Transcript of a Press Conference Call on the International Monetary Fund's Article IV Staff Report on AustraliaWashington, D.C.
Thursday, October 28, 2010
MS. WONG: Hi, everyone. This is Daisy Wong of the International Monetary Fund’s External Relations Department. Thank you very much for dialing in for this conference call on Australia’s Article IV Consultation. I think you have seen the documents on the IMF.org, our website. I’ll turn the call now to Mr. Ray Brooks. He’s the Mission Chief for Australia at the IMF Asia and Pacific Department.
So, Mr. Brooks is here and you could start to ask questions.
MR. BROOKS: Okay, good afternoon. I’m happy to take any questions you have.
QUESTIONER: in your report you say that the RBA has to wait for the global outlook to become clearer in terms of rate moves. At what sort of period of time are you looking at there? What sort of timeframe do you think they have?
MR. BROOKS: Our advice here is just to say, if the recovery’s staying on track, we believe they should tighten monetary policy. We’re not going to precisely tell them about their timing, but I think what we’re most concerned about on the monetary policy side is that with the mining boom causing -- potentially raising inflationary pressures on the economy, there would be a need for a tightening of monetary policy if the downside scenario doesn’t become evident.
The terms of trade is likely to hit historic highs not seen since like the 1950s in Australia when there was a boom during the Korean War, and so it’s important, I think, for monetary policy to react if the recovery remains on track.
QUESTIONER: There’s been a lot of talk in Australia about the need for an inquiry or more work into banking competition. Do you think that that would be worthwhile given the consolidation we’ve seen in the Australian banking sector over the last couple years?
MR. BROOKS: I think the Australian banks have been remarkably sound compared to other banks internationally and that’s one of the reasons Australia got through the crisis. So, what you’ve seen is with the decline of the securitization market, the competition in the mortgage industry has declined so much, so there is an issue concerning competition in the mortgage industry. And that was, I think, on the minds of the policymakers and it’s something that would be useful to look at over time.
QUESTIONER: I was wondering if you could elaborate a little bit more on the monetary policy. How large that step needs to be to address inflation? I’m just talking about a rate hike. How steep that needs to be? The other question I have… I was wondering, given the tensions, global currency tensions, whether you have some concerns regarding the over valuation of the Australian dollar.
MR. BROOKS: Okay, so on your first question about monetary policy, about the extent to which monetary policy needs to be tightened, I think first to make it clear that, you know, if the recovery remains on track and these downside risks which are considerable in the global environment do not appear, it’s then that we would see the need for a tightening of monetary policy. And I think as was made clear in our paper under the authorities’ views that the RBA had agreed that if those risks diminished and further inflation pressures emerged, that the policy rate would need to be raised. We did not give very specific advice about just how much. What we pointed to was, the need to consider two factors, first that there’s a relatively high level of household debt in Australia at over 150 percent of household disposable income and so when you raise interest rates, you’re going to have a fairly immediate effect, particularly given that most of the mortgages in Australia are on variable terms. So, the monetary policy transmission mechanism in Australia works fairly well and fairly quickly.
And the second factor is that the RBA needs to guard against inflationary expectations becoming anchored at too high a level. So, I mean, there are two key factors that I think are very much in the mind of the RBA and certainly our advice is that if the recovery remains on track, the monetary policy would need to be tightened.
As for the exchange rate, we do these estimates of the over valuation where we look forward over the medium term to see where the exchange rate, at current sittings, would mean, where the current account deficit would end up, and then compare that current account deficit to what would be considered a norm for Australia. And by looking at that, it suggests that the currency, from that perspective, is over valued by 5 to 15 percent. But it’s quite uncertain. We present in our paper a chart that shows that uncertainty with some bars around that, so I would certainly emphasize the degree of uncertainty around those estimates.
Part of the overvaluation comes from the fact that you’ve got policy rates in Australia at 4.5 percent and in most e advanced countries in the rest of the world you’ve got 0% interest rates. So, that interest rate differential is contributing to that. Over time as other advanced economies recover, you will tend to see those interest rates in other countries come back to the norm, and you’re likely to see the Australian dollar become less overvalued than those estimates at present.
QUESTIONER: Could I follow up on this please? I was wondering what your concerns are about Australia becoming too reliant on this commodity price boom and on this kind of commodity demand coming from Asia? Is there a danger in that just becoming too one-sided? What are your feelings about that?
MR. BROOKS: We discussed that somewhat in our report. Certainly it’s an opportunity for Australia, I think, because we see this and I think the Australian authorities see this as a very long-lasting phenomena, that you’ve got this trend towards urbanization in Asia, particularly in China, and industrialization that is driving demand for the very things that Australia produces -- iron ore, in particular, and coal -- which are in high demand in Asia.
Now, that’s -- if managed well, I think will benefit Australia, help Australia raise its income permanently, but there are some vulnerabilities that come with it too. As you point out, there’s a downside scenario where there’s a sharp decline in Chinese or Indian demand for commodities. It could have some impact on the commodity prices and spill over to Australia.
But we would emphasize the role of the exchange rate and its flexibility in buffering those changes and demand for commodity prices. At the start of the global financial crisis back in 2008, commodity prices fell quite sharply in world prices, but the Australian dollar also fell, and that limited the impact of the falling world prices on commodity prices in Australian dollars. And what we’ve seen in the past year or so, as world commodity prices have risen, the Australian dollar has gone up with it and cushioned the impact on Australian dollars of that increase in prices. So, the flexible currency is helping to smooth out somewhat these swings in global commodity prices and providing a buffer.
And you also see that the Australian economy is relatively flexible in response to these shocks. And our advice on fiscal policy is to make sure that there are significant surpluses during the good times to give you the buffers during a downturn. So when those downturns -- if a downturn does come along the way, and this road may be bumpy in future even though there’s a very positive, long run outlook for the demand for commodities, there may be bumps along the way.
If fiscal policy runs larger surpluses and reduces debt, they’d be in a strong position to react. In sum, I see the mining boom as an opportunity for Australia but it comes with some vulnerabilities that can be managed through a flexible exchange rate and through fiscal policy.
QUESTIONER: Earlier this month the IMF said that Australian house prices could be moderately overvalued. What made you say that? And do you think that could lead to further falls in houses prices over the next little while?
MR. BROOKS: Yes, we’ve done some work on houses prices in Australia as part of a forthcoming paper we’re going to publish and that would suggest that the house prices in Australia are around 5 to 15 percent overvalued. That was up early part of this year. what we’ve said was based on looking ot some of the fundamentals that drive house prices, including population growth and incomes, particularly including through the terms of trade, and average interest rates over time,
So, taking those factors into account, we saw this range of 5 to 15 percent of overvaluation So, it’s a bit uncertain.
Now, how might that play out? How might that overvaluation, which we consider is pretty moderate -- be resolved? Well, you could have a fall in the house prices back towards the fundamentals or you could have the fundamentals raise up the equilibrium house price back towards where house prices are. And you’ve got -- on that side, you see continuing strong population growth in Australia and continuing income growth, so that’s a possibility.
There is a risk that the decline in the house prices, if it were particularly sharp, could have some impact on household spending and, it could lead to some households reducing their high levels of debt that would also impact household spending.
We don’t think the fallout on banks would be very substantial because one of the key features of the Australian banking system compared with the U.S., for instance, is the number of high-risk mortgages, particularly subprime mortgages, is a very low proportion of mortgages.
QUESTIONER: And just to be clear, you said you’d done the study earlier in the year, but it hasn’t been published yet? Is that right? It’s looking at today’s house prices?
MR. BROOKS: It’s looking at house prices over the last, 20 years in Australia. And it was based on data up until the early part of this year and it will be published in the next few weeks or so. And what we’ve seen since then is a little bit of a moderation in house price growth in recent months as well. So, it’s taking the heat out of the house prices
QUESTIONER: You mentioned population as a key factor there. I think Australia’s got a very strong natural growth rate in population at the moment, but migration has fallen quite sharply, partly because of the strong Australian dollar, but also just during the crisis. Might that tilt the risks towards, you know, the scenario where prices fall slightly?
MR. BROOKS: Yes. I mean, population growth is a key factor when you look at these models of house pricing, we do these across a number of countries, and you see a correlation across a number of countries between fairly high house price growth and population growth. You’ve tended to have higher house price growth as population grows because in many countries there are problems on the supply side, and what you’ve seen in Australia on the supply side, there hasn’t been a significant supply response, the number of housing approvals have stayed remarkably steady despite the strong increase in population growth.
In sum, certainly a factor that would drive the house price market is the degree of population growth in Australia.
QUESTIONER: I was going to follow up on the issue of the mining boom. I mean, this isn’t a new factor for Australia considering that the first one, I believe, was in the 1850s. But I was wondering, you know, the Central Bank has said that they’re going to try and, you know, be preemptive with policy on this one. I was wondering, you know, what you see as something different about this latest mining boom and what should be different as they tackle the policy on that?
MR. BROOKS: What is different about this mining boom to previous booms is that this is the highest level of Australia’s terms of trade since the early 1950s when there was a boom during the Korean War, and if you look at the charts on that, there was a very sharp spike. It wasn’t that long-lasting. Now, this particular boom started back in around 2002, 2003, when there was a sharp pick-up in the terms of trade in Australia as demand grew out of China, in particular. Actually, I was living in Beijing at the time and could see the houses being built and a lot of steel going into the houses in Beijing and a lot of roads being built around Beijing. And it’s that emergence of China and also India that is remarkably different here, this time around, and that’s why it’s more likely to be longer lasting as the trend towards urbanization in China is likely to be a long-lasting trend.
If you look at projections of the urban population in China, it’s going to be an increase in those living in the cities, the demand for infrastructure in the cities, the demand for housing, is considerable, as is the government -- the Chinese government’s plans in terms of infrastructure such as railroads. Railroads being built in China, at around 20,000 miles of railroads planned over the next 8 or 10 years and it’s equivalent to many times across Australia and back in terms of railroads. So, it’s substantially different from the earlier booms.
And how you manage that boom, when it’s -- when you think it’s a permanent boom, you want to facilitate the movement of resources to that sector, so that’s one of the things. I think our advice is to push ahead with these structural reforms to help that happen. And the government there is thinking about tax reform. It’s taken some measures on tax reform, but some further areas that could help is removing some of the barriers to the movement of workers from one part of -- from parts of Australia to the mining areas in Australia. And there you see fairly high stamp duties on house sales being a barrier to people to be able to relocate within Australia. So, if you had tax reform that broadened the consumption tax base in Australia and reduced the stamp duties that are levied at the state level, that may help some of this movement of the workers to the mining areas to Australia.
So, in sum, we see there’s a permanent shift, a long-lasting shift in demand for commodities that needs a policy response to facilitate that shift of resources to the mining sector.
QUESTIONER: I just have one more follow-up, and this is in regard to currency. So, do you, given what your forecast is for Australians, this strong investment, do you expect the currency to continue to strengthen? What’s your forecast on that?
MR. BROOKS: We don’t, per se, forecast the exchange rate. What we’re saying here is when we look at some of the fundamentals and we make some assessment, our assessment is, uncertain as it is, that the exchange rate is about 5 to 15 percent overvalued and one of the factors is that Australia is at a different stage of the cycle than many other advanced economies and the cash rate in Australia that’s set by the Reserve Bank of Australia is at 4.5 percent compared with close to 0 in many other parts of the world, so that’s one of the things driving -- one of the factors behind the appreciation of the exchange rate. Now, that may dissipate over time as other Central Banks around the world move back to more normal interest rates.
QUESTIONER: Australian political parties in the last election were talking about slowing population growth. I’m just wondering what your thoughts are given that the unemployment rate is close to 5 percent, the sort of risks -- or the potential for risks that Australia will see labor shortages and that, in turn, will fuel inflation.
MR. BROOKS: I think one of the concerns about the mining boom is to make -- to help resources move into the mining sector without tensions in the labor market. Now, how you do that? From a policy sense one can help increase the labor supply through tax reform, which is on the agenda in Australia, as well as some suggestions in the tax review of reforms to the tax- benefit system to improve labor supply. And immigration policy is another area that has potential for increasing the labor supply.
So I think if you don’t move those resources into the mining sector, there could well be labor shortages and that could put upward pressure on wages and spill into inflation. That’s why I think that’s a key challenge in managing the mining boom, is to manage the wider implications of that mining boom for the economy including through the labor market.
MS. WONG: Okay, I think we could take the last question. Is there more questions? I think we will conclude our conference call here. So, thanks very much for everybody to participate in the call.
MR. BROOKS: Thank you very much.