Despite the economic turbulence buffeting their neighbor to the south, Canadians involved in metals distribution, manufacturing and the substantial export trade with the United States are still hopeful their country will weather the global financial crisis without a significant downturn.

But some factors, including recessionary trends already affecting Canada, may make that challenge more difficult to achieve, say experts studying the country’s economy.

“We’re looking at a different environment domestically now,” says Aron Gampel, vice president and deputy chief economist with Scotiabank in Toronto, who along with other Canadian economy watchers notes that the country is dependent on raw material prices.  “We are price takers, and we depend upon the powerful manufacturing machines around the world to sustain the big investments that we have. But this country is much better off than many around the world,” he says.

Gampel describes the effect on Canada from the credit crisis and global stock market turmoil as “very complicated,” but adds, “the bottom line is that this is an economy that has a much different set of circumstances [than the U.S.]. We have an economy where the federal government has been consistently in surplus and has been paying down debt, so it has a very favorable balance sheet. We have a banking system that is one of the best and most capitalized in the world.”

The Bank of Canada has stepped in with other countries’ central banks to guarantee liquidity and back interbank loans, but the Canadian government has not intervened by taking equity positions in private banks as governments have done recently in the United States and Europe.

Pedro Antunes, director of national forecasting for the Conference Board of Canada in Ottawa, notes that 11 consecutive years of federal surpluses have reduced government debt levels and interest payments to where they were in the 1960s. “There’s been a lot of fiscal stimulus in terms of personal income tax cuts and transfers to the provinces, and programs around infrastructure,” he says.

However, Antunes adds, Canada is already “living almost in recession,” having had a negative quarter of growth and very weak GDP over the first half the year. “The difference is that we’re still benefiting from raw material prices. The effect of very high raw material prices is feeding through an income effect,” he says.

Canada’s energy, minerals and forestry resources stimulate a lot of activity in the domestic economy, if not directly industrial production, Antunes says: “We are still generating a lot of activity where consumer spending is strong, income is strong and government revenues are strong. Through the first half of this year, that made it feel unlike a recession. In other words, even though GDP growth is weak, the sense is that we’re in a fairly good situation.” 

That is likely to change next year, when raw material prices are expected to weaken. “We see either no growth or there is the risk that raw material prices could decline more substantively,” says Antunes. “That would take away that income effect that has been so good to us, to our domestic economy, for five or six years now.”

Conference Board forecasters—in a business outlook prepared before the recent financial turmoil and released in mid-October after a review—call for Canadian economic growth of 2.2 percent next year, up from 0.8 percent this year. But Antunes contends that weaker material pricing will result in weaker employment, weaker government revenues, weaker consumer spending, weaker household income and weakness in other measures. “It’s going to feel a lot worse than it did this year,” he says.

“I think it is going to be a very challenging year ahead for Canadian manufacturers,” adds Jayson Myers, president of the Ottawa-based Canadian Manufacturers & Exporters trade group. He notes that the outlook is very dependent on the United States, since Canada exports almost half of its production to its closest neighbor.

“It really depends on what U.S. consumers and U.S. industry continue to buy,” Myers says, “and of course that is anything but clear.”

Canadian manufacturers expect a downturn next year around 15 percent across the board, Myers adds. “That’s kind of a worst case scenario, but it’s not out of the question. There is so much uncertainty right now that it is hard to know what to predict.”

If, as expected, the credit crunch continues and the United States falls into a recession, hurting  both industrial customers and consumers, the substantial Canadian automotive industry is almost certain to decline by 15 percent, Myers says. “The more I speak to buyers in other sectors, that seems to be a consensus. It’s a very poor and very dire economic outlook.”

The credit market turmoil is “obviously affecting Canada and everyone in the world. It doesn’t have any boundaries,” says Brian R. Hedges, executive vice president and chief operating officer of Russel Metals Inc., Mississauga, Ontario, one of Canada’s largest metals distributors.

Russel has not yet seen any indications that the economic trends are affecting its customers. “I’m sure we are going to see something eventually, but we haven’t seen anything directly, such as a customer coming to us and saying their credit was pulled,” Hedges says. “It’s there in the mindset of everybody, but I don’t think we’ve had any direct empirical evidence of an impact other than just a generic slowdown.”

While Russel also has some operations in the United States, Hedges is unable to compare how the credit crisis is affecting business on both sides of the border. “The overall impact in the U.S. economy is probably hitting some other players more than it is hitting us,” he says. “The sectors we’ve been in have been OK.”

If a deep recession were to take hold, Hedges says, “the volumes will come off more than they have and ultimately steel prices will come off. Those are the two things that we worry about, obviously.” 

He notes that Canada’s manufacturing sector has experienced recessionary conditions for some time, “although people don’t want to call it that. I’m looking for when we’re going to come out of it. If you’re a manufacturer, you’ve seen a recession for most of this year.”

Russel’s access to credit remains unaffected. “We have no problems,” Hedges says. “We have cash in the bank, we’re only using an existing line and we have a three-year facility. So we don’t have a horizon coming at us like some people might. Our credit terms are staying tight and our bad debts experience is also very good.”

The Canadian dollar had been strengthening against the U.S. dollar earlier in the year, but dropped along with financial markets last month to the low 80-cent range. “That’s going to lower the cost of materials and help [Canadian] manufacturers on the cash flow side,” says Myers. “That’s positive, but it’s going to be short-term. It is going to help as long as you have sales and orders, but not if your orders are beginning to dry up.”

Myers says it will be the end of the year before anyone can really assess the affect of the recent financial turmoil on Canadian manufacturers’ sales and orders. “There are a lot of companies with order books that are still fairly full,” he says. “The situation isn’t bad right now, but the question is what will happen at the end of the year. Are those order books going to look as full by the time January comes around?”

Over the short term, the weak Canadian dollar and lower raw materials costs can help Canadian exporters, as long as there are orders, Myers says. “But that’s a short-term boost. The underlying problem is why the Canadian dollar has gotten so low and why commodity prices have fallen. Of course they are down,” he says, “because of the expectation of recession in the United States and around the world.”

U.S. manufacturers enjoyed a cash flow boost from a favorable exchange rate in recent months, while Canadian companies were running at very thin profit margins. “Many of them were facing credit problems before the credit crisis struck,” Myers says of the Canadian firms. “So there is not a lot of margin providing a cushion here against the downturn. That’s why it looks very, very challenging over the year ahead.”

Russel Metals does not serve the struggling automotive industry, which is currently a drag on many other Canadian companies. “We have sectors that are pretty strong, and they are strong in both” the United States and Canada, Hedges says, including agricultural and heavy equipment. “Where we are having trouble is the pulp and paper and lumber industry,” he says. Most of those customers are in British Columbia and Quebec.

While Russel has little connection to automotive- or housing-related customers, it might see a modest decline from its heavy equipment customers. “It’s off a little bit, but we’ve had years before when we were up or down 5 or 10 percent. That’s pretty normal. I don’t think it is as bleak as everybody says it is.”

The recent decline in energy prices probably will not affect Russel’s business with customers in that sector until next year because drilling programs are already established for the fall, Hedges notes. “The question will be what next year’s drilling programs will look like and if gas and oil stay down,” he says. “It’s probably not going to be good.”

He also expects public works projects to stay strong because the government will spend money to try to help the economy. “It’s [construction of] the strip malls and that kind of thing that will eventually die off if housing doesn’t pick up,” he says.” The big boxes were consuming a lot of steel there for a while. I think that’s going to slow down or stop.”

Overall, Hedges believes the pessimism in the market is overblown. “It’s not as bleak for the manufacturing and service center customer as you would be led to believe reading the paper,” Hedges says. “There are obviously some down- sides to [the economy], but it isn’t the calamity everybody seems to be running around saying it is.”

Scotiabank’s Gampel tends to agree. “We have the view that we should come out of this with our skin intact,” he says, pointing to major gold and diamond mining operations in Canada’s north and west, a new iron ore mine due to open in 2009 in the Northwest Territory and a recent expansion of the Voisey Bay nickel mine. “We still remain optimistic that the global economy will bend but not break. If that’s the case, then commodity prices are likely to find some bottom over the next little while and then rebound, in line with the view that growth in the developing markets will manage to continue—maybe not as strongly—but will manage to outperform the developed nations by a considerable margin.”

The contraction in the global economy will likely accelerate through the rest of this year and into 2009, Gampel says, with Canada probably showing very little growth next year. “But to a great extent, we still believe that Canada will be a relative out-performer and will come out of this in much better financial shape once we get into a period of stabilizing the financial markets and the problems in the United States.”