July 2020 - Monthly Economic Letter
Canadian tourism: Buckling in for a difficult recoveryIt will take years for the industry to regain its footing
The pandemic crisis has caused the sharpest economic contraction in the post-war period and the recovery, which began in May, is likely to be most painful for the hardest hit sectors.
In particular, the tourism industry will show the scars for years to come. Its full recovery will depend on a number of developments, including the permanent reopening of interprovincial and international borders, the emergence of a coronavirus treatment or vaccine, a return of consumer confidence and the survival of the industry's businesses in the interim.
The importance of tourism to the Canadian economy
Canada is the 18th most visited country in the world, according to the World Bank. The country welcomed a record number of more than 21 million international tourists in 2018. The World Bank estimates these visitors injected $22 billion into the economy. (Destination Canada has since reported a new record of 22.1 million visitors was set in 2019).
However, tourism is not limited to international travellers. Visitors from other parts of Canada account for a large proportion of tourism spending. They are particularly important for cultural and entertainment events and restaurants.
Taken together, interprovincial and international tourism generated 1.9% of national GDP ($35 billion) and 3.6% of employment (643,000), according to Statistics Canada data for 2014, the latest year available.
The importance of tourism varies from province to province. While 2.8% of jobs in Manitoba depend on out-of-province (including international) visitors, this figure rises to 6.7% in Prince Edward Island and 5.1% in British Columbia.
Measuring the extent of the damage in 2020
Real-time data provides us with a snapshot of how various tourism-related activities are recovering. For example, Google mobility data on July 5 in Canada, showed that traffic to businesses and recreational venues was down 13% from January's baseline. According to OpenTable data, restaurant reservations were down 57% nationally compared to July 2019.
In the U.S., hotel reservations remained down 30% in early July compared to a year earlier, according to data from Capital Economics. U.S. airport traffic was down 75%. (Similar data is not yet available for Canada.)
Meanwhile, Statistics Canada reports a 98% decline in non-resident inflows into Canada between April 2019 and April 2020, a drop from 1.4-million visitors to less than 25,000 during this period. This represents by far the lowest non-resident inflow in the last 50 years.
In contrast to the reopening of travel between Canada and the European Union on July 1, the closure of the Canada-U.S. border to non-essential travel has been extended. This is a serious blow to the tourism industry, which is expected to see a halving of its activities in 2020, according to the Oxford Economics analysis firm.
4 years to recover from 9/11 in the U.S.
Beyond 2020, the recovery of tourism activity remains difficult to predict. Increased caution about travelling could lead to lean years for the industry. For example, it took four years for the United States to return to pre-September 11, 2001 flight levels.
The Canadian tourism industry will likely depend on short-haul domestic travel this year and in 2021. In particular, hotels outside major cities and national parks may be surprisingly busy, while the postponement or cancellation of conventions and other international events may disproportionately affect metropolitan areas.
Short- and medium-term horizon: Untapped potential
The global tourism industry is expected to return to normal by 2023, Oxford Economics estimates. However, Canada's tourism sector could face more difficulties in the short term than other countries. The Canadian hotel industry is more dependent on foreign visitors than those of several other countries, including the United States, Australia and Germany.
But while 2020 will be a year to forget, some believe that Canada has untapped domestic tourism potential. In fact, Oxford Economics believes Canada has the second largest potential for domestic growth after the United Kingdom. Indeed, the firm notes, Canadians are among those who travel the most and also have a greater propensity to spend their vacations outside their country's borders. Retaining more of those dollars in Canada could give the industry a much-needed boost.
Indeed, Canada has run a tourism trade deficit in the past—Canadians spend more abroad than tourists visiting Canada. This net deficit amounted to more than US$10 billion in 2018, according to the World Bank. That year, Canadians spent almost US$34 billion on foreign tourism compared to US$22 billion in receipts from international tourists visiting Canada.
Encouraging Canadians to vacation at home rather than in the United States, France or elsewhere in the world will help domestic operators survive the crisis.
And that’s just what Canadians are planning to do. Almost nine out of 10 Canadians were planning to stay in Canada this summer, including a strong majority who are staying in their province, according to a BDC survey. Of those planning to travel, less than a quarter were looking to go outside the country. Between 2017 and 2019, that figure was more than 40%, according to the Conference Board of Canada.
What does it mean for entrepreneurs?
- Tourism businesses will have to be patient. Those that want to continue to operate will have to keep a close eye on their cash flow.
- Canadian tourists will remain the best source of business for the next two years. Work with your municipality and industry association to ensure your business is part of regional offerings.
- For Canadian entrepreneurs less affected by the current crisis, encourage local businesses by planning to vacation closer to home.
Longing for the halcyon days of 2019After two months of employment growth, the road to recovery is taking shape
The Canadian economy continues to recover from the health and economic crisis caused by COVID-19. In recent weeks, the Canada-U.S.-Mexico trade agreement came into force and the federal government provided a fiscal update.
COVID-19 infections have stabilized at around 10 cases per million population as of July 10, which is encouraging.
Economic indicators are showing progress, but there are still red flags, especially south of the border. (See section on the United States).
GDP drops 12% in April
Canada's GDP fell 11.6% in April, bringing the cumulative decline since February to 18.2%—a recession whose magnitude is equalled only by its suddenness. These figures are not surprising given that the Labour Force Survey (LFS) published in May found three million jobs had been lost between February and April.
Over these two months, goods-producing industries saw activity decline by 22%, weakened by a slowdown in construction (-27%) and manufacturing (-29%). The near-complete shutdown of the construction sector in Quebec and the automotive sector in Ontario were notable contributors to these results. The easing of health measures in these sectors, however, will lead to a significant rebound in the coming months.
The pandemic also hit the service sector hard (-17%) with a pronounced slowdown of more than 50% in the arts, entertainment and recreation sector, as well as in accommodation and food services. A rebound in these sectors occurred mainly in June, but to a limited extent. The potential for a more robust recovery is lacklustre for the rest of 2020.
Preliminary indicators suggest overall GDP growth of 3% in May, according to Statistics Canada. The job market had by then recovered nearly 10% of its losses and the Monthly Survey of Manufacturing suggests a 6.2% rebound in this sector.
41% of the three million jobs recovered
According to the LFS, 952,900 jobs were added to the Canadian economy in June, bringing the total to 1,242,500 in two months.
The unemployment rate fell for the first time, from 13.7% to 12.3%. Hours worked jumped across all industries but remain rather low in some service sectors such as accommodation and food services (down 47% since February) and information, culture and recreation (28%).
The employment level remains at 9.2% of its pre-pandemic peak (the low point was 15.7% in April). In comparison, the previous worst employment contraction on record was 5.4% and occurred during the recession of the early 1980s. It took 40 months to recover all of the jobs lost.
The LFS, which covers the week of June 15, preceded the reopening of restaurants in many of Canada's largest cities, likely indicating an underestimate of the state of the recovery to date.
Other developments: Credit rating, budget, aluminum
Several other economic news items have made headlines in recent weeks.
First, Fitch downgraded Canada's credit rating from AAA to AA+ (stable outlook). Citing the deterioration in public finances due to measures to support the economy during the pandemic, Fitch notes that the debt-to-GDP ratio is expected to stabilize over the medium term. The downgrade has had no impact on the value of the Canadian dollar, notes the section of this letter on economic indicators. The government's borrowing rate also remained stable, while 10-year bonds continued to trade around 1%.
The Government of Canada presented a budget update on July 8. The deficit is now projected to be $343.2 billion for fiscal 2020-2021, which represents 15.9% of GDP. This would increase the federal government's debt to GDP ratio from 31.1% to 49.1%.
As a share of the economy, this increase brings Canada to its highest debt level since the turn of the century. However, the Canadian government's position still compares favourably to its G7 peers. The country’s general government net debt-to-GDP ratio (which takes into account assets) stood at 41% in April, below that of Germany (49%), the United Kingdom (86%) and the United States (107%). These IMF estimates are likely to be revised higher in each of the countries.
In another development, the Canada-U.S.-Mexico Agreement came into force on July 1. This new trade agreement, which replaces the former North American Free Trade Agreement (NAFTA), began in a climate of tension as the U.S. considered imposing tariffs on Canadian aluminum imports.
What does this mean for entrepreneurs?
- 41% of jobs have been recovered and the economy is likely to show impressive GDP increases in the short term.
- However, the pace of growth is expected to slow in the coming months as some sectors of the economy adapt to the long-term effects of the pandemic on their activities. As such, 34% of the unemployed are now considered temporarily laid off, compared to 50% in April.
- The trajectory of the pandemic in the U.S. is worsening with new highs of more than 50,000 daily cases of COVID-19 infection (as of July 9th). The tightening of health measures in several states illustrates the risk of reopening the economy too quickly and may serve as a foretaste of what could happen in Canada should a second wave occur later this year. (see U.S. article).
The virus will dictate the future course of eventsEncouraging economic indicators against a backdrop of rising infection rates
With an end to lockdowns in many states, Americans have resumed their spending habits and business confidence is on the rise.
However, now that 7.5 million workers have returned to work, a surge in COVID-19 infections is making future economic progress uncertain.
Consumers return to their spending ways
After three months of decline, retail sales jumped 18% in May to come within 6% of their 2019 average level. (Canadian data, which are released later, are expected to show similar growth with the easing of lockdowns).
The Bureau of Economic Analysis reported that vehicle sales rose from 9.1 million to 13.4 million units (seasonally adjusted at an annualized rate) between April and June, another sign consumer confidence was strengthening.
However, the pace of the recovery is likely to slow for a couple of reasons.
First, the closure of most retail stores led consumers to postpone several spring purchases, as evidenced by the savings rate rising to over 30% in April. Then, consumers took advantage of the reopening of stores to catch up and make one-time purchases.
Second, uncertainty related to the surge in infections seems likely to limit consumer enthusiasm. Households will want to set up an emergency fund in the event of a return to lockdowns and further job losses in the second half of 2020.
Businesses are in catch-up mode
The upturn in economic activity revived business confidence in June.
Manufacturers returned to expansion mode, thanks to a rebound in new orders. Indeed, the ISM Manufacturing Index broke through the 50 mark for the first time since March (52.6).
Confidence among service businesses also picked up, with the ISM Non-manufacturing Index hitting 57.1 from 45.4. The business climate, employment levels and new orders contributed to this renewed optimism.
A third of jobs recovered
These events had a positive impact on the labour market, which recovered 4.8 million jobs in June. The U.S. economy has now added 7.5 million jobs since April—a third of the losses caused by the pandemic. The unemployment rate fell from 14.7% in April to 11.1% in June.
However, growth in the labour market is expected to slow. Unemployment claims remain high—more than a million new applications were registered in the first week of July. The weekly average over the past 10 years was 300,000.
Despite recent employment gains, some 18 million people were still receiving unemployment benefits at the end of June. In addition, Congress is expected to agree on the next stage of the economic stimulus package soon, as household incomes were down 4.2% in May.
Risks that will continue to hang over the U.S. economy
Cases of COVID-19 infections had appeared to peak in early April at around 100 cases per million population. Over the next two months, the infection rate declined by 40% before rebounding in mid-June.
A new peak of 190 cases per million population was reached on July 9th, and the trend remained upward. In comparison, cases in Canada peaked at just under 50 cases per million population at the end of April and stabilized below 10 since mid-June.
This resurgence of infections in the U.S. is primarily due to the growth of cases in some of the most populous states in the country—California, Texas and Florida—that had been relatively unaffected in March and April.
These states have reinstated some containment measures, including the closure of bars and restaurants. By early July, six states had reintroduced such restrictions and 15 had suspended the reopening of their economies.
It is therefore possible that the employment situation in mid-July may not be as good as it was in mid-June when the latest jobs survey was conducted.
What this means for Canada
- The pace of recovery accelerated in May and June in the U.S., as evidenced by strong retail sales and a buoyant job market.
- However, the recovery is expected to slow over the summer as cases of COVID-19 reach new highs and several states reintroduce restrictions.
- The measures will hurt economic performance in the U.S. and, consequently, have a negative impact on the recovery of Canadian exports.
- The date for the reopening of the Canada-U.S. border is likely to be delayed beyond July 21. The effects of this closure on the Canadian tourism industry are described in the main article.
Oil prices stabilize but uncertainty remainsAfter several weeks of recovery, oil prices changed little in June
A price war in March, negative prices in April, a rally in May—black gold has seen it all in 2020. That's why a month of price stability in June provided a welcome semblance of normality.
However, the growing strength of the pandemic in the United States, Brazil and Russia continues to weigh on the prospects for a recovery in demand in the second half of the year.
While production cuts by OPEC+ members were renewed until the end of July, the line remains thin between a stable market and the oversupply situation of recent months.
In Canada, new data indicate a contraction in production of more than 20% since the beginning of the year.
A marked decline in market volatility
Oil prices traded in relatively narrow ranges of $35 to $41 for West Texas Intermediate (WTI) and $28 to $33 for Western Canadian Select (WCS). (All figures in U.S. dollars.)
The spread between the two benchmarks has remained stable at around $9 per barrel, compared to over $15 in the first few months of the year. The absence of transportation bottlenecks in Canada contributed to the narrowing of the price differential.
Futures contracts suggest investors expect prices to stabilize in the coming quarters—the WTI contract for delivery in April 2021 was $41.36 compared to $40.06 for August 2020 (as of July 10).
Uncertainty about future demand
The International Energy Agency (IEA) expects global oil demand to fall by 8.1 million barrels per day (mb/d) in 2020, before recovering 5.7 mb/d of those losses in 2021.
It will take until 2022 for demand to return to 2019 levels, the IEA forecasts. This delay is mainly due to an expected weak rebound in demand for kerosene, a petroleum derivative used to fuel aircraft. The IEA estimates that demand for kerosene will remain 25% lower in 2021 than it was in 2019 with intercontinental flights remaining limited until the pandemic is deemed under control.
In the shorter term, relaxation of lockdowns continued around the world in June, although some regions had to reinstate measures, at least temporarily. Localized outbreaks were observed in China (Beijing), South Korea (Seoul), the United States (California, Arizona, Texas, Florida—see U.S. article) and Spain (Catalonia, Galicia).
In mid-June, gasoline demand in the United States remained about 10% lower than a year earlier, compared to a 50% decline in April. However, the recovery is likely to slow. Google's mobility index, which measures traffic levels, did not increase in June and remained 20% below the level observed in January.
The geopolitical situation is another demand risk. A new trade war between China and the United States could loom on the horizon. Tensions between the two countries remain high for a number of reasons, including the status of Hong Kong.
Extension of production cuts
In May, international production was estimated at 89 mb/d, a reduction of almost 12% from the rate observed in 2019. This reduction in supply is attributable both to the OPEC+ agreement and to lower production from other major players, including the United States and Canada.
On June 6, OPEC+ members agreed to extend their production cuts of 9.7 mb/d to the end of July. This agreement will limit an increase in inventories, which remain high.
As of mid-June, the potential storage capacity utilization rate was 76%, according to the IEA. It believes a rate of 80% (plus or minus 5 percentage points) is the operational upper bound. This would mean this threshold has already been reached or surpassed.
The current level of production should nevertheless be enough to bring the market back to equilibrium in the third quarter of 2020 (July to September). However, there is still a fine line between a stable market and the overabundance situation of recent months.
In Canada, data is beginning to show the magnitude of the economic impact of COVID-19 on the energy sector. Domestic production is estimated to have fallen by 530,000 barrels per day in April and potentially experienced a similar decline in May. This represents a reduction of about 20% from the production posted at the beginning of the year (around 5.7 mb/d).
According to the IEA, the absence of a second wave of COVID-19 infections should encourage the resumption of activities in the second half of the year, allowing production to exceed 5 mb/d in the final quarter. Production levels in 2021 could resemble 2019 but would not be accompanied by the prices then in effect (close to $50 per barrel for WCS).
Pandemic evolution will set the tone
While the oil market stabilized in June, the future remains uncertain. The evolution of COVID-19 infection rates will determine the state of commodity markets and, more generally, of economic growth for several quarters to come.
For the time being, international demand is keeping pace with production, but high inventories risk delaying a return to pre-crisis prices, potentially beyond 2021.
In Canada, this will affect the level of activity in oil-producing provinces and the level of investment in their respective energy sectors.
In the short term, it is plausible that the level of production will increase, particularly in Alberta. Current prices make extraction profitable (if only to a limited extent). Nevertheless, geopolitics and the evolution of the pandemic could quickly return producers to a deficit position.
In the longer term, the lack of new investment poses a risk to the profitability of the Canadian industry. It could leave market shares to competitors if current prices do not justify the relatively high cost of increased Canadian production.
For more information on investment trends in the energy sector, the IEA's World Energy Investment 2020 report discusses several scenarios for the coming decade from an international perspective.
The new BOC Governor takes office
The new Governor of the Bank of Canada, Tiff Macklem, used his maiden speech in June to talk about inflation targeting during a pandemic.
He reiterated the importance to the Canadian economy of keeping inflation low, stable and predictable. To do so, the central bank has several tools at its disposal, including its key policy rate, which has been at a low 0.25% since March. It’s expected to remain at that level until at least the end of 2021.
Negative rates, which the bank believes could lead to some instability in financial markets, have been ruled out for the time being. As for the Bank of Canada's ongoing program of asset purchases, described as "quantitative easing" by the new Governor, it will continue until the recovery is confirmed. This unprecedented bond purchase program is designed to ensure lower long-term interest rates and well-functioning credit markets.
As a result, the Bank of Canada's balance sheet almost quadrupled between February and May. The bank now holds assets totalling $470 billion.
The Canadian dollar returns to 2019 levels
The loonie has held within a range of $0.73 to $0.74 U.S. over the past month. This corresponds to a period of relative stability for oil prices (see the Oil section).
Fitch's decision to downgrade Canada’s credit rating from AAA to AA+ (stable) on June 24 had no impact on the value of the Canadian dollar relative to that of the United States. Canada continues to hold the highest possible rating with two other leading credit agencies, Standard & Poor's (AAA) and Moody's (Aaa).
Canadian business confidence points to recovery
The economic recovery continues as 57% of small and medium-sized businesses reported being fully open as of July 6, compared to 53% two weeks prior, according to a Canadian Federation of Independent Business (CFIB) survey (See their weekly dashboard). As well, 34% of companies were fully staffed at that time but only 24% were reporting sales at or above pre-crisis levels.
The rebound in business activity helped boost confidence among entrepreneurs to 54.6 in June, two points higher than May, according to CFIB's Business Barometer Index. This slight increase reflects a growing level of activity, but the outlook remains uncertain.
In this regard, nearly 40% of respondents considered the business climate to be bad, compared to only about 20% who considered it to be good. One in three employers were planning to lay off full-time employees in the next three months, while only 14% were planning to hire.
A few industries continued to score below 50, the threshold below which activity is contracting. This was the case for agriculture, natural resources, construction, and information, arts and entertainment.
Will we avoid deflation?
In May, consumer prices were down (-0.4%) from a year ago.
Prices were still up in four of the eight categories, including food, which was up 3.1%. Prices in transportation and clothing and footwear were down 3% and 5.4%, respectively.
The Bank of Canada's monetary policy aims to keep inflation around its 2% target. However, since the pandemic has had an impact on the consumption habits of Canadians, the current measure of inflation could be reviewed.
In the meantime, the central bank's actions will be aimed at supporting employment and bringing inflation closer to its 1 to 3% target range.