## _cr1451

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---

### Medium-Term Fiscal Consistency — recent developments and fiscal outturn
- Economy transitioning as the terms-of-trade-driven mining investment boom has peaked and the economy moves to the production and export phase; mining-related investment that "accounted for almost half of GDP growth in the past couple of years" is expected to drop sharply in the near term.
- Real economy:
  - Annual growth slowed to 2¼ percent in Q3 2013, below trend growth of around 3 percent.
  - Household savings rate remained above 10 percent.
  - Household debt-to-income ratio stable at around 150 percent.
  - Wage inflation slowed to 2¾ percent (lowest since 2000).
  - Unemployment rate has risen gradually from a trough of 5 percent in mid-2011.
- Inflation and monetary policy:
  - Annual inflation slowed to 2¼ percent in Q3 2013, near the middle of the RBA target band.
  - The RBA eased the policy rate by 225 basis points since November 2011 to 2½ percent.
- Fiscal outturn:
  - Budget deficit reduced from 3 percent of GDP to 1½ percent in 2012/13.
  - Company tax revenue came in around ½ percent of GDP lower than expected.
  - Spending exceeded plans by 1¼ percent of GDP.
  - Government grant of 8.8 billion dollars (about 0.6 percent of GDP) to the central bank to increase its capital reserve will be reflected in the fiscal deficit for 2013/14.
- Financial sector:
  - Australian markets were little affected by May 2013 Fed tapering announcement.
  - Banking system profitability remained strong and balance sheets continued to strengthen.

### Outlook and risks
- Near-term outlook:
  - Growth projected at 2½ percent for the year, rising to about 3 percent by 2016/17.
  - Mining investment drop will keep growth soft in the near term; recovery in non-mining investment is needed to return growth to trend.
- Housing sector risks:
  - House prices are up 12½ percent from the 2012 trough; recent revival could boost near-term growth but raises house price inflation risks in Sydney, Melbourne, and Perth.
  - Many households continue to prepay mortgages; balances in mortgage offset and redraw facilities estimated to be 14 percent of outstanding housing loans or around 23 months of scheduled payments at current interest rates.
  - Average LTV around 50 percent; residential mortgage non performing loans below 1 percent.
- External risks:
  - Key exposures: over half of exports go to emerging Asia and nearly two thirds are non-rural commodity exports.
  - A one percent slowdown in China’s investment growth could lower Australian growth by 0.2 percent (previous IMF work).
  - Treasury’s uncertainty estimate for real GDP growth in 2013-14 ranges from 1½ to 3¼ percent (70 percent confidence interval).
- Policy space:
  - Floating exchange rate provides a key cushion.
  - RBA has room to respond though policy rate at 2½ percent limits scope.
  - Modest public debt allows automatic stabilizers to operate and temper pace of deficit reduction when needed.
- Potential outward spillovers:
  - New Zealand vulnerable given that Australian bank subsidiaries constitute 90 percent of New Zealand’s banking system (ring-fenced and well-capitalized).

### Policies to sustain growth — monetary, fiscal, structural
- Monetary policy:
  - Staff view RBA’s monetary stance as broadly appropriate; monetary policy should remain accommodative and act as the primary macro tool in the near term.
- Fiscal policy and strategy:
  - Government aims to return to a sustained surplus, building to a 1 percent of GDP surplus by 2023/24; detailed fiscal strategy to be announced in May.
  - Government pledged to scrap the carbon tax and the mineral resource rent tax, reducing revenue by about ¼ percentage point of GDP compared to total mining-sector budget revenues of around 2 percent of GDP.
  - Staff support improving the budget position over the medium term to rebuild buffers but caution this should not disrupt near-term growth.
- Structural reforms and infrastructure:
  - Improving multifactor productivity is essential; addressing infrastructure bottlenecks and enhancing project selection and prioritization using rigorous cost-benefit analysis and more private-sector involvement recommended.

### Box 1 — Government fiscal target and spending pressures (intergenerational outlook)
- Government committed to delivering a surplus of 1 percent within the next decade.
- Around 40 percent of government spending is directed to health, age-related pensions and aged care, disability, and education ("social spending").
- Projections (applying Intergenerational Report models, next decade):
  - Health and disability spending expected to increase by ½ percent of GDP each.
  - Education, assistance to the aged and pensions by 0.2 percent of GDP each.
- Fiscal consistency exercise:
  - If non-social spending held at current share of GDP, overall expenditure would reach 26½ percent in ten years.
  - If tax revenue held at its average level over the last decade, resulting budget deficit in 2023/24 would reach 2 percent of GDP.
  - Reaching the government’s budget surplus target would require cutting spending by around 3 percent of GDP (reduce net non-social spending or contain increases in social spending).
- Expenses by function (selected exact figures):
  - 2012/13 - Final budget outcome (Total expenses 25.1 percent of GDP): 4.0%, 3.8%, 1.9%, 0.9%, 14.5%
  - 2023/24 - Required for surplus target (Total expenses 23.5 percent of GDP): 4.5%, 4.5%, 2.0%, 1.1%, 11.4%
  - 2023/24 - Projection under current programs (Total expenses 26.6 percent of GDP): 4.5%, 4.5%, 2.0%, 1.1%, 14.5%
- National Commission of Audit:
  - Mandate includes identifying duplication, inappropriate Commonwealth involvement, and improving efficiency; both phases due by end of March 2014 to inform budget decisions.

### Long-run growth and productivity challenges
- Robust income growth over past decade supported largely by unprecedented terms of trade increase; terms of trade declined almost 20 percent from their 2011 peak and expected to decline further.
- To sustain growth in living standards, a significant pickup in labor productivity and multifactor productivity (MFP) is needed.
- Staff sectoral analysis and required MFP:
  - If mining productivity growth increases to "above 2 percent" and other sectors remain at last decade's average, total MFP growth will rise to "near 1 percent," consistent with GDP growth around "3 percent."
  - To achieve a 3 percent annual growth rate given assumptions on hours and capital, MFP would need to grow at "0.7 percent a year".
- Policy focus: deregulation, infrastructure, water management, utilities reform, and leveraging private capital for infrastructure.

### Mining investment decline, adjustment dynamics, and trade effects
- Mining capital expenditure peaked in 2013 and projected to fall sharply.
- Table 1 — Mining Sector Growth Forecast (selected rows):
  - Growth rate — Mining investment: 3.2, -22.3, -36.9 (years 2013/14, 2014/15, 2015/16)
  - Growth rate — Mining exports: 7.1, 9.4, 12.5
  - Growth contribution — Mining investment: 0.3, -1.8, -2.2
  - Growth contribution — Mining exports: 1.0, 1.3, 1.9
  - Net growth contribution: 1.1, 0.4, 0.8
- Offsetting factors: increases in mining export volumes and declines in import volumes.
- Treasury estimate: "a permanent fall in the terms of trade of around 4 percent in 2013/14 would cause a fall in nominal GDP of around ¾ percent in 2013/14 and 1 percent in 2014/15. The fiscal impact would widen the underlying cash deficit by around 0.2% of GDP in 2013/14 and 0.3% of GDP in 2014/15."

### Financial sector resilience, FSAP recommendations, and supervisory measures
- High-priority FSAP recommendations and implementation status (selected):
  - Develop a top down stress testing framework and publish results (RBA): On track; intended implementation 2014.
  - Devote more resources to stress testing (APRA): Implemented.
  - Introduce higher loss absorbency (HLA) for systemic banks (APRA): On track; framework to come into effect January 1, 2016.
  - Intensify on-site supervision of bank liquidity and upgrade daily liquidity reporting (APRA): On track; adopt Basel III liquidity standards.
  - Ensure ADI implementation of single customer view (SCV) by January 1, 2014 (APRA): On track; some banks received extensions.
- Banking system soundness (selected indicators, 2013 Sep):
  - Return on assets (after tax): 0.8
  - Return on equity (after tax): 13.4
  - Regulatory capital to risk-weighted assets: ~12.0
  - Tier 1: ~10.5
  - Gross impaired assets to total assets: 0.7
  - Specific provisions to impaired assets: 40.1
  - Loans composition (2013 Sep): Individuals 57.2 percent of loans; housing loans 52.8 percent; investor housing 17.6 percent.
- Supervisory mitigants: tight lending standards, full recourse loans, little securitization, APRA powers to implement prudential measures including interest sensitivity buffers.

### External sector, current account, and external debt dynamics
- Current account balance (percent of GDP): 2010: -3.5; 2011: -2.8; 2012: -4.1; 2013: -3.1; 2014 (proj): -3.3
- Net external liabilities (percent of GDP): 2013: 55.9; 2014 (proj): 57.3; projected to stabilize around 60.0 by 2018.
- Gross external debt around 100 percent of GDP (2013).
- Balance of payments (current account balance, US$ billions): 2010: -43.9; 2011: -41.5; 2012: -64.1; 2013: -46.4; 2014 (proj): -49.1
- Goods exports (US$ billions): 2010: 213.3; 2011: 271.2; 2012: 258.0; 2013: 252.2; 2014 (proj): 244.6
- Real effective exchange rate remains about 20 percent above the monthly average since 1983 despite depreciation since April last year.

### Risk Assessment Matrix — selected domestic and external shocks
- Potential domestic shocks:
  - Sharp fall in house and/or commercial real estate prices — Likelihood/Direction: Low; buffers include average LTV of 50 percent and household prepayments equivalent to around twenty-three months of mortgage payments.
- Potential external shocks:
  - Surges in global financial market volatility related to exit from unconventional monetary policy — Likelihood/Direction: High / Medium; orderly tapering likely beneficial, disorderly tapering manageable but could raise long-term yields.
  - Sharp slowdown in China — Likelihood/Direction: Medium / High; over half of exports go to China and emerging Asia.
  - Sustained decline in commodity prices — Likelihood/Direction: Low / High; floating exchange rate would buffer impact but could be adverse given iron ore export share.
- Policy responses to shocks:
  - Room for easier monetary policy and full operation of automatic stabilizers.
  - In a severe shock authorities could consider actions similar to the global financial crisis response, including government guarantees if banks lose access to wholesale funding.

### Key numerical projections and indicators (selected exact values)
- Real GDP growth (percent): 2010: 2.3; 2011: 2.6; 2012: 3.6; 2013: 2.5; 2014 (proj): 2.6
- CPI inflation (annual change): 2010: 2.9; 2011: 3.3; 2012: 1.8; 2013: 2.3; 2014 (proj): 2.1
- Unemployment rate (November 2013): 5.8 percent
- Fiscal balance (accrual basis, percent of GDP): 2010: -4.2; 2011: -3.7; 2012: -3.0; 2013: -1.5; 2014 (proj): -2.6
- Net debt (percent of GDP): 2010: 3.3; 2011: 6.0; 2012: 9.9; 2013: 10.0; 2014 (proj): 12.1
- Nominal GDP (in billions of Australian dollar): 2010: 1,359; 2011: 1,453; 2012: 1,501; 2013: 1,553; 2014 (proj): 1,608
- Public gross debt projections (years 2011–2018): 13.3, 24.3, 27.2, 28.9, 31.2, 32.1, 32.0, 31.8, 31.7
- Real GDP growth (in percent) by year (2011–2018 tabulated): 3.1, 2.6, 3.6, 2.5, 2.6, 2.7, 2.9, 3.0, 3.0

### Staff appraisal — consolidated messages
- Outlook: Economy in transition; mining-related investment expected to drop sharply and recovery in non-mining investment required to return growth to trend.
- Risks: Housing revival could support near-term growth but authorities must be ready to act if credit growth, transactions, and prices accelerate; main external risks are a sharp slowdown in China and global market volatility.
- Monetary policy: Should remain accommodative and act as the primary macro tool in the near term.
- Fiscal policy: Returning to surplus will rebuild buffers but will be challenging given social spending commitments; cuts in projected spending and/or increased revenues likely needed; early policy decisions would preserve flexibility.
- Financial sector: Banking sector is sound and resilient though exposed to highly leveraged households and offshore funding rollover risks; supervisory framework permits targeted responses if needed.
- External stability: Increasing mining exports should improve the trade balance; exchange rate dynamics will be important for transition to balanced growth.

*Source: _cr1451 (IMF staff report content).*

### 1. Medium-Term Fiscal Consistency ________________________________________________________________ 9

### 1. Medium-Term Fiscal Consistency

### Recent economic developments
- Setting: The economy is transitioning as the terms-of-trade-driven mining investment boom has peaked and the economy moves to the production and export phase. Mining-related investment that "accounted for almost half of GDP growth in the past couple of years" is expected to drop sharply in the near term.
- Real economy:
  - Annual growth slowed to 2¼ percent in Q3 2013, below trend growth of around 3 percent.
  - Household savings rate remained above 10 percent.
  - Household debt-to-income ratio stable at around 150 percent.
  - Wage inflation slowed to 2¾ percent (lowest since 2000).
  - Mining exports are growing as new capacity comes on stream; housing market activity has begun to pick up (building approvals, transactions, and prices increasing).
  - Unemployment rate has risen gradually from a trough of 5 percent in mid-2011.
- Inflation and monetary policy:
  - Annual inflation slowed to 2¼ percent in Q3 2013, near the middle of the RBA target band.
  - The RBA eased the policy rate by 225 basis points since November 2011 to 2½ percent, with the most recent cut in August 2013.
  - Market lending rates are well below historical averages; overall credit growth has remained relatively subdued.
- Fiscal outturn:
  - Budget deficit reduced from 3 percent of GDP to 1½ percent in 2012/13.
  - Company tax revenue came in around ½ percent of GDP lower than expected.
  - Spending exceeded plans by 1¼ percent of GDP.
  - The government’s grant of 8.8 billion dollars (about 0.6 percent of GDP) to the central bank to increase its capital reserve will be reflected in the fiscal deficit for 2013/14.
- Financial sector:
  - Australian markets were little affected by May 2013 Fed tapering announcement.
  - Banking system profitability remained strong and balance sheets continued to strengthen.

### Outlook and risks
- Near-term outlook:
  - Growth projected at 2½ percent for the year, rising to about 3 percent by 2016/17.
  - Mining investment drop will keep growth soft in the near term; recovery in non-mining investment is needed to return growth to trend.
  - Headwinds: soft labor market, excess capacity in the non-mining sector, and a strong Australian dollar.
  - Risks are broadly balanced: downside—difficult transition to broader-based growth, persistent strong exchange rate; upside—improving business conditions and housing market revival.
- Housing sector risks:
  - Recent housing revival could boost near-term growth but has increased house price inflation, especially in Sydney, Melbourne, and Perth.
  - Overall credit growth moderate; many households continue to prepay mortgages.
  - Risks: rapid house price growth could trigger expectations-driven price overshooting; banks have increased mortgage lending to the investor segment.
  - A sudden house price decline could reduce consumer confidence and economic activity; authorities need to be prepared to act if household credit growth, transactions volume, and prices accelerate.
- External risks:
  - Key exposures:
    - A sharp slowdown in China and a related sustained decline in commodity prices. Over half of exports go to emerging Asia and nearly two thirds are non-rural commodity exports.
    - Surges in global financial market volatility related to exit from unconventional monetary policy could raise Australian banks’ wholesale borrowing costs.
  - Interlinked risks could amplify shocks: a hard landing in China could worsen terms of trade, reduce household income, trigger house price falls, and affect banks’ balance sheets.
  - Model-based sensitivities: previous IMF work suggests a one percent slowdown in China’s investment growth could lower Australia growth by 0.2 percent; Treasury’s uncertainty estimate for real GDP growth in 2013-14 ranges from 1½ to 3¼ percent (70 percent confidence interval).
- Policy space:
  - Floating exchange rate provides a key cushion.
  - RBA has room to respond; monetary transmission is rapid, but with policy rate at 2½ percent scope is limited.
  - Modest public debt gives scope to allow automatic stabilizers to operate and temper pace of deficit reduction when needed.
- Potential outward spillovers:
  - New Zealand vulnerable due to close trade and financial links; Australian bank subsidiaries constitute 90 percent of New Zealand’s banking system, though they are ring-fenced and well-capitalized.

### Policies to sustain growth
- Monetary policy:
  - Staff view RBA’s monetary stance as broadly appropriate. With inflation within target and growth soft, monetary policy should remain accommodative and act as the primary macro tool in the near term.
- Fiscal policy and strategy:
  - Fiscal position compares well to advanced economy peers though debt increased after the global financial crisis.
  - Government aims to return to a sustained surplus, building to a 1 percent of GDP surplus by 2023/24; a detailed fiscal strategy to be announced in May.
  - Government pledged to scrap the carbon tax and the mineral resource rent tax, reducing revenue by about ¼ percentage point of GDP compared to total mining-sector budget revenues of around 2 percent of GDP.
  - Staff support improving the budget position over the medium term to rebuild buffers but caution this should not disrupt near-term growth.
- Consistency of fiscal projections:
  - Achieving and sustaining a surplus over the next decade will be challenging given current social spending commitments.
  - Staff analysis: achieving a surplus would require either an increase in revenue or sizeable cuts in projected spending.
  - Early decisions on policy changes would help preserve policy flexibility.
- Authorities’ views and actions:
  - Authorities revised down near-term growth projections (in line with staff).
  - They expect policy rate reductions already made to continue having effects and have not ruled out further cuts.
  - Foreign exchange intervention remains part of the toolkit but recently used only at times of market dysfunction.
  - To achieve the surplus aim, sizeable cuts in projected spending would be required; recommendations from the National Commission of Audit will be important.

*International Monetary Fund*

### Box 1. Medium-Term Fiscal Consistency

### Box 1. Medium-Term Fiscal Consistency

### Government fiscal target and spending pressures
- The Government has committed to delivering a surplus of 1 percent within the next decade.
- Around 40 percent of government spending is directed to health, age-related pensions and aged care, disability, and education (here referred to as “social spending”).
- Spending on these areas is projected to increase significantly over the Report’s 40-year horizon; rising health costs account for around two-thirds of the overall increase.
- Some policy and legal changes—in education and the second round of private health insurance in particular—have been made since the Report was published which affect the composition of spending pressures, although the outlook remains broadly the same.

### Projections and fiscal consistency exercise
- Applying the Intergenerational Report’s expenditure growth models and projections for social spending over the next decade:
  - Health and disability spending are expected to increase over the next decade by ½ percent of GDP each.
  - Education, assistance to the aged and pensions by 0.2 percent of GDP each.
- If other “non-social” spending were held at its current level as a share of GDP:
  - Overall expenditure would reach 26½ percent in ten years.
  - If tax revenue is held at its average level over the last decade, the resulting budget deficit in 2023/24 would reach 2 percent of GDP.
  - Reaching the government’s budget surplus target would thus require cutting spending by around 3 percent of GDP, either by reducing net non-social spending or by putting in place policy measures to contain increases in social spending.

### Expenses by function (selected exact figures from composition and scenarios)
- 2012/13 - Final budget outcome (Total expenses 25.1 percent of GDP)
  - 4.0%
  - 3.8%
  - 1.9%
  - 0.9%
  - 14.5%
- 2023/24 - Required for surplus target (Total expenses 23.5 percent of GDP)
  - 4.5%
  - 4.5%
  - 2.0%
  - 1.1%
  - 11.4%
- 2023/24 - Projection under current programs (Total expenses 26.6 percent of GDP)
  - 4.5%
  - 4.5%
  - 2.0%
  - 1.1%
  - 14.5%

### Policy response: The National Commission of Audit
- The government established the Commission as an independent mechanism to review and report on the performance, functions and roles of the Commonwealth government.
- Main objectives include:
  - Identify areas of unnecessary duplication between the activities of the Commonwealth and other levels of government.
  - Identify areas or programs where Commonwealth involvement is inappropriate, no longer needed, or blur lines of accountability.
  - Improve the overall efficiency and effectiveness with which government services and policy advice are delivered.
- Process and timing:
  - The Commission will report to the Prime Minister, Treasurer, and the Minister for Finance with both phases of the audit due by the end of March 2014.
  - The recommendations are expected to inform the decisions presented in next budget.
- Expected fiscal impact:
  - The established priorities are meant to allow savings conducive to improving the medium-term fiscal position.

*Source: Box 1. Medium-Term Fiscal Consistency.*

### 28. Long-run growth. Robust income growth over the past decade has been supported in large

### _cr1451 - 28. Long-run growth. Robust income growth over the past decade has been supported in large

### Long-run growth
- Robust income growth over the past decade has been supported in large part by the unprecedented increase in the terms of trade, which as it unwinds, is likely to detract from income growth going forward.
- A significant pickup in labor productivity will be needed to maintain growth in living standards over the coming decade (Annex 4, Box).
- Productivity in the mining sector should improve as the investments begin yielding results, but this will not be enough to maintain current levels of per capita growth; productivity growth in other sectors will also need to rise.
- Australia already benefited from sizeable productivity improvements following substantial structural reforms in the 1990s, making further scope for improvement challenging.
- A shift to broader-based growth would be helped by making the most of opportunities offered by a growing Asian middle class to support demand for Australia’s services exports—particularly health, education, tourism and professional services.

### Authorities’ views
- The authorities agreed that the greater role of mining in the economy had increased Australia’s exposure to terms of trade fluctuations.
- Australia’s terms of trade have declined by almost 20 percent from their historic peak in 2011, and are expected to decline further over the coming years as global mining capacity increases.
- The government’s medium-term budget revenue projections are based on a significant decline in the terms of trade.
- Despite increased mining exports, the sector will still play a smaller role in Australia’s economy than the service sector, particularly with respect to employment.
- Improving multifactor productivity is regarded as essential for maintaining growth in living standards and will be challenging.
- Addressing infrastructure bottlenecks is a key priority; enhancing the framework for selection and prioritization of infrastructure projects based on rigorous cost-benefit analysis, and including more involvement by the private sector, would help allow for spending on infrastructure consistent with the government’s deficit reduction goals.

### STAFF APPRAISAL — Outlook
- The Australian economy has reached a transition phase as the terms-of-trade-driven mining investment boom of the past decade 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 and return the economy’s growth rate to trend.

### STAFF APPRAISAL — Risks
- Revival in housing market activity could contribute to near-term growth and help address persistent structural supply shortages.
- Authorities will need to be prepared to take actions should credit growth and transactions volume pick up sharply to prevent an unsustainable acceleration in house price inflation.
- Main external risks include a sharp slowdown in growth in China over the medium term and the risk of a surge in global financial market volatility.
- The authorities have both monetary and fiscal policy space to react if the outlook deteriorates.

### STAFF APPRAISAL — Monetary policy
- 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.
- Monetary policy should act as the primary macroeconomic tool for managing aggregate demand in the near term.

### STAFF APPRAISAL — Fiscal policy
- The government’s aim to return the budget to surplus in the coming years will help rebuild fiscal buffers and increase the policy scope to deal with adverse shocks, but will be challenging in light of current social spending commitments.
- Cuts in projected spending and/or increased revenues are likely to be needed, and early decisions on policy changes required would help preserve policy flexibility.

### STAFF APPRAISAL — Financial sector
- The banking sector is 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.
- Banks remain exposed to highly leveraged households and rollover risks associated with short-term offshore funding needs.
- The authorities’ intensive supervisory framework should allow for a targeted response if house price inflation becomes a risk.
- 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.

### STAFF APPRAISAL — External stability
- Increasing mining exports should improve the trade balance, and the current account deficit should settle at a level that stabilizes Australia’s net foreign liabilities.
- Prospects for both near-term growth and external sustainability will depend on whether the exchange rate, which currently looks moderately overvalued, moves consistently with Australia’s fundamentals going forward.
- Monetary policy tightening by major advanced economies would help weaken the dollar and support the transition toward more balanced growth.

### STAFF APPRAISAL — Medium-term growth prospects
- The increased role of the mining sector will make the economy more sensitive to terms of trade shocks.
- 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 key challenge going forward will be finding ways of increasing productivity to maintain growth in Australia’s living standards.
- Addressing infrastructure bottlenecks in a manner consistent with the government’s deficit reduction goals is a priority.

*Source: _cr1451 - 28. Long-run growth. Robust income growth over the past decade has been supported in large (IMF staff report content).*

### 37. It is recommended that the next article IV consultation be held on the standard

### _cr1451 - 37. It is recommended that the next article IV consultation be held on the standard

### Financial Stability — High-Priority FSAP Recommendations and Progress
- Recommendation 1: Develop a top down stress testing framework and publish top down stress test results in the Financial Stability Review (RBA).
  - Implementation: On track. RBA developing framework to complement APRA’s stress tests. Practices at other central banks assessed; stakeholders consulted. Intended implementation 2014.
- Recommendation 2: Devote more resources to stress testing (APRA).
  - Implementation: Implemented. APRA has increased resources and is implementing an internal stress testing strategy.
- Recommendation 3 / 9: Introduce higher loss absorbency (HLA) for systemic banks (APRA).
  - Implementation: On track. APRA released an information paper setting out framework; framework will come into effect from January 1, 2016.

### Financial Sector Oversight — Recommendations and Implementation Status
- Recommendation 4: Intensify on-site supervision of bank liquidity and upgrade daily liquidity reporting requirements to ensure consistency (APRA).
  - Implementation: On track. Liquidity themed reviews increased; APRA will adopt Basel III liquidity standards, including standardized emergency daily reporting capacity.
- Recommendation 5: Improve the effectiveness of conduct of business supervision for insurance companies (ASIC).
  - Implementation: Further consideration required; being considered in light of broader ASIC supervision work.
- Recommendation 6: Ensure sufficiency and stability of ASIC core funding (Treasury).
  - Implementation: Further consideration required; discussions ongoing taking into account broader funding and supervision policy questions.
- Recommendation 7: Extend risk based capital requirements, large exposure rules, and reporting requirements to ensure that AFSL holders are appropriately covered (ASIC).
  - Implementation: Partially implemented. ASIC introduced increased risk based capital adequacy requirements and periodic reporting for additional classes of licensees (e.g. custodians). ASIC is gauging extent of potential risks from large exposures.

### Crisis Management — Recommendations and Implementation Status
- Recommendation 8: Re-evaluate merits of ex-ante funding for the FCS with a view to converting it to an ex-ante funded scheme (Treasury/CFR).
  - Implementation: On track. In August 2013 the previous Government committed to establishing a dedicated Financial Stability Fund, from January 2016. Implementation subject to Financial System Inquiry outcomes.
- Recommendation 10: Ensure ADI implementation of single customer view (SCV) on, or where possible, ahead of the agreed timetable (APRA).
  - Implementation: On track. Prudential Standard required SCV implementation by January 1, 2014; some banks received extensions.
- Recommendation 11: Conduct frequent and focused crisis simulations and other forms of resolution testing (APRA/CFR).
  - Implementation: On track. APRA reviewing internal framework for crisis simulations; CFR Crisis Management Working Group reviewing cross-agency and Trans-Tasman simulation framework.
- Recommendation 12: Continue recovery planning and introduce resolution planning (APRA).
  - Implementation: On track. APRA conducted a pilot recovery plan project for ADIs and is considering a formal recovery planning framework; developing strategies for resolution planning.

### Macroeconomic Overview and Growth
- Real GDP growth:
  - 2010: 2.3
  - 2011: 2.6
  - 2012: 3.6
  - 2013: 2.5
  - 2014 (proj): 2.6
- Contributions to growth show slowing since second half of 2012, partly due to weak private consumption and declining terms of trade as commodity prices fell.
- Mining investment passed its peak in 2013; employment in mining-related sectors may fall back.

### Household Vulnerabilities
- Household debt to disposable income (In percent, 2013Q3 or latest available data): examples shown in figure (specific country values preserved in source charts).
- Household's net saving rate and house price-to-income ratio:
  - Household net saving rate and house price-to-income ratio have steadied; credit growth moderated though house prices began to pick up in recent months.
- Mortgage repayment buffers:
  - Share of housing loans and number of months of buffers shown in figures; households have buffers to weather temporary shocks.

### Inflation and Labor Market
- CPI inflation (annual change): 2010: 2.9; 2011: 3.3; 2012: 1.8; 2013: 2.3; 2014 (proj): 2.1
- Underlying inflation has remained moderate and in the lower half of the band; wage inflation has slowed with weakening labor market conditions.
- Indicators suggest spare capacity in the economy; inflation expectations have declined.
- Output gap and trimmed mean / weighted median inflation series are reported in source figures.

### Monetary Stance
- RBA policy interest rate reduced by 225 bps since late November 2011.
- Real policy rate has remained below its recent average.
- Banks’ funding cost remains above pre-GFC levels; mortgage rates followed the cash rate.
- Market lending rates and real lending rates are below historical averages.

### Fiscal Stance and Outlook
- Several years of gradual tightening expected to reduce the budget deficit through revenue growth and restraint in operating expenditure growth.
- Net debt projection: about 15 percent by 2018/19.
- Commonwealth Government fiscal impulse, underlying cash balance, and projections shown in figures and tables.
- Table 1 fiscal indicators (selected):
  - CPI inflation (2013): 2.3
  - Unemployment rate (November 2013): 5.8 percent
  - Fiscal balance (accrual basis): 2010: -4.2; 2011: -3.7; 2012: -3.0; 2013: -1.5; 2014 (proj): -2.6
  - Net debt: 2010: 3.3; 2011: 6.0; 2012: 9.9; 2013: 10.0; 2014 (proj): 12.1
  - Nominal GDP (in billions of Australian dollar): 2010: 1,359; 2011: 1,453; 2012: 1,501; 2013: 1,553; 2014 (proj): 1,608

### Fiscal Tables — Medium-Term Scenario and Fiscal Accounts
- Medium-Term Scenario (Table 2) highlights (selected):
  - GDP growth projections: 2014: 2.6; 2015: 2.7; 2016: 2.9; 2017: 3.0; 2018: 3.0
  - CPI inflation projections: 2014: 2.1; 2015: 2.3; 2016: 2.5; 2017: 2.5; 2018: 2.5
  - Net external liabilities (percent of GDP): 2013: 55.9; 2014 (proj): 57.3; 2018 (proj): 60.0
- Fiscal Accounts (Table 3) — Commonwealth government (accrual basis, percent of GDP) selected rows:
  - Revenue: 2010/11: 22.0; 2011/12: 22.8; 2012/13: 23.7; 2013/14: 23.7; 2014/15: 23.8
  - Expenditure: 2010/11: 25.7; 2011/12: 25.8; 2012/13: 25.2; 2013/14: 26.4; 2014/15: 25.5
  - Net lending (+) / borrowing (-) (fiscal balance): 2010/11: -3.7; 2011/12: -3.0; 2012/13: -1.5; 2013/14: -2.6; 2014/15 (proj): -1.7
  - Commonwealth government net debt (memorandum): 2010/11: 6.0; 2011/12: 9.9; 2012/13: 10.0; 2013/14: 12.1

### Banking System Developments and Financial Soundness
- Lending structure and funding:
  - Housing loans rising to over half of total lending.
  - Deposit growth allowed banks to reduce use of wholesale funding.
- Capital and profitability:
  - Capital levels rising and exceed regulatory requirements.
  - Return on assets (after tax) around 0.8 (2013 Sep).
  - Return on equity (after tax) 13.4 (2013 Sep).
  - Regulatory capital to risk-weighted assets ~12.0 (2013 Sep); Tier 1 ~10.5 (2013 Sep).
- Asset quality:
  - Gross impaired assets to total assets 0.7 (2013 Sep).
  - Specific provisions to impaired assets 40.1 (2013 Sep).
- Loans composition (2013 Sep): Individuals 57.2 percent of loans; housing loans 52.8 percent; investor housing 17.6 percent.

### Financial Market Indicators
- Resource stock index lagging financial and overall stock indices.
- Credit default swap spreads are low.
- Exchange settlement balances at the RBA remain low compared to 2009.
- Market expectations from overnight swap market align with current policy rates over next year.
- Longer term yields have risen following Fed tapering announcements; sovereign spreads remain low.

### Trade, Current Account, and Balance of Payments
- Composition of exports: rising share of resource sector, especially non-rural commodity exports.
- Exports of coal and iron ore remain strong.
- Imports of capital goods declined sharply from peak, contributing to narrowing current account deficit.
- Current account balance (percent of GDP):
  - 2010: -3.5
  - 2011: -2.8
  - 2012: -4.1
  - 2013: -3.1
  - 2014 (proj): -3.3
- Balance of payments (Table 4, selected US$ amounts):
  - Current account balance (billions of US dollars): 2010: -43.9; 2011: -41.5; 2012: -64.1; 2013: -46.4; 2014 (proj): -49.1
  - Goods exports (US$ billions): 2010: 213.3; 2011: 271.2; 2012: 258.0; 2013: 252.2; 2014 (proj): 244.6

### External Vulnerability and External Debt
- Net external liabilities (percent of GDP): 2012: 55.1; 2013 (proj): 55.9; 2014 (proj): 57.3
- Gross external debt (percent of GDP, Table 5): 2013: 101.4 (or 100.1 in other table variants); gross external liabilities and assets reported in detailed tables.
- Short-term external debt has continued to decline as share of gross debt; short-term gross external debt figures provided in tables (e.g., Short-term gross external debt 2013Q2 values shown in figures).
- Bank gross external debt (2013Q2) relatively low compared with peers (values shown in source figures).

### Interconnections and Spillovers
- Trade links mainly with China, implying exposure to commodity price shocks.
- Financial links concentrated with New Zealand, United States, and United Kingdom; financial links with Asia are increasing from a low base.
- Non-performing assets of banks’ overseas operations are low across regions shown.

### Key Summary Statistics (selected from tables)
- Nominal GDP (2012): A$ 1,501 billion
- Quota (in millions): SDR 3,236
- GDP per capita (2012): US$ 67,556
- Population (June 2013): 23 million
- Unemployment rate (November 2013): 5.8 percent
- Main exports: Iron ores and minerals; coal; rural goods

*Source: IMF staff report and tables as provided in the source content.*

### Annex 1. Risk Assessment Matrix

### Annex 1. Risk Assessment Matrix

### Potential Domestic Shocks
- Sharp fall in house and/or commercial real estate prices.
  - Likelihood/Direction: Low
  - Expected Impact on the Economy and Policy Response:
    - "The pickup in housing market activity could contribute to growth and help boost housing supply. However if prices accelerate together with leverage and transactions this could lead to overshooting. But a collapse of house prices is not an imminent risk."
    - "A construction boom has not accompanied the run-up in house prices and housing supply appears tight in a number of areas."
    - "An average LTV ratio of 50 percent provides a buffer against a large fall in house prices, though it would dent wealth and consumption."
    - "Households have prepayments equivalent to around twenty-three months of mortgage payments."
    - "Commercial real estate prices have adjusted sharply since 2008 and NPLs have passed their peak."

### Potential External Shocks
- Surges in global financial market volatility related to the exit from unconventional monetary policy.
  - Likelihood/Direction: High / Medium
  - Expected Impact on the Economy and Policy Response:
    - "Australia was little affected by the bout of volatility following the Fed’s tapering announcements."
    - "Orderly tapering would likely be beneficial for the economy and may help bring about an exchange rate depreciation. Disorderly tapering may lead to some overshooting but would be manageable."
    - "If financial market disruption is prolonged and affects growth in key emerging Asia or European markets, that could prompt rises in long term bond yields adding to debt service costs."

- Volatility in wholesale and external funding.
  - Likelihood/Direction: Medium / Low
  - Expected Impact on the Economy and Policy Response:
    - "Banks’ reliance on wholesale and external funding has fallen back a little but remains high."
    - "Foreign liability positions are largely hedged and explicit liquidity support from the RBA means that a reversal in capital flows is unlikely to result in forced asset sales."
    - "Nevertheless volatility in funding markets could raise banks’ funding costs which may be passed on to households and corporates."

- Sharp slowdown in China over the medium term.
  - Likelihood/Direction: Medium / High
  - Expected Impact on the Economy and Policy Response:
    - "Over a half of Australia’s exports go to China and emerging Asia, leaving growth prospects vulnerable to their economic outlook."

- Sustained decline in commodity prices.
  - Likelihood/Direction: Low / High
  - Expected Impact on the Economy and Policy Response:
    - "The free floating exchange rate would help buffer the impact on the economy, but as iron ore exports form a substantial part of Australia’s exports a sustained decline would have an adverse effect."

### Policy responses to shocks
- For downside shocks there is room for easier monetary policy and for full operation of automatic stabilizers.
- "In the event of a severe shock the authorities could react as they did at the onset of the global financial crisis including considering a government guarantee if banks lose access to wholesale funding."

### Supplementary findings from Annex 2 (Housing market context and buffers)
- Long-term developments and vulnerabilities:
  - "Real house prices have roughly doubled since 1990."
  - "The median house price to income ratio rose sharply from around 3 at the beginning of the 2000s ... peaking at just over 4 in 2009."
  - "Households’ borrowing capacity increased and they moved to a higher steady state level of indebtedness and higher house prices relative to incomes."
  - "The debt to income ratio rising from among the lowest at 46 percent in 1990 to around 150 per cent in 2013."
  - "Commercial property exposures: 10 percent of the loan book; impaired loans peaked in 2010 at 6 percent of commercial real estate exposures but have fallen back to 2 percent since then."

- Recent trends:
  - "House prices are up 12½ percent from the 2012 trough."
  - "Residential mortgage non performing loans below 1 percent."
  - "Credit growth is moderate and many households continue to pay down debt."
  - "The higher household savings ratio of recent years also suggests a more prudent pattern of household consumption than in the mid 2000s."
  - "Balances in mortgage offset and redraw facilities are estimated to be 14 percent of the outstanding stock of housing loans or around 23 months of scheduled payments at current interest rates."

- Supply-side and regional considerations:
  - "Housing completions are currently averaging 150,000 a year."
  - "Given rapid population growth, housing investment over the last decade has been relatively moderate compared to other OECD economies."
  - "There are some tentative signs that a trend to higher density housing may have started with part of the increase in approvals since 2012 due to approvals for higher density housing."
  - "Regional housing markets have already experienced different patterns of activity and the 2009-2012 experience suggests that a correction in nominal house prices can be tolerated. But a protracted and bumpy adjustment process with shocks to unemployment could leave some borrowers stretched."

- Supervisory and prudential mitigants:
  - "Most mortgage lending is by institutions that are prudentially regulated by a single regulator (APRA) which may enable vulnerabilities to be detected at an early stage."
  - "Lending standards are tightly enforced with a strong regulatory focus on debt serviceability as well as the quality of collateral."
  - "Loans are full recourse."
  - "There is little securitization and few low documentation loans, Australia applies a tighter setting of prudential rules on housing loans than is required under the Basel framework and institutions’ capital positions are strong."
  - "APRA has the powers to implement a range of prudential measures—similar to those adopted or under consideration by other economies—should they be needed; this could include requiring banks to increase interest sensitivity buffers."

*Annex 1. Risk Assessment Matrix — IMF staff.*

### 14.      Average leverage is low, assets provide

### _cr1451 - 14.      Average leverage is low, assets provide

### Household leverage and mortgage buffers
- The average loan to value ratio is around 50 percent.
- Household non-financial assets are around three times bigger than household debt.
- Household financial assets are around twice bigger than household debt.
- Around 4 percent of indebted households currently have debt which exceeds assets.
- Households in the top two income deciles held around 70 percent of mortgage debt in 2010.
- Households in the bottom two income deciles held only 10 percent of mortgage debt in 2010; these tended to be older households with typically smaller mortgages and higher net asset holdings.
- Figure presented: Mortgage Buffers (share of housing loans and number of months), with data backcast before December 2010 to adjust for a reporting change by one bank.

### Banking exposure, non-performing loans, and system resilience
- Residential mortgages account for over 50 percent of total lending among Australian banks, making the financial system exposed to housing market distress.
- Despite large mortgage portfolios and price fluctuations, non-performing housing loans have remained low over the last decade:
  - Total non-performing housing loans less than 0.7 percent of total housing loans.
  - One quarter of these non-performing housing loans are considered impaired.
- Contributing factors to low non-performing rates include low average leverage, substantial asset cover, and concentration of indebtedness at higher income deciles.

### Risks from credit growth, investor activity, and interest-only mortgages
- Recent increase in housing activity has been concentrated in investor loans.
- A relatively high proportion of investor loans and owner-occupier loans are interest only.
- For Australia, interest only mortgages may pose less of a risk because mortgage prepayments remain high even for interest only loans.
- The National Consumer Credit Code provisions require lenders to meet responsible lending standards; lenders must be able to show that the consumer can be expected to repay the loan from their own resources, without having to sell the collateral.
- Information on repayment plans for interest-only mortgages and their sensitivity to interest rate, income, or asset shocks could be helpful for assessment.
- APRA and RBA have emphasized that investor returns on housing are likely to be lower going forward than over the past decade and have noted the need for caution.

### External sector — long view, drivers of current account deficits, and net foreign liabilities
- Australia’s current account has been in deficit for most of the period since 1861; current account deficits have averaged around 4 percent of GDP in the last three decades.
- Gross savings in Australia have been comparable to other advanced economies, but investment has been significantly higher than peers.
- Investment spending in Australia’s resources sector rose from just under 2 percent of GDP in 2002 to the peak of 8 percent of GDP this past year.
- Around half of the value of the resources investment projects is imported, contributing to a widening trade deficit.
- The current account regression in the IMF’s EBA produces persistent one-sided unexplained residuals, implying the deficit has been larger than predicted by fundamental factors.
- Net foreign liabilities increased to around 55 percent of GDP in 2012.
- Public debt held abroad, private financial sector debt, and private nonfinancial corporate sector each accounted for about one third of total net external debt liabilities.
- The resources sector investment boom (estimated to have totaled $284 billion by 2012) did not cause sharp increases in nonfinancial corporate sector net foreign debt because around four-fifths of funding for mining sector physical investment was sourced offshore and three-quarters of that was in the form of foreign direct investment (FDI); since 2007 a large portion of FDI was supplied through reinvested earnings.

### Projections, scenarios, and sensitivity
- BREE projections: total resources sector export volumes will grow by more than 30 percent in the next five years.
  - Iron ore exports forecast to increase by more than 40 per cent over the next three years, with total volumes reaching double their 2008-09 level in 2014-15.
  - Coal export volumes expected to increase by almost 18½ percent over the next three years to reach volumes around 60 per cent higher than in 2008-09.
  - Liquid natural gas (LNG) exports expected to increase by 50 percent in the next couple of years and to double in the medium term.
- Under staff’s baseline scenario:
  - The current account deficit would remain a bit below 4 percent of GDP over the medium term.
  - Net foreign liabilities as a share of GDP are projected to stabilize around 60 percent by 2018/19.
- The projected improvement in the trade balance is expected to be partly offset by a widening income account deficit due to normalization of global interest rates and increased mining income accruing to foreign investors, given large foreign ownership in Australia’s mining sector.
- Assessment is sensitive to household savings behavior and commodity prices; deeper-than-expected private sector deleveraging could push up household and corporate savings and alter outcomes if the decline in terms of trade lasts longer or the transition to broader-based growth is bumpy.

### Exchange rate, capital flows, and non-structural factors
- The real effective exchange rate (REER) is still about 20 percent above the monthly average since 1983 despite depreciation since April last year.
- Regression analysis as part of the IMF’s EBA suggests terms of trade gains and Australia’s positive interest rate differentials contributed to the Australian dollar’s strength since 2009.
- Regression residuals (overvaluation not captured by fundamentals) may be related to short-term factors such as strong portfolio inflows, especially to the official government debt market since 2009.
- The Australian dollar tends to appreciate the most when global risks (proxied by the VIX index) decrease, implying exchange rate strength is related to global “risk-on” episodes and investor risk appetite.
- Estimated overvaluation declined somewhat in 2013; currency movements in 2013 were influenced by RBA policy rate cuts, the May 22 “Fed tapering” speech, subsequent market outflows, and later Fed decisions on QE tapering.
- Much of the dollar’s strength depends on global commodity prices and China’s growth prospects; exit from unconventional monetary policies by major advanced economies may lead to tighter global financial conditions and less portfolio inflows to Australia.

### Near-term challenge: managing the transition from the mining investment boom
- Mining investment spending rose from just under 2 percent of GDP in 2002 to the peak of 8 percent of GDP in 2013.
- The initial surge was driven by coal and iron ore projects; more recently the majority of resources investment has been in LNG projects.
- Australia’s total merchandise imports as a share of GDP in 2003-2012 was 3 percentage points higher than in the previous decade, driven by strong growth in imports of capital goods and consumer goods.
- Investment in the resources sector relied heavily on foreign funding: around four-fifths of physical investment has been sourced offshore and the share of foreign ownership in the mining industry is large.
- Contrast with Norway and Chile where resources sectors are dominated by public companies that have enabled sovereign wealth funds to buffer commodity shocks.

*Source: IMF staff report excerpt (chapter/section provided).*

### 4.      The decline in mining investment and its impact on growth. Mining investment peaked

### 4.      The decline in mining investment and its impact on growth. Mining investment peaked

### Mining investment peak and near-term impact
- Mining capital expenditure peaked in 2013 and is projected to fall sharply in the coming years.
- Mining capital expenditure "accounted for more than half of the GDP growth in the past two years."
- Table 1 — Mining Sector Growth Forecast (2013/14, 2014/15, 2015/16)
  - Growth rate
    - Mining investment: 3.2, -22.3, -36.9
    - Mining related imports: 3.2, -22.3, -36.9
    - Mining exports: 7.1, 9.4, 12.5
  - Growth contribution
    - Mining investment: 0.3, -1.8, -2.2
    - Mining related imports: -0.1, 0.9, 1.1
    - Mining exports: 1.0, 1.3, 1.9
    - Net growth contribution: 1.1, 0.4, 0.8
- Offsetting near-term factors: increases in mining export volumes and declines in import volumes.
- Investment intentions in the resources sector tend to be correlated with commodity prices; higher-than-expected commodity prices could revive delayed or cancelled pipeline projects.

### Non-mining investment dynamics
- Investment outside the resources sector has been weak due to:
  - the strong exchange rate weighing on non-mining sector competitiveness,
  - a general lack of business confidence,
  - a possible shift in household savings behavior (Lowe 2013).
- As mining investment declines, non-mining sectors could benefit from increased available investment-related resources and falling costs, notably:
  - construction industry — capacity constraints from strong mining demand may ease;
  - labor productivity in construction is "the highest in more than ten years" (Figure 4), so construction investment could absorb slack.
- Non-mining sectors may also benefit from a weakening elevated exchange rate and strengthened business confidence.

### Employment and labor reallocation
- Resources sector share of total employment doubled from the mid 2000s to "around 9¾ percent in 2011/12."
- About one quarter of the overall employment increase was in resources extraction; the remainder in industries servicing mines (Bishop et al 2013).
- Mining output and employment are relatively insensitive to Australian cycles and more sensitive to world economic cycles (Battersby et al 2013).
- The investment boom supported wage growth in less skilled occupations (Minifie 2013); as the sector moves to a more capital-intensive phase, demand for labor is expected to fall, creating potential skills mismatches that could impede smooth labor reallocation.

### Effects across states and spillovers
- Mining investment boom supported rapid growth in Western Australia, Queensland and Northern Territory, with strong wage growth attracting migration and "fly-in, fly-out" workers.
- Distribution of mining receipts is dispersed nationally via:
  - purchases of intermediate inputs from non-mining states,
  - widely dispersed Australian equity holders,
  - tax payments to government to be spent across the country (Connolly and Orsmond 2011).
- Negative impacts of investment decline in resource-rich states could transmit quickly to other parts of the country.

### Coping with increased volatility and terms of trade shocks
- Increased mining size raises exposure to external demand volatility and terms of trade shocks, but first-round effects might be relatively contained:
  - mining supply is relatively inelastic; prices likely to remain above marginal cost for most projects, so export volume effects might be small.
  - the floating exchange rate can help buffer shocks by depreciating when the terms of trade falls, improving tradable sector competitiveness.
  - negative impacts on mining revenues/profits are shared between Australia and abroad because mining companies have globally distributed shareholdings; domestic bank exposures are low as investment is largely financed by FDI.
  - the sector’s effective company tax rate is 15 percent compared to 25 percent for the corporate sector as a whole.
  - additional revenues from state royalties and the federal resource rent tax are "small, under 1 percent of GDP."
- Treasury estimates: "a permanent fall in the terms of trade of around 4 percent in 2013/14 would cause a fall in nominal GDP of around ¾ percent in 2013/14 and 1 percent in 2014/15. The fiscal impact would widen the underlying cash deficit by around 0.2% of GDP in 2013/14 and 0.3% of GDP in 2014/15." Staff simulations show comparable results.
- Second-round effects (confidence, household income, consumption) could amplify impacts; model simulations indicate that as mining exports increase by 30 percent, the impact of a temporary negative external demand shock in emerging Asia on nominal GDP could increase by one-fifth (Annex Figure 2).

### LNG and commodity-market risks
- LNG has grown from "less than 5 percent of world gas consumption in 2000 to over 10 percent."
- IEA forecasts Australia's LNG exports will increase rapidly from 2015, making Australia the world’s largest exporter of LNG.
- Asian and Pacific importers historically agree long-term, oil-indexed contracts, but more diverse and competitively-priced supplies could shift pricing away from oil-indexation, increasing price sensitivity for LNG producers and posing challenges for high-cost Australian LNG projects.

### Historical experience and cross-country comparisons
- Previous mining booms were associated with poor macro outcomes (high inflation and unemployment); the 1980s resources boom example: 24 percent rise in hourly wages in 1982 for metals manufacturing led to a 16 percent rise in wages across the workforce, followed by double-digit inflation and unemployment (Connolly and Orsmond 2011).
- Recent stability amid a larger mining boom reflects institutional improvements: floating exchange rate, inflation-targeting, decentralized wage bargaining, and product market flexibility.
- Cross-country experiences differ:
  - Norway: robust growth after oil investment boom due to strong oil exports.
  - Chile: rapid growth after copper investment boom owing to strong productivity growth following structural reforms.
  - Australia is unlikely to replicate Norway’s export-led trajectory because the commodity sector is small relative to the rest of the economy; Australia already benefited substantially from 1990s structural reforms, limiting scope for a large post-investment productivity jump in non-resource sectors.

### Productivity, potential output, and long-run growth
- To sustain long-run growth "around 3 percent," multifactor productivity (MFP) growth needs to reverse its declining trend to offset likely decline in capital input growth (Figure 7).
- Footnote assumptions: Assuming hours worked grow at the same rate as population at an annual rate "around 1.8 percent", capital input grows in line with GDP, and relative labor and capital income shares remain at current levels, a 3 percent annual growth rate requires MFP to grow at "0.7 percent a year", close to the historical average of 1994-2011.
- Staff sectoral analysis: if mining productivity growth increases to "above 2 percent" and productivity growth in other sectors remains at the average level of the last decade, total MFP growth will rise to "near 1 percent," consistent with GDP growth at around "3 percent."
- BREE (2013) finds that after adjusting for deposit depletion and production lags, mining MFP increases from an average annual rate of negative "0.65" to positive "2.5 per cent" between 1985-86 and 2009-10.
- Productivity challenges noted:
  - measured mining productivity fell partly due to investment-to-output lags;
  - mining boom contributed to skills shortages hampering productivity growth;
  - utilities sector shift to more expensive energy sources and technologies adversely affected measured productivity.
- Policy focus to deliver broader-based productivity growth includes deregulation, infrastructure, water management, and utilities reform; infrastructure financing highlighted as a priority while chairing the G20.

*Source: _cr1451 - 4.      The decline in mining investment and its impact on growth. Mining investment peaked*

### References

### _cr1451 - References

### References cited
- Arsov, I., Shanahan, B. and T. Williams, 2013, “Funding the Australian Resources Investment Boom,” RBA Bulletin March Quarter 2013.
- Battersby, B., Kouparitsas, M. and J. Munro, 2013, “Uncovering the Sources of Sectoral Employment Fluctuations,” Treasury Working Paper, 2013-03.
- Bishop, J., Kent, C., Plumb, M. and V. Rayner, 2013, “The Resources Boom and the Australian Economy: A Sectoral Analysis,” RBA Bulletin, March 2013.
- BREE (Bureau of Resources and Energy Economics), 2013, “Productivity in the Australian Mining Sector,” March 2013.
- Conolly, E., Jaaskela, J. and M. van der Merwe, 2013, “The Performance of Resource-exporting Economies,” RBA Bulletin September Quarter 2013.
- Connolly, E. and D. Orsmond, 2011, “The Mining Industry: From Bust to Boom,” RBA Research Discussion Paper 2011-08.
- Deloitte, 2013, “Oil and Gas Reality Check 2013 – A Look at the Top Issues facing the Oil and Gas Sector”.
- Francis, M., 2008, “Adjusting to the Commodity-Price Boom: The Experiences of Four Industrialized Countries,” Bank of Canada Review, Autumn 2008.
- Gross, I., and J. Hansen, 2013, “Reserves of Natural Resources in a Small Open Economy,” RBA Research Discussion Paper 2013-14.
- Kumhof, M., D. Laxton, D. Muir, and S. Mursula, 2010, “The Global Integrated Monetary and Fiscal Model (GIMF) – Theoretical Structure,” IMF Working Paper 10/34.
- Lowe, P.,2013, “Investment and the Australian Economy,” Address to the CFA Australia Investment Conference, October 2013.
- Minifie, J., 2013, “The Mining Boom: Impacts and Prospects,” Grattan Institute, July 2013.
- Productivity Commission (PC), 2009, “Australia’s Productivity Performance”.
- Stevens, G., 2013, “Economic Policy after the Booms,” Address to the Anika Foundation Luncheon, July 2013.
- U.S. Geological Survey (USGS) 2011 Minerals Yearbook.

### Annex 5 — Public Debt: Key findings and baseline projections
- Australian general government gross debt is expected to peak at around 32 percent of GDP in 2015 and is among the lowest in advanced nations.
- The authorities‘ medium-term objective is to reduce the budget deficit over the projection period and reach to surplus afterward.
- For the General Government, the baseline envisages a stabilization of gross debt at around 30 percent of GDP in the projection period and for net debt to increase to just under 20 percent of GDP.
- The standard shocks in the DSA are all considered to be downside scenarios.

Standard DSA scenario outcomes:
- Primary balance shock: based on keeping a constant primary balance as a proportion of GDP at the level of 2013. Gross debt would rise slightly reaching around 40 percent of GDP by 2018.
- Historical shock: based on keeping a constant primary balance as a proportion of GDP at the level of the average of the last 10 years. This leaves gross debt little changed at around 30 percent of GDP by 2018.
- Contingent liability shock: assuming a rescue by the public sector of 10 percent of the financial sector. Gross debt would reach a little over 50 percent of GDP on impact and would stay at that level by 2018. Staff considers this to be a tail risk, given that the FSAP found the financial system to be resilient to a number of stress scenarios. Such a shock would in any case leave public debt at manageable levels.

### Annex 5 — External debt: Key findings and scenarios
- Australia’s net foreign liabilities have fluctuated between 55 and 60 percent of GDP for a number of years, within which net debt liabilities equated to around 50 percent of GDP.
- Gross external debt, around 100 percent of GDP, is relatively low among advanced countries.
- As at the end of March 2013, Australian entities overall had a net foreign currency asset position equivalent to 27 percent of GDP (ABS Cat No 5302.0, June 2013). This is before taking into account the use of derivatives for hedging purposes.
- Because most of Australia’s foreign liabilities are denominated in Australian dollars and the majority of its foreign assets are denominated in foreign currencies, a depreciation of the Australian dollar would reduce the size of Australia’s net foreign liability position.

Scenario and stress-test notes:
- Shaded areas in charts represent actual data. Individual shocks are permanent one-half standard deviation shocks. Ten-year historical average for the variable is also shown.
- Historical scenarios use ten-year historical averages to project debt dynamics five years ahead.
- Permanent 1/4 standard deviation shocks are applied to real interest rate, growth rate, and current account balance.
- One-time real depreciation of 30 percent occurs in 2010 in one scenario. This scenario assumes foreign exchange hedging effectively covers 80  percent of foreign currency denominated debt, consistent with the findings of the 2013 ABS Foreign Currency Exposure survey. Because Australian entities as a whole have a net foreign currency position, a depreciation of the Australian dollar would reduce the size of Australia’s net foreign liability position.

### Key numeric indicators and projections (selected, preserved exactly as stated)
- Public gross debt projections: 13.3, 24.3, 27.2, 28.9, 31.2, 32.1, 32.0, 31.8, 31.7 (years 2011–2018 as tabulated).
- Public gross financing needs: 4.7, 4.3, 3.6, 3.7, 3.7, 2.3, 2.1, 2.5, 2.9 (years 2011–2018).
- Real GDP growth (in percent) by year: 3.1, 2.6, 3.6, 2.5, 2.6, 2.7, 2.9, 3.0, 3.0 (years 2011–2018).
- Inflation (GDP deflator, in percent) by year: 4.0, 4.2, -0.2, 0.9, 0.9, 1.9, 2.6, 2.5, 2.4 (years 2011–2018).
- Nominal GDP growth (in percent) by year: 7.2, 6.9, 3.4, 3.4, 3.5, 4.6, 5.6, 5.6, 5.5 (years 2011–2018).
- Effective interest rate (in percent) by year: 6.4, 6.2, 5.6, 4.4, 4.5, 4.6, 4.7, 4.1, 4.1 (years 2011–2018).
- Change in gross public sector debt (cumulative): 0.4, 3.8, 2.9, 1.8, 2.2, 0.9, -0.1, -0.2, -0.1, 4.5 (periods shown).
- Identified debt-creating flows (cumulative): 0.2, 3.8, 3.5, 3.3, 3.0, 1.2, 0.2, 0.2, 0.6, 8.5 (periods shown).
- Primary deficit (cumulative): 0.3, 3.9, 3.0, 3.1, 2.7, 1.2, 0.4, 0.7, 1.0, 9.1 (periods shown).
- Primary (noninterest) revenue and grants (percent of GDP): 34.4, 31.5, 32.5, 33.0, 33.4, 33.9, 34.3, 34.7, 35.0 (cumulative 204.2).
- Primary (noninterest) expenditure (percent of GDP): 34.7, 35.4, 35.5, 36.1, 36.2, 35.1, 34.7, 35.3, 35.9 (cumulative 213.3).
- Automatic debt dynamics (contribution): -0.1, -0.1, 0.5, 0.3, 0.3, 0.0, -0.2, -0.4, -0.4, -0.6 (periods shown).
- Real interest rate contribution: 0.3, 0.4, 1.4, 0.9, 1.0, 0.8, 0.6, 0.5, 0.5, 4.3 (periods shown).
- Real GDP growth contribution: -0.4, -0.5, -0.8, -0.7, -0.7, -0.8, -0.9, -0.9, -0.9, -4.9 (periods shown).
- Residual, including asset changes (cumulative): 0.2, 0.0, -0.7, -1.6, -0.8, -0.3, -0.3, -0.4, -0.7, -4.0 (periods shown).
- Australia: External debt indicators: net foreign liabilities fluctuating between 55 and 60 percent of GDP; net debt liabilities around 50 percent of GDP; gross external debt around 100 percent of GDP.
- As at the end of March 2013: net foreign currency asset position equivalent to 27 percent of GDP.

*Source: IMF staff (content unit: _cr1451 - References).*

### Annex 6: Australia Main Recommendations of the 2012 Article IV

### Annex 6: Australia Main Recommendations of the 2012 Article IV Consultation

### Fiscal Policy — findings and recommendations
- Findings:
  - The plan to maintain surpluses over the medium term should help relieve pressure on monetary policy and thereby the exchange rate, and put Australia in a better position to deal with future shocks and the long-term cost of aging.
  - Australia's modest public debt gives the authorities scope to delay their planned return to surpluses in the event of a sharp deterioration in the economic outlook.
  - The sharper-than-expected decline in revenues as commodity prices declined and the economy slowed have delayed the timing of the authorities' plan to return to surplus.
  - The budget deficit was reduced from 3 percent of GDP to 1½ percent in 2012/13.
  - 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.
  - 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.
  - Gross debt is projected to continue to increase, with total central government debt securities on issue rising to 26 percent of GDP by 2023-24 if there are no policy changes.
- Policy recommendations / actions:
  - Return to fiscal surplus while avoiding undue prejudice to growth to help rebuild fiscal buffers.
  - Make early decisions on the spending cuts and revenue increases needed to reach fiscal objectives.
  - The government established a National Commission of Audit to assess the role and scope of government and the efficiency of government spending; the final Audit will be completed in March and will inform the detailed fiscal strategy announced in the May budget.

### Monetary Policy — findings and recommendations
- Findings:
  - The RBA's high degree of credibility and the rapid monetary transmission in Australia allows monetary policy to react quickly and flexibly to changing economic circumstances.
  - The RBA has eased monetary policy by 225 basis points since November 2011 to 2.5 percent.
  - Annual growth slowed to 2¼ percent in Q3 2013, below the trend growth of around 3 percent.
  - Inflation remains anchored in the Reserve Bank of Australia’s (RBA) target range.
  - 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.
- Policy recommendations / actions:
  - If the global recovery stalls or international markets are disrupted, monetary policy should act as the first line of defense and the RBA has the scope to cut the policy rate and provide liquidity support to banks.
  - Maintain accommodative monetary policy to support the transition toward broader-based growth while watching prospects of tighter monetary policy in major advanced economies as a factor that may help weaken the Australian dollar.

### Financial sector — findings and recommendations
- Findings:
  - Stress testing indicates that the major banks are adequately capitalized and are likely to withstand large macroeconomic shocks, but would require RBA liquidity support to withstand an extreme funding shock.
  - The funding situation of banks has continued to improve over the post-crisis period as banks have shifted to more stable and longer maturity sources of funding.
  - Banks could be exposed to highly leveraged households and to rollover risks associated with offshore funding needs.
  - The financial system remains sound and well managed; intensive and proactive supervisory framework limits likelihood that house price fluctuations will have an adverse impact on the financial system.
- Policy recommendations / actions:
  - Continue to emphasize intensive bank supervision and introduce higher loss absorbency for systemically important banks.
  - Remain vigilant to household leverage, rollover risks, and segments of the housing market where activity has picked up relatively strongly.
- Implemented / announced measures:
  - APRA put in place its framework for Basel III capital requirements in January 2013, raising the level and quality of the regulatory capital.
  - APRA has introduced the Basel Framework for domestic systemically important banks.
  - The Basel III liquidity standards will be introduced 2015--ahead of the committee's deadline.
  - Looking ahead, banks are well placed to meet APRA's accelerated capital requirements.

### Housing market and household balance sheets — findings and risks
- Findings:
  - Nationwide housing prices have risen by 17 percent since early 2012.
  - Overall credit growth has remained moderate with many households continuing to prepay mortgages.
  - Features mitigating systemic risk:
    - Household credit growth has accelerated only modestly and households’ aggregate debt-to-income ratio has been stable for several years.
    - Balances in mortgage offset and redraw facilities are equivalent to over 20 months of scheduled repayments (at current interest rates).
    - The average LTV on the stock of outstanding mortgages is 50 percent.
    - Around 0.7 percent of Australian banks’ mortgage portfolios are classified as non-performing, and around three quarters of these are well covered by the value of collateral.
- Policy recommendations / actions:
  - Authorities should be prepared to take preventative actions if rapid house price growth gives rise to expectations-driven, self-reinforcing demand dynamics and price overshooting.
  - APRA’s proactive, risk-based supervision should continue to subject institutions that pose greater systemic risks to more intensive supervision and potentially higher capital or other prudential requirements.

### External sector and exchange rate — findings and recommendations
- Findings:
  - The mining investment boom has peaked and the economy is moving to the production and export phase.
  - Mining-related investment accounted for almost half of GDP growth in the past couple of years and is expected to drop sharply in the near term.
  - Mining investment as a share of GDP peaked around 7½ percent in 2012/13.
  - Australian LNG projects currently underway are estimated to account for more than two thirds of current global LNG investment.
  - The Australian dollar depreciated by around 15 percent on a trade-weighted basis since April 2013.
  - The current account deficit is expected to remain stable at around 4 percent of GDP over the next few years (authorities’ expectation).
  - Staff assessment: the exchange rate currently appears to be modestly overvalued in real effective terms.
- Policy recommendations / actions:
  - The floating exchange rate should continue to act as a shock absorber and a buffer in the event of a sustained fall in commodity prices.
  - A lower exchange rate should help tourism, education, manufacturing, and support a pick-up in non-mining investment.

### Growth, labor market, and transition dynamics
- Findings and projections:
  - Annual growth slowed to 2¼ percent in Q3 2013; trend growth is around 3 percent.
  - Mining exports are growing as new capacity comes on stream; non-mining investment recovery will be needed to underpin demand and return growth to trend.
  - Consumption growth has been modest and the household savings rate has remained above 10 percent.
  - Labor market conditions have remained soft and the unemployment rate has risen; authorities expected unemployment to drift up to a peak of 6¼ percent by mid-2015.
  - The authorities expect growth for the current year to be slightly below potential (at 2½ percent), with growth picking up modestly in subsequent years.
- Policy recommendations / actions:
  - Monetary policy should remain the primary macroeconomic tool in the near term to manage aggregate demand given accommodative stance and constrained fiscal maneuver in the short run.
  - Renewed structural reforms to strengthen competition in labor and product markets and address infrastructure bottlenecks are critical to raise productivity and diversify sources of growth.

### Structural reform agenda — findings and commitments
- Findings:
  - The unprecedented rise in the terms of trade over the past decade accounted for almost half of the recent rise in national income.
  - Productivity growth has been relatively low over the past decade and must be lifted to sustain income growth as terms of trade and demographic trends become less favorable.
- Authorities’ commitments and actions:
  - Commissioned the first comprehensive review of competition laws since the early 1990s.
  - Embarked on a wholesale review of the financial services sector, the first review of the sector in 16 years.
  - Committed to a review of the taxation system (details to be announced).
  - Undertaken to streamline regulatory approval processes for large-scale projects.
  - Begun to outline a plan for significant investments in economic infrastructure, including leveraging private capital, to overcome supply-side bottlenecks.
- Policy recommendation:
  - Implement an ambitious structural reform agenda focused on lifting productivity over the next decade.

### Key statistics and indicators (selected values as reported)
- Nominal GDP (2012): A$ 1,501 billion
- GDP per capita (2012): US$ 67,556
- Population (June 2013): 23 million
- Unemployment rate (November 2013): 5.8 percent
- Main exports: Iron ores and minerals; coal; rural goods
- Macroeconomic projections (selected):
  - Real GDP: 2010: 2.3; 2011: 2.6; 2012: 3.6; 2013: 2.5; 2014 Proj.: 2.6
  - CPI inflation: 2010: 2.9; 2011: 3.3; 2012: 1.8; 2013: 2.3; 2014 Proj.: 2.1
  - Unemployment rate: 2010: 5.2; 2011: 5.1; 2012: 5.2; 2013: 5.7; 2014 Proj.: 6.2
  - Fiscal balance (accrual basis, percent of GDP): 2010: -4.2; 2011: -3.7; 2012: -3.0; 2013: -1.5; 2014 Proj.: -2.6
  - Net debt (percent of GDP): 2010: 3.3; 2011: 6.0; 2012: 9.9; 2013: 10.0; 2014 Proj.: 12.1
  - Interest rate (90-day bill, percent): 2010: 5.0; 2011: 4.5; 2012: 3.1; 2013: 2.6
  - Terms of trade (percent change): 2010: 16.4; 2011: 12.9; 2012: -10.2; 2013: -4.5; 2014 Proj.: -5.3
  - Nominal GDP (in billions of Australian dollar): 2010: 1,359; 2011: 1,453; 2012: 1,501; 2013: 1,553; 2014 Proj.: 1,608
- Exchange rate movements:
  - U.S. dollar/Australian dollar (period average): 2010: 0.92; 2011: 1.03; 2012: 1.04; 2013: 0.97
  - Trade-weighted index: 2010: 70.9; 2011: 75.7; 2012: 76.9; 2013: 73.8
  - Real effective exchange rate (2005 = 100): 2010: 114.8; 2011: 123.0; 2012: 126.1; 2013: 120.6

*Source: Annex 6: Australia Main Recommendations of the 2012 Article IV Consultation (IMF staff report materials included in the provided content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1451.pdf_