JOE OLIVEWR HAS A PROBLEM
In last year’s budget, the price of oil was $110 a barrel. In June, the price of a barrel of oil began to fall and by October it was down to close to $80. The government was not at all concerned by this decline or to emerging risks in the global oil market.
Indeed the government was so confident that the risks were minimal that in the same month Prime Minister Harper, with great fanfare, announced major tax cuts, including income splitting.
In November, Finance Minister Joe Oliver faithfully followed up with his economic and fiscal update. Based on an oil price of $81 a barrel, the government believed that they could still afford their 2011 political commitments, while still posting a surplus of $1.6 billion in 2015-16.
Since then everything has changed.
Oil prices have continued to fall and are now below $50 a barrel and projected to fall to $40 a barrel, and perhaps lower. Saudi Arabia, the key player in determining the price of oil, has stated they could accept $20 a barrel. The reality is that no one really knows the future of oil prices.
On Wednesday of last week, Minister of finance Joe Oliver was still claiming, that despite the collapse in oil prices, the government would still record a surplus of $1.6 billion, the same number he recorded in the fall update, based on an oil price of $81 a barrel.
Not surprisingly, no one believed him. His credibility was beginning to erode.
To undermine his credibility even further, the TD bank issued a report that said, that at a price of oil at $40 a barrel, the government’s contingency reserves would be depleted and the government would be in deficit in 2015-16. We also came to the same conclusion.
The “penny finally fell” on Joe Oliver.
On Thursday, Joe Oliver announced that the budget would be delayed until some time after March 31. He did not say in April; only that it would be after March 31. Last year, the budget was delivered in February. The previous two budgets were delivered in March. There is in fact no legal requirement for the government to have a budget at all.
The Finance Minister stated that he had postponed the budget because he needed more time to better understand prospects for the global economy and the outlook for oil prices.
What will Mr. Oliver know in April that he wouldn’t know in February or March? First, Mr. Oliver would have more information on the final budget outcome for 2014-15. The government will record a surplus this year, even though they are forecasting a deficit. The only question is how big a surplus and how much of it might carry forward to 2015-16.
Secondly, he would also have more information on oil prices. But what happens if oil prices are still in the $40 to $50 range. In a speech last week the Deputy Governor of the Bank of Canada stated that oil prices could stay low for some time. Most oil market experts also believe this. If this happens will he delay the budget even more?
The postponement of the budget is a clear indication that the government doesn’t know what to do either in political or policy terms. The Harper government has bet its reputation as a sound fiscal manger on eliminating the deficit in 2015-16. Nothing else has mattered to this government; not economic growth and not job creation.
And now there is a very good chance that this won’t happen and the Harper government is completely confused about what to do.
There is a lot a stake here. The government’s fiscal credibility is at stake and so is its political credibility. A collapse of fiscal credibility will inevitably lead to a collapse of political credibility. How the government prepares its 2015 budget will have a major impact on the outcome of the 2015 election.
If they do table a budget, what will Minister Oliver and Prime Minister Stephen Harper do in that budget?
One option would be to accept accept that the “unexpected” decline in oil prices has changed everything. The consequence of this decline is that the government is likely to record a deficit in 2015-16. This is due to circumstances beyond the control of the government. Despite this the government has a sound fiscal structure with a low and stable debt burden. This approach would represent a realistic view of the economic circumstances, and would be seen as credible. Premier Jim Prentice seems to be favoring this approach for Alberta.
The government would take some political flak for not meeting its “commitment” to eliminate the deficit, but this would be manageable since, there is no better alternative.
This is not what this government will do. Most likely they will decide that the commitment to a surplus in 2015-16 and in subsequent years takes precedence over everything.
This leads to two other options.
First, put pressure on the Department of Finance to come up with an “acceptable forecast”. The Minister has already hinted that he would be prepared to change how the assumption of oil prices is made for his budget forecast.
The forecast might assume, for example, that oil prices would increase in 2015 and 2016 or he might simply adopt the average oil price of the private sector economists consulting. He has never done this before. Either way this would provide him with more revenues than simply assuming the existing price of oil, which is what the Department of Finance has done in the past.
Changing the “forecast methodology” would leave Mr. Oliver open to the charge that he is “fudging” the numbers. The budget would have no fiscal credibility and no political credibility.
Second, introduce new spending cuts. There has been talk by some Ministers that the government will have to consider new spending restraint measures in order to fulfill the commitment to a balanced budget. But direct program spending has already been cut significantly and extending the freeze on operating budgets could seriously impede program delivery.
In macroeconomic policy terms this would be a terrible mistake. The government may have a deficit in 2015-16 but it does not have a deficit problem. In a situation of significant uncertainty, where,