NO.097

IMF COMMENDS AUSTRALIA’S STRONG ECONOMIC PERFORMANCE

The IMF Executive Board has commended Australia’s strong economic

performance and reform record in its annual assessment of the Australian

economy. The IMF considers the outlook for Australia’s economy remains

favourable, noting that “Australia continues to reap the benefits of

sustained implementation of appropriate macroeconomic policies and structural

reforms.”

In its Public Information Notice released today, the IMF “commended

the authorities for Australia’s strong performance, with six years

of budget surpluses, falling public debt, low inflation, high and rising

productivity, and a long period of uninterrupted growth that has underpinned

a dynamic job market”. The Fund also expects inflation to remain comfortably

within the medium-term target band, while unemployment has fallen to levels

not seen since the early 1980s. The current account deficit is expected

to improve as growth becomes better balanced, with domestic demand growth

gradually returning to trend and net exports becoming an alternative engine

of growth as the global economy strengthens and the effects of the drought

dissipate.

The Executive Board believes that the risks to Australia’s short-term

economic outlook are balanced, with the possibility of a sharp correction

in the housing market, further increases in oil prices and a weakening of

external demand balanced by the upside potential of domestic demand remaining

buoyant. In particular, the IMF notes that recent indicators are consistent

with a soft landing in the housing market and that macroeconomic policy

is well placed to respond should any downside risks materialise.

While Australia’s strong economic performance is expected to continue,

the report highlights the challenges from an ageing population. The IMF

supports the Government’s “ambitious agenda of reforms”

to raise productivity and labour force participation and calls for further

broad based reforms in these areas. Indeed, the IMF notes that implementation

of the Government’s reform agenda “would move Australia to the

forefront of defining international best practice in the area of structural

policies to address the economic implications of ageing, as it is now in

the area of macroeconomic policies”.

The IMF Public Information Notice is attached, with the complete Article

IV Staff Report and related papers available at the IMF’s website http://www.imf.org,

and on the Treasury web site

http://www.treasury.gov.au.

9 November 2004

CANBERRA

Contact: Amanda Kennedy

03 9650 0244

 

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International Monetary Fund

700 19^th Street, NW

Washington, D. C. 20431 USA

IMF Concludes 2004 Article IV Consultation with Australia

On October 27, 2004, the Executive Board of the International

Monetary Fund (IMF) concluded the Article IV consultation with Australia.¹

Background

The expansion is now entering its 13^th year, with unemployment

falling to levels not seen since the early 1980s. After slowing in

the first half of 2003, economic activity rebounded, underpinned by

continued buoyancy of domestic demand and a gradual recovery from the drought.

For the year as a whole, real GDP growth was 3 percent, only moderately

lower than the 3.8 percent in 2002, as strong domestic demand

continued to offset weak net exports and a large decline in agricultural

output. The strength in domestic demand was broadly based, with consumption,

housing and business investment all growing at above-trend rates. Domestic

spending was underpinned by supportive financial conditions, substantial

increases in household wealth from a surge in dwelling prices, a strong

labor market, and a rebound in farm incomes. The buoyant domestic economy

and the substantial appreciation of the Australian dollar led to a deterioration

of the current account deficit from 4.4 percent of GDP in 2002

to 6 percent in 2003. A boost in imports pushed net exports to

a record low in the first quarter of 2004, before net exports recovered

as imports retreated in the second quarter. As a result, GDP growth was

weaker than expected, although the economy retained significant momentum.

Headline inflation, which has remained within the RBA’s target range

of 2–3 percent, masks very different trends in tradables and

nontradables inflation. While CPI inflation for nontradable goods was around

4 percent, price increases for tradable goods declined sharply since

March 2003 due to the large appreciation of the Australian dollar.

Recent data show that the dampening effect on inflation from tradable goods

may be eroding due, to a large extent, to the recent easing of the Australian

dollar.

Monetary policy was kept on hold during the first three quarters of 2003,

reflecting conflicting risks to the outlook at the time. The RBA had to

contend with the potential for protracted weakness in the external environment,

further appreciation of the Australian dollar, uncertainty about the recovery

from the drought, on the one hand, and continued rapid growth in housing

credit on the other. By the end of 2003, however, with external risks

abating, domestic demand growing faster than expected, signs of recovery

in the agricultural sector emerging, and the housing sector continuing to

expand at an unsustainable rate, the RBA increased the Official Cash Rate

(OCR) by 25 basis points in both November and December. The RBA kept the

OCR unchanged at its policy meetings in the first three quarters of 2004,

based on emerging signs of easing domestic spending, a cooling in the housing

market, and subdued inflation pressures.

The centerpiece of the 2004 Budget is the government’s More

Help for Families package, which provided assistance to Australian families,

continued the government’s ongoing structural tax reform, and enhanced

incentives to save for retirement. It contained additional tax cuts and

new expenditure initiatives of $A 37 billion over five years (an average

of about 0.9 percent of GDP each year), while maintaining a modest

cash surplus of less than ½ percent of GDP each year through the

medium term. The Commonwealth net debt was projected to turn negative by 2007/08.

Forward-looking indicators of economic activity point to continuing strength,

albeit with some moderation, in domestic demand and there are some signs

of slowing in the housing sector. Real GDP growth is projected near potential

of about 3¾ percent in 2004. The gradual cooling of domestic

demand is expected to be, at least partially, offset by a pick up in external

demand and a rebound in the agricultural sector, bringing about the long

awaited rebalancing of sources of growth. The main risk to the outlook centers

on the housing market and the associated build-up in household indebtedness,

but recent indicators suggest a soft landing is likely. Medium-term prospects

remain favorable.

Executive Board Assessment

Executive Directors commended the authorities for Australia’s strong

performance, with six years of budget surpluses, falling public debt, low

inflation, high and rising productivity, and a long period of uninterrupted

growth that has underpinned a dynamic job market. They attributed this performance

to the authorities’ exemplary record of macroeconomic and financial

management and implementation of structural reforms, carried out in a transparent

economic policy formulation framework.

Directors concurred that the outlook for the economy remains favorable.

A sharp correction in the housing market, further increases in oil prices,

and a weakening of external demand are factors that could affect the positive

outlook, but Directors felt that these downside risks were balanced by the

upside potential of domestic demand remaining buoyant. Directors agreed

that growth is likely to be rebalanced, with domestic demand growth gradually

slowing and net exports picking up as the global economy strengthens and

agricultural output recovers from the drought. They noted, in particular,

recent data that are consistent with a soft landing in the housing market

and cooling of domestic demand.

Directors commended the authorities’ successful management of monetary

policy—based on inflation targeting—in the face of diverging

pressures from a strong housing market and robust domestic demand, on the

one hand, and weakness of net exports and an appreciation of the Australian

dollar, on the other. They pointed out that the main risk in the short term

centers on the housing market and the associated buildup of household indebtedness,

and considered that the measured actions of the Reserve Bank of Australia

(RBA), including some tightening of the official cash rate target in late 2003,

contributed to a welcomed cooling in the market. They viewed the RBA’s

current wait-and-see stance as appropriate in light of subdued inflation

pressures and remaining uncertainties in the housing market.

Directors agreed that the flexible exchange rate combined with a strong

risk management culture have helped increase the resilience of the Australian

economy. The significant appreciation of the Australian dollar during the

past two years mainly reflected a weak U.S. dollar, strong commodity

prices, Australia’s more favorable cyclical position compared with

other industrial countries, and a bounce back from the Australian dollar’s

undervalued level in 2001. Directors supported the authorities’

policy to limit foreign exchange interventions to situations where the exchange

rate is clearly misaligned or to calm disorderly market conditions.

Directors regarded Australia’s fiscal position as fundamentally sound,

and noted that revenue had remained stronger than expected during the first

half of 2004. They endorsed the authorities’ medium-term strategy

of aiming for a balanced budget over the business cycle to support sustainable

economic growth. They called attention to the significant long-term spending

pressures due to increasing healthcare costs and population ageing, and

welcomed the recent amendment to the Pharmaceutical Benefit Scheme, which

will help contain the growth of healthcare spending.

Directors supported the envisaged structural reforms in the 2004 Budget

to promote labor force participation and productivity growth in order to

achieve higher growth, close the potential long-term fiscal gap, and address

the challenge of an ageing population. They welcomed the measures to reform

the tax and income support system to provide better incentives to work,

such as reducing effective marginal tax rates for low-income families returning

to work, allowing older workers to access their superannuation benefits

without having to stop working, and tightening the eligibility requirement

for the Disability Support Pension. Directors also welcomed the government’s

plans to take additional measures to further increase labor market flexibility,

reform the welfare system, enhance competitiveness, and invest in research

and development and infrastructure, in order to further strengthen long-term

growth prospects.

Directors commended the soundness of Australia’s financial system

and strong risk management culture. They welcomed the steps that had been

taken to strengthen financial supervision, including the latest legislative

changes on insurance industry supervision and audit reform. Directors concurred

that developments in the housing market are unlikely to pose systemic risk

to the financial system, as indicated by the Australian Prudential Regulation

Authority’s recent stress tests. While a combination of external and

domestic shocks could result in a sharp increase of household savings and

weaker GDP growth that would have a negative impact on banks’ balance

sheets, such a “worst case scenario” is unlikely. At the same

time, Directors pointed to potential risks stemming from the sustained high

current account deficit and the build-up of private external debt, and advocated

close monitoring of corporate and banks’ balance sheets. Directors

commended the authorities for their preparation for the implementation of

Basel II regulatory capital requirements, and welcomed their interest in

participating in an FSAP in the near future.

Directors praised the authorities for their commitment to trade liberalization.

Australia’s pursuit of bilateral free trade agreements was seen as

supportive of the country’s multilateral liberalization efforts. Directors

commended the authorities for their recent unilateral decision to provide

complete duty- and quota-free market access to the least developed countries,

and were encouraged by the envisaged further liberalization of the more

protected sectors.

Directors welcomed Australia’s constructive involvement in neighboring

Pacific Island countries, including a significant increase in aid allocation

to the region in the 2004 budget. They noted that the authorities remain

committed to achieving the UN official development assistance target.

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF’s assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

 

Table 1. Australia: Selected Economic and Financial Indicators, 1998-2003

	1998	1999	2000	2001	2002	2003
Output and demand (percent change)
Real GDP	5.2	4.3	3.2	2.5	3.8	3.0
Total domestic demand	6.6	5.6	2.2	1.3	6.5	6.2
Private consumption	4.6	4.9	3.1	2.8	4.2	4.3
Fixed investment	8.2	7.0	1.5	-1.1	15.5	9.6
Exports of goods and services	0.0	4.5	11.2	1.6	0.3	-2.3
Imports of goods and services	6.0	9.1	7.8	-4.2	11.5	11.3
Inflation and unemployment (in percent)
CPI inflation	0.9	1.5	4.5	4.4	3.0	2.8
Unemployment rate	7.7	6.9	6.3	6.8	6.4	6.1
Saving and investment (in percent of GDP)
Gross national saving	19.0	18.7	19.6	19.5	18.7	18.9
General government saving	3.9	4.7	2.9	2.7	2.9	3.1
Private saving 1	15.1	14.0	16.8	16.8	15.9	15.9
Gross capital formation	23.9	24.7	23.1	20.7	23.1	24.8
Fiscal Indicators (in percent of GDP) 2
Commonwealth budget
Revenue	24.2	24.7	26.5	24.0	22.8	23.4
Underlying expenditure 4	24.0	24.0	24.4	23.1	22.9	22.4
Underlying cash balance 4	-1.0	0.7	2.1	0.9	-0.1	1.0
Fiscal balance (accrual basis)	-0.4	0.6	2.1	0.9	-0.5	0.8
Money and credit (end of period)
M1 (percent change)	6.1	9.7	9.4	21.3	-9.3	8.7
M3 (percent change)	7.0	9.4	4.9	14.6	10.3	13.7
Private domestic credit (percent change)	10.3	11.0	11.8	8.8	11.9	14.7
Interest rate (90-day bill, in percent)	4.8	5.7	6.2	4.2	4.8	5.5
Government bond yield (10-year, in percent)	5.0	7.0	5.5	6.0	5.5	5.6
Balance of payments (in percent of GDP)
Current account	-4.9	-5.7	-4.0	-2.4	-4.4	-6.0
of which: Trade balance	-1.4	-2.5	-1.2	0.5	-1.3	-2.9
Terms of trade (percent change)	-4.1	-0.9	5.4	1.4	2.3	4.0
External assets and liabilities (in percent of GDP)
Net external liabilities	55.1	55.1	53.8	53.5	56.7	59.5
Gross short-term external debt	30.6	33.2	40.1	39.8	40.7	36.8
Net short-term external debt	17.4	17.3	22.5	23.7	22.8	17.6
Gross official reserves	4.3	5.5	5.2	5.3	5.2	4.6
Exchange rate (end of period)
US$/$A	0.614	0.654	0.554	0.509	0.566	0.750
Trade-weighted index	53.3	56.4	51.7	50.2	52.0	62.9
Nominal effective exchange rate 5	95.3	100.3	92.0	89.8	92.9	110.1
Real effective exchange rate 5	78.4	83.3	79.3	79.2	83.1	99.2

Sources: Data provided by the Australian authorities; and IMF staff estimates.
¹Includes public trading enterprises.
² Fiscal year ending June 30.
³ The sharp drop in 2001 reflects tax reform, including income

tax cuts, the removal of the Wholesale Sales Tax, and the reduction in

grants to States.
⁴ Underlying expenditure and balance exclude asset sales and

other one-off factors; cash basis.
⁵ IMF, Information Notice System index (1990 = 100).

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¹ Under Article IV

of the IMF’s Articles of Agreement, the IMF holds bilateral discussions

with members, usually every year. A staff team visits the country, collects

economic and financial information, and discusses with officials the country’s

economic developments and policies. On return to headquarters, the staff

prepares a report, which forms the basis for discussion by the Executive

Board. At the conclusion of the discussion, the Managing Director, as Chairman

of the Board, summarizes the views of Executive Directors, and this summary

is transmitted to the country’s authorities.