The Canadian economy still appears to be growing, but that growth has slowed a bit in recent years as the country grapples with a volatile housing market, plummeting energy prices, and sky-high consumer debt levels.
David McKay, the CEO of Royal Bank of Canada (TSX:RY)(NYSE:RY), is cautious about the health of the Canadian economy. He believes the country could take 15 years to “reinvent itself” after its manufacturing and service sectors began to shrink following the 2009 financial crash. Many of the jobs that were lost in that period simply aren’t coming back.
“So the economy has had to reinvent itself: create new customers and new markets with new products and new manufacturing capability,” he said. “That takes time. That can take a decade; that can take 15 years.”
Interestingly, Canadian companies appear to be playing the economic transition conservatively, employing limited use of debt. That’s in stark contrast to Canada’s overstretched consumer base.
For example, McKay believes that businesses aren’t borrowing at typical rates, opting to play it safe until the economy is on better footing. “We’re not seeing utilization of revolving credit lines, which means customers are building inventory, building receivables,” he said. “It feels like we’re still in a risk-off mentality with small business and commercial customers, in that they’re waiting for a more confident, clear picture of the economy.”
Meanwhile, Canadians themselves are mired in more debt than ever. In June, Statistics Canada reported that the debt-to-disposable income ratio for the average Canadian is 165%–near record highs. For every $1 of disposable income, the average person now has $1.65 in debt. Canada has seen the largest increase in household debt relative to income of any major developed country since 2000.
The parliamentary budget office also released a report predicting that debt levels will continue to rise over the next five years as interest rates normalize. “Household debt-servicing capacity will become stretched further as interest rates rise to ‘normal’ levels over the next five years,” the report said. “Based on PBO’s projection, the financial vulnerability of the average household would rise to levels beyond historical experience.”
A potential mortgage meltdown
A stabilization in the oil markets has not only helped economic production and employment, but it’s also given a nice boost to the loonie. The area of concern today is the mortgage market.
Total household debt last quarter, including both consumer credit and loans, totaled $1.9 trillion. However, most of that ($1.3 trillion) is mortgage-related debt. That could present a major headwind should the growth in home prices start to slow.
Even Bank of Montreal (TSX:BMO)(NYSE:BMO) is worried. This year it commented that the rapidly rising real estate market will end poorly for consumers, lenders, and the economy as a whole. “Odds are that if this kind of price growth continues, it will end badly,” a bank analyst said in a research note. Bank of Canada governor Stephen Poloz has said that over 720,000 households could struggle to make debt payments during a downturn.
While investors have welcomed higher oil and natural gas prices, major risks still await the Canadian economy.
