Public Information Notice No. 10/144

Public Information Notice: IMF Executive Board Concludes 2010 Article IV Consultation with Australia

October 28, 2010

On October 27, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Australia.¹

Background

Despite growth slowing due to the global financial crisis, Australia was one of the few advanced economies to escape recession in 2009. This reflected growing links with Asia, including strong demand for commodities from China and India, a prompt and significant macro policy response to the global crisis, a healthy banking sector, and a flexible exchange rate. The labor market also proved to be flexible in the face of the shock.

With the recovery well on track and dissipating spare capacity, policy stimulus is appropriately being withdrawn. The RBA has raised the policy rate to 4½ percent in six steps, the most recent in May. The increases in the policy rate have flowed through effectively to both mortgage and business lending rates which have returned close to their 10-year averages. As originally planned, the fiscal stimulus is being reduced starting in 2010.

A mining boom is underway, as commodity prices have rebounded and the outlook remains favorable. Real GDP growth is projected at 3–3½ percent in 2010 and 2011, with private investment in mining and commodity exports taking over from public demand as the main driver of growth. The terms of trade is expected to rise to historic highs in late 2010, driving a mining boom that is likely to be long lasting, given increasing ties with fast-growing emerging Asia.

The main risks relate to the global outlook and, in the near term, are tilted largely to the downside. If the global recovery stalls and Chinese demand for commodities declines, Australia’s terms of trade could fall sharply. In addition, concerns about fiscal sustainability in Europe could disrupt global financial markets and push up the cost of capital for Australian borrowers. On the domestic front, a fall in house prices, which Fund staff assesses could be mildly overvalued, and deleveraging by highly indebted households could negatively impact private consumption and slow the recovery. An upside risk is that the mining boom may have a larger-than-expected impact on output and inflation.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They commended the authorities’ decisive policy response on the back of sound fundamentals which, together with strong demand from emerging Asia, cushioned the impact of the global crisis. Australia’s economic prospects are favorable, driven by a mining boom and increasing integration with emerging Asia, although the near-term outlook is somewhat clouded by the uncertain global environment.

Directors welcomed the Reserve Bank of Australia’s (RBA) timely unwinding of monetary stimulus. They noted that if the recovery and economic growth remain on track and downside risks dissipate, monetary policy might need to tighten further to contain inflation pressures. Should the global recovery stall, the RBA has scope to cut the policy rate.

Directors agreed that the pace of exit from fiscal stimulus was appropriate. They commended the authorities’ plan to return to surplus by 2012/13 and noted that there is enough fiscal space to slow the pace of exit or loosen fiscal policy in response to a downside scenario. Directors also noted that the automatic fiscal stabilizers should be allowed to operate fully, given that the growing dependence on mining may amplify the business cycle. This implies running larger budget surpluses during upswings to help avoid potential overheating and build a buffer against a sharp fall in commodity prices.

Directors welcomed the recent review of the tax system, including the introduction of the mineral resource rent tax (MRRT). They stressed the importance of broadening the coverage of the MRRT beyond iron ore and coal. Directors noted that more reliance on consumption-based taxes would allow for the elimination of inefficient state taxes and make room for reductions in personal income taxes, and encouraged the authorities to build consensus toward this end.

Directors welcomed the fact that the Australian banks are sound. They commended the Australian Prudential Regulation Authority’s (APRA) regular stress testing and the authorities’ efforts to improve banks’ own stress testing capabilities and to extend stress testing beyond the banking sector. Directors encouraged continued vigilance to risks in the mortgage sector and close monitoring by APRA of banks’ risk assessments and strategies.

Directors noted the vulnerabilities arising from the projected widening of the current account deficit and sizable short-term external debt. Efforts to raise national saving, including through a return to budget surpluses, would help contain current account deficits. Directors considered that rollover risks associated with short-term external debt could be reduced further by encouraging banks to extend the maturity of their offshore funding.

Directors recognized that the floating exchange rate has served Australia well and provides an important buffer against external vulnerabilities. They noted staff’s assessment that the Australian dollar may be mildly overvalued from a medium-term perspective, while recognizing that the extent of overvaluation is uncertain.