Mission Concluding Statement 

Australia: Staff Concluding Statement of the 2021 Article IV Discussions

September 23, 2021

Washington, DC: 

• Following swift economic recovery from COVID-related lockdowns in 2020, new outbreaks set back economic activity in the near term, posing fresh challenges. Recent progress in the vaccination campaign offers a pathway out of lockdowns starting in the December quarter and will enable an ensuing economic recovery.
  
  
• Supportive and well-coordinated fiscal and monetary policies soften the near-term economic impact and lay the foundation for post-lockdown recovery. Fiscal and monetary support should stay nimble amid very high uncertainty, and additional stimulus should be provided if downside risks materialize.
  
  
• Surging housing prices raise concerns about affordability and financial stability. Structural reforms to boost housing supply and targeted support for low-income households are needed to improve housing affordability. Macroprudential policy should be tightened and lending standards closely monitored.
  
  
• Promoting innovation, competition, and infrastructure investment, focusing on climate change policies, and addressing inequality will be important to achieve high, sustainable, and inclusive growth over the medium term.

Prior to the mid-2021 outbreaks, the economic recovery was strong. By 2021Q2, output had recovered to well above pre-pandemic levels, faster than in most advanced economies. The large-scale JobKeeper wage subsidy program, together with other fiscal support and very accommodative monetary policy, was instrumental in limiting the pandemic’s impact on activity and the labor market. Household and firm balance sheets remained resilient, and the banking sector continued to have strong capital and liquidity buffers. The external position and exchange rate in 2020 remained broadly in line with fundamentals and desirable policies, with a significant increase in the current account surplus largely reflecting temporary factors.

The renewed COVID-19 outbreaks and ongoing lockdowns are posing near-term economic challenges. In response to the expected, sizable near-term economic contraction, the Commonwealth and state/territory governments have responded quickly with new support measures, including the COVID-19 Disaster Payment programs for affected individuals and support grants for impacted businesses. These programs, which function like automatic stabilizers, are softening the fall in output and employment. They will support the expected recovery once lockdowns are eased in step with further progress in the vaccination campaign, which has accelerated from a slow start earlier in the year. While there remains high uncertainty, under the baseline scenario, GDP is expected to grow by 3.5 percent in 2021 and 4.1 percent in 2022, while underlying inflation is projected to reach 2 percent by end-2022 and remain within the RBA target range thereafter. Reduced migration due to ongoing border restrictions is expected to limit potential output in the near- and medium term. Despite improvements in aggregate household and corporate balance sheets, business insolvencies may rise as temporary support measures expire, in particular for SMEs. Despite the lockdowns, housing prices have continued to surge.

Risks to the outlook are tilted to the downside in the near term and broadly balanced beyond that. Near-term downside risks are centered around the pandemic, with the contagious Delta variant testing Australia and many of its trading partners. Other downside risks include a tightening of global financial conditions, geopolitical tensions, an eventual housing market correction, and climate-related risks. Upside risks include faster recovery in household consumption and business investment after the ongoing lockdowns, supported by strong household and business balance sheets.

Reflecting heightened uncertainty, economic policies should remain agile and supportive.

• Fiscal policy should continue to support vulnerable households and viable businesses. COVID-19 Disaster Payments and business support grants are broadly adequate and appropriately targeted, contingent on pandemic triggers and loss of hours worked or revenue. Given their flexible design, these programs can be scaled up or reoriented rapidly as needed. If downside risks materialize that would endanger the broader economic recovery, the authorities should provide additional targeted fiscal support, taking advantage of Australia’s substantial fiscal space, underpinned by robust public debt sustainability.

• Monetary policy should remain data-dependent and nimble in a highly uncertain environment. Accommodative monetary policy settings will be important during the lockdowns and ensuing recovery. The timing and pace of policy normalization should be calibrated commensurate with the recovery in a gradual and well-sequenced manner. Clear communications, stressing the state-contingency of forward guidance, will be important for a smooth transition. If downside risks materialize, the RBA has space to provide additional support by expanding its asset purchases, reinstating term funding facilities, lengthening the maturity of the yield target, and/or introducing negative rates.

Although employment impacts of the pandemic have been less severe than anticipated, supportive labor market policies will be important to entrench the recovery. Wage subsidies during the 2020 lockdowns were contingent on maintaining employment relationships, helping limit adverse labor market outcomes. Given renewed outbreaks, additional business support contingent on maintaining employment relationships may become warranted if risks of a stronger employment impact increase. Monitoring the effectiveness of active labor market policies and strengthening them where needed can ensure adequate and inclusive support to disproportionately affected groups, including those facing underemployment or long-term unemployment, as well as casual workers. While wage subsidies to support apprentices and trainees have been extended with high take-up, the JobMaker Hiring Credit program has played a relatively minor role thus far. The latter program should be reviewed and reinstated, particularly if the labor market recovery is slow, to incentivize more widespread take-up to increase employment, retention, and skills development. Scaling up programs for career support to find jobs and acquire training should be also considered.

Macroprudential policy should be tightened to address gradually rising financial stability risks . While the surge in housing prices has been driven largely by owner-occupiers taking advantage of low mortgage rates and fiscal support programs, high debt-to-income mortgages are on the rise amid elevated household debt, and investor demand has begun to increase from low levels. Lending standards should be monitored closely, and macroprudential measures should be employed to address incipient risks. Options include increasing interest serviceability buffers and instituting portfolio restrictions on debt-to-income and loan-to-value ratios.

Financial sector policies should continue enhancing financial sector resilience. There is a need to ensure that the monetary, financial and regulatory frameworks remain appropriate in a changing environment. The authorities are revising the bank capital framework to make it more flexible, risk-sensitive, and competition-enhancing, aiming to increase the risk weights for high-risk mortgages and lower risk weights for SME lending to reduce banks’ concentration risks in housing. The government has approved major financial market infrastructure reforms to enhance licensing, supervisory, and enforcement powers of the Australian Securities and Investment Commission (ASIC) and the RBA. The RBA will be granted crisis management and resolution powers over Australian clearing and settlement facilities. New regulations on climate and cyber risks and open banking are welcome, and the authorities should continue their efforts in these areas. To facilitate assessment of climate and transition risks and foster better allocation of capital, ASIC can further improve standardized disclosures of exposure to climate-related risks for large, listed companies. The Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) framework should be further strengthened by expanding coverage to relevant non-financial and business professionals.

Housing supply reforms would help support affordability. Supply-side reforms, including more efficient planning, zoning, and better infrastructure, could improve housing supply. Commonwealth and state/territory governments should consider providing more financial incentives for local governments to streamline zoning regulations and improve infrastructure. Promoting flexible work arrangements could allow workers to move away from capital cities, improving affordability. In addition, governments should focus on providing targeted fiscal support for low-income households and expand social housing.

An integrated framework for climate change policies can reduce uncertainty and catalyze environmentally friendly investment. Australia has made progress in reducing greenhouse gas emissions, including by improving the emissions profile of land use and increasing the share of renewables in electricity generation, and Australia’s commitment to step up investment in developing low emissions technologies is welcome. That said, if Australia were to follow other countries in setting a time-bound net-zero emissions target, this would require faster progress within a comprehensive policy framework. While politically challenging, implementing broad-based carbon pricing, along with measures to mitigate transition risks for impacted industries and regions, would be the most effective way to achieve emissions reductions and complement the investment strategy. While less efficient than a broad-based carbon price, alternative regulatory reforms can also be considered, including enhancing the Emissions Reduction Fund and its Safeguards Mechanism, and employing sectoral policies aimed at reducing emissions, including in energy generation, transportation, and agriculture.

Tax reforms can help strengthen investment and promote efficiency. A longstanding recommendation is for Australia to reduce its relatively high direct taxes and instead strengthen indirect taxes, by reducing the corporate income tax burden and relying more on goods and services tax (GST) revenue, while making the impact of the latter less regressive for households through targeted cash transfers. Transitioning from a housing transfer stamp duty to a general land tax would improve efficiency by providing a more stable revenue source for states and territories, while promoting labor mobility. Such reforms could be complemented by reducing structural incentives for leveraged investment by households, including in residential real estate.

Australia’s efforts to support the rules-based international trading system are welcome. Australia is signatory of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CP-TPP) and the Regional Comprehensive Economic Partnership (RCEP) and has been strengthening its network of bilateral free-trade agreements. Its strong support of the WTO process is helping to buttress the rules-based international trading system. Australia’s recently amended foreign direct investment framework aims at safeguarding national security. The issuance of guidance for implementing the reform and the authorities’ intention for continued judicious use of this policy are welcome and will help ensure that the FDI approval process remains simple and transparent.

Structural reforms are essential for tackling Australia’s longstanding productivity slowdown and ensuring an inclusive recovery. Promoting innovation and competition are priorities for raising medium-term growth, while the swift implementation of infrastructure projects can support the short-term recovery and alleviate medium-term growth constraints. Recent reforms that enhanced the R&D tax incentive will encourage innovative investment, though scope remains to ease its administrative burden and scale up government R&D spending. Rapid implementation of the Digital Economic Strategy is essential to build skills and infrastructure for digitalization. There is scope to ease the regulatory burden faced by businesses, including through continued reforms to digitize business-government interactions. Widening the scope of automatic cross-jurisdictional recognition of occupational licenses can further boost competition, while reducing financing constraints for SMEs can help improve resource allocation. Recent reforms to the childcare subsidy program and increased funding for aged care and the National Disability Insurance scheme will help promote an inclusive recovery. Continued reforms in the education sector can improve education outcomes and ensure equal opportunities.

The mission would like to thank the authorities and counterparts in the private sector, think tanks, universities, and other organizations for frank and engaging discussions.