Transcript No. 2000/101

Ladies and gentlemen. Thank you for your attendance. I am stopping over in

New York on the way to the G20 meeting of the 20 nations considered important to the

stability of the international financial system which is meeting in Montreal: 20 Finance

Ministers and Central Bank Governors tomorrow. And I expect this to be an important

meeting discussing a number of international financial events, including the state of the

world economy, the work that’s been done to stabilise the international financial

system and work which is yet to be done, something that Australia has made quite a

contribution on, particularly in promoting transparency surveillance in our own region

amongst the economies of the Asia Pacific. We’ve been very active in a group called

the Manilla Framework which has been developing peer surveillance and improving technical

capabilities throughout the region. And very active also in the Financial Stability Forum

which has been looking at disclosure and transparency by international hedge funds and

ways to promote increased surveillance in relation to investment in those hedge funds.

I expect that it will be a fruitful meeting. I’ve taken the opportunity in

New York to do a number of speeches and make a number of presentations on the

Australian economy. This is certainly the first time I’ve been through New York since

we’ve accomplished tax reform on 1 July and it’s a tax reform which will be very

pro investment. We reduced the company tax rate on 1 July to 34 per cent. We’ll

reduce it further to 30 per cent next July. We’ve cut capital gains tax effectively

in half and recently announced measures which will encourage US pension funds to invest

and to invest in venture capital, capital gains tax free. I expect that this will aid

investment in Australia and there’s certainly been a great deal of interest in those

measures that we recently announced. And to have the opportunity to explain them first

hand to would-be investors has been an valuable opportunity and also to talk generally

about the Australian economy. But I’m very happy to answer any questions.

Mr Costello, can you tell us what was discussed about the Australian dollar, the level

of the Australian dollar and overseas confidence [inaudible]?

Well, I think there’s a great deal of interest, particularly in the US/Euro

exchange rate. That seems to be the main interest, particularly from the US end. Obviously

that’s had an effect on the Australian dollar over recent times but it’s

certainly not considered the main volatility on exchange rates, which continues to be an

interest in the Euro.

Do you see that nexus continuing up?

Well I don’t think … There obviously has been a nexus between the way in

which both the Euro and the $A have moved. I don’t think there’s a reason for

it. I don’t think that the Australian dollar is related to the Euro at all. Australia

has been on a very different economic cycle. Our growth has been substantially higher than

Europe and our unemployment lower and our productivity performance much more impressive.

There’s been a lot of work done here in the United States on the kick-up in the

United States labour productivity which has been very impressive. And there are few

countries that have done better in terms of a pick-up in labour productivity than the

United States. One of those few countries is Australia. The improvement in labour

productivity in the late 1990s in the United States is a very impressive 2.6 per

cent. And the recent Federal Reserve Bulletin noted that one of the few countries to do

better was Australia, which had an improvement of 3.1 per cent over the same period. So

obviously there’s a lot of interest in the Australian economy’s performance but

there’s no reason to think that the Australian economic cycle mirrors Europe or is

the same as the European cycle.

Treasurer, do you believe your visit here, your meetings with various financiers, may

change that perception. Do you think that trying to disconnect the Australian dollar from

the Euro in people’s perception can be achieved [inaudible]?

I don’t think that there’s … For those that look at economies carefully,

they would know that the European cycle and the Australian cycle is quite different, that

one of the problems that Europe’s been struggling with in recent years has been low

growth, high fiscal deficits and low productivity. Whereas in Australia you’ve had

growth above 4 per cent, we are now in our fourth year of fiscal surplus, last financial

year we had the largest surplus in Australian history, we have paid our debt to GDP ratio

down to 8 per cent comparing with rates of 40 per cent in Europe and indeed in America. So

I think people who study these things closely know that there’s a difference between

the Australian cycle and the European cycle. Nonetheless, we have to observe on exchange

rates that they’ve been moving together in recent times, although perhaps more

recently there’s been a bit of a break. And it’s just worth re-emphasising the

differences amongst those that don’t follow things perhaps as carefully as others.

Mr Costello, was there a perception with the people that you met over the weekend that

the currency is under valued and that it’s not a true reflection of the state of the

Australian economy?

I think all of the literature which has been put out of independent analyses would say

that the exchange rate has not been reflecting fundamentals. I’m not adding anything

to that literature here. I’m just observing that happens to be the fact in the

literature that’s been published.

Mr Costello, there was some literature published by Morgan Stanley a couple of weeks

ago saying you probably need to seek a contingent credit line from the IMF to defend the

dollar and particularly to [inaudible] foreign reserves worth 5 bil US. Have you spoken to

Morgan Stanley on this trip? Are you likely to? Has the Government spoken to them about

this research? And do you have any public response?

Well, that would be, if anybody was saying that, I don’t think they’d be a

very well informed observer. That’s just a silly suggestion. I can’t imagine

that anybody would be suggesting it for a moment.

What are the people you’re meeting with telling you about? Do they believe the US

dollar is over valued and is going to come back down? Do they believe that there is a

floor on the Australian dollar which [inaudible]? What’s the message coming back to

you?

Well, the important thing from an economic policy point of view is that we run a strong

economy. And if you believe in floating exchange regimes, and we do – and this will be the

subject, I imagine, of a lot of the discussion in Montreal – what other alternatives are

there? There are some countries that run fixed exchange rate regimes. We don’t. We

believe in a floating exchange rate. If you believe in a floating exchange rate, and we

do, then the exchange rate over time reflects economic fundamentals. So the important

thing is to have strong economic fundamentals. What are the strong economic fundamentals?

They are these: growth, inflation, employment, productivity. Well, if we want to run an

economy which is growing strongly, and it is. We want to keep inflation low, and it’s

important that we don’t lose sight of that, but it is. We want an economy where

productivity is high and we need to promote that. How do we promote strong productivity?

Well, we need good tax reform. We’re getting it. We need labour market reform.

We’re working on it. We need improved privatisation. We are trying to overcome Senate

obstacles. We’re needing competition. We’re continuing to do work on that. And

the other good fundamentals are improvement in employment outcomes. Now, unemployment is

still too high in Australia. It’s 6 per cent. It’s the lowest in a decade but

it’s still too high. And we need to continue working on that. And I think if we can

continue the growth of the Australian economy, that we can take it down through 6. We

forecast 6 in June next year but if you ran the Australian economy at 4 per cent, you

could take it down through 6 after that. But I think that if you run a strong economy and

you concentrate on fundamentals, fundamentals is what produces outcomes.

Mr Costello, in those meetings you’ve had, despite the Government’s own

strong fiscal performance, is there any concern in the feedback you’ve had that

Australia has a large, reasonably large, current account deficit and this is part of the

reason why the dollar’s under pressure because we’re competing with the US for

foreign capital?

I think, let me make at this point, the current account deficit’s something we

always keep an eye on. What’s happened in the Australian situation is over the last

year it’s declined. The current account deficit has declined and we actually think it

will continue declining. On the other hand, what’s happened in the United States is

that the current account deficit has increased and you may actually be seeing convergence.

But that doesn’t mean we get complacent about it, just because it’s declining.

It means that we have to continue good policy which will keep it declining. Now obviously

the export boom that’s going on in Australia at the moment is helping the current

account. But another thing that the Government can do is it can build savings. And

that’s why it’s important to keep returning Budget surpluses. Last financial

year, the Government added $13 billion to Australia’s savings. And this is an

important point about Australia’s current account: not $1 of that current account is

Government related. That is, the Government is not out there borrowing. Since I became the

Treasurer of Australia, in net terms we have not borrowed. That is, the Government adds to

savings. So all of the current account, to the extent that it draws down on savings, is

from the private sector. If the private sector is making good decisions and it is

borrowing for good returns, it’s a better quality of current account. You’d be

much more worried if it were the Government out there running a deficit and also borrowing

on the capital markets. But that doesn’t detract from the point that the Government

should be building savings in a situation where you have a current account deficit and

that’s why I believe it’s very important for Australia to continue to run

surpluses. This idea that, okay, we’ve run three surplus Budgets in a row, we’re

running another one this year and we’ve got forward estimates, so this will be five

or six surpluses, we can give the game away is wrong. We can’t give the game away.

We’ve got to continue to run those surpluses and to keep Australia in a strong

position.

Do you think Australia deserves a AAA rating for [inaudible] the Government should be

[inaudible] AAA rating for its fiscal performance or will you have to put in some more

surpluses [inaudible]?

Well, Australia was downgraded in rating terms twice during the 1980s and since I

became Treasurer we’ve been upgraded once. We’re still not back to where we were

in the 1980s. It would be nice to be back there and certainly if that were the result of

our policy we’d be very pleased. But let me put this gloss on it: from the

Government’s point of view, although it would be important, you’ve got to

remember from the Government’s point of view we’re not borrowing anyway. Since I

became the Treasurer, we haven’t borrowed in net terms. So it’s not as if this

is feeding into our cost of borrowing because we just don’t borrow. In fact, if you

get one complaint from some of these finance houses, they’ll say, you know, why

don’t you put an issue out there because we’d like to do it for you. And you

say, well, we’ve not been in the business of borrowing since 1996. We’re

actually repaying debt. But to the extent that it’s the sovereign rating that moves

the corporate ratings, it would help corporate Australia if you got an upgrade in

sovereign rating. So it would be of assistance to corporate Australia. So if that were the

outcome of our fiscal policy, I’d be pleased. But you’ve got to remember that we

direct our policy at the fundamentals and if we get the fundamentals right, that should

follow.

A lot of people have fond memories of when one Australian dollar bought one US dollar

and everything you’ve said today – Australia’s economic out-performance

– would indicate that should be the case rather than a dollar buying 50 cents. I

wonder whether you can ever foresee a time when the Australian dollar will have that type

of strength again and I wonder if you can tell us why you think the Australian dollar is

so under-valued on fundamentals?

Well, I think those fond days that you look back at were the days of the fixed exchange

rate. But that used to be the case when Australia ran a fixed exchange rate. In fact, when

we fixed our exchange rate, we used to fix it above one US dollar. When we floated our

exchange rate, those days ended. As I said before, you can have an argument about whether

you agree with a floating exchange rate or a fixed rate. There are countries around the

world that run fixed rate exchanges regimes. We are not one of them. We do not believe

that they are better. Because a floating exchange rate gives you an arm of economic policy

that allows adjustment. It allowed us an adjustment during the Australian financial

crisis. It gives you another arm. Now, whilst you have a floating exchange rate,

you’ve got to live with volatility. And you’ve got to live sometimes with the

fact that markets can overshoot. But in the longterm, a floating exchange rate reflects

economic fundamentals. That’s why you concentrate on the fundamentals. The important

things are growth, productivity, the fiscal position. The important things are employment.

That’s what you direct your policy at and that’s what we are going to continue

to direct our policy at. If you lose sight of the fundamentals, you won’t be running

a better economy nor will you be improving living standards for your citizens.

[inaudible] you paint a fairly optimistic outlook for the future of the Australian

economy, I wonder how do you feel about the protracted impact on inflation from the

Australian dollar?

Well, the exchange rate is not that direct an effect on consumer prices. It’s not

as big as some people make out. What it is a much more immediate and direct effect on

prices is oil. Again, something we can’t control. We don’t govern the world oil

price. In fact, there are no countries, perhaps other than major producers, that govern

the world oil price. So you would expect that to feed into consumer prices. But I make the

point, and it’s done in this country, this country abstracts from consumer prices

external effects like oil and produces a core inflation rate. We’ll be doing the

same. When the September CPI comes out, it will have a one-off spike from the GST and we

will be abstracting from that to get a core rate. The important thing is to make sure that

these external factors don’t feed back into your domestic price structure. And

it’s the domestic price structure that you’re actually looking at. Now, after we

abstracted oil last time, we had a core inflation rate of around 2.4. It’s consistent

with our band. Once you abstract the one-off GST effect, we’ll be looking to see

whether it’s consistent with our band again, which is 2-3 per cent. And our forecasts

are that it will be. Now, it’s very important that people understand this point. In

the September quarter CPI, which is going to come out in about two days, you will have a

one-off price effect for GST, which we forecast to be about 3-. That is, tax change will

add 3- this quarter and then next quarter it will start subtracting as the cost effect of

the abolition of wholesale sales tax flows through. So that figure should be subtracted by

3- to have a look at the underlying, or core, inflation to see what the real situation

is. If you like, in future quarters you can add back in the fact that it’s detracting

to try and get your core, or underlying, inflation rate. That’d be the fair thing to

do.

Mr Treasurer, do you expect that the G20 meeting will seek to discuss extensively the

strong US dollar and could actually reach some resolutions to attempt to re-align world

currencies?

I expect that the G20 would discuss the strong US dollar and particularly the US

dollar/Euro exchange rate. That was certainly a subject of discussion at the most recent

IMF meeting and you know that there were other events at that time. I’m not for a

moment predicting other events. Please do not misunderstand me. But it would be impossible

to have a meeting of the 20 Finance Ministers and Central Bank Governors together without

discussing the rise of the US dollar and the effect that that is having both on the US and

particularly on the US/Euro exchange rate. And I imagine that there will be some

discussion. I can’t tell you what the outcome of that will be but it would be

impossible to imagine that a meeting would take place without it coming up in some form or

fashion.

Do you hope there could be some relief for the Australian dollar as a result

[inaudible]?

I don’t think the subject of the discussions will get around to the Australian

dollar …

No but as a result of talking about the US dollar, the Australian dollar …

… but certainly I’d be surprised if the US/Euro exchange rate was not discussed

in some form or fashion. Last question, thank you.

A very quick one. Did you buy any US currency when you came over and what rate did you

get?

I think I actually had some and the rest I’ve taken on a credit card.

So you’ll be hammered when you get home?

Well, no I expect to get a warm welcome when I get home. I’ll be seeing my wife

and children. Thank you very much.