Public Information Notice No. 07/112

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Australia

September 12, 2007

On August 31, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Australia.¹

Background

Australia has experienced more than 15 years of continuous economic growth, benefiting recently from strong terms of trade gains. After a modest slowdown, growth expanded to 3¾ percent over the year to March 2007. The lengthy expansion has brought the economy to a position of near full employment. Inflation had eased in late 2006 and early 2007, but accelerated in the second quarter.

The current account deficit was 5½ percent of GDP in 2006, reflecting high business investment. The trade deficit narrowed, while the investment income balance continued to deteriorate, reflecting large net dividend payments. The Australian dollar has appreciated substantially over the past few years, but does not appear misaligned once the recent terms of trade gains are taken into account. Net foreign liabilities increased to over 60 percent of GDP, but survey evidence shows that there is limited exposure to foreign exchange risk.

After being kept on hold since November 2006, monetary policy was tightened in August, as signs of renewed inflation pressure began to emerge. The fiscal position continues to be strong, with surpluses recorded in nine of the last ten years. The 2007/08 (July 2007-June 2008) budget projects the underlying cash surplus to decline from 1.7 to 1 percent of GDP, and to remain at that level in the medium term.

Staff project GDP growth to accelerate above 4 percent in 2007 and moderate in 2008. The current account deficit should remain stable as the balance on goods and services improves, while the income deficit continues to deteriorate. Headline CPI inflation is expected to be slightly over 2 percent in 2007, and to stay in the upper half of the Reserve Bank of Australia's target band thereafter.

Executive Board Assessment

Executive Directors commended the Australian authorities for their exemplary macroeconomic management, which is widely recognized as being at the forefront of international best practice. Sound fiscal, monetary, and structural policies, against a background of sizable terms of trade gains, have created the conditions for a continued expansion, supported by high employment levels. Directors expressed confidence that the authorities will continue to implement the reforms needed to spur efficiency in order to enhance productivity and income growth, and face long-term economic challenges, particularly related to population aging.

Directors praised Australia's very strong fiscal position, with fiscal policy firmly focused on medium- and long-term objectives. Additional revenues resulting from the terms of trade boom have been managed prudently, and the 2007/08 Budget continues appropriately to target budget surpluses. Directors recommended that, going forward, the surplus be allowed to exceed budget forecasts if growth and revenues are stronger than expected given the strength of economic activity. Directors agreed that State and Territory Governments would need to make prudent decisions on the timing and extent of infrastructure investments over the next few years.

Directors regarded the continuing flexibility of the exchange rate as a valuable shock absorber for the economy, and noted that the currency appreciation in the first half of 2007 helped to ease inflation pressures. While the Australian dollar has appreciated substantially over the past few years, Directors saw no clear signs of misalignment of the exchange rate, given the improvement in the terms of trade. Directors agreed that Australia's external deficit appears sustainable, although the resulting debt requires continued careful monitoring.

Directors considered the recent increase in the official interest rate to be appropriate in light of emerging inflation pressures. They commended the willingness of the Reserve Bank of Australia to take appropriate and timely action, noting that, in light of the recent global financial market turbulence, it will be desirable to maintain flexibility in the conduct of monetary policy.

Directors observed that the financial sector is stable and well-capitalized. Supervision is well-established and continues to be refined. At the same time, a number of potential vulnerabilities identified by the 2006 Financial Sector Assessment Program (FSAP) remain. In particular, it is important to continue to monitor the exposure of banks to developments in the household sector. Directors noted that Australian banks' exposure to U.S. subprime mortgage loans is low, and the direct impact of the recent credit market turbulence on Australia has been modest. Continued vigilant monitoring of evolving market developments is nevertheless warranted.

Directors supported the authorities' National Reform Agenda, and welcomed its focus on enhancing labor force participation and productivity as sources of future growth. Sustained progress on the agenda will prepare Australia to cope with the impact of population aging. While Australia is well-placed to deal with long-term fiscal challenges, continued attention will also need to be given to the efficiency of health-care spending. Directors welcomed the release of the second Intergenerational Report, which assesses the sustainability of government policies over the next 40 years. They emphasized that this report was an important further step in improving transparency of the government and increasing the government's ability to plan for the future, particularly by focusing debate on productivity and participation.

Directors welcomed the authorities' efforts in advancing multilateral trade negotiations, and their commitment to double Australia's official development assistance by 2010.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.