Public Information Notice: IMF Concludes Article IV Consultation with Australia
February 15, 2000
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On January 28, 2000, the Executive Board concluded the Article IV consultation with Australia.1
Over the past eight years, Australia has enjoyed an extended period of economic expansion, strong productivity growth, and low inflation. Growth averaged 4¼ percent (compared to a 30-year average of 3½ percent), underpinned by a sizable pickup in labor productivity and total factor productivity. Inflation has been held to 2 percent on average, compared to 9 percent over the previous two decades. The recovery's durability and strength reflect improvements in the policy framework, including fiscal policy's medium-term orientation, inflation targeting, and labor and product market reforms.
Economic growth picked up to about 4½ percent in the two years to September 1999. Domestic demand has been the engine of growth, given the unfavorable external environment-roughly two-fifths of Australia's exports are destined for crisis-hit Asia and Japan. Household consumption was robust—underpinned by increases in the value of household assets that more than offset an increase in household indebtedness—while the household saving ratio continued to decline. Fixed investment also posted strong growth in the post-crisis period—underpinned by low interest rates, strong corporate profits, and Olympics-related construction—but there was some scaling back of capital spending in the mining and manufacturing sectors reflecting the weakness in commodity prices and manufactured exports. Net exports made a negative contribution to growth in 1998 and the first three quarters of 1999, due to the weakness of external demand and strong domestic demand that boosted imports. Reflecting strong growth and greater labor market flexibility, the unemployment rate has been trending down since the early 1990s, and reached about 7 percent in December 1999.
The current account deficit widened from nearly 5 percent of GDP in 1998 to some 6 percent of GDP in the first three quarters of 1999. Strong domestic demand boosted imports, while a contraction in partner-country import demand and weaker commodity prices depressed exports. Australia's net external liabilities to GDP ratio was 60 percent in end-September, one of the highest ratios among industrial countries.
Financial market sentiment toward Australia has remained favorable despite the worsening external imbalance. The spread between Australian and U.S. government bond yields has fallen from 200-300 basis points at mid-decade to about 50-60 basis points in recent months. Moreover, S&P in May 1999 upgraded Australia's foreign currency sovereign rating from AA to AA+, citing in particular the government's fiscal restraint and success in reducing public debt.
Inflation, which was running below the RBA's 2-3 percent medium-term objective over the two years to June 1999, picked up slightly in the September quarter to about 2 percent. A sizable pickup in labor productivity and discounting by Asian suppliers help to explain the inflation performance up to June 1999, which took place against the backdrop of an expansionary monetary policy stance. While the pickup in inflation in the September quarter reflects mainly the impact of world petroleum price increases—wage and unit labor cost increases remained moderate—an end to the contractionary external environment facing Australia led the RBA to increase the cash rate by 25 basis points on November 3, 1999.
Fiscal policy has been on a consolidation path since the mid-1990s, reducing public debt and the long-term interest rate differential vis-à-vis the United States. The Commonwealth's underlying cash balance improved from deficits of 3-4 percent of GDP in the early 1990s to a surplus of ¾ percent of GDP in 1998/99 (July/June). The newly-adopted accrual measure and the structural balance show a surplus of similar magnitude. Fiscal consolidation over this period has involved structural expenditure cuts, while cyclical factors and tax-bracket creep have boosted revenues. Commonwealth net debt has declined to 12 percent of GDP from a peak of 19 percent in 1996, facilitating a fall in Australian interest rates toward international levels. Fiscal policy has also sought to improve economic efficiency through a landmark tax reform package and more recent business tax reform proposals.
The staff's near-term outlook is for a moderate slowing in growth, some pickup in inflation, and a gradual narrowing of the current account deficit. Recent retail sales data suggest ongoing strength of private consumption, and recent approvals data suggest that housing investment will also underpin growth. In contrast, some slowing of business investment from recent high levels is suggested by surveys of investment intentions. With the external environment continuing to improve, net exports are projected to make a positive contribution to GDP growth in 2000 for the first time since 1997. Inflation—excluding the first round impact of the GST—is expected to rise toward the upper end of the authorities' 2-3 percent target range over the next 1-2 years, reflecting a pickup in unit labor costs (as productivity growth eases and the labor market tightens), an end of price discounting by Asian suppliers, and higher world oil prices. Overlaid on this will be the impact of indirect tax reform which, while difficult to assess precisely, is nevertheless expected to have a significantly larger impact on the price level in the third quarter of 2000 than the estimated long-term impact of about 2 percent.
Executive Board Assessment
Executive Directors commended the authorities on the Australian economy's extended period of strong noninflationary growth, and the remarkable resilience of the economy in the face of the Asian crisis. This performance reflected the authorities' sustained commitment to sound macroeconomic policies and ongoing structural reforms. Moreover, Directors considered that the economic outlook was also favorable: output was expected to grow near potential; inflation should remain manageable despite some pickup in both foreign and domestic price pressures; and the current account deficit was expected to narrow as the external environment improved further.
Against this background, Directors' comments focused on three issues: the appropriateness of near-term policy settings, as the economy could be close to its full operating potential; external vulnerability, because the strength of domestic demand had widened the current account deficit and further increased the ratio of net external liabilities to GDP; and the sustainability of productivity growth over the medium term.
On monetary policy, Directors endorsed the recent increase in the cash rate by the Reserve Bank last November, and considered that a further move in the same direction would be needed in order to secure an appropriately neutral stance. Directors agreed that acting in a forward-looking, preemptive manner was preferable to waiting until actual inflationary pressures surfaced. Looking further ahead, Directors considered that the need for any further action should be assessed on the basis of careful monitoring of the risks to inflation, which could arise from continued strong credit growth and asset price increases, further declines in the unemployment rate toward the NAIRU, price pressures from foreign sources, and possible wage demands associated with the introduction of the goods and services tax in July. Overall, Directors considered that monetary policy management would be challenging in the period ahead, owing to both the cyclical position of the economy and the effects on the economy of the wide-ranging structural reforms.
On fiscal policy, Directors noted that the consolidation path envisaged in the recent midyear outlook should help to maintain market confidence while the current account deficit remains high, and enhance the credibility of the authorities' medium-term fiscal objectives. In particular, Directors considered that the gradual improvement in the fiscal surplus in the current fiscal year, and the further increase by 2002/03, was consistent with the official objectives of maintaining budgetary surpluses while economic prospects remain sound, and reducing government expenditure and net debt ratios. Consistent with fiscal prudence, Directors supported the recently announced levy on high-income taxpayers to offset the costs associated with peacekeeping efforts in East Timor in 2000/01. Directors welcomed the extensive tax reform under way, which will improve the integrity and fairness of the tax system and reduce its complexity. They recognized that the mild fiscal stimulus in 2000/01 reflected the short-term implications of achieving the long-term benefits of tax reform, and supported the recent political agreement to implement the business tax reform in a revenue-neutral fashion. Directors supported the authorities' intention to prepare an intergenerational assessment of long-term fiscal issues and considered that, pending a consensus on the extent of long-term budgetary pressures, a prudent course would be to maintain a conservative fiscal stance over the medium term.
Directors considered that the risks associated with Australia's high current account deficit and the high ratio of net external liabilities to GDP were manageable, provided the authorities continued to implement strong macroeconomic policies and structural reforms, and remained vigilant in monitoring developments in the banking sector. Directors' assessment was underpinned by several factors, including: the level of the Australian dollar, which would facilitate a narrowing of the current account deficit over the medium term; widespread hedging against exchange rate movements; the strong financial position of banks, households, and corporates; and the transparent policy framework. Directors noted that their assessment was also shared by markets, which had maintained a low spread between Australian and U.S. government bonds despite the widening of the current account deficit over the past two years.
Directors considered that, while the pickup in productivity growth in recent years partly reflected cyclical factors, it was also due to continued progress in implementing structural reforms. They took note of the staff's analysis, which suggests that such reforms had raised Australia's sustainable total factor productivity growth rate, thereby enhancing the growth potential of the economy. Directors considered that, in order to build on this performance, sustained implementation of the structural reform agenda was essential, including through: continued application of the national competition policy; reductions in the general import tariff rate and in tariff rates on passenger motor vehicles and textiles, clothing, and footwear, in line with existing commitments; further deregulation of the labor market, with the objective of replacing the award system with a single national minimum set of working conditions; and steps to reduce social welfare dependency while maintaining an adequate safety net.
Directors noted that Australia publishes an array of high-quality economic and financial statistics that are well-suited for surveillance.