Exporter Situation to Worsen before Improving

Stephen Poloz

Export Development Canada-Oct 31, 2007

Canada’s overall export performance is forecast to remain lacklustre in 2008. And there will continue to be a wide range of experience across specific export markets and particular sectors.

Total export volumes (adjusted for price effects) are now forecast to increase by just over 1% in 2008, after being essentially flat over 2006-07. Not all sectors will share in the same experience, however. Growth will be strong in such sectors as agri-food, fertilizers, energy, aerospace and machinery. In contrast, sectors like consumer goods, ores, metals, chemicals, plastics, rail equipment, telecom and cars will be weak. The geographic pattern of Canadian exports will also see a wide divergence. Exports to the major economies will be almost flat, while exports to emerging markets will rise 11% in 2008, after 24% in 2007.

But the main underlying story belongs to the exporters themselves, rather than their exports, for export sales, as soft as they are, can understate the pain being borne by exporters. The vast majority of Canadian exporters price their wares in U.S. dollars. Accordingly, a rise in the Canadian dollar leaves the price (in U.S. dollars) of Canadian exports unchanged, but simply cuts into the profit margin of the exporter. The latter then has a choice – either cut costs to restore margins, or try to raise U.S. dollar prices, a strategy that runs the risk of cutting into sales. The result can be rising exports, which sounds like a good thing, but pain for the exporter.

Indeed, exporters are dealing with a virtual triple storm: high input prices; slowing growth in the U.S. and elsewhere; and the strong Canadian dollar. The reaction to these stresses will vary by sector and by company. But examination of the U.S. experience during its high-dollar period from 1998-2003 suggests that there may be a push toward more globalization – more investment in foreign economies, more imported components – and more spending on cost-saving equipment.

By this time next year, there may be some signs of improvement in exporters’ situation. As the U.S. growth slowdown goes global, we expect to see some moderation in commodity prices, including energy, which would most likely mean some retreat in the overvalued Canadian dollar. But there are two caveats to these bits of relief: they will come in the context of slower global economic growth; and the entire forecast is based on an outright assumption.

That assumption is of a stabilization in the U.S. consumer. At this point, we have almost no statistical basis for this assumption. The meltdown in the U.S. housing sector is getting bigger every month, and therefore the collateral damage to the rest of the U.S. economy, and then on the world, is simply not forecastable at this time. The U.S. economy is much like a bicycle that needs growth of 2% or more to remain upright, and our forecast has the economy operating close to this critical growth rate. It would not take much for the U.S. economy to tip over into recession, in which case exports, and exporters, would be noticeably weaker than we are forecasting.

The bottom line? The 2008 forecast is for moderating growth, slow export sales, and continued stress for Canadian exporters. But it must be admitted that this forecast hinges on a big unknown – the psychological condition of the U.S. consumer – so business plans should be stress-tested.