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Canada Current Account Deficit - a Warning Sign for Canadians ?

( From Statistic Canada, Wiki, CapeBretonPost, HuffPost, CBC News, About.com, Business Recorder )

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Current account balances

Current account balances



In the financial account (unadjusted for seasonal variation), transactions in loans and deposits accounted for most of the inflows in the quarter, as inward and outward transactions in both securities and direct investment were largely offsetting. This contrasted with the general trend observed since 2009, where net inflows in the form of securities have been the main contributor to the financing of the ongoing current account deficit.

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Current account



Deficit on trade in goods narrows



The deficit on trade in goods was reduced by $2.3 billion in the fourth quarter to $2.8 billion. This largely reflected increased exports, led by energy products and by farm, fishing and intermediate food products. The goods surplus with the United States was up $2.0 billion on stronger exports in the fourth quarter, although for the year 2012, it was reduced by $6.8 billion to $42.1 billion. The deficit on goods with all other countries reached a record of $54.0 billion in 2012, up $6.0 billion from 2011.







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Total exports of goods were up $1.7 billion to $114.5 billion in the fourth quarter. Energy products accounted for $1.6 billion of this increase, led by higher prices as volumes were down. However, the crude petroleum portion of energy reflected both higher prices and volumes. Higher export volumes of canola and of other crop products contributed to the $1.1 billion increase for farm, fishing and intermediate food products. Increases were moderated by a reduction in the exports of metal ores and non-metallic minerals, mainly on lower volumes.



Total imports were down $0.6 billion to $117.3 billion in the fourth quarter. Volumes were down for several major categories of goods, leading to reductions in imports of industrial machinery (-$0.5 billion) and motor vehicles (-$0.4 billion). Chemicals products and forestry products were also down. These import reductions were partially offset by higher imports of energy products, which increased $0.7 billion through stronger prices and volumes, as well as by higher volumes of aircraft and other transportation equipment (+$0.4 billion).



Trade in services deficit edges down



The deficit on trade in services was reduced by $0.1 billion in the fourth quarter from a high of $6.2 billion the previous quarter. For the year 2012, the deficit in trade in services reached a new high at $24.6 billion, mostly on the travel account.



Commercial services and travel accounted for the majority of changes in the fourth quarter. The surplus on commercial services edged up $0.1 billion, as imports weakened in the fourth quarter. Increased spending by Canadians on visits to the United States was partially offset by larger spending by overseas travellers coming to Canada. This resulted in a slight increase in the deficit on international travel to $4.6 billion.



Investment income deficit expands



The deficit on investment income advanced $1.8 billion in the fourth quarter to $6.9 billion. This mainly reflected increased earnings of non-residents on their foreign direct investment in Canada, which advanced $1.9 billion on higher dividend payments. On the other side of the ledger, earnings on Canadian direct investment abroad were up $0.3 billion. Higher interest paid to foreign holders of Canadian bonds pushed the deficit on portfolio investment income up a further $0.2 billion.



Financial account



Foreign portfolio investors continue to acquire Canadian debt securities but divest of equities



Foreign investors added $16.3 billion of Canadian securities to their holdings in the fourth quarter, half the level of the previous quarter. Acquisitions of Canadian debt securities remained robust at $22.4 billion, but were partly offset by a sizable decline in foreign portfolio holdings of Canadian equities.







Non-resident investors increased their holdings of federal debt instruments by $12.4 billion in the fourth quarter, adding both short and long-term instruments. Retirements and coupon payments in December moderated the inflows. Foreign holdings of private corporate debt securities were up by $13.3 billion, on the strength of net new issues of bonds. This closed another year of strong foreign investment in Canadian debt securities as non-residents added $82.2 billion worth to their holdings, with federal bonds accounting for nearly 40% of these transactions.



Foreign portfolio investors reduced their holdings of Canadian equities by $6.1 billion in the fourth quarter, the largest divestment since the fourth quarter of 2007. This was related to cross-border mergers and acquisitions activity, with non-resident portfolio investors rendering their Canadian shares to foreign direct investors. Foreign purchases of Canadian stocks on the secondary market slowed to $0.7 billion. Canadian stock prices were up by 0.9% in the fourth quarter, following a 6.2% increase in the third quarter.



Canadian investment in foreign securities increases further



Canadian investors acquired $17.0 billion of foreign securities in the fourth quarter, the largest investment since the second quarter of 2007, just before the onset of the global credit crisis. Over three-quarters of this activity was in foreign bonds, mainly US government instruments. This was partially offset by retirements of maple bonds.



Canadian investment in foreign stock markets slowed to $4.7 billion, marking an eighth straight quarter of investment. Acquisitions were led by US stocks. On an annual basis, Canadians acquired the largest amount of foreign securities in five years, as they increased their holdings of bonds for the first time during this period. As of the third quarter of 2012, nearly 80% of Canadian holdings of foreign securities were in equity.







Inward direct investment led by mergers and acquisitions



Foreign direct investment in Canada was $14.9 billion in the fourth quarter, up from $8.0 billion in the third quarter. Inflows reflected strong merger and acquisition transactions, the largest such activity since the second quarter of 2011. Foreign direct investors from Europe accounted for most of the investment in the country.



Outward direct investment moderates, but remains strong



Funds sent abroad by Canadian direct investors eased to $16.8 billion, following a strong third quarter. Outflows related to mergers and acquisitions were reduced to $4.4 billion from $10.7 billion in the third quarter. Outside of mergers and acquisitions, the energy and mining sector was also lower. Nevertheless, Canadian direct investment abroad has exceeded foreign direct investment in Canada for a fifth straight year in 2012.



Transactions in loans and deposits generate inflows of funds



Transactions in the other investment category of the financial account generated a net inflow of $17.3 billion in the fourth quarter. This was the second straight quarter of expansion in Canadian deposit liabilities at $26.5 billion, mostly reflecting an increase in foreign currency deposits held by non-residents. As well, loans to non-residents through reverse repurchase agreement transactions led to a reduction on the asset side in the fourth quarter.



Comments



​BMO senior economist Benjamin Reitzes wrote in an analysis that “for a third straight quarter, Canada’s current account deficit was at near-record levels.”



He also suggested the deficit will at a high level for some time.



“With the U.S. economy only slowly picking up steam, as fiscal uncertainty muddies the outlook, and commodity prices down, Canada’s current account gap is expected to remain sizeable through 2013.”



“If the recent weakness in the Canadian dollar persists, that could provide some assistance, but at current levels, the loonie remains overvalued.



Reitzes noted that for 2012 the current account deficit appears to have come in at about 3.9 per cent of gross domestic product, which he said was the second widest since 1981. ( See graph below )









Goods balances by geographic areas

Foreign investment in Canadian securities

Canadian investment in foreign securities

What Are the Consequences of the Current Account Deficit ?

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In the short-run, a current account deficit is mostly advantageous. Foreigners are willing to pump capital into a country to drive economic growth beyond what it could manage on its own.



However, in the long run, a current account deficit can sap economic vitality. Foreign investors may begin to question whether economic growth can provide an adequate return on their investment. Demand could weaken for the country's assets, including the country's government bonds. As this happens, yields will rise and the national currency will gradually lose value relative to other currencies. This automatically lowers the value of the assets in the foreign investors' currency, which is now getting stronger. This further depresses the demand for the country's assets. This could lead to a tipping point, at which investors will dump the assets at any price.



The only saving grace is that the country's holdings of foreign assets are denominated in foreign currency. As the value of its currency declines, the value of the foreign assets rise, thus further reducing the current account deficit. In addition, a lower currency value should increase exports, as the goods and services become more competitively priced. Similarly, demand for imports should lessen, as inflation on foreign goods and services sets in. These trends should stabilize any current account deficit. Regardless of whether the current account deficit unwound via a disastrous currency crash or a slow, controlled decline, the consequences of a current account deficit would be the same -- a lower standard of living for the country's residents.



The Situation

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Canada’s current account deficit remained at “near-record” levels at the end of 2012, despite dropping in the fourth quarter thanks mostly to increased exports to the United States.



Canada's current account deficit (on a seasonally adjusted basis) decreased $0.8 billion to $17.3 billion in the fourth quarter of 2012.

​Economists had expected a deficit of $17 billion, according to estimates. The reduction to the goods deficit was partially offset by the increase of the investment income deficit. ( See graph below )

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Definition of a Current Account Deficit

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A current account deficit is when a country's government, businesses and individuals imports more goods, services and capital than it exports. That's because the current account measures trade, as well as international income, direct transfers of capital, and investment income made on assets, according to the Bureau of Economic Analysis. When those within the country rely on foreigners for the capital to invest and spend, that creates a current account deficit. Depending on why the country is running the deficit, it could be a positive sign of growth, or it could be a negative sign that the country is a credit risk

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Components of a Current Account Deficit

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The largest component of a deficit usually a trade deficit. This simply means the country imports more goods and services than it exports. (Find out the Current U.S. Trade Deficit)



The second largest component is usually a deficit in the net income. This occurs when the country exports dividends on stocks, interest payments made on financial assets, and wages paid to foreigners working in the country. If all payments made to foreigners are greater than the interest, dividends and wages made by foreigners to the country's residents, the deficit will rise.



The last component of the deficit is the smallest, but often the most hotly contested. These are direct transfers, which includes government grants to foreigners. It also includes any money sent back to their home countries by foreigners. (Source: Bureau of Economic Analysis, Current Account)

What Causes a Current Account Deficit ?

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Countries with current account deficits are usually big spenders, but are considered very credit worthy. These countries' businesses can't borrow from their own residents, because they haven't saved enough in local banks. They would prefer to spend than save their income. Businesses in a country like this can't expand unless they borrow from foreigners. That's where the credit-worthiness comes into the picture. If a country has a lot of spendthrifts, it won't find any other country to lend to it unless it is very wealthy and looks like it will pay back the loans.



Why would another country lend to such a spender, even if it is credit-worthy? Well, usually the lender country also exports a lot of goods and possibly even some services to the borrower. Therefore, the lender country can manufacture more goods and give jobs to more of its people by lending to the spendthrift country. Both countries benefit.

Details of the Canada s Current Account Deficit

TD Bank economist Leslie Preston said Canada’s relatively strong domestic economy has pulled in imports, while a softer global economy has hindered Canadian exports, but the deficit should continue to narrow.



“Early signs of improvement were seen in the fourth-quarter’s smaller current account deficit,” Preston said.



​“Canada has been in a sustained current account deficit position for four years now, as a relatively stronger domestic economy pulls in imports, while a softer global demand backdrop hinders our exports,” TD economist Leslie Preston said in a commentary.



“We do not expect a return to surplus over the next couple of years, but the deficit should continue to narrow as global growth improves and demand for Canada's exports picks up, particularly as the U.S. economy gains momentum,” Preston said.

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“However, one sore point in the fourth-quarter was the decline in imports, particularly in industrial equipment, which is a disheartening sign for the Canadian economy.”

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