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US Trade Protectionism to Jeopardise Canada's AAA Credit Rating

© Photo : JeangagnonThe main Montreal branch of the Bank of Montreal, Canada's oldest bank
The main Montreal branch of the Bank of Montreal, Canada's oldest bank - Sputnik International
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The new US President is adamant about imposing customs tariffs on imports and severely battering NAFTA, which is expected to adversely affect the lion's share of Canadian manufacturing, thus hampering Ottawa's ability to attract capital.

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Kristian Rouz – The protectionist approach of the new White House administration might impair the sovereign credit ratings of its closest foreign trade partners, most prominently, Canada, due to its excessive exposure to bilateral trade ties with the US. While US President Donald Trump is aiming to renegotiate the NAFTA trade deal, potentially putting Canada in a less advantageous position in its trade with the US, the new US customs tariffs might hit southbound Canadian exports.

Subsequently, Canada's reputation among investors as a top-rate borrower might suffer, rendering Canadian government bonds cheaper and yields higher. This could put upward pressure on the nation's borrowing costs, impairing the availability of credit and, ultimately, economic growth in Canada.

International credit rating agency Fitch Ratings sounded the alarm, saying that investor perception of Canada as first-rate borrower (Fitch currently gives Canada an AAA rating) might be badly shaken by Trump's urge to renegotiate NAFTA and slap US-bound imports with a customs tariff. In their recent report, Fitch analysts said that Canada's excessive exposure to trade with the US puts its credit trustworthiness "at risk".

"Countries hosting US direct investment, at least part of which has financed export industries focused back on the US, are at risk of being singled out for punitive trade measures." Fitch said. "Countries with the highest stock of US investment in manufacturing are Canada, the UK, Netherlands, Mexico, Germany, China and Brazil."

The greatest risk to Canada's credit rating at this point is the lingering uncertainty over the Trump administration's approach to trade. While its general protectionist disposition is rather clear, the exact losses to bilateral trade and Canada's exports, potentially inflicted by the looming border taxes and reviewed NAFTA provisions, are still impossible to properly assess.

"US policy predictability has diminished, with established international communication channels and relationship norms being set aside and raising the prospect of sudden, unanticipated changes in US policies with potential global implications," Fitch warned.

A significant share of Canadian manufacturing is export-oriented, and most of the nation's exports in manufactured goods go south of the border. The Canadian manufacturing sector is currently more competitive than its American counterpart in the US domestic market, mainly due to lax monetary policies in Canada, lower production costs and comparable quality control standards – in other words, by buying Canadian, US consumers are getting products that are the same quality as those made in the US, but cheaper.

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Should Trump implement decisive protectionist measures, Canadian goods will become dearer for US buyers, who might then opt to change their consumer preferences.

Fitch also said that other economic policy measures proposed by Trump, including business deregulation, tax cuts and infrastructure investment, will spur US growth, which has remained unimpressive during the past several years. This will somewhat brighten growth prospects for America's trade partners as well, including Canada, but still, the inevitable re-assessment of trade ties stirs uncertainty.

This lack of clarity is always bad for credit ratings, even though things might play out well after all.

Among near-term risks for Canada's credit rating and economic stability, Fitch mentioned a likely decline in volumes of bilateral trade, a slump in capital flows and workforce migration, and higher political tension.

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Other US-Canadian issues might include a potential devaluation of either the US dollar, the loonie, or both – whoever devalues quicker, wins.

If Canada's US-oriented manufacturers suffer lower profits, their credit profiles will deteriorate, limiting their ability to obtain financing. This is how Trump could undermine business investment in Canada.

What Canada could do under such circumstances is an attempt to further reduce production costs, mainly via an expansion in immigration, thus hampering growth in wages. This is also an unattractive scenario for many Canadians. Another option is a successful renegotiation of NAFTA or striking a separate trade deal with Trump, in an attempt to mitigate the negative spillovers of Trump's policies which could adversely affect Canada's economy.

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