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IMFSurvey Magazine: Countries & Regions

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Strong Commodity Demand, Sound Policies Support Australia

Iron ore mine in Newman, Australia, where resources sector investment and strong demand for commodities have buoyed growth (photo: Karen Kasmauski/Corbis)

ECONOMIC HEALTH CHECK

Strong Commodity Demand, Sound Policies Support Australia

IMF Survey online

November 15, 2012

  • Growth buoyed by strong commodity demand and resources sector investment
  • Near-term policy mix, medium term fiscal strategy needed to manage risks
  • Financial sector still vulnerable to international wholesale funding disruption

The Australian economy has demonstrated considerable resilience in the face of the global financial crisis, and is in a strong position to respond to any external shocks, says the IMF in its annual assessment of the country’s economy.

The country’s economy has been growing faster than most advanced countries, and is expected to grow by around 3 percent this year—broadly in line with trend—and by about 3 percent next year, as new natural resources-related investment reached record levels.

Prudent macroeconomic policy management has supported Australia’s strong economic performance and contributed to its resilience in the face of the global financial crisis.

The country’s growth has been buoyed by strong commodity demand which is supporting Australia’s export earnings and driving an investment boom.

Although Australia would not be able to avoid the impact of a major global shock, “it has both the monetary and fiscal policy space to respond to near-term shocks, with monetary policy serving as the first line of defense,” said Masahiko Takeda, IMF mission chief for Australia.

Australia’s flexible exchange rate also provides a buffer against shocks, particularly to fluctuations in global commodity demand, he added.

IMF economists believe that Australia’s exchange rate may be overvalued, and this is weighing on trade-exposed manufacturing and tourism, which are growing below trend.

“Overall, the current policy mix is appropriate,” says Takeda, “and should take pressure off the exchange rate,” he added.

Macroeconomic policy mix

The IMF economists believe the government’s deficit reduction path strikes a balance between reducing public debt and the need to contain any adverse impact on economic growth. In their report, they support the government’s plan to maintain surpluses over the medium term which should put Australia in a better position to deal with future shocks and the long-term cost of an aging population.

The report also describes the current accommodative monetary stance as appropriate, given expected inflation within the target range, the strong Australian dollar, and the government’s efforts to return the budget to surplus this year.

The economists also said the high credibility of the Reserve Bank of Australia and the rapid monetary policy transmission in Australia allow monetary policy to react quickly and flexibly to changing economic circumstances.

A resilient financial system

Australian banks are profitable, and are among the most highly rated globally, with good asset quality. They are well placed to implement Basel III—the global regulatory standards on bank capital adequacy and liquidity—says the report.

But the IMF economists also note that banking system is large, highly concentrated and interconnected, with four major banks that are systemic, with large exposures to mortgages, which rely on wholesale funding.

Stress testing, carried out as part of an update to the Financial Sector Assessment Program—a comprehensive and in-depth analysis of the country’s financial sector—indicates that the major banks are adequately capitalized and are likely to withstand large macroeconomic shocks, but would require liquidity support from the Reserve Bank of Australia, to withstand an extreme funding shock.

The IMF welcomed the banks’ continuing efforts to move to more stable funding sources, reducing their exposure to global market turmoil. IMF economists encouraged the authorities to continue to emphasize intensive, proactive and risk-based bank supervision.

To further bolster financial system stability, the IMF believes that higher loss absorbency for systemically important banks may be desirable, as part of a multipronged approach that includes supervision and recovery and resolution planning.

Making the most of the mining boom

A key structural policy challenge, identified by the economists, is to facilitate the movement of resources across the economy, as the mining sector moves rapidly from a phase of rapid commodity price increase to a period—currently under way and expected to peak in the next few years—of large-scale investment, and to rapid growth in exports as investment projects are completed.

Although Australia will remain an advanced services-oriented economy, the increasing role of the mining sector in the economy will increase the exposure of the country to volatile commodity prices, says the IMF.

Takeda welcomed the recently released government White Paper on Australia in the Asian Century, and praised the government’s efforts to formulate a policy strategy for dealing with the economy’s longer-term structural transition, making the most of the opportunities offered by the growth of Asian economies.


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