What nixing NAFTA would mean for markets

The odds that NAFTA will be torn up seem to be increasing, says an RBC report.

Beyond hurting Canada’s GDP, a partial or complete dismantling of the agreement would likely mean near-term financial-market volatility, which would further weigh on business and consumer confidence, and growth.

Read: Slower growth for Canada in 2018

The results: the loonie would weaken, investors in Canadian equities would pull back — at least in the short term — and interest rates would face downward pressure as investors pile into safer assets, says the report.

Further, “the Bank of Canada would likely shift to an even more gradual rate-hiking path than is currently priced into markets.”

Keep WTO commitments?

Though it would still be challenging, the end of NAFTA would be more manageable provided the U.S. continues to respect its WTO commitments.

For example, a hike in tariffs to WTO levels (i.e., a 4% across-the-board hike) would lower Canadian GDP by about 1% over five to 10 years — though that’s still significant, as it represents about $20 million of annual output over time, in today’s dollars.

On the brighter side, only a minority of the half-million Canadians working in trade-sensitive sectors would be affected.

More difficult to quantify are “broader spillovers into non-trading industries, the impact of uncertainty on business investment and the potential cost of non-tariff barriers,” says the report.

Manufacturing takes the hit

The auto sector is particularly sensitive to tariff increases, so could potentially bear a greater share of the negative impact.

Read: Expect car costs with older clients

(Canadian auto exports to the U.S. totalled $63 billion last year. In turn, the sector’s direct contribution to GDP was only about $8 billion, because intermediate goods cross the border multiple times at different stages of production.)

In addition, sectors with U.S. trade of at least double their Canadian production footprint make up about 6% of Canadian GDP and about 5% of Canadian employment.

Outside the auto sector, these include manufacturing in household appliances, computer equipment, cleaning products and rubber.

And industries that trade little could experience “second-round” effects. For example, auto workers’ support of the retail and construction industries could be affected.

Ontario would feel the most heat, reveals a BMO report by senior economist Robert Kavcic.

“U.S. exports in vulnerable sectors account for roughly 20% of Ontario GDP, the highest share in Canada by a wide margin,” says Kavcic.

Other effects

Loss of NAFTA would also mean loss of a dispute settlement mechanism, so Canada could be vulnerable to non-tariff barriers, too.

Read: 5 issues to consider during NAFTA negotiations

“It would be possible for [U.S.] policymakers with a protectionist bent to come up with new rules that could significantly impact trade flows,” says the report.

Also, there could be restrictions to the temporary cross-border movement of professionals.

If the U.S. doesn’t honour its WTO commitments, which would be a lower-probability scenario, the result could be “significantly more distortionary tariffs along the lines of the 20% import duties on softwood lumber and 300% tariffs on Bombardier CSeries jets already announced by the U.S. Commerce Department,” says the report.

In such a scenario, it’s likely the U.S. would focus on areas where Canada has a trade surplus. That could bring the energy sector under scrutiny.

Read the full RBC report and BMO report.