OTTAWA — Ottawa's budgetary shortfall narrowed in the first quarter of the fiscal year, the federal deficit dropping to $7.2 billion from the $12.5 billion it reached a year earlier.

That puts the government on track to meet its prediction of a $49.2 billion deficit for 2010-11, though there's still plenty of reason to keep an wary eye on the global economy, the Finance department said Friday.

While economic forecasters are more optimistic about the prospects for growth this year than they were when Finance Minister Jim Flaherty released his budget in February, the Finance Department maintained a cautious outlook, noting that "there remains considerable uncertainty with respect to the strength of the global economic recovery."

"Overall, three months of fiscal information is not sufficient to draw any firm conclusions about the outlook for the year as a whole. A comprehensive update of the fiscal outlook for this year and beyond will be provided in the fall."

A large part of the deficit -- the amount of money spent over and above that taken in -- was attributed to federal spending mandated by the Conservative government to help deal with the recession. About $3 billion of the shortfall was due to tax reductions, enhanced Employment Insurance benefits and infrastructure funding.

Government revenues were up $1.9 billion or 3.7 per cent, mainly reflecting increases in GST revenues and personal income tax revenues.

Ottawa tightened its purse strings during the period, with program expenses down $3.2 billion or 5.5 per cent. Much of that reflected the fact that federal coffers were opened to support the flailing automotive industry last year.

For the month of June, the federal government spent $2.8 billion more than it took in. That was a big improvement on the $5-billion deficit it racked up in the same month last year. Government spending was $2.7 billion lower, a drop of about 12.9 per cent, on lower transfer payments to the provinces.

The government piled up huge deficits to pay for stimulus spending to fight the recession and help the battered auto industry. But Ottawa plans to balance its books over the next few years, in part by keeping spending growth under control.

That goal should be achievable, the Conference Board of Canada wrote in a report Friday.

"In fact, the future now looks even brighter than what the federal budget projected," the board said in Lessons From the Recession and Financial Crisis commentary, predicting Canadian economic growth "in 2010 to significantly exceed the consensus view used in the federal budget."

"At the federal level, debt paid down over the past decade has given the federal government room to manoeuvre to manage deficits and debt over the medium term," the think-tank said.

"By around 2015, with the economy fully recovered from the recession, we expect the federal books to be back in balance."

CIBC economist Warren Lovely expects that when public accounts are reported--which show what the deficit actually was, rather than a projection-- last year's official deficit will be smaller than what was in the budget. Meanwhile, this year's deficit could be "comfortably and significantly" below what is expected.

"That means less debt accumulation and a better starting point for next year," Lovely said.

Recent figures from the Finance Department show last year's deficit likely totalled about $47 billion, well below the budget's $53.8-billion estimate. And in the first two months of this year Ottawa is already $3 billion better off than it was at the same point in 2009.

But while Ottawa is making good progress and is currently ahead of its budget plan, it could be somewhat derailed by a slowing global economy, Lovely added.

"The strong fiscal results that we're seeing out of Ottawa are the by-product of a healthy economy," he said.

"For the current year the numbers should be much better than planned, where there is some risk is with respect to next year where a slower U.S. economy could exert a dampening influence on Canada."

Canada's largest trading partner and southern neighbour is struggling with weak job creation, a faltering and uncertain recovery which could negatively impact the Canadian recovery, which goes hand in hand with how much the government is able to pay down next year, Lovely said.

"Next year's numbers aren't necessarily at risk but we may just not repeat windfall revenue gains."