Canada's Murky Political Outlook Makes Markets Jittery

THE unusual uncertainties of Canada's five-way federal election campaign have left the country's foreign exchange, bond, and stock markets on edge.

With less than five weeks until the Oct. 25 election, traders on Bay Street, Canada's financial center, have become avid poll readers, hanging on every nuance of what candidates say and do.

Currency traders trembled this month when Liberal Party candidate Jean Chretien appeared to advocate lower interest rates and a less-independent central bank. His aides spent last week back-pedaling, saying at a news conference that Mr. Chretien is satisfied with the bank's inflation-fighting policies.

On Sept. 7 and 8, the Toronto Stock Exchange went on a two-day, 172-point (4.2 percent) nose-dive that analysts attribute partly to the country's murky political outlook.

Trading in Canadian bonds has slowed to a crawl because so many investors are sitting on the sidelines until after the election, bond traders say. ``The financial markets are jittery because there's no clear picture of which party will form a government - and whether that government will be a majority or a minority government,'' says Michael Scuglia, chief bond trader for Toronto Dominion Bank.

Polls show an almost even split between Chretien's Liberals and Prime Minister Kim Campbell's Progressive Conservative Party. If an election were held today, neither party would win a majority of the seats in Canada's 295-seat House of Commons, pollsters say. The markets favor a conservative majority government, believing it has the strongest commitment to reducing the federal deficit, projected at $32.6 billion (Canadian: US$24.7 billion) in the 1993-1994 fiscal year.

Canada's provincial and federal governments carry combined debt of $636 billion. And concerns are rife in financial circles that the load might grow quickly and become unbearable under a minority government, in which two parties compromise on policy. Many worry that a Liberal tie to the the socialist New Democratic Party (NDP), for example, would lead to less-controlled spending.

Bthere is wariness because the NDP is weak, and the balance of power could fall to one of two regional parties that have never before held power: the Alberta-based Reform Party, and the Bloc Qucois (BQ), the Quebec-based federal separatist party.

Investor sensitivity to Canada's separatist threat was underscored when Robert Bourassa, a staunch federalist, announced last week that he would resign early next year as premier of Quebec. Traders around the world instantly sold Canadian dollars, interpreting the move as a boost for the BQ. The dollar fell one-half cent, before recovering. The Canadian dollar fell almost half a cent on Monday - leaving it at just over 75.6 United States cents.

``My sense is that there is still going to be more of a reaction than we've seen in currency and in the interest-rate market,'' says Leo de Bever, chief economist at Nomura Canada Inc., the Toronto-based office of the Japanese securities company.

Canada has been attractive to foreign investors because of its fast-growing economy and low inflation relative to the US. In the past decade, foreign investors have tripled holdings of Canadian debt to about 35 percent of Canada's total, according to the Toronto Dominion Bank. Japan's share grew from 4 percent to 20.8 percent (about $50 billion) in that time.

``People assume because the Conservatives are ahead that they'll win,'' he says. ``But a minority government would call into question what might happen to fiscal, interest rate, and other government policies.... The whole [Quebec] separatist issue is coming to fore again, and that's never good for ... markets.''

Frank Mersch, chief Canadian equities strategist for Altamira Investment Services, a $10 billion mutual fund group, says the market does not yet reflect a possible minority government.

``Foreigners still consider it just a two-party race,'' he says, ``When word gets out that this could be a minority government, there are going to be some changes.''