Mission Concluding Statement 

Australia: Staff Concluding Statement of the 2024 Article IV Mission

October 2, 2024

• Growth has slowed; while inflation is retreating from its peak, it remains elevated as demand-supply imbalances persist particularly in sectors like rents, new dwellings and insurance. The mission projects a modest economic recovery next year, pushing growth from 1.2 percent for 2024 to 2.1 percent for 2025, bolstered by real income growth and resilient labor markets. The uncertain global environment and geoeconomic fragmentation pose significant external risks.
• Near-term policies should continue to focus on reducing inflation while nurturing economic growth. The Reserve Bank of Australia's continued restrictive monetary policy stance aimed at combating persistent inflation is appropriate. Should disinflation stall, policies may need to be further tightened while preserving targeted support to vulnerable households amid rising living costs. Financial sector policies should prioritize preserving stability, while tackling localized vulnerabilities arising from tightened financial conditions. Addressing the housing affordability challenges requires a holistic approach to tackle the continued supply shortfall.
• Australia's robust economic institutions and policy frameworks can be further enhanced to underpin stability and foster growth in the long term. Structural policies should focus on enhancing resilience, revitalizing productivity growth through enhancing competition and innovation — including leveraging AI technology responsibly — and strategically navigating the climate transition.

Washington, DC:

I. CONTEXT AND RECENT DEVELOPMENTS

1. Australia's resilient economy faces cyclical challenges. Recent decades of strong growth are attributed to effective policies, strong institutions, flexible prices, strong regional trade links, and robust population growth. Post-pandemic stabilization efforts have included a balanced set of macro policy measures to manage demand and bring inflation back to target while preserving the gains in the labor market. Progress in reducing price pressures and bringing inflation back to target has been slower than expected. In this context, significant policy challenges remain in rebalancing the economy while navigating cyclical headwinds.
2. Economic growth has continued to decelerate. Under tightened policies, growth slowed to 1.0 percent (y/y) in the second quarter of 2024, down from 1.9 percent (y/y) a year ago. Per capita private consumption was down 1.9 percent (y/y) in 2024Q2, as real disposable income per capita declined due to high inflation, elevated interest rates, and tax payments growing faster than incomes prior to recent income tax cuts. Younger Australians, who are more likely to rent or hold mortgages, have seen a greater impact on spending. Despite recent resilience, private business investment has started easing, growing at just 1.6 percent (y/y). Economic activity has been supported by public demand and large state infrastructure projects. The labor market has eased somewhat but remains relatively resilient, with unemployment at 4.2 percent in August 2024, and the vacancies-to-unemployment ratio still above pre-pandemic levels. The current account fell into deficit in early 2024, driven primarily by the normalization of commodity prices.
3. Inflation has continued to ease from post-pandemic highs, but price pressures remain elevated. Restrictive monetary policy and an easing in supply pressures led to headline inflation falling to 3.8 percent (y/y) in the second quarter of 2024 from a peak of 7.8 percent (y/y) in late 2022. Headline inflation—as measured by the monthly CPI indicator—declined to below 3 percent in August due in part to sizeable temporary electricity subsidies. However, underlying price pressures remain elevated, most notably in non-tradable sectors like rents, new dwellings, and insurance, reflecting ongoing demand-supply imbalances. The mission welcomes the second consecutive Commonwealth Government budget surplus in FY2023/24. This was achieved by saving revenue windfalls from a resilient labor market and higher commodity prices, and identifying expenditure reductions or reprioritizations, while implementing cost-of-living relief measures. While acute demand and supply imbalances in the housing market have begun to ease, national house prices have surpassed pandemic-era peaks and the momentum persists, with rents also rising significantly.

II. OUTLOOK AND RISKS

4. The economy is projected to recover gradually. Growth is expected to start picking up in the second half of the year, reaching 1.2 percent for 2024 and 2.1 percent for 2025. Real wage growth is expected to boost private consumption, while public demand is expected to remain solid. Meanwhile, it remains too early to assess to what extent the recent income tax cuts would be saved or spent by households. Starting in 2025, private demand is also expected to benefit from gradual monetary policy easing and a rebound in dwelling construction after the resolution of bottlenecks. However, growth will remain below its potential rate until 2026, when it is forecast to converge to 2.3 percent. Labor market conditions are anticipated to soften gradually, with a modest rise in unemployment to about 4.5 percent. Trimmed mean inflation is expected to sustainably return to the RBA’s target range at end-2025, with underlying price pressures easing only slowly. Upside risks to inflation include a slower than forecast rebalancing in labor market demand and supply, potential larger fiscal impulses, demand impact of recent house price increases, and higher tradable prices due to rising geoeconomic fragmentation.
5. With large uncertainty surrounding the macroeconomic baseline, the balance of risks is tilted to the downside:

• External risks: The uncertain external environment, including weakness in major trading partners, poses risks to Australia’s growth. Geoeconomic fragmentation, which could potentially reconfigure global trade, poses risks to external demand, especially given Australia's sizeable commodity exports and diverse trading partners. Rising shipping costs and volatile energy and food costs stemming from global geopolitical tensions could complicate the fight against inflation. At the same time, Australia's pivotal role in the Pacific in providing aid and remittances, enhances regional economic stability and development. Additionally, Australia's economy continues to benefit from positive regional interactions, such as labor migration that addresses domestic capacity constraints and skills shortages.
• Domestic risks: The disinflation process may stall due to persistent services inflation, a stronger-than-expected fiscal impulse, or spillovers from global trade and supply chain disruptions; this may in turn raise prospects of higher-for-even longer interest rates, with implications for consumption and investment. Conversely, growth may be weaker than forecast, or unemployment may rise faster than projected (for example, if the current labor market tightness proves to be localized), potentially requiring the Reserve Bank to lower interest rates sooner.

III. NEAR-TERM POLICIES TO BRING DOWN INFLATION WHILE NURTURING GROWTH AND PRESERVING FINANICAL STABILITY

6. Near-term policies should focus on managing the final phase of returning inflation to target while nurturing growth. The baseline policy mix should be orchestrated carefully to achieve these objectives and ensure price and financial stability. The current restrictive monetary policy stance is essential to address risks of prolonged inflation. Fiscal policy should support disinflation as the economy continues to grapple with supply capacity constraints. Additionally, macroprudential policies should maintain a stringent stance to mitigate the risk of excessive vulnerabilities in household balance sheets, particularly in the context of rising house prices. Should disinflation stall, monetary policy may need to be further tightened, supported by tighter fiscal policy while nurturing growth, and preserving targeted support to vulnerable households amid rising living costs. This contingent policy mix should ensure monetary and fiscal authorities complement each other to avoid overburdening any single policy instrument. In the face of external shocks, Australia’s commitment to a flexible exchange rate, will allow monetary policy to focus on domestic policy objectives.
7. In this context, the RBA’s decision to maintain its restrictive policy stance in the near-term is appropriate. The still persistent inflation and emerging upside risks emphasize the importance of a tight monetary stance until the inflation outlook sustainably aligns with the target range. This stance is supported by the strong transmission of monetary policy through the Australian housing sector, largely due to a high proportion of variable-rate mortgages, and a possibly slow yet important transmission via non-mining business investment. While inflation expectations have remained anchored, the RBA should continue to build on its recent efforts and explore ways to further strengthen its communications capabilities and effectively guide the general public’s and the market’s understanding of its data dependent decision-making process and their expectations regarding policy shifts in an uncertain global policy environment.
8. Should disinflation stall, a tighter fiscal stance would be warranted, while better targeting of transfers could more efficiently support vulnerable households. The FY2024/25 Commonwealth budget is projected to deliver a positive fiscal impulse based on the mission’s estimates. A preannounced personal income tax (PIT) cut and new expenditure items including broad-based cost-of-living support, are expected to contribute to moving the budget to a deficit. The mission’s analysis shows that while the cost-of-living support lowers the price level on a temporary basis, it may inject some additional stimulus into the broader economy. The permanent PIT cut increase households' disposable income, but it remains too early to assess the extent to which they will be saved or spent and therefore the extent and timing of any impulse to demand. State and Territory budgets have proven more expansionary than expected in the near-term, incorporating further cost-of-living support and infrastructure spending. Should disinflation stall, expenditure rationalization at all levels of government could help lower aggregate demand and support a faster return of inflation to target. In particular, infrastructure spending could be carefully prioritized to avoid aggravating construction capacity constraints, by focusing on boosting productivity and facilitating the green transition. In addition, transfers should be made targeted wherever possible.
9. Financial sector policies should prioritize maintaining stability, while carefully addressing localized vulnerabilities arising from tightened financial conditions. Banks are in a strong position, showcasing high capital levels, solid liquidity, and healthy profits, while also demonstrating resilience in recent stress tests conducted by the Australian Prudential Regulation Authority (APRA). While most households and businesses continue to be resilient, financial pressures are evident in vulnerabilities in low-income households and small-medium enterprises, and challenges to firms' profitability under tight financial conditions. More generally, concerns about hidden leverage or vulnerabilities, combined with new and emerging global risks, could resurface. Thus, the mission welcomes APRA’s plan for the first system stress test to better understand interconnectedness across the financial system, providing a platform to quantify, assess and respond to identified risks. The mission team also welcomes APRA’s close monitoring of lending standards and regular review of macroprudential policy settings and would reiterate its recommendation that the authorities consider preemptively expanding their toolkit to include additional borrower-based measures, such as Debt-to-Income and Loan-to-Value Ratio, to manage household indebtedness and ensure financial stability amidst the housing market pressures. While financial supervisory and regulatory reforms have been undertaken to enhance resilience, data gaps on Non-Bank Financial Institutions pose challenges to effective risk oversight, including its exposure to commercial real estate (CRE) sector.
10. A holistic policy package is needed to address housing affordability issues. Australia faces a significant housing supply shortfall, exacerbated by structural challenges such as restrictive planning and zoning regulations, high land costs, infrastructure deficits, and residential dwelling investment around decade lows. These barriers, coupled with high interest rates, elevated building costs, and labor shortages, have led to a substantial backlog in housing development, contributing to escalating prices and affordability concerns. To address these issues, a comprehensive strategy is essential, focusing on increasing construction worker supply, relaxing zoning and planning restrictions, supporting the built-to-rent sector, expanding public and affordable housing, and reevaluating property taxes (including tax concessions to property investors) and stamp duty to promote efficient land use. At the same time, capital flow management (CFM) measures that discriminate between residents and nonresidents are not consistent with the Fund’s Institutional View and should be replaced by non-discriminatory measures.

IV. Medium-Term Reform Priorities to Strengthen Economic Resilience

11. Australia's robust economic institutions and policy frameworks can be further enhanced to underpin stability and foster growth. The establishment of a new Monetary Policy Board and strengthened governance arrangements and decision-making processes, in line with international best practices, would bolster central bank operational autonomy and enhance monetary-fiscal policy synergies. Tax reforms should target system efficiency and fairness, reducing reliance on direct taxes and high capital costs that hinder growth. Tax breaks, including from capital gains tax discount and superannuation concessions, could be phased out to generate a more equitable and efficient tax system. Forthcoming environmental and demographic changes will put structural upwards pressures on government spending. Expenditure reforms should therefore aim to enhance spending efficiency and sustainability, emphasizing improved governance in infrastructure projects and strengthening intergovernmental collaboration. The aged care reforms and NDIS review represent positive forward steps. As long-term spending pressures rise, the authorities can consider bolstering their fiscal policy framework with clearer anchors.
12. Efforts to rejuvenate Australia's productivity growth, including through competition policy, should be prioritized, focusing on reforms across capital and labor markets. Initiatives grounded in the five pillar Productivity Agenda—emphasizing innovation, a level playing field for firms, and human capital enhancement—are crucial for resilient medium-term growth. Enhancing innovation through building intangible capital, promoting R&D, creating a supportive environment for swift adoption of technologies, supporting intellectual property rights, and ensuring policy certainty are vital. The work of the authorities to improve the competition landscape, including data-based assessments of the use and impact of worker restraints (non-compete clauses), and reforms of merger rules towards a risk-based system using notification thresholds, together with initiatives to support labor market efficiency including expanding access to quality early childhood education and enhancing skills development to align with market needs, are critical for bolstering productivity.
13. The advent of AI technologies introduces both opportunities and challenges to the Australian labor market, necessitating proactive labor market policies. With a significant portion of occupations highly exposed to AI, reminiscent of other advanced economies, the focus should be given to public awareness programs, as well as ensuring appropriate access to training and upskilling for workers who may be affected. These measures, coupled with ongoing assessment and policy flexibility, should aim to maximize AI's productivity benefits, while mitigating the risks of job displacement and worsening inequality. This approach underscores the importance of agility and adaptation in policymaking to keep pace with rapidly evolving technological advancements. Efforts at the country level, must be complemented by multilateral collaboration, to ensure safe and responsible AI use globally.
14. Australia's approach to climate change and the global transition presents a multifaceted challenge, balancing risks and opportunities. To ensure an orderly transition to a low-carbon economy, a balanced mix of mitigation and adaptation, combined with transition policies, is crucial. Progress towards ambitious emission reduction goals necessitates addressing construction bottlenecks and community engagement issues, and potential solutions include an economy-wide carbon price or targeted sectoral policies. The domestic and global transition toward renewable energy would likely impact jobs, exports, and revenues, particularly given Australia's status as a leading coal exporter. Thus, adapting to climate risks and fostering resilience, particularly in the financial sector and vulnerable communities, is of paramount importance. At the same time, emerging opportunities in green metals, green hydrogen and critical minerals mining and processing could mitigate these risks.
15. Australia’s continued efforts to support multilateral solutions are welcome, including the rules-based international trading system. In this respect, the "Future Made in Australia" program goal of supporting the green transition, should be balanced with efforts for a careful design of the program and keeping it narrowly targeted to where market solutions fall short due to the presence of externalities or other market imperfections. In this context, adherence to core market-based principles, that are essential to minimizing trade and investment distortions in line with WTO obligations, crowding in private investments, while supporting economic resilience and net-zero objectives, would be key. Finally, the mission team would like to commend Australia’s continued voluntary participation in the review of transnational aspects of corruption through which the country is sending a powerful positive signal, which, if followed by other advanced economies, will help address more systematically transnational aspects of corruption and deliver a better governance world.

The IMF mission team would like to express its deep appreciation to the Australian authorities and other interlocutors for their close engagement and cooperation. Our unstinting gratitude particularly goes to the counterparts at the Treasury and the Reserve Bank of Australia for the substantial time and effort devoted to supporting our work. The team looks forward to maintaining this constructive engagement and policy dialogue.