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Canada's economy out of the woods? Think again

Micha Pawlitzki | Photographer's Choice | Getty Images

The state of Canada's finances is back in focus this week with economists questioning whether the country has managed to combat a worrying rise in private debt.

An independent policy think tank, called the Fraser Institute, made headlines last Wednesday when it described concerns as "overblown," adding that there was little evidence that Canadian households were irresponsibly borrowing too much.

However, that argument is now being challenged by David Madani, an economist focused on the north American nation at Capital Economics. He called the research "misleading" as it only showed the payments on debt interest, not the principal repayments which reduce the original loan amount.

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Onerous leverage?

"Principal repayments often represent a large portion of debt obligations, especially when it comes to housing mortgage debt," he said in a note released on Monday.

"Should market interest rates rise over the next several years, as we anticipate, household debt obligations will become much more onerous."

Canada's economy has seen house prices and debt levels continue to climb despite the global financial crash of 2008. Former governor of the Bank of Canada, Mark Carney, warned of elevated household debt levels on several occasions during his tenure.

New statistics in March showed that Canadian households held roughly C$1.63 ($1.32) of credit market debt for every dollar of disposable income in the fourth quarter of 2014 – a record high, according to Statistics Canada who published the data.

The country has also had to deal with a dramatic fall in the price of oil with its economy very much reliant on the commodity. The central bank delivered a rate cut in January and market participants are gearing up for another policy meeting this week. The current governor of the Bank of Canada, Stephen Poloz, said last week that this policy was "working" and that the cut would benefit households with a mortgage.

'Fallacy'

The Fraser Institute, meanwhile, also noted in its research last week that growing debt levels in Canada are being tempered by the fact that asset and net worth levels are increasing at a far greater rate.

Again, this sort of thinking has been lambasted by economists. Steve Keen, head of the School of Economics, Politics & History at Kingston University in London, told CNBC Tuesday that it was a "fallacy" to rely on rising assets.

Speaking more generally, rather than with reference to Canada, he said that the value of assets is the value of leverage and a "feedback process" existed between the two.

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"It's much more sensible to compare the level of debt to the level of income," he said.

The Bank of Canada is expected to keep its target for the overnight rate at 0.75 percent, according to Capital Economics. First-quarter GDP (gross domestic product) figures are due out on Friday and will came in at an annualized 0.2 percent, the research consultancy firm also stated, lower than the average 2.5 percent growth over the second half of last year, it added.