Can exporters repeat in 2006?

Written by Stephen Poloz

A year ago it appeared that Canadian exporters might have a disastrous year in 2005. Yet the export numbers have turned out to be quite good, for most sectors. How did they do it? And can they pull off a repeat performance in 2006?

Consider that during the second half of 2004, the Canadian dollar had risen from the mid-70s into the low 80s against the U.S. dollar. Export growth, which had surged in mid-2004, slackened steadily, and by early 2005 the export slowdown was clear. With the dollar hitting brand new highs in early 2005, exporters and economists alike were pessimistic — exports were forecast to weaken further, imports would strengthen, and Canada’s economic growth would slow.

As it happened, though, export growth began to pick up again in the second half of 2005. As of October, total exports were 12% higher than year-ago levels, 6% higher after adjusting for price effects. Higher prices came mainly from oil, coal and especially natural gas. But export volumes have been growing strongly across a wide front, not just in energy.

Economists were certainly right about one thing — imports surged in the wake of the rising Canadian dollar. But the economy failed to slow, for two reasons. First, exports only slowed temporarily. Second, the surge in imports was mainly in new machinery and equipment. This reflected strong domestic investment spending, which of course boosts Canada’s economic growth at the same time that higher imports moderate growth.

Export strength outside of energy has come from metals, lumber, agri-food, machinery and, yes, even the crisis-ridden automotive sector. Metals exports have ridden the strong growth in global industrial production, especially in Asia. Agri-food exports have been boosted in particular by the removal of restrictions on U.S. beef imports. Soft spots have been pulp and paper, and consumer goods. This is where the combination of a strong dollar and soft international prices — even deflation in a range of consumer goods — has been very stressful for exporting companies.

Good growth in Canada’s machinery and equipment exports may be the most intriguing outcome for 2005. Points of strength include office machinery, computers, telecom equipment, aerospace and agricultural machinery. With productivity up strongly in the manufacturing sector, the inevitable conclusion is that these companies in particular have been using the strong dollar to invest in equipment upgrades and to build their global supply chains to cut costs. This virtuous combination has boosted export sales growth and improved profit margins, often at lower prices. Our forecast is that this productivity-enhancing strategy will continue to pay off in 2006 — with slower export growth of around 4%, but continued growth nonetheless.

The bottom line? Canadian exporting companies will face yet another source of stress in 2006 in the form of slower global economic growth. This should translate into softer prices for energy and other raw materials, and a lower Canadian dollar, which will provide welcome relief. Nevertheless, this combination is likely to demand at least as much ingenuity from exporters as last year.

January 12, 2006

The views expressed here are those of the author, and not necessarily of Export Development Canada.

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