NO.080

IMF COMMENDS THE STRENGTH AND RESILIENCE OF THE AUSTRALIAN ECONOMY

The IMF has commended Australia’s continued strong economic performance

and the Government’s commitment to structural reform in its annual assessment

of the Australian economy. The IMF notes that Australia’s economic expansion

is now in its 14th year, and that ‘Australians’ incomes have turned

around decisively’ since the early 1990s, with wide ranging reforms helping

to lift per capita incomes ‘to almost 10 per cent above the OECD average’.

The IMF commends Australia’s ‘exemplary setting of economic policies’

and notes that the resilience of the economy ‘reflects increased flexibility

at the microeconomic level’ as well as ‘prudent and flexible management

of monetary and fiscal policies within transparent medium-term policy frameworks’,

citing low unemployment, increased competition, low inflation and the near elimination

of public debt among the benefits of reform.

IMF staff consider that the prospects for the economy remain strong, with growth

expected to continue at around 2¾ per cent during the remainder of 2005,

rising to around 3½ per cent in the medium term as high levels of investment

in the export sector boost capacity. Large gains in the terms of trade are expected

to lead to a declining current account deficit, and even as the terms of trade

gains subside in the medium term, the current account deficit is expected to

continue to decline in line with more moderate domestic demand.

Identified risks to the outlook include the possibility of a rapid reversal

of recent terms of trade gains and a pronounced downturn in the housing market

— although the IMF states that ‘after a year of stability in the

housing market, potential risks appear to have eased’. While acknowledging

these risks, the IMF notes the increased stability and resilience of the economy,

as shown by Australia’s strong economic performance through the Asian

crisis, the global IT slump and severe drought. The IMF also observes that there

is ‘ample scope for macroeconomic policies to cushion the economy against

either external or domestic shocks’.

The IMF strongly supports moves for additional reform, stating that the Government

is well-placed to implement additional far-reaching structural reforms to help

Australia remain ‘one of the strongest performing economies among the

economically advanced countries’. The Government is commended for steps

already taken to address the fiscal challenge of an aging population, and the

IMF calls for continued effort in this regard.

The IMF also ‘urged the implementation’ of the Government’s

industrial relations reforms to ‘widen employment opportunities and raise

productivity by enhancing flexibility in work arrangements’. The IMF’s

view is that ‘further reforms of industrial relations are needed to expand

labour demand and facilitate productivity gains’, and that the implementation

of the Government’s proposed workplace relations reforms would have ‘substantial

medium-term growth benefits’.

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

Staff Report and Selected Issues Papers available at the IMF’s website,

http://www.imf.org, and on the Treasury website,

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

13 September 2005

CANBERRA

Contact: David Alexander

02 6277 7340

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International Monetary Fund

700 19^th Street, NW

Washington, D. C. 20431 USA

Public Information Notice (PIN) No.

FOR IMMEDIATE RELEASE

August 29, 2005

IMF Concludes 2005 Article IV Consultation with Australia

On August 29, 2005, the Executive Board of the International

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

Background

Australia has implemented wide-ranging structural reforms and strengthened

the frameworks for monetary and fiscal policies over the past two decades. As

a result, Australia’s economic expansion is now in its 14^th

year, with growth averaging 3 percent owing to a combination of strong job

creation and high productivity growth. Inflation has remained low and the consistent

fiscal surpluses in recent years have contributed to the elimination of net

public debt.

Real GDP rose by 3 percent (y/y) in 2004, but growth slowed in the second

half of 2004. The slowdown mostly reflected a deceleration of domestic demand

following a welcomed cooling of the housing market, with housing prices slowing

from an annual average growth of 17percent in 2001–03 to being largely

flat in the year to March 2005. As a result, consumption growth moderated and

dwelling investment fell. Business investment remained buoyant, reflecting high

levels of profitability and capacity utilization. Employment has grown strongly,

at 3 to 4 percent in 2005, reducing unemployment to a 28-year low of 5 percent,

with no sign of generalized wage pressures.

The external current account deficit widened to 6percent of GDP in 2004 as

payments to foreign investors rose owing to high mining sector profits. The

trade balance was stable, with increases in the terms of trade to historically

high levels offsetting the strong growth in imports following the large exchange

rate appreciation in 2002-03. In the first quarter of 2005, the real exchange

rate stood 16percent above its average level since 1990. Export volume growth

was limited to 4 percent despite the strong global demand for commodities, partly

as a result of constraints on mine capacity and on transportation infrastructure

in some areas. The current account was financed mainly through external debt

issues by financial institutions, with net external liabilities rising to 65percent

of GDP.

CPI inflation has been steady at about 2percent, with a waning of the effects

of the exchange rate appreciation on tradable goods prices balanced by a modest

easing in the inflation rate of nontradable goods. Having kept interest rates

on hold since late2003, the Reserve Bank of Australia (RBA) raised the target

cash rate by 25 basis points to 5 percent in March2005, to lean against a

projected rise in inflation to about 3percent by the end of 2006.

The fiscal position continued to be strong. In the 2005Budget released in

May, the government projected the underlying cash balance to reach 1.1percent

of GDP in 2004/05, compared with the surplus of 0.3percent of GDP projected

in the 2004Budget. Revenue is projected to be almost 1percent of GDP higher

than budgeted, with company taxes particularly buoyant, partly reflecting the

boost in profits from rising export commodity prices.

Growth is expected to rise from 2percent in 2005 to about 3percent in the

medium term, although this will require continued strong growth in productivity.

Domestic demand growth will likely remain moderate as stimulus from the housing

market fades, while exports are expected to strengthen as substantial investment

in the export sector boosts capacity. As a result, the external current account

deficit is expected to decline back to its historical average of about 4percent

of GDP in the medium term even as part of recent terms of trade gains unwind

owing to increases in the global supply of commodities. While headline inflation

may approach 3percent in 2005 because of higher oil prices, the recent easing

in domestic demand growth suggests that underlying inflation will edge up only

modestly before declining back towards the middle of the target range in the

medium term.

Executive Board Assessment

Executive Directors commended the authorities for the sustained strength of

Australia’s economic performance, which they attributed to an exemplary

setting of economic policies and institutions, supported by broad consensus

on many issues. This includes wide-ranging structural reforms implemented over

the past two decades, along with a prudent and flexible management of monetary

and fiscal policies within transparent medium-term policy frameworks that has

helped enhance the resilience of the economy. Going forward, Directors encouraged

the authorities to continue with their structural reform efforts, in order to

further raise productivity and labor force participation and address the fiscal

impact of an ageing population.

Directors concurred that the outlook for the economy is favorable. While growth

had slowed somewhat in the second half of2004 owing to a welcome cooling of

the housing market and the earlier appreciation of the Australian dollar, the

resumption of growth in early2005 is expected to continue, with demand underpinned

by strong job creation and business investment. Medium-term prospects for stronger

growth in exports supported by high investment in the resource sector, together

with moderate growth in domestic demand, will tend to narrow the large external

current account deficit.

Directors viewed the current wait-and-see monetary policy stance of the Reserve

Bank of Australia as appropriate. While headline inflation may approach 3 percent

in2005 owing to higher oil prices, underlying inflation is likely to remain

consistent with the authorities’ targets over the medium term, given the

moderation in domestic demand growth. Directors welcomed the stabilization of

the housing market in2004 and2005, together with the easing in household credit

growth, which partly reflected astute and timely policy actions. Nevertheless,

close monitoring of the housing market and household sector finances will need

to continue.

Against this background, Directors welcomed the continued improvement in risk

management techniques by banks, and supported the timely refinements of prudential

regulations in response to the emergence of nonstandard household lending. To

preserve the soundness of Australia’s financial sector, they encouraged

continued efforts to enhance financial regulation, and welcomed the authorities’

commitment to using the forthcoming FSAP to help identify reform priorities.

Directors agreed that Australia’s medium-term fiscal position is robust,

with the underlying fiscal surplus projected at almost 1percent of GDP on average

over the next four years, partly reflecting large increases in export commodity

prices. Since not all of these gains may be lasting, Directors considered the

allowance for a substantial decline in export prices in the medium-term revenue

projections of the2005 Budget to be appropriately prudent. They also welcomed

the tax reductions in the past two budgets, which, by contributing to a mildly

expansionary fiscal stance, may have helped cushion the recent slowing in growth.

Directors considered that exchange rate flexibility will continue to play a

key role in tempering the impact of possible shocks on growth, including those

that might arise from a rapid reversal in recent terms of trade gains. They

also supported the free operation of the automatic fiscal stabilizers and the

readiness of monetary policy to respond flexibly to external or domestic shocks.

Directors noted the role that extensive foreign currency hedging is playing

in contributing to the resilience of the economy to substantial exchange rate

fluctuations. At the same time, Directors concurred that the high level of private

external debt, in the context of sustained current account deficits, requires

continued close monitoring.

Directors considered that Australia’s strong track record of successful

implementation of structural reforms bodes well for addressing the significant

economic challenges that lie ahead from an ageing population and rising healthcare

costs. They endorsed the authorities’ strategy to address those challenges

through further reforms to boost medium-term growth, and hence the revenue base,

complemented by measures to enhance the sustainability of expenditure. Directors

observed that Australia’s sound economic outlook and robust fiscal position

create an exceptional opportunity to implement these reforms.

Directors accordingly welcomed the measures announced in the2005 Budget to

expand labor force participation by encouraging the transition from welfare

to work. They supported the proposed reforms of the industrial relations system

aimed at further improvements in labor market flexibility that would facilitate

additional gains in productivity and employment. The authorities should also

continue efforts to raise labor force participation among the population aged

over 55 to moderate the impact of population ageing on the outlook for employment

and growth.

To further raise productivity and incomes toward those in the leading economies,

Directors recommended the adoption of an ambitious new reform agenda in key

infrastructure sectors. In particular, steps to improve the price signals for

water, land transportation, and electricity would enhance incentives for their

efficient use and stimulate timely investments to expand infrastructure capacity.

The importance of stronger competition in the communications sector and increased

research and development was also highlighted.

Directors welcomed the recent reforms of pharmaceutical benefits and Medicare

as important steps to address rising healthcare costs, which are the main source

of long-term fiscal pressures. Further efforts to enhance the sustainability

of healthcare spending will nevertheless be needed, and Directors encouraged

the authorities to explore how incentives in the health system could be strengthened

to improve healthcare productivity growth. Directors agreed that the proposed

Future Fund, by covering unfunded public service pension liabilities, and operating

in accordance with international best practices, is also set to play a valuable

role in meeting long-term fiscal challenges.

Directors commended Australia’s commitment to trade liberalization under

the Doha Round, and the increase in official development assistance. They encouraged

the authorities to continue to make progress toward the United Nations target.

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. This PIN summarizes the views of the Executive Board as expressed

during the August 29, 2005 Executive Board discussion based on the staff report.