Canadian homes 10pc overvalued, says IMF

Canadian homes were about 10 per cent overvalued at the end of last year despite government efforts to rein in the market, the IMF says.

It warns that authorities may have to intervene a fifth time in the mortgage market if personal debt levels do not stabilise.

The International Monetary Fund, in its annual report on Canada, also says the Canadian dollar is 5 to 15 per cent higher than warranted by long-term economic fundamentals.

Although government measures since 2008 to cool overheated mortgage borrowing and house prices have helped prevent a US-style housing bubble, prices and construction are both still excessive, the IMF says.

"The jury is still out on whether this is going to take care of the problem," Roberto Cardarelli, IMF mission chief for Canada, said after releasing the report.

Since the IMF conducted its study, there have been more signs of moderation.

Home prices grew at the slowest pace in three years in December year on year, and housing starts fell more steeply than expected in January.

Cardarelli said the high indebtedness increased Canada's vulnerability to an external shock because people could not borrow their way out of a crisis if they were already maxed out.

In the IMF's soft landing scenario, a housing slowdown, including an 11.5 per cent drop in prices over five years, would subtract 0.4 percentage points from gross domestic product a year.

It urges Ottawa to be ready to intervene again if there was a sustained increase in the household debt-to-income ratio from the record high 164.4 per cent in the third quarter of 2012.

"These measures could include higher down-payment requirements, lower caps on debt service-to-income ratios, and tighter loan-to-value ratios on refinancing," the IMF says.

It says the Bank of Canada should not use interest rate rises to curb household borrowing except as a last resort, and it urges the central bank to keep its benchmark rate on hold at 1 per cent until growth regains momentum, which it expects late this year.

The IMF forecasts 1.8 per cent economic growth this year following a sluggish spell late last year, broadly in line with that of the government and central bank. It sees growth picking up in the second half as the US, Canada's top trade partner, recovers.

Growth could be weaker if there is a downturn in the United States or Europe, or if commodity prices slide further.

Wading into a controversial domestic debate, the report says the sharp appreciation of the Canadian dollar and increased competition from China "contributed to the decline of Canada's manufacturing market share in the United States over the last decade".

It notes that the Canadian authorities "only partially agreed" with this view, saying the decline of manufacturing was a trend among all advanced economies. The main opposition party, the New Democrats, has clashed with the ruling Conservatives on this issue, arguing that the strong currency has hammered manufacturing jobs.

The IMF says the federal government is on track to balance its budget by 2015-16, but the fiscal outlook for some of the largest provinces such as Ontario and Quebec is less certain.

A priority in the medium term will be to contain health-care costs, a provincial responsibility, it says.

The IMF urges the federal government to consider two new approaches to fiscal planning, but policy makers appear reluctant to agree, the report says.

It suggests Ottawa publish a "fiscal sustainability report" every three to five years that would review progress by each level of government - federal, provincial, territorial and municipal - on managing debt and deficits.