Canada feeling the European heat

The sovereign debt crisis in Europe has rattled global markets and while there is no serious threat of contagion to Canada, the impact is certainly being felt here, says Jeremy Rudin, assistant deputy minister, financial sector policy branch, department of finance, Canada.

Speaking at the Bloomberg Sovereign Debt Conference at the beginning of 2012, he said the Bank of Canada’s falling economic forecast stems from issues on The Continent.

“Europe is an important trading partner for Canada and we do think in Canada that [there exists] the potential for this situation to get worse [and] it is very important for European governments to get ahead of this,” said Rudin.

The Canadian banking system and financial markets, however, are at no significant risk.

“Canada has relatively low levels of debt with very strong commitment to public finances and very clear policies which both the federal and provincial governments are following to restore budget balance in the wake of the financial crisis,” he said. “[Canadian] banks are well capitalized and very well supervised and well managed in our view.”

But he cautions investors to keep their powder dry. “From a Canadian point of view there is an element of important tail risk [from the European crisis],” he said.

While declining to quantify its impact, he said he’d “rather urge people to address it because it is real [and] there is a possibility, even if it is not the most likely scenario, that the European crisis could have a disruptive effect on the global financial markets.”

It is important to manage the crisis and to not count on muddling through, he added.

“European governments need to [have in place] enough resources in order to make sure that sovereigns can manage through periods of illiquidity,” said Rudin. “They need to address the capitalization of their banking system to make sure that the flow of credit continues in Europe and around the world as European economies are heavily dependent on bank credit and they need to address some fundamental fiscal issues that have given rise to these concerns.”

Europe, and indeed the world, can learn a great deal from Canada’s experience and how its financial system, credit markets and its economy managed to escape the crises of the past two years.

Rudin said Canada adopted “a lax fiscal policy for an extended period” and eventually reversed it, followed by “a long string of budgetary surpluses that brought debt down quite low by G-7 standards.”

Canada has a 20-year history of setting and meeting inflation targets, he said adding that the “agreement between the government and the BoC about inflation targeting has just been renewed for another five years.”

That track record and credibility, which took time to achieve, allows policymakers the opportunity to take extraordinary measures without undermining the longer-term well being of the economy, said Rudin.

“Going into the crisis, Canadian requirements for risk-weighted capital were above international minimum,” he said adding such a push to banking regulation turned out to be useful.

“We had a simple leverage ratio, which was considered a very old fashioned and out-of-date approach, but it’s come back into vogue, and for obvious reasons.”