As interest rates rise, Canada's unexploded debt bomb ticks louder

November 25, 2022
David Williams

In April, business leaders across Canada lamented that the federal government’s policies in recent years have created a “sugar pops” economy (Williams 2022). The analogy refers to federal policies that kept our economy buzzing on a “sugar high” of short-term macroeconomic stimulus and credit expansion, while doing little to engender long-term prosperity for people through higher labour productivity, business investment per worker, and real per capita incomes. Fast forward several months and interest rates have risen steeply. In that context, let’s examine just one of Canada’s structural weaknesses: high and pervasive indebtedness.

Canada is the 4th most indebted advanced economy

Bank of International Settlements (BIS) statistics show that all sectors of Canada’s economy – households, non-financial corporations and governments – have ramped up debt levels in the years since the Global Financial Crisis of 2008-09 (Figure 1).

Figure 1

All sectors of Canada's economy have taken on more leverage

As at 2022Q2, the combined level of debt across sectors stands at 3¼ times Canada’s GDP (Table 1). Canada is the 4th most indebted country among the 29 advanced countries for which we have data on all-sector debt. Canada’s household sector is the 3rd most indebted among that group, the government sector is the 11th most indebted, and the non-financial corporate sector is the 13th most indebted.

Table 1

Canada is the 4th most indebted advanced country

Canada has by far the highest private sector debt-servicing ratio among G7 countries

If there is an upside to runaway inflation of 7-8% per annum, it is that it assists borrowers by eroding the real value of debt, albeit at the expense of lenders. The downside is that central banks must respond. Central banks around the world are belatedly but steeply raising policy interest rates to try to cool demand and regain control over inflation. As a result, for example, the five-year Canada government bond rate, a key benchmark for mortgage lending, has jumped from less than 0.5% between April 2020 and January 2021 to 3.7% in early November 2022. That is a staggering 320-basis point (3.2 percentage point) increase in only 22 months.

The debt-servicing ratio (DSR) is the ratio of interest and principal payments to income. Canada’s private sector – households and non-financial corporations combined – already has the highest DSR among G7 countries and Australia (Figure 2). Note, Australia is a useful comparison as it is a small, resource-based economy, like Canada. Canada’s DSR could rise in coming quarters as income growth slows during a global recession and as loans outstanding come due for renewal at much higher interest rates.

Figure 2

Canada's private sector debt servicing ratio exceeds G7 countries and Australia


Ottawa’s “sugar pops” economic growth strategy could be about to get its comeuppance. As interest rates rise sharply, and loans come due for renewal and refinancing, some unpleasant chickens are coming home to roost. Meanwhile, growth in Canadian real GDP per capita was close to zero before the pandemic, dropped significantly in 2020, less-than-fully recovered in 2021 (unlike other advanced economies), and is now set to fall further in 2023 during an expected global recession. Canadian policymakers need to start getting serious about the unglamourous work of addressing the country’s structural problems (of which credit-dependence is only one), growing the income pie on a per capita basis, and doing so in a prudent and balanced manner.

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