NO.092

IMF SAYS AUSTRALIAN ECONOMY CONTINUES TO PERFORM STRONGLY

The IMF has predicted continued strong growth in the Australian economy

as a result of sound fiscal and monetary policy and the Government’s

commitment to structural reform. In its annual assessment of the Australian

economy today the IMF states that:

“…Australia’s economy has continued to perform remarkably well

over the past year, despite encountering major adverse shocks, including

persistent weakness in the global economic environment and a sustained,

severe drought at home.”

The IMF says the Australian economy’s ability to generate strong growth

outcomes in a difficult international environment is due to its sound

macroeconomic policies and the continued implementation of structural

reforms. Australia’s economy has outperformed most other advanced countries

in recent years.

IMF staff noted that the outlook remains favourable, with economic growth

expected to pick up in 2004. Beyond 2004, the IMF expects that the existence

of sound fiscal and monetary policy frameworks and the Government’s commitment

to further structural reforms will enable Australia’s economy to continue

to grow strongly and inflation to remain moderate. The current account

deficit is forecast to narrow in 2004 as the farm sector recovers.

The IMF has noted a number of risks to the forecast. The primary risk

is that the international economic recovery will falter. Domestically,

the drought remains a major risk. Although rains have resumed in many

parts of the country, they have not yet been sufficient in some regions

to ensure a strong rebound in agricultural production. The IMF believes

that the recent run-up in housing prices is largely explained by economic

fundamentals, particularly low interest rates and solid income growth.

The IMF also notes as a risk the sharp appreciation of the currency.

The IMF states that Australia’s fiscal strategy is fundamentally sound

and is consistent with the objective of balancing the budget on average

over the course of the economic cycle. The IMF also commended the Government

for producing a “well-conceived and comprehensive strategy”

to deal with the pressures arising from the ageing of the population.

The IMF calls for the implementation of the announced changes to the

Pharmaceutical Benefits Scheme.

The complete Article IV Staff Report is available at the IMF’s website

www.imf.org, which can also be

accessed through the Treasurer’s website.

30 October 2003

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

IMF Concludes 2003 Article IV

Consultation with Australia

On October 22, 2003, the Executive Board of the

International Monetary Fund (IMF) concluded the Article IV consultation

with Australia.¹

Background

Australia’s economy has continued to perform remarkably well over the

past year, despite encountering major adverse shocks, including persistent

weakness in the global economic environment and a sustained, severe drought

at home. Real GDP growth picked up from 2¾ percent in 2001 to just over

3½ percent in 2002, led by buoyant domestic demand. The strength of domestic

demand reflected an easing of monetary policy in 2001 (which was only

partially reversed in 2002), further moderate fiscal stimulus during 2001/02,

an improvement in the terms of trade, and a competitive exchange rate.

Continued strength in the housing sector-supported by a low interest

rate environment, government incentives to first-time homeowners, and

perceived high rates of return on property-and a robust rebound in business

investment underpinned the growth momentum in 2002. In the first half

of  2003, GDP growth slowed to 1.4 percent (seasonally adjusted annualized

rate), as the drought, weak foreign demand, and appreciation of the Australian

dollar placed a substantial drag on exports. Domestic demand also softened.

Employment growth picked up, bringing the unemployment rate down from

6.8 percent at end-2001 to 5.8 percent in August  2003. Inflation has

remained in check. CPI inflation picked up in early March 2003 to an

annual rate of 3.4 percent, reflecting a temporary rise in oil prices

and drought-related food price increase; subsequently, it has come back

down, easing to a 2.6 percent annual rate in September 2003. Measures

of core CPI inflation have remained relatively stable and within the

Reserve Bank of Australia’s (RBA’s) 2-3 percent official target range.

Housing prices continued to post strong gains, with an index of real

property prices in major cities rising by 18½ percent in 2002 and some

46 percent over the past three years. After significant weakness in 2000-01,

the Australian dollar has strengthened markedly over the past year and

a half, appreciating by June 2003 by almost 30 percent against the U.S. dollar

and by about 12 percent on a real effective basis since its low in early 2002.

The external current account deficit has widened, increasing from about

2.4 percent of GDP in 2001 to 6.7 percent in June 2003.

In response to slowing growth in 2001, the RBA cut the short-term cash

rate six times to a post-war low of 4¼ percent. Monetary conditions also

eased as a result of the depreciating Australian dollar. As domestic

demand recovered strongly, the RBA raised the cash rate by a total of

50 basis points in May-June 2002 to 4¾ percent. Subsequently, the cash

rate has remained unchanged.

With the domestic and international economic environment expected to

strengthen, the May 2002 Budget was intended to withdraw some of the

fiscal stimulus that had been injected in the previous two years. The

Commonwealth budget and the state and local government sector were projected

to be in approximate balance in 2002/03. In the event, Australia’s participation

in the war in Iraq resulted in some unanticipated defense and security

expenditures, while growth was slightly weaker than had been expected.

Nevertheless, revenues proved to be surprisingly robust, and the Commonwealth

budget recorded an underlying cash surplus of 1 percent of GDP in 2002/03.

The May 2003 Budget forecasts small underlying cash surpluses in 2003/04

and over the medium term after the introduction of new measures including

tax cuts and modest expenditure increases in the areas of defense and

domestic security, health care, and higher education.

Real GDP growth is expected to slow to 3 percent in 2003 reflecting continued

sluggish external demand growth, ongoing effects of the drought, and

the appreciation of the exchange rate. Risks to the short-term outlook

have become more balanced, with upside risks becoming more prominent

given continuing strength in domestic demand and recovery in agriculture

from the drought. Downside risks stem from the possibility of further

weakness in external demand and/or appreciation of the Australian dollar.

A sharp correction in housing prices also could have significant adverse

effects across the economy.

Executive Board Assessment

Executive Directors commended the continued strong performance of the

Australian economy in the face of persistent weakness in external demand

and a severe drought at home. They attributed Australia’s ability to

generate robust economic growth with low inflation to the enhanced resilience

of the economy, brought about, in turn, by steadfast pursuit of prudent

macroeconomic policies and structural reforms within transparent policy

frameworks.

Directors acknowledged that a number of risks cloud the economic outlook,

including those generated by the uncertain outlook for external demand,

the drought, rapidly rising property prices, and a sharp appreciation

of the currency. However, they noted that Australia’s economic fundamentals

are strong, and that the authorities remain committed to sound macroeconomic

management and structural reform. Overall, they judged Australia’s near-

and medium-term economic growth prospects to be favorable, and expected

inflationary pressures to be held in check.

Directors noted that the inflation targeting framework has worked well.

They considered the stance of monetary policy during the past year to

have been generally appropriate, and recommended that the authorities

continue to remain cautious and alert to signs of changing circumstances.

Directors considered that the rapid increase in housing prices poses

a challenge for monetary policy in the near term, particularly in view

of the appreciation of the Australian dollar. While agreeing that the

increase in housing prices largely reflects economic fundamentals up

to now, they cautioned that there may be speculative elements at work

in some parts of the market, and that the authorities should continue

to monitor housing market developments closely. Although monetary policy

should not target asset prices, attention has to continue to be given

to the impact that possibly unsustainable increases in housing prices

could have on economic activity and inflation. Directors agreed that

the appreciation of the Australian dollar is generally in line with its

medium-term equilibrium value and is mostly due to the relative strength

of the Australian economy.

Directors regarded Australia’s fiscal position as fundamentally sound,

reflecting the authorities’ disciplined implementation of their policy

framework. Directors endorsed the authorities’ strategy of balancing

the budget on average over the business cycle. They noted the authorities’

preference to use discretionary fiscal policy in a manner that would

make a lasting contribution to potential output rather than just temporarily

boost demand. In this context, they noted that the very sound fiscal

position provided scope for the full functioning of automatic stabilizers.

Directors noted the significant fiscal pressures that the authorities

are likely to face over the longer term as a result of the aging in the

population. They praised the authorities’ strategy to cope with aging-related

pressures. In particular, forward planning was considered preferable

to delaying actions, which may lead to undesirable imbalances in the

future. They also considered that the strategy outlined in the 2003/04

budget to tackle these challenges-which emphasizes raising labor force

participation rates and sustaining strong productivity growth-is comprehensive

and well conceived. Directors noted that the authorities are already

implementing a range of measures in line with this strategy, as well

as exploring other specific options for reforms. They agreed that the

government may need to run somewhat larger budget surpluses than currently

planned in order to build up a sufficient stock of resources to meet

financing needs, particularly for comprehensive reforms in such areas

as the personal income tax and the income support system.

Directors considered sound and stable macroeconomic policies and further

reform of the personal income tax system to be essential elements of

the authorities’ strategy to strengthen growth. They concurred that,

the fiscal position permitting, it would be desirable to raise further

the income thresholds at which the different marginal tax rates apply,

and to bring down over time the top marginal tax rate. Moreover, reductions

in the personal income tax might be needed to maintain an internationally

competitive tax system.

Directors agreed that a comprehensive reform of the complex system of

income support would provide stronger incentives for labor force participation.

They noted that the interplay between the current income support and

the personal income tax system creates high effective marginal tax rates

when individuals move from welfare to work. The transition to work would

be facilitated by reducing these high effective marginal tax rates through

further income tax reform, improved support services-including employment,

job training, and child care services-and a more tapered reduction in

assistance. Tightening eligibility for income support programs and instituting

penalties for breach of obligations with regard to unemployment benefits

would provide stronger incentives to return to employment. Directors

noted that proposed changes to the industrial relations system and investment

in education would also help raise labor market participation rates,

enhance the flexibility of the labor market, and increase labor productivity.

Directors also noted the authorities’ efforts to reduce health care cost

pressures, and urged the authorities to implement the announced changes

to the Pharmaceutical Benefits Scheme.

Directors commended the authorities for their commitment to trade liberalization.

With trade barriers to other countries not being raised, 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.

However, they encouraged Australia to further raise its level of official

development assistance.

Directors noted the soundness of Australia’s financial system, and they

commended the authorities for the steps that have been taken to strengthen

financial supervision. They welcomed the results of the recent stress

tests of the housing loan portfolios of individual banks, which suggest

that these institutions could safely manage a sharp decline in housing

prices and avoid systemic disruptions. Directors agreed, however, that

close supervision of the lending standards and information systems of

financial institutions will need to be maintained. They also welcomed

the steps that have been taken to strengthen supervision of the insurance

industry, and they encouraged the authorities to proceed expeditiously

with their planned reforms to strengthen the governance of superannuation

funds. Directors commended the authorities for their efforts to combat

money laundering and the financing of terrorism, noting that Australia

is in full compliance with the recommendations of the Financial Action

Task Force.

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.

Australia: Selected Economic and Financial Indicators, 1997-2002
			1997	1998	1999	2000				2001	2002
Output and demand (percent change)
Real GDP			3.8	5.3	4.5	2.8				2.7	3.6
Total domestic demand			3.6	6.6	5.7	1.9				1.5	5.9
Private consumption			4.0	4.6	4.9	3.2				2.9	4.0
Fixed investment			9.9	8.2	7.7	-0.1				-1.2	13.0
Exports of goods and services			11.1	0.1	4.4	11.0				1.3	-0.2
Imports of goods and services			10.5	5.9	9.1	7.4				-4.1	11.4
Inflation and unemployment (in percent)
CPI inflation			0.3	0.9	1.5	4.5				4.4	3.0
Unemployment rate (annual average)			8.2	7.7	7.0	6.3				6.7	6.3
Saving and investment (in percent of GDP)
Gross national saving			18.7	19.0	18.9	19.3				19.1	18.1
General government saving			1.8	3.9	4.5	2.8				3.0	2.8
Private saving 1/			16.8	15.1	14.5	16.5				16.1	15.3
Gross capital formation			21.8	23.9	24.8	23.0				20.6	22.5
Fiscal Indicators (in percent of GDP) 2/
Commonwealth budget
Revenue			24.2	24.7	26.4	24.0	3/			22.8	23.4
Underlying expenditure 4/			24.0	24.0	24.3	23.1	3/			23.0	22.4
Underlying balance 4/			0.2	0.7	2.1	0.9				-0.1	1.0
Commonwealth government net debt			14.8	11.9	9.2	6.4				5.3	3.9
Money and credit (end of period)
M1 (percent change)			13.3	6.1	9.7	9.4				21.3	-9.3
M3 (percent change)			7.1	7.0	9.6	4.8				14.8	10.4
Private domestic credit (percent change)			11.3	10.3	11.1	11.9				8.8	11.8
Interest rate (90-day bill, in percent)			5.1	4.8	5.7	6.2				4.2	4.8
Government bond yield (10-year, in percent)			6.0	5.0	7.0	5.5				6.0	5.5
Balance of payments (in percent of GDP)
Current account			-3.1	-4.9	-5.7	-4.0				-2.4	-4.4
of which: Trade balance			0.4	-1.4	-2.5	-1.2				0.5	-1.3
Terms of trade (percent change)			2.0	-4.1	-0.9	5.5				1.5	2.2
External assets and liabilities (in percent of GDP)
Net external liabilities			52.5	55.1	55.0	53.8				53.6	56.9
Gross short-term external debt			27.7	30.6	33.1	40.1				39.9	40.9
Net short-term external debt			14.8	17.4	17.2	22.5				23.8	22.9
Gross official reserves			4.8	4.3	5.5	5.2				5.3	5.2
Exchange rate (end of period)
US$/$A			0.653	0.614	0.654	0.554				0.508	0.566
Trade-weighted index			58.4	53.3	56.4	51.7				50.2	52.0
Nominal effective exchange rate 5/			105.5	95.3	100.3	92.0				89.8	92.9
Real effective exchange rate 5/			85.9	78.0	82.9	78.9				78.7	82.6
Sources: Data provided by the Australian authorities; and Fund staff estimates.
1/ Includes public trading enterprises.
2/ Fiscal year ending June 30 of the following year.
3/ The sharp drop in 2000 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).

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 October 22, 2003 Executive Board

discussion based on the staff report.