Trade gap reveals potential for volatile loonie

Reuters reports that Canada’s current account deficit widened in Q2, as the country’s international trade gap grew because imports rose, as revealed by Statistics Canada data. The seasonally adjusted current account deficit stood at $16.3 billion in the second quarter; however, that’s short of economists’ forecasts of a $17.4-billion gap.

The current account is Canada’s broadest measure of trade, explains National Bank senior economist Krishen Rangasamy in an economics report. The current account deficit of $16.3 billion equals about 3.6% of GDP, he says.

Andrew Grantham, senior economist at CIBC, says in a note that the Q2 current account deficit isn’t surprising, given lower oil prices.

Read: Why foreigners have been exiting the oil patch

Further, he says the figure was lower than consensus expected largely because of a better starting point, as the Q1 deficit was revised to $12.9 billion from $14 billion. That’s because the goods deficits was a bit narrower in Q1 than expected.

Still, a growing current account deficit could be cause for concern.

Domestic savings vs foreign investment

“The persistence of red ink on the external balance for 35 consecutive quarters suggests there’s more to the deficit than cyclical factors,” says Rangasamy.

One root cause is arguably the lack of domestic savings.

“Dissaving by both government and households tends to bid up imports not just of goods and services, but also of capital to finance investment,” he says.

Regardless, running a current account deficit means Canada borrows from abroad to pay for expenditures. That’s not so bad if foreign capital inflows are long term, stable and raise the country’s potential growth, says Rangasamy.

But that’s not the case.

“Unfortunately for Canada, the main source of financing is short-term capital,” he says. “The external deficit in Q2 was entirely financed by portfolio and other short-term capital inflows for the seventh consecutive quarter.”

That leaves Canada vulnerable to shifts in investor sentiment, thereby potentially making the Canadian dollar more volatile, he concludes.

Read: Reasons to close your currency hedge

Says Grantham: “Although it wasn’t as bad as expected, the widening in the current account deficit during Q2, and only modest help going forward from crude prices, highlight a headwind to further C$ appreciation from here.”

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