Economic Health Check
Australia on Path to Broader-based Growth, says IMF
February 12, 2014
- Economy buoyed by strong emerging market demand for commodities
- With mining boom over its peak, key need is to transition to broader-based growth
- Strong policy frameworks can ease the transition, but pickup in productivity growth also needed
Australia’s mining investment boom has passed its peak, and the country is now confronting the need to generate broader-based growth, says the IMF in its annual assessment of the Australian economy.
The IMF’s Article IV report says the mining investment boom—which accounted for almost half of Australia’s GDP growth in the past couple of years—has peaked and the economy is moving to the mining production and export phase.
Mining-related investment is expected to drop sharply in the near term, and a recovery in non-mining investment will be needed to underpin demand, suggests the report.
Australia’s economy is expected to grow at 2½ percent this year—slightly below trend—and rise to about 3 percent by 2016. While resource exports will expand rapidly and contribute to future growth, the outlook for the non-resource sector is more uncertain, say the report’s authors.
Exchange rate moderately overvalued
Despite some recent depreciation, the IMF economists believe that Australia’s exchange rate is still moderately overvalued and is weighing down non-mining activity.
The main external risk to the Australian economy remains a slowdown in growth in China over the medium-term and a related fall in commodity prices.
“Australia’s flexible exchange rate provides a buffer against shocks and the authorities have both monetary and fiscal policy space to react if the outlook deteriorates,” said Brian Aitken, IMF mission chief to Australia.
Policies to sustain growth
In the report, the IMF economists say that Australia's fiscal position, with low debt and deficits, compares well to its advanced economy peers. The government’s aim to return the budget to surplus over the coming decade will help rebuild fiscal buffers and increase the ability to deal with adverse shocks. But this aim will be challenging in light of current social spending commitments.
“Monetary policy should remain accommodative—inflation is within the target range, growth is currently on the soft side, and the real exchange rate is still strong,” says Aitken. “Monetary policy should act as the primary macroeconomic tool for managing aggregate demand in the near term,” he added.
The report says that higher house prices would be expected to support demand through a more accommodative monetary policy.
After several years of weak activity during which house prices lagged growth and construction activity was weak, there have been signs of a pickup.
Recent revival in housing market
The report’s authors welcome the recent revival in housing market activity. They say it could contribute to near-term growth and begin to help address persistent structural supply shortages.
Looking forward though, as in any situation where asset price inflation accelerates, attention should be paid to the risks posed by a prolonged period of rapid price growth, which could give rise to over-optimism about future price increases, leading to overshooting.
Should credit growth and transactions volume pick up sharply, the authorities should be prepared to take action, says the report.
“The authorities’ intensive supervisory framework should allow for a targeted response if house price inflation becomes a risk,” said Aitken.
“There are features of the Australian regulatory and supervisory approach to property lending which would limit the impact of a sharp decline in house prices on the financial system,” he added.
The report also describes the banking sector as sound—balance sheets have strengthened over the past year, and stress tests show the major banks would be able to withstand a sizeable shock to output, terms of trade, rising unemployment, and a fall in property prices.
But the IMF economists also note that the banks remain exposed to highly leveraged households and rollover risks associated with short-term offshore funding needs.
Transition to broader-based growth
The IMF economists say that the increased role of the mining sector will make the economy more sensitive to terms-of-trade shocks. But, the floating exchange rate will play an essential role in buffering shocks by depreciating when terms of trade fall, making other tradable goods and services more competitive.
The IMF report notes that a key challenge in the future will be finding ways of increasing productivity to maintain growth. Against this background, addressing infrastructure bottlenecks consistent with the government’s deficit reduction goals is a priority.
A shift to broader-based growth would be helped by making the most of opportunities offered by a growing Asian middle class, which could support demand for Australia’s services exports—in particular health, education, tourism, and professional services.