Australia: IMF Staff Concluding Statement of the 2017 Article IV Mission
IMF News, November 20, 2017
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- Published: November 20, 2017
Overview and recent developments
- Recovery has continued under the transition from the mining boom despite setbacks.
- Domestic demand growth has strengthened, and employment growth has picked up markedly since the beginning of the year, most of it in full-time jobs.
- Labor market slack remains present, and wage growth has remained weak.
- Inflation outcomes are below the mid-point of the Reserve Bank of Australia’s target range of 2 to 3 percent, influenced by weak wages, stronger retail competition, and continued declines in import prices.
- With stronger terms of trade, the current account deficit has narrowed substantially and the trade balance has moved into surplus, primarily because of higher global prices for coal and iron ore.
- Conditions are in place for a pickup in growth to above-trend rates driven by a stronger global outlook, recent employment growth, and a stronger contribution from infrastructure investment, more than offsetting the declining contribution from dwelling investment.
Growth outlook and macro policy stance
- The growth pickup is likely to be modest; inflation and wages will be slow to rise.
- Household consumption is expected to be held back by low real wage growth, given labor market slack and structural change in some sectors.
- Economic slack is projected to decline gradually; upward pressure on prices and wages should emerge once the economy has been at full employment, including lower underemployment, for some time.
- Monetary policy:
- Cash rate is at 1.5 percent.
- Monetary policy is judged appropriately accommodative and should remain firmly focused on ensuring stronger sustained momentum in domestic demand and inflation.
- Fiscal policy:
- The overall fiscal stance is expected to be broadly neutral in 2017 and 2018, with a welcome pickup in public investment.
- The Commonwealth government’s budget repair strategy is anchored by medium-term budget balance targets and is predicated on a rapid rebound of nominal growth to trend.
- Australia has fiscal space to absorb risks and protect or, if needed, increase spending envelopes for infrastructure investment and structural reforms supporting trend growth and productivity.
Risks to the outlook
- Near-term risks have become more balanced.
- Downside risks:
- Large external shocks, including their interaction with the domestic housing market.
- Unexpectedly tighter global financial conditions flowing through to domestic financial conditions while the economy is still recovering.
- Exposure to downside risk from China through trade links in commodities and services.
- Domestic weakening of consumer spending if household income improvements are more gradual than expected or if a cooling housing market and high debt-to-income ratios discourage further declines in household saving rates.
- Upside risk:
- Improved global outlook could lead to a stronger-than-expected recovery underpinned by a larger pickup in non-mining business investment.
Managing housing imbalances and financial sector risks
- Housing market expectations:
- The housing market is expected to cool, mainly as building completions catch up with demand in major eastern capital regions.
- Given strong population growth and foreign buyer interest, demand growth for housing is expected to remain robust; prices should stabilize rather than fall significantly in the absence of a major shock.
- Declines in household debt-to-income ratios would need to be driven by strong nominal income growth and amortization.
- Policy responses taken:
- Commonwealth and States have used a multi-pronged approach to address housing market imbalances and systemic risks to banks.
- Prudential policies by the Australian Prudential Regulation Authority (APRA) have lowered banking sector risks through sequential tightening of underwriting standards, including:
- Tighter standards on origination of interest-only loans.
- Reinforced a cap on lending growth to investors.
- State measures to help qualified first-time homebuyers: grants and exemption from stamp duty.
- Commonwealth assistance to build home deposits via the superannuation system.
- Supply-side measures and recommendations:
- Strengthening housing supply through increasing supply of developable land and efficiency of its use, including higher housing densification, ramping up infrastructure spending, and reforms to planning and zoning.
- Complementary measures to increase supply of affordable housing targeted to lower- and middle-income households.
- Supply-side policies could reduce location costs, support agglomeration benefits, and help raise productivity and trend growth.
- Recommendation: housing-related tax settings should be reformed—replace State stamp duty regimes with a systematic land tax regime applying to all residential and commercial properties; transition can be gradual to avoid disruptive impacts on State revenues; cash flow problems for low-income homeowners can be addressed through deferment options.
- Prudential and capital reforms:
- Tighter mortgage underwriting standards combined with higher capital adequacy and liquidity requirements have strengthened banks’ resilience.
- APRA is refining the capital adequacy framework and in July 2017 clarified capital requirements for Australian banks to “be unquestionably strong,” as suggested by the 2014 Financial Sector Inquiry.
- APRA is preparing regulations to address systemic risk from banks’ concentrated exposure to residential mortgages through capital requirements.
Fostering long-term growth: infrastructure, innovation, and tax reform
- Drivers of past slowdown and scope for reform:
- The decline in trend output growth over the past decade was driven mainly by lower labor force growth and lower rates of capital accumulation following the mining investment correction.
- Average productivity growth has picked up recently, primarily because of higher capital stock utilization in the mining sector.
- Reforms could lift productivity growth further.
- Infrastructure:
- There is scope to expand infrastructure spending beyond the recent fiscal boost.
- International metrics indicate Australia has a notable infrastructure gap compared with many other advanced economies.
- Further investment could improve physical and digital interconnectivity domestically and with trading partners, contributing to higher growth.
- Innovation, R&D, and skills:
- Australia’s research and development (R&D) share of GDP lags other OECD members.
- The relatively small National Innovation and Science Agenda (NISA) is only funded through FY2018/19.
- Recommendation: clearly implement the upcoming 2030 Strategic Plan for the Australian Innovation, Science and Research System by defining scope and funding of policy instruments.
- Recommendation: define a longer-term envelope for active labor market policies for workforce re-education and skill upgrades (for example, supporting the levy proposed to maintain the new Skilling Australians Fund).
- Tax reform:
- The Commonwealth lowered the corporate income tax rate for SMEs with the goal of broadening it to all firms at an even lower rate.
- A comprehensive tax reform could increase tax efficiency, investment, labor demand, and reduce inequality by:
- Lowering taxes on income from mobile factors of production (capital and labor).
- Increasing reliance on taxes on immobile factors of production (land) and indirect taxes on consumption.
- Undertaken in a revenue neutral way.
- Replacing stamp duties with a broad-based land tax complements this approach.
- Concerns about regressive consumption taxes at a time of low wage growth could be addressed by broadening the base, reducing generous tax concessions (some not means-tested), and revising the design of income tax reform.
- Two developments could encourage reconsideration of broad tax reform:
- Significant corporate income tax reductions in other large advanced economies with capital flow implications for Australia.
- The ongoing Horizontal Fiscal Equalisation Review by the Productivity Commission reopening consideration of distribution of GST revenues, which could allow for a broader package for agreement between the Commonwealth and the States.
- Structural reform agenda:
- The Productivity Commission’s inaugural 5-Year Productivity Review has proposed structural reforms in health, education, urban development, and regulatory aspects of market efficiency.
- These proposals could define new policy parameters and increase certainty about policy directions for business investment decisions.
- These build upon the recently enacted legislative agenda of the Competition Policy Review (the Harper report) at the Commonwealth level; further State-level agreements are still needed to fulfill the Harper report’s implementation.
IMF Staff Concluding Statement of the 2017 Article IV Mission — November 19, 2017