Canada is on course to record "modest" deficits in the next two years and faces the "distinct possibility" of falling into the red this year as well, says a report by Canada's independent parliamentary budget officer.

Kevin Page gave the sobering outlook on Thursday morning in his first fiscal and economic assessment of the country.

The report projects a deficit of $3.9 billion in 2009-10 and $1.4 billion in 2010-11, with a return to modest surpluses of $1.6 billion in 2011-12 and $3 billion in 2012-13.

The parliamentary budget office's analysis is based on current government plans, assuming there are no major fiscal policy changes.

Though the government could still manage a surplus in 2008-09, the report says it may instead record a deficit.

"While the year-to-date surplus as of August is currently at $1.2 billion, it will be some time before the implications for revenues of the recent financial market turmoil are known," the report states.

"There is a distinct possibility of a deficit in 2008-09."

It doesn't specify how much in the red the government may be in 2008-09, only saying there is "a distinct possibility of a deficit" since the effects of recent financial turmoil are still unknown.

In a worst-case scenario, Canada could see deficits peak at roughly $14 billion in the next fiscal year, the report says. On the other end of the spectrum, its most optimistic projection foresees a balanced budget this year.

Tories partly responsible for fiscal squeeze: report

Though Canada's disappearing surplus is partially the result of a global financial crisis, the report says the minority Conservative government shoulders some of the responsibility because of policy decisions during Prime Minister Stephen Harper's first term in office.

"The weak fiscal performance to date is largely attributable to previous policy decisions as opposed to weakened economic conditions," the report says.

It pinpoints the government's second one-percentage-point reduction in the goods and services tax and reductions in corporate income taxes for causing the lowest budget balance in the first five months of the fiscal year in recent times.

In August, the year-to-date budget surplus stood at $1.2 billion, down from $6.6 billion the year before.

Liberal Leader Stéphane Dion blasted the Conservatives for putting the federal government in its first deficit position in 10 years.

"Mr. Harper and [federal Finance Minister Jim Flaherty] will try to blame the global economic crisis, but the truth is it is their own economic mismanagement and poor planning that has caused this situation," Dion said in a press release.

Dion reiterated his accusation that the Tories have squandered a $13-billion surplus left by the preceding Liberal government and halted their practice of keeping a $3-billion contingency reserve to help ease unforeseen economic troubles.

"Mr. Harper leads the biggest spending by a federal government in Canadian history. He spent, spent and spent, he cut the wrong taxes, and he left no buffer and no room to manoeuvre."

The report forecasts Canada will experience an economic slump similar to one in 2001 when it felt the effects of a U.S. recession, but did not tumble into recession itself. The downturn will likely be "much less severe" than the recessions Canadians saw in the early 1980s and 1990s, it says.

"That said, the outlook for the Canadian economy is highly uncertain and depends crucially on developments in the global economy and global financial markets," the report says.

The report states that a global recession is expected due to the market turmoil caused by the collapse in the U.S. subprime mortgage market and subsequent credit tightening.

Canada is "highly exposed" to financial developments around the world, particularly with its largest trading partner, the United States, it says.

While Canada's labour market has recently been "slightly stronger" than expected, rising unemployment rates are forecast, with a peak of 6.9 per cent expected in 2009, down from the government's prediction of 6.4.

The report also notes that consumer confidence has fallen to its lowest level since 1982, when the economy was in a deep recession.

3 options for government

The report's goal was to provide parliamentarians with an assessment of the economy from non-politicians, and it outlines three possible courses of action they could take amid growing financial uncertainty.

Under the stay-the-course approach the government has taken so far, it wouldn't introduce any major fiscal stimulus.

The second approach would see Ottawa doing its utmost to fulfil the Conservative party's campaign promise to maintain a balanced budget, forcing it to auction off Crown assets or increase taxes or both. Flaherty has already floated the possibility of putting assets up for sale, but has not suggested any tax hikes.

This approach could "prolong or exacerbate the economic slowdown," the report warns.

The third option would see the government increase spending to stimulate the economy in the short term. The report says this could provide a buffer if a slowdown is expected to be "particularly severe," but would weaken the government's fiscal position in the short and long term.

Page and his staff spent the last couple of months crunching numbers and consulting with 18 different private sector financial institutions and watchers, looking for a "consensus" view of the economy, then conducted their own analysis.

The report comes a week before Finance Minister Jim Flaherty delivers the government's economic update. It also comes a day after the government delivered a throne speech suggesting the country may have to run a deficit.

The parliamentary budget officer is a new post, promised by the Tories in their 2006 election platform to provide an independent source of information to MPs on economic policy.