick.

Supply chains are something that Canadian producers will continue to have to work on. We're late to the game in terms of adopting competitive supply chains. I'm optimistic that we will have some success in penetrating other markets.

Mr. Perrault: One of the issues with our export performance, obviously, as you appointment out, is whether our firms are competitive enough to compete on a global scale. A weaker dollar helps to some extent as it reduces our costs in foreign currency terms. As some of us have alluded to, it makes investment a little more challenging and a little more expensive, which matters a tremendous amount to the extent that productivity growth in Canada historically has been weak compared to other G7 economies. There is a fundamental issue with respect to the productivity of our firms, which has affected manufacturing prospects.

That being said, as Mr. Jean indicated, we have seen in Ontario and to some extent in B.C. a bit of a resurgence in manufacturing currently. That started probably before the dollar started to go down most aggressively. There is reason for optimism, but there is a fundamental challenge with productivity in the country, which is partly related to something Mr. Burleton indicated: firms' desires and interests in being innovative. You can come into the productivity side with firms developing services, products or techniques for doing things that differentiate themselves from others; and you kind of need both in order to be able to do well in the global economy.

Ms. Desjardins: Yes, I agree with my colleagues in terms of how we ensure that this actual rotation to the export side of the equation really occurs. We are seeing investment that is very slow outside of the energy patch, so we need to see that pick up to broaden the prospects that Canadian businesses will be able to meet the demands. If we see a pickup in exports, and domestic demand remains relatively resilient, then capacity will be stretched in many of these industries. Certainly, we need to see willingness. Some uncertainty in the environment, some of which stems from the decline in the Canadian dollar, is holding these companies back.

Better days ahead certainly in terms of sentiment towards our currency and our prospects for growth will underpin a pickup in investment and support all of the anticipated increased demand for our exports.

Mr. Jean: You have two categories of business: those sensitive to the currency of non-energy exports and those not sensitive to the currency. Within the two categories, some are expected to be leaders going forward to carry growth for exports, and there are some where you can't have that expectation.

For example, an export category that is sensitive to the currency and that can be expected to carry growth forward includes aerospace products, aluminum and pharmaceuticals. Research shows that those are the categories of exports. Export performance in Quebec where those export categories are important in the makeup of the total exports has increased by 25 percent in the first three quarters of 2015 versus 2014. That's enormous. In aluminum, there's a 12 percent increase. In pharmaceuticals, you have a 36.3 percent increase.

So to the question of whether we can compete, clearly for those categories I think we can. To the question of whether we can compete, for example, in clothing and paper, those industries that are perhaps sensitive to the currency but subject to the long-term force of globalization, we can't really hold that expectation.

It's going to be a bit of a mix and match, but I think in a number of areas we are able to compete.

Mr. Mendes: I broadly agree with what my colleagues have said. We lost manufacturing capacity when the loonie was very highly valued.

I don't expect that we're going to see some sort of manufacturing revolution with the weak Canadian dollar. I think as we've said, global competitiveness has increased. Where I think Canada needs to focus is higher-value-added products, but even then, the headwinds from weak global demand are still present. I think that, appropriately so, central banks around the world are keeping interest rates low to support demand, but it's not going to come back immediately.

As I mentioned in my opening remarks, I think services are a place Canada can focus as well. Canada leads the world, leads the OECD countries, in tertiary education, which places us in a very unique situation to take advantage of services exports.

Now, when we look at services exports versus goods exports, we see it as a small component, but that's because it's difficult to measure services exports sometimes. If we look at it on a different scale than what StatsCan actually produces on a value-added scale, it's very close to the same level there.

We think that services exports will take a little more prominence in Canada. I already have anecdotal evidence — I'm not going to name the specific companies, but there is evidence that there are software and media companies that are seeing significant increases in their revenues coming from the United States. You can think of companies that would either move their head office or keep their head office in Canada because they can pay their employees in Canadian dollars but still operate largely in the U.S. or on a global basis.

Mr. Porter: I think we certainly can compete at this current exchange rate, but I think there are four factors to believe that we're not going to get the same kind of lift or torque as we would have in the past from this exchange rate and this kind of growth that we are seeing in the U.S.

One is the lack of spare industrial capacity that others have spoken to. Just to give you one little fact on that front or an example, last year we had record auto sales in both Canada and the U.S., yet auto production in this country fell by 5.5 percent last year. That's one factor.

The second factor, something that's different from the 1980s and 1990s, is that we have much more competition from places like Mexico and the auto side in China and almost everywhere else.

The third factor is certainly that the Canadian dollar has not been falling by itself. We have fallen in line with almost every other major currency out there.

The fourth factor is some of the non-labour costs that have been rising, most notably in Ontario, for things such as electricity, which has somewhat dampened competitiveness.

For all those factors, I don't think we can really expect the same kind of lift in exports that we would have in the past.

Senator Black: Do I take, then, as a conclusion of the panel that you are generally optimistic about Canada's ability to be an export nation and rebalance the equation if we get our innovation and productivity right? Is that fair?

Mr. Porter: Yes, but that's a big "if.''

Senator Black: I know. That's your next panel.


Senator Maltais: Since I had to step out for a few minutes, someone else may have asked my question, so please set me straight, if that's the case.

The price of oil causes the loonie to fluctuate significantly. Currently, production is outstripping demand. And we recently learned that Iran will be bringing another one million barrels of oil to the market every day. Could that cause the price of oil to drop yet again, or will prices remain stable? Could it affect the Canadian dollar?


Mr. Mendes: I'll just mention that I think when you look at financial markets, especially the oil market, once we know that Iran is going to come back online, a lot of that gets priced into the market immediately. My expectation would be that that's largely priced in.


Mr. Jean: I would say more or less the same thing. When you take, for example, what the International Energy Agency said about oil, in other words, that it would take quite a few more quarters before the current oil surplus began to drop off. The agency put out that prediction last month. We've seen a lot of volatility in the price of oil, but it hasn't been an additional factor.

We knew Iran's decision was coming. Financial markets have long taken into account the idea that the current surplus is going to take much longer to be absorbed than expected, but I don't have the sense that it can still bring down the price of oil. The crucial thing to consider will be the supply adjustment. What may have been the biggest surprise in 2015 was the fact that production, particularly in North America, didn't drop as much as anticipated, in light of what was happening with prices. Prices are now at levels that are jeopardizing not only future projects, but also a certain number that are under way. Production should slow down. Once the markets get that signal, we'll see oil prices rebound somewhat.


Ms. Desjardins: Yes. I agree. I think the supply adjustment will come likely more from the U.S. side of the equation. That's the area where we saw significant growth. And now, as we go forward, many of these U.S. producers are running into significant difficulties. They're running into difficulties because they're not able to cover their costs. So for the current time, that's running with a loss, but it also impedes the amount of capital that investors are willing to give them for future production.

So I think when we look at the supply side of it, yes, you're going to have new production from Iran coming to the market, but I think you're going to see a commensurate decline in production from some of these U.S. producers. Therefore, this will gradually lead to the oversupply coming down and a more balanced market as we get through the end of 2016. It takes a while, but I think that's the way it's going to play out.

Mr. Burleton: We talked a bit about financialization of the Canadian dollar. From what I'm reading, something like 85 percent of oil in the U.S. is unhedged this year, and that's a much lower level. A lot of companies had hedges in place when oil was above $50 and $60, and they've allowed those to drop off. I think many are counting on that to begin to accelerate the U.S. shale decline.

But don't underestimate the U.S. dollar as well. I think most models show a pretty tight fit, at least recently, between the U.S. dollar changes and the U.S. dollar oil prices. I think some of us are banking on the U.S. dollar to lose some ground later this year, and that should be another precondition to set oil higher.

Senator L. Smith: I asked a similar question yesterday, and I'll ask it today. It's a crystal-ball question. I know you don't like making forecasts and recommendations necessarily, but if you had to give three steps that would be critical for the dollar and for our economy to rebound, what would they be? If I could just ask you to help out.

We've talked about productivity, we've talked about manufacturing, but those things have been talked about for the last 25 years. We've talked about better-trained people in terms of we're well trained at the high end, but our trades — Germany built its economy after World War II because they developed a committed trade discipline with education.

I'm just wondering for Canada, what are the three things that would need to happen from an economic perspective? I know we're talking about the dollar, but it's tied to economics. Could you give us some insight? It would be helpful for the people listening today, who would be able to understand in a more direct way as opposed to the high-end way. We are televised, and a lot of people are listening, and this is a very important focus that the Banking Committee has. I think it's important for us to impart messages so that we can come to not only discussion but some form of direction.

Mr. Burleton: Senator, I think some of my earlier comments in the formal part were more relative to the 1990s. I do think the direct policy impact on the falling loonie back then was much more important in terms of the fact that we had very uncompetitive tax rates and our government's fiscal position was in terrible shape. A lot of those issues have been addressed. I do think there is more chatter now about the fact that the commodity sector has been a key driver of growth in this economy, but now we're seeing a rotation away, which I think if anything may put more emphasis on the need to take that innovation file and further it.

I do know there is a lot of unfinished business in innovation. It's not maybe so much in the tax rates but in some of the programs we have. And, again, maybe we should have a separate hearing on innovation because it's a very complicated issue. That's something we've got to hone in on more, and we lack data to understand some of the elements there, so it will be key that we continue to dig.

Senator L. Smith: Will that innovation be driven by business, or will it be driven as a combination of business and government?

Mr. Burleton: A combination of business and government, absolutely. And that's part of it, with good, strong relationships there. But I come back to that I think a lot of the issues that will pull the Canadian dollar up aren't a direct government purview. It comes down to differences in interest rates that the U.S. is offering, different points in the cycle. Remember, the U.S. is coming out of a very severe recession and has more upside to growth. We call it the macho effect: the fact that they have more upside potential in growth. We're coming off a period where we've had a very heavily taxed consumer, and we don't just have that upside to growth. We're counting on this rotation, but it's probably for a little while going to leave us at a weak growth rate. Governments pick away and do things to help that, but it's a tough one on oil. There's very little control over the oil price.

Mr. Mendes: I co-authored a paper recently with my colleague Benjamin Tal. We found that about 50 percent of R&D spending comes from small and medium-sized businesses. But one of the problems that small and medium-sized businesses often have is that they lack access to proper funding. Getting access to funding to these companies can help us increase innovation and productivity in the country.

The second thing I would mention is an education mismatch. We have people in Canada striving for a higher education, but we need them to go into the STEM fields more. That will help our economy as well.

From a higher-level perspective, I would say that the federal government and the Bank of Canada are on the right track. Easier monetary policy is one of the key ingredients to helping our economy rebound. There are people who will take hits at the Bank of Canada for lowering interest rates because of the risks surrounding it, but I would say it's an absolute net benefit when it comes to the labour market, promoting investment, things like that. Associated with that, the federal government running a moderate fiscal deficit in a time like this, and using it to fund infrastructure projects, seems appropriate as well.

Mr. Perrault: It's obviously a multi-faceted question. From a shorter-term perspective, I think what you really have is an economy that requires support. We are going through a very significant transition, very significant negative shock that the Bank of Canada has up to this point been accommodative with, so that has helped. Our view is that growth in the first part of the year will be pretty low as investment and activity in the oil patch continue to be affected by what's going on. To the extent there is uncertainty about the outlook, that's clearly feeding weakness in the first part of the year, but it's depressing household spending to some extent, and it's obviously affecting investment. So a key factor in kind of a return to sustainable decent growth is for those kinds of feelings of uncertainty to abate. And you can get that to some extent by policy-makers making people feel better, and the bank does a little bit when it moves interest rates. It's not just about the fact that interest rates are going lower; it's about the fact that there's someone out there trying to help. That has helped to some extent. I think you are likely to see that, assuming the government puts forward some kind of stimulus package, which will only come into effect in the second half of the year or early next year. It depends on what they do.

I think clearly that will be of benefit, but those are shorter-term things. There is a longer-term issue, which is that what we consider to be potential output in Canada as the long-term growth rate of the economy has come down quite a bit. Part of that is as a result of the fact that the oil patch is smaller now and the energy sector is going to be smaller now than it was, so there is a permanent loss in output resulting from that. But part of that is the fact that the population is aging and productivity growth has been relatively low, so there are some big adjustments required in the economy for potential growth to come back to levels closer to where they've been.

It's probably impossible for that to happen. You're talking about things relating to allowing the labour market to adjust, having the proper incentives in the labour market for people to go from one industry to another, retraining programs and those kinds of things. We have, as Mr. Mendes indicated, a fairly high proportion of students coming out of the system in what we call the STEM fields: science, technology, engineering and math. It's actually quite high relative to the G7 standards. What is funny about the Canadian economy though is that Canadian firms tend to use those less than other economies. Schools are pumping out, by and large, people in the right fields, but for whatever reason they're not being used as much in our firms as they are in other countries. I don't know why that is. I'm sure people have done some research on that, but it gets to some extent to an issue we were talking about earlier that related to innovation and the desire and need for firms to be more innovative in their approach. And in there it's easy to say the government has a responsibility and there are things the government is doing that are kind of holding firms back. A fair amount of the dynamic here is firms being more cautious.

Pardon me for going on at length here, but there is almost a cultural dimension to this, which is that we're Canadians, we're kind of nicer and we're a little more risk-averse; we're not like the killer Americans. And you see that in the data. Productivity growth is a little lower, but firms don't see as important a need to innovate in Canada as they would in our main competitor economies. How do you change that? It's a kind of mindset. You can throw as much money as you want at it from a federal government and provincial government perspective, but at the end of the day, if a firm is just not interested in innovating — but some are and a lot do — where do you go with that?

The Chair: Is it a cultural thing? Is it the schools? The schools are producing business people and the innovators and the engineers and the scientists, but they are less cautious. Is it partly the result of the schools, risk-free schools sort of?

Mr. Perrault: Surveys have been done — I don't have the precise data with me — that look at what we call the management acumen of firms in Canada. And there are, generally speaking, fewer business folks running businesses in Canada than in other countries and certainly relative to the U.S. We have fewer MBAs that run businesses or are in management structures, and that goes to some extent to the cultural aspect, which is that when you get an MBA you're basically learning how to maximize profits in a firm.

I think there is a bit of a culture shift, and it's not necessarily that the schools aren't producing these people, it's just that firms for whatever reason have a different preference for the kind of people they want to hire, by and large, relative to the Americans.

The Chair: Did you want to add something, Mr. Porter?

Mr. Porter: I was going to make a general overall comment to Senator Smith's question. Keep in mind that as recently as a couple of years ago we were widely seen as the toast of the town, one of the most successful economies in the world, and I don't think the world has completely changed. What has changed obviously is that we're dealing with a commodity price shock, and there will be an adjustment. I think monetary and fiscal policy will play a role in that adjustment, but I don't think low commodity prices always equal an unsuccessful Canadian economy. Some of the best years of growth that we have had in recent decades were in the late 1990s, admittedly during the height of the tech boom. That was also a period of very low commodity prices. Low commodity prices do not cast us into a period of low growth forever.

Senator Massicotte: We often interpret broad stock indexes, maybe the S&P 500, as a reflection of how well the economy is doing. We think it's a prediction of future economic growth or the contrary; yet when you look at the news, and oil prices go down, if you notice the trend in the last couple of years, the stock market goes down, particularly the S&P. The Canadian market you can understand because we are perceived to be oil- or commodity-oriented.

If you look at the S&P 500 or the emerging world markets, if oil goes up that seems to be good news and therefore the S&P goes up. As we all know, in some countries it's the opposite effect. Does the S&P go up because oil and gas companies form a significant factor in the calculation of that index? Or is it really good? In other words, oil price goes up, S&P goes up, it must be good for the world; the economy is doing great. Is that accurate?

Mr. Porter: This is something that has been bedevilling a lot of people this year. On days when oil prices slump, you see the Japanese and European markets dropping, and of course they are big oil importers; they should benefit from lower oil prices. The best explanation I've seen for this tight correlation between oil prices and global equity markets so far this year is some concern that some of the large sovereign wealth funds in the oil producers are now becoming forced sellers of financial assets as oil prices drop.

In other words, the Saudi Arabias and the UAEs of the world are reducing their equity market holdings, or that's the perception, at least in the financial markets. Whether that's happening or not is debatable. The view is that as oil prices drop below $30, some of these the sovereign wealth funds are going to have to sell equities because it doesn't make any economic sense.

Mr. Mendes: I have heard the same thing as Mr. Porter. But I question why Japanese equities are sometimes underperforming other markets when they are a huge oil importer.

I would propose a slightly different explanation. The global economy is suffering from weak demand, and inflation in many countries is very close to zero and near deflationary territory. There are two things at play there: Weaker oil prices are going to depress headline inflation and push back against a lot of the European Central Bank's work and the Bank of Japan's work, which is working to increase inflation and expectations; it's working against that.

I would also mention something I'm sure you already know is risk sentiment. Markets move broadly with risk sentiment, and on days when risk sentiment is higher, oil and stock markets will be moving in that direction together.


Senator Bellemare: I have a comment I'd like to make before I get to my question. My comment has to do with your answers in relation to the adjustment process and productivity innovation. You talked about human resources, and perhaps we should pay more attention to those human resources in order to change the culture in our companies. That's what I took away from your remarks.

My question is fairly straightforward. International trade is hugely important to Canada; it's a practice we will always be engaged in. Interprovincial trade, however, also presents many opportunities. In the short and medium terms, do you think we can do more to stimulate interprovincial trade so as to restructure our economy and strengthen our companies, since we wouldn't have to worry about the whole currency issue?

Mr. Jean: That's an excellent question, and it is one of the problems. As for the inflexibility that hampers interprovincial trade, as we see in the labour market, Canada is one of the worst-performing countries when it comes to labour mobility, despite the east-west flow of workers resulting from the boom in the energy sector. Internationally, we score very poorly in that regard. Because of that inflexibility, our growth isn't as strong as it should be. Interprovincial trade is another element that has long been defined as a problem, given the tremendous growth potential it holds.

In the public sector, we are starting to see some partnerships, such as between Quebec and Ontario in the area of hydroelectricity, and that's a step in the right direction. But there's still much to do, especially for companies. Earlier we talked about Canada's production potential, our growth potential. These are the types of initiatives that will help us counter other factors that negatively impact our growth potential. Yes, more and more, I think the dynamics of interprovincial trade will be front and centre in the debate.


Senator Massicotte: I want to thank you very much for your contribution to a very important debate for Canadians. I found it very interesting, in spite of the fact that you only see a 30 percent probability of your being right.

The Chair: I want to thank the witnesses. It has been a great session. I want to thank your employers for letting you come here and participate. The testimony is going to be very helpful to Canadians and to public policy-makers. We didn't expect you to be fortune tellers or soothsayers, but you did a great job as economists and business people.

(The committee adjourned.)