IMF Executive Board Concludes 2008 Article IV Consultation with AustraliaPublic Information Notice (PIN) No. 08/123
September 23, 2008
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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2008 Article IV Consultation with Australia is also available.
Sound macroeconomic policies and structural reforms in Australia have delivered more than sixteen years of economic expansion. Recently a commodity price boom, driven by robust global demand, has pushed the economy up against capacity constraints. As resources pressures mounted, broad-based inflation pressures emerged, and CPI inflation rose to 4½ percent. The large current account deficit increased net foreign liabilities to 60 percent of GDP, accumulating primarily as debt on financial institutions' balance sheets.
In response to rising inflation, the Reserve Bank of Australia (RBA) tightened monetary policy, raising the cash rate 100 basis points between August 2007 and March 2008. In addition, higher funding costs from the global financial turmoil pushed up lending rates further and tightened credit conditions. Recently, the tight monetary conditions and deteriorating confidence slowed household expenditure, suggesting that the easing in growth required to return inflation to the target band has commenced. In early September, the RBA reduced the cash rate by 25 basis points, assessing that markets had tightened monetary conditions beyond what was required to reduce inflation.
The Commonwealth government has run surpluses in recent years that have eliminated its net debt. Revenue outcomes have consistently surprised on the upside, driven in part by the buoyancy in corporate tax revenue related to the commodity boom. However, increased spending and tax cuts over the previous three years offset some of the restraint from the automatic stabilizers. In addition, the states increased capital spending, shifting their budget balances to small deficits. In the latest 2008-09 Budget (July-June), the new government has taken a more contractionary fiscal stance, with expenditure restraint and a higher projected underlying cash surplus.
The banking sector is sound with stable profits, high capitalization, and few nonperforming loans. The global financial turmoil has increased funding costs and highlighted the rollover risk associated with banks' short-term debt. Banks are adjusting the structure of their funding in response to the turmoil, increasing liquidity, and lengthening the maturity of their funding.
Executive Board Assessment
Executive Directors commended the Australian authorities on their impressive economic management in the fiscal, monetary, and structural areas, which has spurred a sustained and long-lasting economic expansion. Looking ahead, Directors considered that the sound macroeconomic framework should permit Australia to weather the global downturn and contain inflationary pressures.
Directors welcomed the authorities' confirmation of their strong commitment to the inflation targeting framework, which has served Australia well and will contribute to anchoring medium-term inflation expectations and facilitating a lasting reduction in price pressures. They noted that the RBA had responded to the buildup in inflationary pressures in recent years through a substantial tightening of monetary policy. More recently, against the backdrop of the global financial turmoil, the tightness of the financial markets, and the evolution of economic conditions, the RBA moved to a less restrictive monetary policy by reducing the cash rate. Directors welcomed this action and the authorities' readiness to follow a cautious monetary policy aimed at achieving the 2-3 percent inflation target range over time, based on a continuous assessment of prospects for demand and inflation in the period ahead. Wage and price developments in particular will require careful monitoring, taking into account the high core inflation and pressures stemming from the commodity price boom.
Directors welcomed the support that prudent fiscal policy is providing for monetary policy. They noted that the reduction in public spending growth in the latest budget will help reduce inflation, and the intention to save any further positive revenue outcomes in 2008/09 will allow the automatic stabilizers to work. Looking ahead, if growth and revenues are stronger than expected, Directors recommended that the surplus be allowed to exceed budget forecasts until it is clear that inflation will decline. They agreed
that, to the extent that the improvement in the budget balance is structural and associated with permanently higher commodity prices, there should be scope to reduce taxes or increase spending over the medium term. Directors welcomed the establishment of three new funds for longer-term spending on health, education, and infrastructure, with contributions to come from the 2007/08 and 2008/09 surpluses.
Directors regarded the flexible exchange rate policy as appropriate, and observed that the currency appreciation in recent years had eased inflation pressures. Directors noted the staff's assessment that, with the recent depreciation, the Australian dollar is now broadly in line with medium-term fundamentals. They observed that wider current account deficits and the accumulation of external liabilities have increased external vulnerability in recent years. However, Directors considered that vulnerability will be contained as the associated high rates of investment contribute to export capacity, and as the medium-term external current account deficit narrows to its historical norm.
Directors considered that the banking system is sound, but that some vulnerabilities remain. They commended the authorities' timely and fitting response to the credit market turmoil, with the RBA providing liquidity support and the Australian Prudential Regulation Authority intensifying its monitoring of banks. Directors noted that the banking sector remains profitable and well capitalized. However, they encouraged the authorities to monitor carefully the sector's vulnerability to rollover risks arising from short-term wholesale funding and to the risks associated with the large indebtedness of the household sector. Directors commended the authorities for the progress in implementing the 2006 Financial Sector Assessment Program (FSAP) recommendations, including the strengthening of the failure resolution and crisis management framework. They also welcomed the planned introduction of liquidity guidelines to reduce the risk of disruptions arising from loss of access to offshore funding.
Directors encouraged the authorities to take advantage of the positive macroeconomic performance to advance structural reforms. They considered that, if implemented fully, the broad reform agenda should enhance the flexibility of the economy and lift productivity and labor force participation.