## _cr10331

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### Increasing ties with Emerging Asia and Australia’s growth potential
- Resilience to the crisis:
  - Australia escaped recession in 2009.
  - Contributing factors: growing links with Asia (strong commodity demand from China and India); prompt macro policy response; healthy banking sector; flexible exchange rate.
  - Prior to the recession: 17 years of continuous growth; unemployment at historical lows; inflation expectations well-anchored.
- Exchange rate and financial markets:
  - The Australian dollar depreciated sharply at the onset of the crisis, then appreciated in real effective terms by 35 percent between March 2009 and September 2010.
  - Financial markets largely recovered: bank CDS spreads narrowed; stock market and bond yields recovered.
- Monetary and fiscal response:
  - RBA policy rate moves: cut from 7¼ percent to 3 percent over the seven months to April 2009; later raised to 4½ percent in six steps (most recent increase in May).
  - Commonwealth government ran budget surpluses of around 1–1¾ percent of GDP in the six years before the crisis, eliminating net debt.
  - Fiscal stimulus: 4⅓ percent of GDP in the two years to June 2010 (above the G-20 average).
  - Underlying cash deficit: about 4 percent of GDP in 2009/10.
  - Government began unwinding crisis-related measures as conditions normalized.
- Banking sector and financial stability:
  - Banks’ assets: predominantly credit; mortgage loans account for half of total lending.
  - Liabilities: mainly domestic deposits; wholesale funding remained sizable.
  - Capital adequacy improved to about 12 percent after banks raised private capital.
  - Nonperforming loans rose to less than 2 percent of assets; impaired assets remain low by international standards.
  - Policy support: “four pillars policy”; Guarantee Scheme for Large Deposits and Wholesale Funding (introduced late 2008) — guarantee withdrawn for new liabilities in March 2010.
- Labor market, mining boom, and activity composition:
  - Employers reduced hours rather than widespread layoffs; unemployment peaked at less than 6 percent in mid-2009, later fell to just over 5 percent.
  - Commodity prices (iron ore and coal) rebounded; private sector mining investment rose.
  - Mining, public investment, and household consumption underpinned activity in early 2010.
- Inflationary pressures and exit from stimulus:
  - Core inflation fell below 3 percent y/y in June 2010; wage growth moderated.
  - Spare capacity began to be used up as unemployment fell and capacity utilization rose.
  - RBA began withdrawing monetary stimulus in late 2009; policy rate increased to 4½ percent in six steps; policy rates held on pause in recent months due to global uncertainty.
  - Lending rates returned close to 10-year averages as policy increases flowed through.

### Credit growth, current account, outlook and risks
- Credit developments:
  - Credit growth showing signs of recovery.
  - Sharp slowing in credit growth after the crisis driven by falls in business and personal credit.
  - Mortgage credit growth remained positive due to government incentives for first time home buyers and quick pass through of policy rate reductions.
  - Personal credit growth has recently picked up; business credit continues to contract.
- External position:
  - Current account deficit fell to 3⅓ percent of GDP in the first half of 2010.
  - Net external liabilities rose to about 60 percent of GDP by mid-2010.
  - Near-term projection: current account deficit to narrow to less than 2½ percent of GDP due to jump in the terms of trade.
  - Medium-term projection: deficit forecast to widen to about 6 percent of GDP, reflecting higher resource-sector investment (including LNG projects).
- Outlook and key projections:
  - Real GDP growth projected at 3–3½ percent in 2010 and 2011.
  - Output gap expected to close in mid-2011.
  - Terms of trade expected to rise to historic highs in late 2010; mining boom likely long lasting.
  - Gorgon project capital expenditure: $43 billion (3½ percent of GDP) over 2009–14.
- Risks:
  - Downside risks largely global: stalled global recovery or weaker Chinese commodity demand could sharply lower terms of trade.
  - European fiscal sustainability concerns could disrupt global financial markets and raise cost of capital.
  - Domestic downside risks: fall in house prices and deleveraging by highly indebted households.
  - Upside risk: mining boom may have larger-than-expected impact on output and inflation.
- Monetary policy guidance:
  - Staff supported removal of monetary stimulus since late 2009; holding rates since May 2010 appropriate amid uncertainty.
  - If recovery proceeds, staff advised further tightening to contain mining-driven inflation pressures.
  - Key considerations: high household indebtedness; inflation projected close to top of 2–3 percent target band.
  - RBA has scope to cut policy rate and provide liquidity if world growth falters or markets are stressed.
  - RBA objective: average inflation between 2 and 3 percent over the cycle.
- Fiscal policy exit and targets:
  - Government strategy: return budget to a surplus of 0.2 percent of GDP by 2012/13.
  - Measures: allow fiscal drag to raise tax receipts while keeping tax-to-GDP ratio below 23.6 percent on average; hold real government spending growth to 2 percent or less per year until surplus; once surplus achieved retain 2 percent real cap on spending until surplus is at least 1 percent of GDP (projected for 2015–16).
  - Commonwealth net debt projected to peak at 6 percent of GDP in 2011–12; projected to return to zero by 2018/19.
  - Staff supported pace of withdrawal if recovery proceeds as expected.

### European sovereign debt turbulence — scenarios and projected impacts
- Two GPM scenarios:
  - Scenario1: Limited Impact — direct impact concentrated in Europe; mild increase in Euro area risk premium; spillovers limited to trade effects.
  - Scenario2: Significant Disruption — global financial markets severely disrupted because European fiscal consolidation plans are viewed as not credible or not sufficient.
- GPM Simulation — Deviations from Baseline (World and regions)
  - Scenario1: Limited Impact
    - World: -0.1 (2010), -0.3 (2011), -0.1 (2012)
    - Euro Area: -0.1 (2010), -0.6 (2011), 0.0 (2012)
    - United States: -0.1 (2010), -0.2 (2011), 0.0 (2012)
    - Japan: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - Emerging Asia: 0.0 (2010), -0.2 (2011), -0.1 (2012)
    - Latin America: 0.0 (2010), -0.1 (2011), -0.1 (2012)
    - Remaining countries: 0.0 (2010), -0.3 (2011), -0.1 (2012)
  - Scenario2: Significant Disruption
    - World: -0.3 (2010), -1.5 (2011), -0.3 (2012)
    - Euro Area: -0.3 (2010), -2.2 (2011), -0.9 (2012)
    - United States: -0.5 (2010), -1.9 (2011), 0.3 (2012)
    - Japan: -0.1 (2010), -1.3 (2011), -0.9 (2012)
    - Emerging Asia: -0.1 (2010), -0.9 (2011), -0.1 (2012)
    - Latin America: -0.1 (2010), -0.8 (2011), -0.3 (2012)
    - Remaining countries: -0.2 (2010), -1.1 (2011), 0.0 (2012)
- FPAS Simulation for Australia — Deviations from Baseline (Selected)
  - Scenario1: Limited Impact
    - GDP growth: 0.0 (2010), -0.1 (2011), -0.1 (2012)
    - Output gap: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - Core inflation: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - Commodity prices: -0.4 (2010), -1.7 (2011), -2.9 (2012)
    - Interest rates: -0.2 (2010), -0.5 (2011), -0.7 (2012)
    - Fiscal balance: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - REER: -0.1 (2010), -0.3 (2011), -0.5 (2012)
  - Scenario2: Significant Disruption
    - GDP growth: 0.0 (2010), -0.3 (2011), -0.5 (2012)
    - Output gap: 0.0 (2010), -0.3 (2011), -0.8 (2012)
    - Core inflation: 0.0 (2010), -0.1 (2011), -0.6 (2012)
    - Commodity prices: -0.6 (2010), -6.1 (2011), -12.4 (2012)
    - Interest rates: -0.7 (2010), -1.6 (2011), -2.4 (2012)
    - Fiscal balance: 0.0 (2010), -0.1 (2011), -0.9 (2012)
    - REER: -0.2 (2010), -0.9 (2011), -1.5 (2012)
- Overall assessment: impact on Australia is mild due to policy space and importance of emerging Asia, but output effects are longer lived because commodity prices remain below baseline for an extended period.

### Fiscal framework, tax reform, and managing the commodity boom
- Fiscal framework:
  - Charter of Budget Honesty requires fiscal policy to moderate cyclical fluctuations and maintain Commonwealth Government debt at prudent levels.
  - Government strategy: achieve budget surpluses on average over the medium-term to moderate pro-cyclical impact from the terms of trade.
  - During 2004–2008 upswing, budget surpluses were limited to 1¾ percent of GDP.
- Saving windfalls and stabilizers (staff advice):
  - Allow automatic fiscal stabilizers to operate fully to avoid overheating.
  - Save revenue windfalls to build buffers against sharp falls in commodity prices and permit stabilizers to operate during downturns.
- Downside terms-of-trade scenario (staff estimate):
  - Budget projects terms of trade to fall gradually by about 20 percent over the next 15 years and settle about 30 percent above the average of the past 20 years.
  - Staff estimate: a permanent fall in the terms of trade of 20 percent over the next year could reduce nominal GDP by 4 percent relative to baseline (assuming exchange rate depreciates by 10 percent) and worsen the budget balance in 2011/12 by 1–1½ percent of GDP relative to baseline.
- Tax reform and MRRT:
  - Introduction of the mineral resource rent tax (MRRT) in 2012, accompanied by a cut in the company tax rate from 30 to 29 percent (authorities’ policy).
  - Staff recommendations: consider broadening MRRT to resources beyond iron ore and coal; increase reliance on consumption-based taxes; eliminate inefficient taxes (including state stamp duties); consider cutting company tax rate to 25 percent over the medium term.
  - Authorities’ constraints: objective to keep Commonwealth tax revenues on average below 23.6 percent of GDP; political difficulty in increasing consumption taxes (GST rate not to be increased or base broadened).
- Managing the mining boom:
  - Challenges: facilitate resource shift to mining without triggering inflation; increased revenue volatility; potential amplification of business cycle.
  - Sound management could permanently raise household incomes and support higher potential growth.

### Financial stability, household vulnerabilities, and supervisory recommendations
- Household exposure:
  - Household debt exceeds 150 percent of households’ disposable income.
  - Less than 10 percent of owner-occupiers had mortgages with loan-to-value ratios higher than 80 percent and debt-service ratios greater than 30 percent.
  - Top two income quintiles hold almost three quarters of household debt.
- Stress testing and resilience:
  - APRA 2009/10 stress test macro scenario: 3 percent contraction of real GDP in Australia in the first year followed by V-shaped recovery; unemployment rising to 11 percent; fall in house prices of 25 percent; fall in commercial property prices of 45 percent.
  - Results: none of the banks would have breached the 4 percent minimum Tier 1 capital requirement; weighted average reduction in Tier 1 capital ratios over the three-year scenario was 3.1 percentage points.
- Staff recommendations:
  - Remain vigilant; explicitly include funding risk in future scenarios given sizable short-term external debt.
  - APRA should review probability of default and loss given default assumptions.
  - Examine potential mortgage sector risks given high household debt and possible house price overvaluation.
  - Extend stress testing beyond banking to insurance and other financial institutions.
  - Encourage banks to rely more on medium and long-term funding.
- Contingency planning:
  - APRA closely monitors banks’ liquidity and funding plans.
  - Planned Trans-Tasman crisis management exercise with New Zealand to identify banking crisis challenges.
- Authorities’ views:
  - Agreed on need for vigilance; aggregate stress test results published; committed to adopting Basel Committee international enhancements.

### External vulnerabilities and exchange rate assessment
- External balances and debt:
  - Net external liabilities projected to increase to about 64 percent of GDP in 2015.
  - Current account deficit projected to widen to 6 percent of GDP over the medium term.
  - Short-term external debt: 46 percent of GDP in mid-2010; short-term external debt comprises almost half of gross external debt.
  - Funding from European banks was just over US$300 billion at end-2009 (about ¼ of gross external debt).
- Key external debt snapshots:
  - Gross external debt (A$ billions): Jun-08: 1,103; Dec-09: 1,232; Jun-10: 1,291.
  - Of which short-term (A$ billions): Jun-08: 529; Dec-09: 523; Jun-10: 596.
  - Gross external debt (US$ billions): Jun-08: 1,062; Dec-09: 1,105; Jun-10: 1,100.
  - Of which short-term (US$ billions): Jun-08: 509; Dec-09: 469; Jun-10: 508.
  - Gross external debt (percent of GDP): Jun-08: 93.4; Dec-09: 98.0; Jun-10: 99.1.
  - Short-term (percent of GDP): Jun-08: 44.8; Dec-09: 41.7; Jun-10: 45.7.
  - Short-term to gross external debt: Jun-08: 47.9; Dec-09: 42.5; Jun-10: 46.2.
  - US$/$A (end of period): Jun-08: 0.96; Dec-09: 0.90; Jun-10: 0.85.
- Mitigating factors:
  - More than 40 percent of external debt is in Australian dollars; bulk of remainder hedged.
  - Flexible exchange rate acts as buffer: depreciation would reduce US$ and Euro funding required.
  - Australian banks hold relatively small foreign-currency–denominated assets.
- Exchange rate assessment (staff estimates of overvaluation):
  - Macroeconomic balance approach implies overvaluation of about 7½ percent (current account deficit norm at almost 5 percent of GDP).
  - ERER approach suggests an overvaluation of 6 percent (using June 2010 benchmark, assuming flat terms of trade).
  - External sustainability approach implies an overvaluation of about 13½ percent (assuming net foreign liabilities stabilize at 60 percent of GDP); to stabilize NFL at 55 percent of GDP, REER would need to depreciate by about 15 percent.
  - Staff note overvaluation likely temporary and may dissipate with normalization of interest rates in advanced economies.
- Policy recommendations on external funding:
  - APRA should encourage more medium- and long-term funding to reduce rollover risk.
  - Plans to raise compulsory superannuation contribution from 9 to 12 percent of earnings over time and return to budget surpluses should help increase national saving.
  - Authorities committed to development and adoption of international liquidity standards, noting limited government securities supply and challenges with Net Stable Funding Ratio.

### Staff appraisal, macro policy guidance and headline indicators
- Staff appraisal:
  - Global crisis impact milder than in other advanced economies; mining boom and ties with emerging Asia underpin favorable medium-term growth.
  - Monetary policy: RBA appropriately unwound stimulus; further tightening needed if recovery and mining pressures persist; ample room to cut if global stress emerges.
  - Fiscal policy: pace of exit appropriate if recovery proceeds; plan to return to surplus by 2012/13 strengthens resilience.
  - Fiscal advice: allow automatic stabilizers to operate; save windfalls; prepare downside budget scenarios to build support for larger surpluses in good times.
  - Tax policy: MRRT welcome; consider broadening MRRT coverage; greater reliance on consumption taxes to enable elimination of inefficient state taxes and reductions in personal income taxes.
  - Financial sector: banks sound but vigilance required; reduce rollover risks by extending offshore funding maturities.
- Recommendation on Article IV cycle:
  - Staff recommends next Article IV consultation be held on the standard 12-month cycle.
- Selected headline indicators (as reported):
  - Nominal GDP (2009): $A 1,255 billion (US$996.4 billion)
  - Quota (in millions): SDR 3,236.40
  - GDP per capita (2009): US$45,237
  - Population (October 2010): 22.5 million
  - Unemployment rate (September 2010): 5.1 percent
  - Main exports: Metal ores and minerals; tourism, coal and coke (fuel).
  - ODA (2009-10): 0.3 percent of GDP
- Summary of key macro projections and indicators (selected series preserved exactly):
  - Real GDP: 2007: 4.8; 2008: 2.2; 2009: 1.2; 2010: 3.0; 2011: 3.5
  - CPI inflation: 2007: 2.3; 2008: 4.4; 2009: 1.8; 2010: 3.0; 2011: 3.0
  - Gross national saving (percent of GDP): 2007: 23.1; 2008: 24.7; 2009: 23.6; 2010: 25.7; 2011: 27.2
  - Current account (percent of GDP): 2007: -6.2; 2008: -4.5; 2009: -4.4; 2010: -2.4; 2011: -2.3
  - Terms of trade (percent change): 2007: 4.6; 2008: 14.3; 2009: -8.3; 2010: 18.9; 2011: 2.0
  - Net external liabilities (percent of GDP): 2007: 55.9; 2008: 56.3; 2009: 61.1; 2010: 56.9; 2011: 55.5
  - Household debt: exceeds 150 percent of disposable income (aggregate statement).
  - Short-term external debt (mid-2010): 46 percent of GDP.
  - Real effective exchange rate (2007–2010): 131.1; 128.9; 125.6; 139.0

*Source: IMF staff report content from _cr10331 (IMF).*

### 1. Increasing Ties with Emerging Asia and Australia’s Growth Potential ....................................... 11

### 1. Increasing Ties with Emerging Asia and Australia’s Growth Potential

### Resilience to the Crisis
- Australia was one of the few advanced economies to escape recession in 2009.
- Factors cited for resilience:
  - Growing links with Asia, including strong demand for commodities from China and India.
  - Prompt and significant macro policy response to the global crisis.
  - A healthy banking sector and a flexible exchange rate (Table 1, Figure 1).
- Prior position before the recession:
  - 17 years of continuous growth.
  - Unemployment at historical lows and inflation expectations well-anchored.

### Exchange Rate and Financial Market Developments
- Exchange rate movements:
  - The Australian dollar depreciated sharply at the onset of the crisis, then appreciated in real effective terms by 35 percent between March 2009 and September 2010 (Figure 2).
- Financial market recovery:
  - Australian financial markets largely recovered from the global crisis.
  - Bank CDS spreads narrowed; stock market and bond yields recovered (Figure 2).

### Monetary and Fiscal Response
- Monetary policy:
  - Reserve Bank of Australia (RBA) cut its policy rate from 7¼ percent to 3 percent over the seven months to April 2009.
  - The RBA later raised the policy rate to 4½ percent in six steps, with the most recent increase in May (Figure 5).
  - Mortgage and business lending rates reflected policy moves effectively.
- Fiscal policy:
  - The Commonwealth government ran budget surpluses of around 1–1¾ percent of GDP in the six years before the crisis that eliminated its net debt.
  - The government provided a fiscal stimulus of 4⅓ percent of GDP in the two years to June 2010, above the G-20 average.
  - The operation of automatic stabilizers and the stimulus shifted the budget into an underlying cash deficit of about 4 percent of GDP in 2009/10 (Table 2).
- Fiscal exit:
  - The government began unwinding crisis-related measures as conditions normalized (see Appendix I).

### Banking Sector and Financial Stability
- Asset and liability structure:
  - Banks’ assets consist predominantly of credit, with mortgage loans accounting for half of total lending.
  - Banks’ liabilities are mainly domestic deposits, but wholesale funding remained sizable (Figure 3).
- Capital and profitability:
  - Capital adequacy improved to about 12 percent after banks raised private capital.
  - Profitability remained healthy (ROA, ROE, net interest margins depicted in Figure 3).
- Asset quality and provisioning:
  - Nonperforming loans rose to less than 2 percent of assets.
  - Impaired assets are low by international standards, though they increased recently.
- Policy support measures:
  - The “four pillars policy” (which does not allow the four large banks to merge), sound regulation and supervision, and the government’s Guarantee Scheme for Large Deposits and Wholesale Funding (introduced late 2008) helped maintain stability.
  - The guarantee was withdrawn for new liabilities in March 2010 as market conditions normalized.

### Labor Market, Mining Boom, and Activity Composition
- Labor market flexibility:
  - Employers reduced hours worked rather than laying off staff; unemployment peaked at less than 6 percent in mid-2009 and later fell to just over 5 percent.
  - Employment and hours worked rebounded following the trough (Figure 4).
- Mining boom and investment:
  - Commodity prices (notably iron ore and coal) rebounded and are expected to remain high in the near term based on demand from China and India.
  - Private sector investment in mining rose; public investment and a pickup in household consumption underpinned activity in early 2010.
- Contribution to growth:
  - The mild slowdown was also attributed to limited dependence on manufacturing; consumption, investment, and net exports’ contributions shown in Figure 1.

### Inflationary Pressures and Exit from Stimulus
- Inflation and resource pressure:
  - Core inflation fell below 3 percent y/y in June 2010 while wage growth moderated, but spare capacity began to be used up as unemployment fell and capacity utilization rose (Figure 4).
  - Headline inflation and consumer expectations rose recently; tradables inflation increased (Figure 4).
- Monetary withdrawal:
  - The RBA began withdrawing monetary stimulus in late 2009 and increased the policy rate to 4½ percent in six steps; policy rates were held on pause in recent months due to global uncertainty (Figure 5).
  - Increases in policy rate flowed through to mortgage and business lending rates, returning them close to 10-year averages.
- Interest rate dynamics:
  - The policy rate adjustments aligned with an estimated Taylor-type rule and stabilized real policy rates; average funding costs and bank spreads to OCR increased, pushing up lending rates (Figure 5).

*Source: _cr10331 - 1. Increasing Ties with Emerging Asia and Australia’s Growth Potential (IMF staff content).*

### 11. Credit growth is showing signs of

### _cr10331 - 11. Credit growth is showing signs of

### Credit developments
- Credit growth is showing signs of recovery.
- The sharp slowing in credit growth following the onset of the crisis was driven by falls in business and personal credit.
- Mortgage credit growth, while slowing, remained positive, reflecting:
  - the introduction of government incentives for first time home buyers, and
  - the quick pass through of policy rate reductions into mortgage rates.
- More recently, personal credit growth picked up, although business credit continues to contract.

### Current account and external position
- Strong commodity demand helped reduce the current account deficit.
- The current account deficit fell to 3⅓ percent of GDP in the first half of 2010, as iron ore and coal exports picked up, and dividend and profits payments declined.
- Net external liabilities have risen over the past few years to about 60 percent of GDP by mid-2010.
- The current account deficit is projected to narrow in the near-term to less than 2½ percent of GDP, due to the jump in the terms of trade.
- The deficit is forecast to widen to about 6 percent of GDP over the medium term, mostly reflecting higher investment in the resource sector, including on LNG projects.

### Outlook and key projections
- Real GDP growth is projected at 3–3½ percent in 2010 and 2011.
- Private investment in mining and commodity exports is expected to take over from public demand as the main driver of growth.
- The output gap is expected to close in mid-2011.
- Household consumption will be supported by strong income growth, buoyed by the recent rebound in employment.
- The terms of trade is expected to rise to historic highs in late 2010, driving a likely long lasting mining boom.
- Gorgon project: capital expenditure of $43 billion (3½ percent of GDP) over 2009–14.

### Risks
- Main risks relate to the global outlook and are tilted largely to the downside in the near term.
- If the global recovery stalls and Chinese demand for commodities declines, Australia’s terms of trade could fall sharply.
- Concerns about fiscal sustainability in Europe could disrupt global financial markets and push up the cost of capital for Australian borrowers.
- Domestic downside risks include a fall in house prices and deleveraging by highly indebted households, which could negatively impact private consumption.
- An upside risk is that the mining boom may have a larger-than-expected impact on output and inflation.

### Authorities’ views (macroeconomic outlook)
- Authorities agreed with staff’s economic outlook, although they viewed the risks as more balanced.
- They noted downside risks from market concerns about the fiscal outlook for some European economies.
- They expect strong demand for mineral exports to continue to support the recovery.

### Monetary policy: staff advice and authorities’ stance
- Staff supported the removal of monetary stimulus since late 2009, given improvement in the economic outlook.
- Keeping policy rates on hold since May 2010 was judged appropriate given increased uncertainty.
- With lending rates close to ten-year averages and economic activity responsive to cash rate adjustments, the RBA has scope to wait for clearer outlook signals.
- If the recovery proceeds and downside risks dissipate, staff advised that monetary policy will need to be tightened further to contain inflation pressures generated by the mining boom.
- Key considerations for the RBA in determining additional tightening:
  - High level of household indebtedness making domestic demand more responsive to interest rates.
  - Inflation projected to remain close to the top of the 2–3 percent target band; guard against inflation expectations becoming anchored too high.
- If world growth falters or global markets come under severe stress because of concerns over European sovereign debt, the RBA is well positioned to respond:
  - ample scope to cut the policy rate and provide liquidity support for banks.

- The RBA will continue to monitor developments and set monetary policy to achieve an average rate of inflation of between 2 and 3 percent over the cycle.

### Fiscal policy: exit from stimulus and targets
- The government’s strategy to exit fiscal stimulus is projected to return the budget to a surplus of 0.2 percent of GDP by 2012/13.
- With above trend growth forecast, the government intends to achieve this goal by:
  - allowing tax receipts to increase through fiscal drag while keeping the tax-to-GDP ratio below the 2007/08 level of 23.6 percent on average;
  - holding real growth in government spending to 2 percent or less per year until the budget returns to surplus;
  - once the budget is back in surplus, retaining a 2 percent real cap on spending growth, on average, until the budget surplus is at least 1 percent of GDP, currently projected for 2015–16.
- Staff supported the pace of withdrawal of fiscal stimulus, if the recovery proceeds as expected.
- The exit from the stimulus, which began in 2010, sees Commonwealth government net debt peaking at 6 percent of GDP in 2011–12.
- The fiscal adjustment is faster than past consolidations in Australia and exit plans in most other advanced economies.
- Returning quickly to budget surpluses would put Australia in a stronger position to deal with future shocks.
- Authorities project Commonwealth net debt to return to zero by 2018/19.

### Box 2 — Potential impact of European sovereign debt turbulence (scenarios and impacts)
- Two GPM scenarios considered:
  - Scenario1: Limited Impact — direct impact largely concentrated in Europe; mild increase in Euro area risk premium; spillovers limited to trade effects.
  - Scenario2: Significant Disruption — global financial markets severely disrupted because European fiscal consolidation plans are viewed as not credible or not sufficient.

- GPM Simulation — Deviations from Baseline (World and regions)
  - Scenario1: Limited Impact
    - World: -0.1 (2010), -0.3 (2011), -0.1 (2012)
    - Euro Area: -0.1 (2010), -0.6 (2011), 0.0 (2012)
    - United States: -0.1 (2010), -0.2 (2011), 0.0 (2012)
    - Japan: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - Emerging Asia: 0.0 (2010), -0.2 (2011), -0.1 (2012)
    - Latin America: 0.0 (2010), -0.1 (2011), -0.1 (2012)
    - Remaining countries: 0.0 (2010), -0.3 (2011), -0.1 (2012)
  - Scenario2: Significant Disruption
    - World: -0.3 (2010), -1.5 (2011), -0.3 (2012)
    - Euro Area: -0.3 (2010), -2.2 (2011), -0.9 (2012)
    - United States: -0.5 (2010), -1.9 (2011), 0.3 (2012)
    - Japan: -0.1 (2010), -1.3 (2011), -0.9 (2012)
    - Emerging Asia: -0.1 (2010), -0.9 (2011), -0.1 (2012)
    - Latin America: -0.1 (2010), -0.8 (2011), -0.3 (2012)
    - Remaining countries: -0.2 (2010), -1.1 (2011), 0.0 (2012)

- FPAS Simulation for Australia — Deviations from Baseline (Selected)
  - Scenario1: Limited Impact
    - GDP growth: 0.0 (2010), -0.1 (2011), -0.1 (2012)
    - Output gap: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - Core inflation: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - Commodity prices: -0.4 (2010), -1.7 (2011), -2.9 (2012)
    - Interest rates: -0.2 (2010), -0.5 (2011), -0.7 (2012)
    - Fiscal balance: 0.0 (2010), -0.1 (2011), -0.2 (2012)
    - REER: -0.1 (2010), -0.3 (2011), -0.5 (2012)
  - Scenario2: Significant Disruption
    - GDP growth: 0.0 (2010), -0.3 (2011), -0.5 (2012)
    - Output gap: 0.0 (2010), -0.3 (2011), -0.8 (2012)
    - Core inflation: 0.0 (2010), -0.1 (2011), -0.6 (2012)
    - Commodity prices: -0.6 (2010), -6.1 (2011), -12.4 (2012)
    - Interest rates: -0.7 (2010), -1.6 (2011), -2.4 (2012)
    - Fiscal balance: 0.0 (2010), -0.1 (2011), -0.9 (2012)
    - REER: -0.2 (2010), -0.9 (2011), -1.5 (2012)

- Overall assessment: The impact on Australia is mild due to policy space and the importance of emerging Asia, but the output effect is longer lived because commodity prices remain below baseline for an extended period.

### Managing the mining boom
- The mining boom is expected to be long lived but brings vulnerabilities requiring policy response.
- Challenges:
  - Facilitating a shift of resources to the mining sector without giving rise to inflationary pressures.
  - Growing dependence on mining may amplify the business cycle and make government revenue more volatile.
- Sound management of the boom could permanently raise household incomes and support higher potential growth.

*Source: IMF staff report content from _cr10331 - 11. Credit growth is showing signs of (PDF).*

### 25. The framework laid out in the

### _cr10331 - 25. The framework laid out in the

### Fiscal framework and commodity boom
- Charter of Budget Honesty requires fiscal policy to contribute to moderating cyclical fluctuations and maintain Commonwealth Government debt at prudent levels.
- Government strategy: achieve budget surpluses on average over the medium-term to moderate the pro-cyclical impact from the terms of trade.
- During the upswing in commodity prices from 2004–2008, budget surpluses were limited to only 1¾ percent of GDP, with cuts in personal taxes and increases in spending providing a fiscal stimulus.

### Staff advice on saving windfalls and stabilizers
- Allow automatic fiscal stabilizers to operate fully to help avoid potential overheating from faster-than-expected Asian growth.
- Recommendation: save revenue windfalls to:
  - build a buffer against a sharp fall in commodity prices;
  - permit automatic stabilizers to operate fully during downturns.

### Downside scenarios for terms of trade
- Budget projects the terms of trade to fall gradually by about 20 percent over the next 15 years and settle about 30 percent above the average of the past 20 years.
- Staff suggested preparing downside scenarios where the terms of trade return quickly to the long-run average.
- Staff estimates (footnote):
  - A permanent fall in the terms of trade of 20 percent over the next year could reduce nominal GDP by 4 percent relative to baseline, assuming the exchange rate depreciates by 10 percent, and worsen the budget balance in 2011/12 by 1–1½ percent of GDP relative to baseline.
  - Estimates are subject to considerable uncertainty and do not take account of a possible policy response.
- Rationale: Running larger surpluses during good times would strengthen the sovereign balance sheet and provide fiscal space to cushion sharp deteriorations in the terms of trade and address long-term pressures from aging and rising health care costs.

### Tax reform to manage the boom and reallocate resources
- Staff welcomed the tax review as a comprehensive blueprint for tax reform.
- Planned policy actions noted:
  - Introduction of the mineral resource rent tax (MRRT) in 2012, accompanied by a cut in the company tax rate from 30 to 29 percent to encourage investment.
- Staff observations and recommendations:
  - MRRT strengthens automatic stabilizers but is less effective than the original super profit tax proposal.
  - Consider broadening MRRT coverage to mineral resources beyond iron ore and coal.
  - Increase reliance on consumption-based taxes to:
    - allow elimination of inefficient taxes that impede labor mobility (including stamp duties at the state level);
    - make room for reductions in federal personal income taxes to encourage increases in labor supply and saving.
- Authorities’ constraints and views:
  - Objective to keep Commonwealth tax revenues on average below the 2007/08 level (23.6 percent of GDP) may constrain revenue increases, but as an average over the medium term it is not a substantial near-term constraint.
  - Political challenges exist for running larger surpluses due to pressure to cut taxes when revenue growth is strong.
  - Authorities raised concerns about managing public assets once Commonwealth net debt is reduced to zero.
  - Increasing consumption taxes is politically difficult because they are perceived as regressive; government policy: GST rate will not be increased or the base broadened.

### Structural reforms and infrastructure
- Reforms underway aim to reduce inconsistent and unnecessary regulation and restrictions on competition across Commonwealth, State and Territory governments.
- Commonwealth actions include investing in education, promoting effective regulation and more efficient use of existing infrastructure, and developing more transparent frameworks for new infrastructure investment decisions.

### Long-term fiscal pressures: aging and health care (Box 3)
- Intergenerational Report 2010 projects government spending on health, age-related pensions and aged care could rise by 5.3 percent of GDP by 2049–50 from the projected low point in 2015–16.
  - Rising health care costs account for around two-thirds of the overall increase.
- Pensions:
  - Government will progressively increase the retirement age from 65 to 67 years beginning in 2017 and revise means test arrangements.
  - Pension reforms combined with savings mean the pension reforms will be fully offset by 2020–21.
  - Government spending on age-related pensions projected to increase from around 3 percent of GDP in 2009/10 to around 4 percent of GDP in 2050.
- Policy implication: further action needed to contain the public share of costs; measures to raise labor force participation and productivity would help address budget pressures.

### Tax policy reform principles and recommendations (Box 4)
- Five core principles: Equity; Efficiency; Simplicity; Sustainability; Policy consistency.
- Overarching objective: promote stronger long-term growth by increasing workforce participation and productivity.
- Main recommendations included:
  - introducing a rent tax on nonrenewable resources;
  - cutting the company tax rate from 30 percent to 25 percent over the medium term to increase business investment, including FDI;
  - reducing complexity of personal income tax, including high tax-free threshold with a constant marginal rate for most people; removing stamp duties and replacing them with a broad-base land tax;
  - enhancing taxes on consumption (excluding the GST) and broadening the consumption tax base; using a broad-based cash flow tax to finance abolition of other taxes, including payroll tax and inefficient State consumption taxes;
  - promoting higher workforce participation through improved child care support and clearer work incentives in income support payments.
- Government endorsement: introducing a mineral resource rent tax on iron ore and coal and cutting the company tax rate from 30 to 29 percent in 2012.

### Financial stability and banks’ domestic vulnerabilities
- Key risks and observations:
  - Concern that good crisis performance may embolden banks to take on riskier strategies.
  - Need for strong capital and liquidity buffers and vigilant supervision.
- Household exposure:
  - Household debt exceeds 150 percent of households’ disposable income.
  - Less than 10 percent of owner-occupiers had mortgages with loan-to-value ratios higher than 80 percent and debt-service ratios greater than 30 percent.
  - Households in the top two income quintiles hold almost three quarters of household debt.
  - APRA sets a floor of 20 percent for losses given default on residential mortgages.
- Stress test results (APRA 2009/10 scenario):
  - Three-year macroeconomic scenario assumed: global downturn resulting in a 3 percent contraction of real GDP in Australia in the first year, followed by a V-shaped recovery; unemployment rising to 11 percent; fall in house prices of 25 percent; fall in commercial property prices of 45 percent.
  - Results: none of the banks would have breached the 4 percent minimum Tier 1 capital requirement of the Basel II framework.
  - The weighted average reduction in Tier 1 capital ratios from the beginning to the end of the three-year stress scenario was 3.1 percentage points.
- Staff recommendations:
  - Remain vigilant to emerging risks and explicitly include funding risk in future scenarios due to banks’ sizable short-term external debt.
  - APRA should review assumptions regarding probability of default and loss given default in light of recent experience.
  - Examine potential risks in the mortgage sector given high household debt, house price overvaluation, and potential volatility from the mining boom.
  - Extend stress testing beyond banking to other financial institutions such as insurance companies.
- Contingency planning:
  - APRA closely monitors banks’ liquidity and funding plans.
  - Planned Trans-Tasman crisis management exercise with New Zealand to identify challenges in a banking crisis.
- Authorities’ views:
  - Agreed on need for vigilance.
  - Aggregate stress test results published; no need to publish individual results.
  - Committed to adopting international enhancements to capital quality and quantity being developed by the Basel Committee.
  - Australian banks are unlikely to require significant increases in capital to meet enhanced requirements as they are already well capitalized, with common equity comprising a significant proportion of tier-one capital.

### Household vulnerabilities (Figure 8 highlights)
- Household debt remains very high relative to disposable income.
- Household interest payments to disposable income declined during the global crisis.
- Net wealth to disposable income has improved over the last decade, with housing wealth accounting for a large share and financial wealth a relatively low share.
- Real house prices increased substantially since 1990, leaving households vulnerable to an unwinding of the run-up in house prices.

*Source: _cr10331 - 25. The framework laid out in the*

### 38. Australia’s main external

### 38. Australia’s main external

### External vulnerabilities
- Net external liabilities projected to increase to about 64 percent of GDP in 2015.
- Current account deficit projected to widen to 6 percent of GDP.
- Projected increase in the current account deficit to about 6 percent of GDP over the medium term, together with sizable net external liabilities and short-term external debt, present some risks.

### Short-term external debt and funding risks
- Short-term external debt for the whole economy: 46 percent of GDP in mid-2010.
- Short-term external debt comprises almost half of gross external debt and is largely held by financial institutions.
- Disruptions in global capital markets (for example, a pullback by European banks) could raise the cost of capital for Australian banks.
- Funding from European banks was just over US$300 billion at end-2009, about ¼ of gross external debt.
- A disruption to external funding could put significant pressure on Australian banks because of their short-term offshore funding.

### Key external debt statistics (end-of-period snapshots)
- Gross external debt (expressed in billions of Australian dollars): Jun-08: 1,103; Dec-09: 1,232; Jun-10: 1,291.
- Of which short-term (A$ billions): Jun-08: 529; Dec-09: 523; Jun-10: 596.
- Gross external debt (expressed in billions of U.S. dollars): Jun-08: 1,062; Dec-09: 1,105; Jun-10: 1,100.
- Of which short-term (US$ billions): Jun-08: 509; Dec-09: 469; Jun-10: 508.
- Gross external debt (As percent of GDP): Jun-08: 93.4; Dec-09: 98.0; Jun-10: 99.1.
- Of which short-term (As percent of GDP): Jun-08: 44.8; Dec-09: 41.7; Jun-10: 45.7.
- Short-term to gross external debt: Jun-08: 47.9; Dec-09: 42.5; Jun-10: 46.2.
- US$/$A (end of period): Jun-08: 0.96; Dec-09: 0.90; Jun-10: 0.85.
- NGDP, last 4 qtrs sum. SA, billions: Jun-08: 1,182; Dec-09: 1,256; Jun-10: 1,302.

### Mitigating factors and exchange rate dynamics
- Gross assets and liabilities are relatively small despite relatively large net external liabilities.
- Gross external debt (99 percent of GDP in mid-2010) and short-term debt are smaller than in many other advanced economies.
- More than 40 percent of external debt is in Australian dollars and the bulk of the remainder is hedged, limiting currency risk.
- The flexible exchange rate provides an important buffer: a depreciation of the Australian dollar would reduce the U.S. dollar and Euro funding required to meet banks’ desired Australian dollar funding.
- Australian banks hold relatively small amounts of foreign currency–denominated assets, limiting the need for foreign currency funding.
- Short-term debt has risen over the past 5–6 years but remains less than in most other advanced countries as a share of GDP.

### Exchange rate assessment (Box 5)
- Staff estimates suggest the currency is mildly overvalued by 5–15 percent from a medium-term perspective, subject to considerable uncertainty.
- Macroeconomic balance (MB) approach:
  - Estimates the current account deficit norm at almost 5 percent of GDP.
  - Fixed effect: -2.8 percent.
  - Population growth contribution: -3.0 percent.
  - Relative fiscal balance contribution: 0.4 percent.
  - Projected current account deficit is just above the MB norm, implying an overvaluation of about 7½ percent.
- Equilibrium real exchange rate (ERER) approach:
  - Using June 2010 as the benchmark, suggests an overvaluation of 6 percent (assuming terms of trade remain flat over the medium term).
- External sustainability (ES) approach:
  - Implies an overvaluation of about 13½ percent, assuming net foreign liabilities stabilize at the mid-2010 level of 60 percent of GDP.
  - To stabilize NFL to 55 percent of GDP, the REER would need to depreciate by about 15 percent.
- Staff note the overvaluation is likely temporary and may dissipate with eventual normalization of interest rates in the United States and other advanced economies.

### Policy recommendations and authorities’ views
- To reduce rollover risk: APRA should encourage banks to rely more on medium and long-term funding.
  - APRA issued a discussion paper on liquidity risk in September 2009 emphasizing stress testing and a three-month “market disruption” scenario; proposals were put on hold after the Basel Committee liquidity proposals in December 2009.
- Authorities’ views:
  - Acknowledge CA deficits from excess investment over saving expose Australia to risks from shifts in offshore investor sentiment.
  - Note foreign investors’ willingness to fund the CA deficit owes to Australia’s strong macroeconomic management, fiscal position, structural reform, and sound financial regulation and supervision.
  - Plans to raise compulsory superannuation contribution from 9 to 12 percent of employee earnings over time and to achieve budget surpluses on average over the medium term should help increase national saving.
  - Agree on the need for careful assessment of liquidity risks and commitment to development and adoption of international liquidity standards, but note limited government securities supply and challenges with the originally proposed Net Stable Funding ratio.

### Staff appraisal and macro policy guidance
- The impact of the global crisis was milder than in other advanced economies; a mining boom and integration with emerging Asia underpin favorable medium-term growth prospects.
- Monetary policy:
  - RBA has appropriately unwound earlier monetary policy stimulus.
  - If recovery remains on track, monetary policy will need to tighten further to contain inflation pressures from the mining boom.
  - If the global recovery stalls or capital markets come under severe stress, the RBA has ample scope to cut the policy rate and provide liquidity support.
- Fiscal policy:
  - Pace of exit from fiscal stimulus is appropriate if recovery proceeds as expected; plan for a return to surplus by 2012/13 strengthens resilience to future shocks.
  - Automatic fiscal stabilizers should be allowed to operate fully; save revenue windfalls and run larger budget surpluses during upswings to avoid overheating and build buffers.
  - Consider preparing a downside budget scenario in which commodity prices fall sharply to build political support for larger surpluses in good times.
- Tax policy:
  - Recent review including introduction of the MRRT is welcome; consider broadening MRRT coverage beyond iron ore and coal.
  - Tax reform should facilitate reallocation of capital and labor to the mining sector.
  - Greater reliance on consumption-based taxes could allow elimination of inefficient state taxes and reductions in personal income taxes to encourage labor supply and saving.
- Financial sector:
  - Banks remain sound but authorities should remain vigilant as banks could adopt riskier strategies.
  - APRA’s regular stress testing and efforts to improve banks’ own stress testing capabilities are commendable; continued close monitoring by APRA is needed.
  - Rollover risks could be reduced further by encouraging banks to extend the maturity of their offshore funding.

*Source: _cr10331 - 38. Australia’s main external*

### 54. Staff recommends that the next

### _cr10331 - 54. Staff recommends that the next

### Recommendation on Article IV Consultation
- Staff recommends that the next Article IV consultation be held on the standard 12-month cycle.

### Headline economic indicators (selected)
- Nominal GDP (2009): $A 1,255 billion (US$996.4 billion)
- Quota (in millions): SDR 3,236.40
- GDP per capita (2009): US$45,237
- Population (October 2010): 22.5 million
- Unemployment rate (September 2010): 5.1 percent
- Main exports: Metal ores and minerals; tourism, coal and coke (fuel).
- ODA ( 2009-10): 0.3 percent of GDP.

### Output, demand, inflation, and labor (percent change / percent)
- Real GDP: 2007: 4.8; 2008: 2.2; 2009: 1.2; 2010: 3.0; 2011: 3.5
- Total domestic demand: 2007: 6.8; 2008: 3.8; 2009: 0.5; 2010: 4.4; 2011: 4.4
  - Private consumption: 2007: 5.2; 2008: 1.9; 2009: 1.7; 2010: 3.3; 2011: 3.0
  - Total investment: 2007: 9.8; 2008: 9.0; 2009: -1.1; 2010: 8.4; 2011: 6.1
- Net exports (contribution to growth) 2007–11: 1/ -1.6; -1.7; 2.0; -2.1; -0.7
- CPI inflation: 2007: 2.3; 2008: 4.4; 2009: 1.8; 2010: 3.0; 2011: 3.0
- Unemployment rate: 2007: 4.4; 2008: 4.2; 2009: 5.6; 2010: 5.2; 2011: 5.1

### Saving, investment, and fiscal indicators (percent of GDP)
- Gross national saving: 2007: 23.1; 2008: 24.7; 2009: 23.6; 2010: 25.7; 2011: 27.2
  - General government saving: 2007: 5.1; 2008: 4.1; 2009: 2.6; 2010: 2.1; 2011: 2.8
  - Private saving 2/: 2007: 18.0; 2008: 20.5; 2009: 21.0; 2010: 23.6; 2011: 24.4
- Gross capital formation: 2007: 28.9; 2008: 29.1; 2009: 28.0; 2010: 28.2; 2011: 29.5
- Fiscal indicators (cash basis, percent of GDP) 3/:
  - Receipts: 2007: 25.0; 2008: 25.0; 2009: 23.3; 2010: 21.9; 2011: 22.2
  - Payments: 2007: 23.2; 2008: 23.0; 2009: 25.2; 2010: 25.9; 2011: 24.9
  - Underlying cash balance: 2007: 1.6; 2008: 1.7; 2009: -2.2; 2010: -4.2; 2011: -2.9
  - Fiscal balance (accrual basis): 2007: 1.6; 2008: 1.8; 2009: -2.4; 2010: -4.1; 2011: -2.8
  - Net debt: 2007: -2.7; 2008: -3.8; 2009: -1.3; 2010: 3.3; 2011: 5.8

### Money, credit, and interest rates (end of period)
- Interest rate (90-day bill, in percent) 4/: 2007: 7.2; 2008: 4.1; 2009: 4.2; 2010: 4.3
- Treasury bond yield (10-year, in percent) 4/: 2007: 6.3; 2008: 4.0; 2009: 5.6; 2010: 5.6
- M3 (percent change) 4/: 2007: 22.7; 2008: 14.7; 2009: 5.8; 2010: 4.2
- Private domestic credit (percent change) 4/: 2007: 17.2; 2008: 7.6; 2009: 0.8; 2010: 1.6

### External sector (percent of GDP and related measures)
- Current account: 2007: -6.2; 2008: -4.5; 2009: -4.4; 2010: -2.4; 2011: -2.3
  - Trade balance (goods): 2007: -1.8; 2008: -0.3; 2009: -0.5; 2010: 1.4; 2011: 1.6
- Terms of trade (percent change): 2007: 4.6; 2008: 14.3; 2009: -8.3; 2010: 18.9; 2011: 2.0
- Net external liabilities (percent of GDP): 2007: 55.9; 2008: 56.3; 2009: 61.1; 2010: 56.9; 2011: 55.5
- Net external debt (percent of GDP): 2007: 51.7; 2008: 55.0; 2009: 51.9; 2010: 50.0; 2011: 48.7
- Gross official reserves 4/ (percent of GDP): 2007: 2.7; 2008: 3.8; 2009: 3.7; 2010: 3.2

### Exchange rate indicators (period average)
- U.S. dollar/Australian dollar: 2007: 0.84; 2008: 0.85; 2009: 0.79; 2010: 0.97
- Trade-weighted index: 2007: 67.5; 2008: 66.3; 2009: 63.2; 2010: 71.5
- Real effective exchange rate 5/ (2007–2010): 131.1; 128.9; 125.6; 139.0

### Fiscal accounts (accrual basis) and medium-term projections (Commonwealth government, percent of GDP)
- Revenue (2005/06–2014/15 sample): 26.1; 25.5; 25.7; 23.8; 22.5; 22.7; 24.0; 24.3; 24.5; 24.7
  - Tax component (sample): 24.6; 24.1; 24.1; 22.2; 20.6; 21.3; 22.7; 23.1; 23.2; 23.5
    - Income tax (sample): 17.6; 17.4; 17.7; 16.1; 14.5; 15.3; 16.4; 17.0; 17.3; 17.5
- Expenditure (sample): 24.2; 23.7; 23.7; 25.9; 26.1; 25.0; 24.4; 24.2; 23.9; 23.7
- Fiscal balance (accrual basis, sample): 1.5; 1.6; 1.8; -2.4; -4.1; -2.8; -0.7; 0.2; 0.4; 0.8
- Underlying cash balance (cash basis, sample): 1.6; 1.6; 1.7; -2.2; -4.2; -2.9; -0.8; 0.1; 0.3; 0.6
- Commonwealth government net debt (memorandum): -0.4; -2.7; -3.8; -1.3; 3.3; 5.8; 6.2; 6.0; 5.5; 5.1
- Consolidated general government gross debt (memorandum): 10.1; 9.4; 9.6; 13.9; 20.4; 23.5; 24.4; 24.4; 23.2; 22.5
- Nominal GDP (in billions of Australian dollars, memorandum): 1,001; 1,091; 1,182; 1,255; 1,300; 1,414; 1,485; 1,568; 1,658; 1,745

### Medium-term scenario highlights (2008–15 projections)
- Real GDP (percent change) projections: 2008: 2.2; 2009: 1.2; 2010: 3.0; 2011: 3.5; 2012–15: 3.5; 3.3; 3.3; 3.2
- Current account balance (percent of GDP) projections: 2008: -4.5; 2009: -4.4; 2010: -2.4; 2011: -2.3; 2012: -3.9; 2013: -4.7; 2014: -5.4; 2015: -6.0
- General government gross debt (percent of GDP) projection: 2008: 9.8; 2009: 9.5; 2010: 11.6; 2011: 17.6
- Interest rates (percent) projections: 3-month T-bill: 2008: 5.6; 2009: 6.0; 2010: 6.7; 2011: 7.0; 2012: 3.4
- Capital adequacy (percent): Regulatory capital to risk-weighted assets: 2008: 10.4; 2009: 10.4; 2010: 10.2; 2011: 11.4; 2012: 12.0
- Asset quality (Q4 quarterly indicators): Impaired assets to total assets: 2008: 0.2; 2009: 0.2; 2010: 0.2; 2011: 0.8; 2012: 1.2

### Appendix I — Unwinding crisis-related monetary and fiscal measures
- Monetary policy rate moves:
  - RBA cut policy rate from 7¼ percent to 3 percent over the seven months to April 2009.
  - RBA increased policy rate by 150 basis points to 4½ percent in six moves starting October 2009; most recent increase in May.
- Liquidity support and swap arrangements:
  - RBA extended collateral eligible in repo operations to include residential mortgage-backed securities, commercial paper, and asset-backed commercial paper; larger share of repos up to one-year maturity.
  - RBA established a US$30 billion swap line with the U.S. Federal Reserve Bank in September 2008 (initially through April 2009, later extended to February 2010).
  - Government announced it would purchase up to $A 16 billion of residential mortgage-backed securities.
  - Swap line was used up to early 2009, and expired on February 1, 2010.
- Funding guarantees:
  - Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding announced October 12, 2008; commenced November 28, 2008.
  - Scheme guaranteed deposit balances up to and including $A 1 million per customer in eligible authorized deposit-taking institutions and existing or new large deposits (over $A 1 million) and wholesale funding (for a fee of 70 to 150 basis points depending on credit rating).
  - Branches of foreign-owned banks were included after commencement for a fee.
  - Wholesale funding guarantee phased out for new liabilities from March 31, 2010; remained in effect only for previously guaranteed liabilities for their relevant term.
  - Deposit guarantees up to and including $A 1 million per customer per institution continue without charge until October 2011, when coverage level will be revised.

### Appendix II — FSAP 2006 key recommendations and implementation progress (selected)
- Banking / Risk management:
  - Recommendation: Continue to ensure strong risk management practices, including regular stress testing.
  - Progress: Basel II implemented since January 2008; five major banks approved to adopt internal models for credit and operational risk. Stress testing regularly carried out; APRA assesses and drives enhancements.
- Failure resolution and crisis management:
  - Recommendation: Develop formal failure management process.
  - Progress: Financial Claims Scheme (FCS) introduced October 2008 (deposit protection limit $A 1 million). Council of Financial Regulators reviewing FCS parameters; crisis management simulation exercise held in 2009. 2010 legislation enhanced APRA’s crisis management powers.
- Supervisory capacity:
  - Recommendation: Ensure supervisory agencies have adequate resources and flexibility.
  - Progress: APRA received additional funding in 2007/08 Budget and $A 45.5 million in October 2008 over four years; ministerial-consent requirement removed for certain administrative actions; ASIC received substantial funding increases; APRA released discussion paper proposing new supervisory framework for cross-industry financial conglomerates.
- Cooperation with New Zealand regulators:
  - Recommendation: Build on Trans-Tasman coordination for crisis management.
  - Progress: Legislative changes formalizing mutual alertness to interests in times of stress came into force December 2006; protocol agreed to establish joint procedures; joint crisis management exercise expected second half of 2011.
- Insurance sector reforms:
  - Recommendation: Push ahead with Stage II reforms (capital management, reinsurance documentation, corporate governance standards, disclosure).
  - Progress: APRA harmonizing prudential requirements across life, general insurance, and banking sectors; Direct Offshore Foreign Insurers must be authorized by APRA from July 1, 2008; Discretionary Mutual Funds subject to rigorous information collection.
- AML/CFT:
  - Recommendation: Prioritize legislative and operational arrangements.
  - Progress: AML/CFT Act adopted December 2006; first tranche implemented covering financial service providers, gambling services, and bullion dealers; implementation complete. Second tranche under consideration. Legislation implemented to facilitate information exchange between AUSTRAC and APRA.

*Sources: Data provided by the Australian authorities; IMF staff estimates and projections; IMF staff.*

### Appendix III. Australia: Main Recommendations of the 2009 Article IV Consultation

### Appendix III. Australia: Main Recommendations of the 2009 Article IV Consultation
(Consultation Discussions Ended on August, 5, 2009)

### Fiscal policy — staff recommendations and authorities’ actions
- Staff view: scope for further fiscal stimulus should the outlook for growth weaken further, although monetary policy should be the first line of defense.
- Staff advice if near-term growth is slower than expected: let the automatic stabilizers fully operate.
- Staff welcomed authorities’ fiscal strategy and intention to return to surpluses in 2015-16, but noted that further fiscal adjustment may be needed.
- Staff recommendation on spending: growth of real spending would need to be constrained below the 2 percent annual real rate envisaged in the budget.
- Staff recommendation on revenues: if revenues were higher than currently expected, authorities should strive for an earlier return to surplus.
- Authorities’ actions/outcome:
  - With the economy recovering at a faster pace than expected, the fiscal stimulus has started to be withdrawn as originally planned and revenue windfalls have been largely saved.
  - The current fiscal strategy envisages returning to a budget surplus by 2012/13, three years earlier than envisaged.
  - Once the budget is back in surplus, the government will retain a 2 percent real cap on spending growth, on average, until the budget surplus reaches 1 percent of GDP.

### Monetary policy — staff recommendations and authorities’ actions
- Staff suggested that the RBA exercise caution in tightening in view of the fragile state of the global economy.
- Staff suggested that if the outlook for growth and inflation weakens, the RBA had scope for further cuts in the policy rate.
- Staff suggested that the authorities consider unconventional easing monetary policy measures, in the unlikely event that such measures are needed.
- Authorities’ actions/outcome:
  - As the recovery was stronger than expected the RBA started to withdraw monetary stimulus, raising the policy rate to 4½ percent in six steps, the most recent in May.

### Financial sector policy — staff recommendations and authorities’ actions
- Staff recommended:
  - Future stress tests should be based on more extreme scenarios than used in the past.
  - Stress tests should be undertaken jointly with subsidiaries.
  - Banks should continue to manage carefully their short-term offshore debt.
  - The planned introduction of new liquidity guidelines should encourage less reliance on short-term wholesale funding.
- Authorities’ actions/outcome:
  - APRA conducted stress tests, most recently in 2009/10 in cooperation with the Reserve Bank of New Zealand and the New Zealand subsidiaries of Australian banks.

### External sector and risks highlighted by staff and Executive Board
- Key risks noted:
  - Global outlook risks tilted largely to the downside; if global recovery stalls and Chinese demand for commodities declines, Australia’s terms of trade could fall sharply.
  - Concerns about fiscal sustainability in Europe could disrupt global financial markets and push up the cost of capital for Australian borrowers.
  - Domestic risks: a fall in house prices (assessed by Fund staff as possibly mildly overvalued) and deleveraging by highly indebted households could negatively impact private consumption and slow the recovery.
  - Upside risk: the mining boom may have a larger-than-expected impact on output and inflation.
- Executive Directors’ views:
  - Commended authorities’ decisive policy response and sound fundamentals.
  - Welcomed RBA’s timely unwinding of monetary stimulus; noted that if recovery remains on track and downside risks dissipate, monetary policy might need to tighten further to contain inflation pressures; if the global recovery stalls, the RBA has scope to cut the policy rate.
  - Agreed pace of exit from fiscal stimulus was appropriate; commended plan to return to surplus by 2012/13 and noted enough fiscal space to slow pace of exit or loosen policy in a downside scenario.
  - Recommended allowing automatic fiscal stabilizers to operate fully; emphasized running larger budget surpluses during upswings to avoid overheating and build buffers against sharp falls in commodity prices.
  - Noted vulnerabilities from projected widening of the current account deficit and sizable short-term external debt; recommended efforts to raise national saving (including return to budget surpluses) and encourage banks to extend maturity of offshore funding.
  - Recognized the floating exchange rate as an important buffer; noted staff assessment that the Australian dollar may be mildly overvalued from a medium-term perspective.

### Policy recommendations on tax and structural issues
- Directors welcomed recent review of the tax system, including the introduction of the mineral resource rent tax (MRRT).
- Directors stressed importance of broadening MRRT coverage beyond iron ore and coal.
- Directors recommended more reliance on consumption-based taxes to allow elimination of inefficient state taxes and make room for reductions in personal income taxes; encouraged authorities to build consensus toward this end.

### Data, surveillance, and technical issues
- Data provision: adequate for surveillance. Australia subscribed to the Special Data Dissemination Standard (SDDS); metadata posted on the DSBB.
- ABS initiatives: including prices of financial services in the CPI and developing new measures of labor underutilization.
- STA engagement: meetings in September 2006 to encourage reporting of monetary data using standardized report forms (SRFs); March 2010 STA mission to prepare Data Module of the ROSC assessment.
- APRA/FSAP participation:
  - FSAP missions: November 30–December 14, 2005, and March 26–April 12, 2006.
  - FSSA, Detailed Assessment of Observance of Standards and Codes, and Technical Note on Investor Protection, Disclosure, and Financial Literacy published as Country Reports No. 06/372, No. 06/415, and No. 06/437, respectively.

### Selected economic indicators and projections (2007–11)
- Nominal GDP (2009): $A 1,255 billion (US$996.4 billion)
- Quota (in millions): SDR 3,236.40
- Unemployment rate (September 2010): 5.1 percent

Output and demand (percent change)
- Real GDP: 4.8; 2.2; 1.2; 3.0; 3.5
- Total domestic demand: 6.8; 3.8; 0.5; 5.4; 4.4
  - Private consumption: 5.2; 1.9; 1.7; 3.3; 3.0
  - Total investment: 9.8; 9.0; -1.1; 8.4; 6.1
- Net exports 1/ (contribution to growth): -1.6; -1.7; 2.0; -2.1; -0.7

Inflation and unemployment (in percent)
- CPI inflation: 2.3; 4.4; 1.8; 3.0; 3.0
- Unemployment rate: 4.4; 4.2; 5.6; 5.2; 5.1

Saving and investment (in percent of GDP)
- Gross national saving: 23.1; 24.7; 23.6; 25.7; 27.2
  - General government saving: 5.1; 4.1; 2.6; 2.1; 2.8
  - Private saving 2/: 18.0; 20.5; 21.0; 23.6; 24.4
- Gross capital formation: 28.9; 29.1; 28.0; 28.2; 29.5

Fiscal indicators (cash basis, in percent of GDP) 3/
- Receipts: 25.0; 25.0; 23.3; 21.9; 22.2
- Payments: 23.2; 23.0; 25.2; 25.9; 24.9
- Underlying cash balance: 1.6; 1.7; -2.2; -4.2; -2.9
- Fiscal balance (accrual basis): 1.6; 1.8; -2.4; -4.1; -2.8
- Net debt: -2.7; -3.8; -1.3; 3.3; 5.8

Money and credit (end of period)
- Interest rate (90-day bill, in percent) 4/: 7.2; 4.1; 4.2; 4.3; ...
- Treasury bond yield (10-year, in percent) 4/: 6.3; 4.0; 5.6; 5.6; ...
- M3 (percent change) 4/: 22.7; 14.7; 5.8; 4.2; ...
- Private domestic credit (percent change) 4/: 17.2; 7.6; 0.8; 1.6; ...

Balance of payments (in percent of GDP)
- Current account: -6.2; -4.5; -4.4; -2.4; -2.3
  - Of which: Trade balance (goods): -1.8; -0.3; -0.5; 1.4; 1.6
- Terms of trade (percent change): 4.6; 14.3; -8.3; 18.9; 2.0

External assets and liabilities (in percent of GDP)
- Net external liabilities: 55.9; 56.3; 61.1; 56.9; 55.5
- Net external debt: 51.7; 55.0; 51.9; 50.0; 48.7
- Gross official reserves 4/: 2.7; 3.8; 3.7; 3.2; ...

Exchange rate (period average) 4/
- U.S. dollar/Australian dollar: 0.84; 0.85; 0.79; 0.97; ...
- Trade-weighted index: 67.5; 66.3; 63.2; 71.5; ...
- Real effective exchange rate 5/: 131.1; 128.9; 125.6; 139.0; ...

*Source: IMF staff.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10331.pdf_