IMF Executive Board Concludes 2013 Article IV Consultation with AustraliaPress Release No. 14/53
February 12, 2014
On February 10, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Australia.
The Australian economy has performed well relative to many other advanced economies since the global financial crisis. However, a transition phase has now been reached as the terms of trade driven mining investment boom of the past decade has peaked and the economy is moving to the production and export phase. Mining-related investment which accounted for almost half of GDP growth in the past couple of years is expected to drop sharply in the near term, and a recovery in non-mining investment will be needed to underpin demand and return the economy’s growth rate to trend.
Annual growth has slowed to 2¼ percent in the third quarter of 2013, below the trend growth of around 3 percent. In addition to the slowdown of investment in new mining projects, non-mining investment has been weighed down by excess capacity and an overvalued exchange rate. Consumption growth has been modest and the household savings rate has remained above 10 percent. On the plus side mining exports are growing as new capacity comes on stream and in recent months housing market activity has begun to pick up with building approvals, transactions, and prices increasing. Nevertheless labor market conditions have remained soft and the unemployment rate has risen. Inflation remains anchored in the Reserve Bank of Australia’s (RBA) target range.
After several years where house prices have lagged income growth and construction has been weak, the recent revival in housing market activity could contribute to near-term growth and begin to help address persistent structural supply shortages but has also boosted house price inflation. To date overall credit growth has remained moderate with many households continuing to prepay mortgages. Looking forward though, there is a risk that rapid house price growth could give rise to expectations-driven, self-reinforcing demand dynamics and price overshooting, and the authorities would need to be prepared to take preventative actions.
In response to weakening demand the RBA cut its policy interest rate substantially over the last two years. This has begun to support interest-sensitive spending and asset values. With growth currently on the soft side, the real exchange rate still strong and efforts to reduce the budget deficit likely, monetary policy should remain accommodative and act as the primary macroeconomic tool for managing aggregate demand in the near term. The prospects of tighter monetary policy in major advanced economies may help weaken the Australian dollar, a key factor for achieving broader-based growth in the economy.
The budget deficit was reduced from 3 percent of GDP to 1½ percent in 2012/13. The goal of returning the budget to surplus last year was held back by slower-than-projected output growth and weaker commodity prices. Revenue fell short of projections as the lower terms of trade together with the persistently strong Australian dollar reduced nominal GDP and dented corporate profitability. Spending was also somewhat higher than anticipated. The government has announced the broad aim of reaching a fiscal surplus in a few years, and the aim of reaching a 1 percent surplus in a decade. A more detailed framework will be established when the government announces its fiscal strategy in May.
Executive Board Assessment2
Executive Directors commended the authorities for their sound and prudent macroeconomic management which has contributed to a strong economic performance in recent years. Directors noted that the Australian economy rests on solid fundamentals but its near-term outlook remains vulnerable to terms-of-trade shocks and downside risks. Against this background, they agreed that the transition to a growth path along which investment in mining plays a lesser role presents important policy challenges in the period ahead.
Directors considered that the current macroeconomic policy mix is broadly appropriate. With inflation in the target range, growth below trend, and the real exchange rate on the strong side, monetary policy should remain accommodative and act as the primary tool for short term aggregate demand management. Directors also supported the government’s aim to return to fiscal surplus without undue prejudice to growth to help rebuild fiscal buffers in the coming years. In this context, they emphasized the usefulness of early decisions on the spending cuts and revenue increases needed to reach the fiscal objectives.
The financial system remains sound and well managed. Furthermore, the intensive and proactive supervisory framework limits the likelihood that house price fluctuations will have an adverse impact on the financial system. Directors observed, however, that banks could be exposed to highly leveraged households and to rollover risks associated with offshore funding needs. Accordingly, they encouraged the authorities to remain vigilant.
Directors emphasized that Australia’s floating exchange rate has been an important element of its macroeconomic policy framework and has served the country well by cushioning terms of trade shocks. They took note of the staff’s assessment that the exchange rate currently appears to be modestly overvalued in real effective terms.
Directors welcomed the authorities’ plans to embark on a comprehensive new round of structural reforms. They concurred that renewed efforts to strengthen competition in labor and product markets as well as to address infrastructure bottlenecks are critical to increase productivity and further diversify the sources of growth.