The federal budget deficit narrowed to $17.7 billion at the end of December, the finance department reported Friday, prompting increased speculation the country's books could be back in surplus a year earlier than forecast.

The deficit as of December — which includes the first nine months of the fiscal year — was $9.7 billion smaller than it was for the same period in the previous fiscal year.

The government in its November economic update estimated it would have an annual deficit of $31 billion by the end of the current fiscal year on March 31st.

But TD economist Sonya Gulati predicted Ottawa will project a shortfall of between $26 billion and $27 billion for 2011-2012 in next month’s budget.

The date for the budget hasn’t been announced yet.

If the government does lower its projection, Gulati said, “we expect the upcoming budget to lay out the government’s cards as to how and where expenditure restraint will be secured.”

On Thursday, Finance Minister Jim Flaherty said the budget will take a moderate approach to cost-cutting and will not be "draconian" in its spending restraint.

"As a result and all else equal, it looks like the government could squeeze out a surplus in 2014-15, one year earlier than the current plan," Gulati said.

The department said the deficit in the month December was $353 million. The deficit was $1.35 billion in the same month a year earlier.

Debt costs rise

The Finance Department said the deficit shrank because revenue growth substantially outpaced a more modest rise in program spending.

Budgetary revenues in December rose by $1.4 billion, or 6.8 per cent, compared with the same month a year earlier. Revenue for the first nine months of the fiscal year was up $7.1 billion, or 4.2 per cent, to $174.2 billion.

December program spending rose by 2.7 per cent, or $504 million, on higher transfer payments to persons and other levels of government.

So far in the fiscal year, program expenses are down by $3.0 billion, or 1.8 per cent, at $168.34 billion.

The costs of servicing the debt over the last nine months rose by $405 million to $23.6 billion.

With files from The Canadian Press