Public Information Notice No. 12/127

Public Information Notice: IMF Executive Board Concludes 2012 Article IV Consultation with Australia

November 15, 2012

On November 12, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Australia.¹

Background

The Australian economy has been growing faster than most advanced countries, benefiting from its trade linkages with Asia, particularly China. Growth accelerated from 2¾ percent in the second half of 2011 to 4 percent in the first half of 2012, driven by private domestic demand and exports. However, growth has been uneven with mining-related sectors expanding strongly, in contrast with below-trend growth in other sectors. The high Australian dollar is weighing on trade-exposed manufacturing and tourism, which along with the uncertain global economic outlook is contributing to a broadly pessimistic mood, and weak investment growth outside the mining sector. Although survey measures of consumer and business sentiment remained below their long-run averages, household consumption grew in line with solid household income growth.

Australia’s terms of trade peaked in 2011, pushing up the real effective exchange rate further and narrowing the current account deficit to 2¼ percent of GDP. By the second quarter of 2012, the terms of trade had fallen by around 10 percent, driven by declines in spot prices for iron ore and coking coal of 25 and 30 percent respectively. In recent months, however, the Australian dollar has remained high despite lower export commodity prices and the weaker global outlook, in part related to portfolio reallocations of large reserve holders toward Australian government debt.

Consumer Price Index (CPI) inflation has eased with underlying measures of inflation remaining near the middle of the 2-3 percent target band, largely due to the declining tradable goods prices associated with the appreciation of the exchange rate. Wage growth is also moderate, just marginally above its 10 year average in June 2012 with private sector wage growth faster than in the public sector. The labor market has performed well in international comparison, with a low unemployment rate at below 5½ percent.

The Reserve Bank of Australia (RBA) has lowered the policy rate by 150 basis points since November 2011, with the most recent cut in October 2012. Initially, when inflation moderated at the end 2011, the RBA moved to remove a mildly restrictive monetary policy stance. During 2012, as the outlook for the global economy deteriorated accompanied by a slightly weaker domestic outlook for 2013, and with projected inflation consistent with the target, the RBA shifted to an accommodative monetary policy stance. Interest rates for borrowers, a key indicator of the overall stance, are now slightly below their medium-term averages.

The 2011/12 underlying cash deficit came in at 3 percent of GDP, about 1½ percentage points higher than forecast during the 2011-12 Budget, due to both weaker receipts and higher expenditure. Structural factors have kept receipts as a percent of GDP below pre-crisis levels and have also contributed to receipts falling short of projections by 0.9 percent of GDP during 2011/12. High levels of mining sector investment and associated depreciation deductions have dampened growth in mining company tax receipts relative to profit growth. Changing consumer spending patterns away from the retail sector towards services have lowered retail company tax receipts. Furthermore, lower house and equity price growth rates, especially compared with pre-crisis rates, lowered capital gains tax receipts. Payments during 2011/12 exceeded forecasts by 0.6 percent of GDP mainly due to payments related to natural disasters and the accelerated transfer payments to households and businesses as compensation for higher energy costs following the introduction of carbon price.

Executive Board Assessment

Executive Directors commended the Australian authorities for their sound and prudent macroeconomic management, which had contributed to impressive growth, low unemployment, and subdued inflation. They noted that the economic outlook remains favorable, although risks are tilted to the downside, including a possible deterioration in external demand and elevated stress in the global financial market. Directors underscored the need to preserve adequate policy space to respond to adverse shocks and to persevere with structural adjustments aimed at facilitating more balanced growth.

Directors agreed that the current accommodative monetary stance is broadly appropriate. They also concurred that there is scope for further easing if warranted by economic circumstances. Policy effectiveness is supported by the central bank’s high degree of credibility and a well-functioning transmission mechanism.

Directors supported the government’s consolidation plans, which allow a reduction in public indebtedness without prejudice to growth through a combination of spending restraint and reprioritization, tax measures, as well as use of proceeds from mineral resources. They welcomed the intention to maintain budgetary surpluses over the medium term, thus strengthening fiscal buffers against future shocks and the long-term cost of population aging. Directors noted nevertheless that, in the event of a sharp deterioration in the economic outlook, and hence revenue underperformance, delaying the return to surpluses could be an option, given Australia’s modest debt-to-GDP ratio. Allowing automatic stabilizers to operate fully could also help relieve pressure on monetary policy.

Directors noted that Australia’s flexible exchange rate is a critically important element of the macroeconomic policy framework. They observed, however, that the Australian dollar, which remains moderately above its long-term average, has exerted pressure on non-mining tradable sectors, widening the current account deficit and net foreign liabilities. Raising national saving, including through budget deficit reduction and further incremental increases in employer provided pension contributions, would help narrow the current account deficit over time.

Directors welcomed the Financial Sector Assessment Program (FSAP) Update, which found Australia’s financial system to be sound, resilient, and well managed. They underscored the importance of continuing intensive bank supervision, providing liquidity support, and ensuring that systemically important banks have adequate capital buffers. Directors welcomed progress in increasing the competitiveness of the banking system, and encouraged further steps aimed at reducing banks’ short-term wholesale debt and broadening domestic funding sources. Close monitoring of developments in the housing market and household debt levels should continue to be priorities in the oversight of the financial sector.

Directors commended the government’s efforts to facilitate a structural transition toward a services-oriented economy. More specifically, they encouraged Australia to seize the opportunities offered by the growth of Asian economies, including by enhancing productivity and flexibility in the product and labor markets. They welcomed the government’s White Paper on Australia in the Asian Century, laying out a strategy for actively engaging with the region.