High debt levels leave the economy vulnerable to future shocks
While the pandemic remains the key risk in the near-term outlook, high levels of debt are the most significant risk to our long-term economic fortunes.
There is no doubt that the swift action of the federal government to aid households and businesses ensured the economic decline caused by the pandemic was not larger than what we experienced.
However, that massive support came with a cost: federal debt skyrocketed. Interest rates are currently very low, making that debt affordable, but they will continue to rise from their record lows. As a result, federal debt-servicing costs in 2025 will be nearly double what they were in 2020. By 2030, they are expected to increase 2.3 times relative to 2020.
The federal transfers that boosted household income growth, combined with restrictions that limited consumers’ ability to spend, had a positive impact on the household-debt-to-income ratio last year.
However, this improvement will be short-lived because households have been racking up mortgage debt, and income growth will slow after being propped up by government transfers.
With households and governments supporting the recovery, these high levels of debt and what they mean for the sustainability of spending are key risks to our outlook.
Federal net debt $C billions
Ratio of household debt to disposable income
Sources: Statistics Canada, forecasts by Deloitte
Top 10 risks to monitor The base-case economic outlook is positive, but there are many potential risks
Health risks: Vaccination against COVID-19 is reducing risk, particularly in advanced economies. However, many emerging market economies are still facing significant health risks and vaccination will take considerable time. This can create headwinds for economic growth, and the risk of vaccine-resistant variants will persist until global levels of vaccination improve.
Inflation: Central banks and governments have massively increased money supply, with monetary authorities arguing that the recent rise in inflation is temporary. However, if the circulation of money (i.e., velocity) accelerates or wage pressures from labour shortages increase, the possibility of an inflation shock cannot be ruled out.
Business debt: Many businesses have been kept afloat by cheap credit and government support programs. This raises the possibility that many zombie businesses—effectively insolvent companies that don’t close—have been created. As government support programs end and interest rates rise, the economic scars from the recession may become apparent, with an accompanying increase in insolvency and bankruptcy.
Government debt: In the wake of the 2008-09 financial crisis, a fiscal crisis started in Greece that spread to several other European countries. Given the dramatic deficits governments around the world are running due to their pandemic response efforts, it’s likely that financial markets will worry about the capacity of some countries to meet their financial obligations. As the European crisis a decade ago proves, this sort of concern can quickly spread once fiscal risk becomes a financial market focus.
Increased taxation: Related to the fiscal risks, governments will need to find a way to rebalance fiscal policy during the recovery. It’s likely that higher personal and business taxes will be part of the governmental rebalancing efforts. The G-7’s desire to implement a global minimum corporate tax is just an example of the tax risks.
Increased business concentration: Large companies have gained market share during the pandemic, which hit smaller firms harder. This increased business concentration could lead governments to implement changes to competition policy.
Reshoring and industrial policy: The pandemic disrupted supply chains and led to a dramatic increase in the role of government. As the pandemic wanes, governments appear to be increasingly enamoured with industrial policy and a desire to have essential products manufactured domestically. While deglobalization is unlikely, industrial policy runs the risk of weakening the role of market prices for resource allocation and investment. There may be some economic gains from this, but the history of industrial policy shows it can create a lot of risk as well.
ESG and transition to low-carbon future: There is a strong trend toward factoring environmental, social, and governance issues into business decisions and government policy. The objectives of ESG considerations are clearly desirable, but they can create considerable economic disruption.
Residential real-estate boom and related household debt: Particularly in Canada, the housing boom and rising household borrowing remains a key concern.
Geopolitical tensions: Despite the change in leadership in the United States, friction between that country and China continues to pose global risks.