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Australia: Staff Report for the 2018 Article IV Consultation

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2019
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Context

1. Australia is on the final leg of rebalancing and adjustment after the end of the commodity price and mining investment boom. Exchange rate flexibility and monetary easing have moderated the adverse demand impacts, as have the orientation of its exports towards the dynamic Asia economies and rapid population growth supported by immigration. Nevertheless, as in many other advanced economies since the Global Financial Crisis (GFC), the adjustment to the demand shocks has been protracted, with weak inflation and low wage growth amid persistent economic slack. Although nominal wage growth has started to pick up, it is slow and has not yet contributed significantly to inflation, which has remained below the Reserve Bank of Australia’s (RBA’s) target range of 2 to 3 percent.

Real GDP and Demand Components

(2002Q1=1, logs)

Sources: Haver Analytics and IMF staff calculations.

2. The housing market has started to cool after a long boom, but accumulated vulnerabilities are high. The large house price increases after the GFC were primarily driven by demand fundamentals, amplified by supply constraints. But household debt has risen to around 190 of households’ gross disposable income as a result, and housing assets have become overvalued. Housing market dynamics have eased since mid-2017, as interest rates have bottomed out, investor demand has weakened, and lending standards and bank capital requirements have been tightened. Commercial bank exposure to residential real estate has remained substantial at over 50 percent of total assets.

3. Australia has benefitted from China’s rapid growth, but, by the same token, is now more exposed to China-related risks, while also facing other structural challenges. It faces infrastructure gaps after more than a decade of rapid population growth, challenges of urbanization and agglomeration, and housing supply constraints. While increased trade and commodity linkages with China have led to substantial income gains, productivity growth has been lagging. As in other advanced economies, potential growth has been lower since the GFC, and securing future productivity is an important policy challenge.

Recent Developments, Outlook, and Risks

A. Developments Over the Past Year

4. Growth picked up to above trend in the first half of 2018 driven by domestic demand before slowing in 2018Q3, but inflation and wage growth has remained subdued.

  • Demand. Annual growth has picked up to 3.0 percent in 2018Q1-Q2, with solid private and public consumption and residential investment more than offsetting the drag from delays in public investment plans and drought. After a prolonged sharp contraction, mining investment has stabilized, supporting a rebound in Western Australia. Growth slowed down in 2018Q3, as private consumption and non-mining business investment moderated, offsetting an increase in public investment. Reflecting weak disposable income growth, the household saving ratio has declined further.

  • Labor markets. The economic momentum has resulted in improvements in labor market conditions, with the unemployment rate declining to 5.1 percent in November, closer to staff’s estimate of NAIRU of 4.8 percent. Other indicators, however, suggest continued labor market slack, including the underemployment rate, which, while starting to decline, remains well above its longer-term average. Wage growth remains weak—although it has started to pick up recently—likely reflecting multiple factors including greater labor force participation from female and older workers in response to cyclical labor market conditions (Box 1), sticky adjustment of longer-duration wage contracts, and structural change in the economy and labor markets.

  • Prices. Headline inflation has hovered around the floor of the Reserve Bank of Australia’s (RBA’s) target range of 2–3 percent. The disinflationary effects from strong retail competition have weighed on core inflation, while one-off declines in some administrative prices have temporarily lowered headline inflation.

State Final Demand

(Contributions to annual growth)

Sources: ABS and Haver Analytics.

Unemployment and Underemployment Rate

(%)

Source: Haver Analytics.

Private Wage Price Index

(% change)

Source: Haver Analytics.

Consumer Price Inflation

(Annual % change)

Sources: Haver Analytics and IMF staff calculations.

5. The external position in 2018 is tentatively assessed to be broadly in line with fundamentals and desired policies. The current account deficit narrowed substantially in 2017 and 2018, mostly reflecting stronger terms of trade and a ramp-up in new resource exports including liquified natural gas. As in the 2017 External Balance Assessment, the preliminary mid-point estimate of the current account gap in 2018 is -1.0 percent of GDP, suggesting that the current account deficit has remained broadly in line with fundamentals and desirable policies (Annex I). After substantial real depreciation so far in 2018, driven in part by a widening interest differential in favor of the U.S. dollar, the picture has been less clear-cut for the exchange rate, as some estimates of the related gaps suggest continued overvaluation. Given current policies, the current account deficit is projected to remain within 2½–3 percent of GDP over the medium term, lower than the historical average.

Cumulative Quarterly Change in the Current Account

(Cumulating from end-2011; % GDP; contributions from…)

Real Effective Exchange Rate

(1995Q1=100, logs)

Sources: Haver Analytics and IMF staff calculations.

6. The housing market has been cooling. House prices, after rising by 70 percent in the past decade at the national level and by roughly 100 percent in Sydney and 90 percent in Melbourne, have started to decline. A cooling market momentum has also been evident in a lower turnover of the housing stock and lower public auction clearance rates. Several factors have contributed to the cooling, including tightening credit supply, an increase in the housing supply coming to the market, and easing domestic and foreign demand. Nevertheless, rental vacancy rates have remained stable or declined in the smaller capital cities, while the increased supply of new dwellings available for rent has been absorbed by strong population growth. Residential investment growth has picked up in the first three quarters of 2018, and the pipeline of pending residential construction has remained strong, as has the completion rate of new apartment buildings with significant shares of presales.

Residential Property Prices

(2011Q3–2012Q2=100)

Source: ABS.

Household Debt

Sources: RBA, Haver Anaytics and IMF staff estimates.

7. The mortgage credit cycle peaked in mid-2015, and interest rates appear to have bottomed out. Annual housing credit growth slowed to 5 percent in October 2018. Growth in lending to investors has been much lower following prudential measures to curb riskier mortgages (especially interest-only loans) in April 2017. Banks have reportedly further tightened their lending standards in response to evidence of misconduct emerging from the Royal Commissioninto Misconduct in the Banking, Superannuation, and Financial Services Industry and asset quality risks associated with a cooling housing market. Following a small but sustained increase in wholesale funding costs reflecting in part spillovers from U.S. monetary policy normalization, three of the major banks raised mortgage rates by 14–16 basis points in September and October 2018. However, the interest rates for new mortgages have remained lower than those of existing mortgages, reportedly because of increased competition among banks for high credit-quality borrowers. Housing loan delinquencies have been trending up, albeit remaining at low levels.

ADI-Impaired Facilities and Past Due Loans

(In percent)

Source: APRA

8. Australian banks are well capitalized and profitable. Following the requirement for capital to be “unquestionably strong,” banks’ capital levels are high in relation to international comparators. Banks’ dependency on wholesale funding has been reduced but remains substantial at about one-third of total liabilities, of which two-thirds are from external sources.

Residential Term Loans to Households 1/

(Y/Y percent change)

Sources: APRA and Haver Analytics.

1/ ADIs with greater than A$1 billion of term loans.

Residential Term Loans to Households-Investor and Interest-only Loans 1/

Sources: APRA and Haver Analytics.

1/ ADIs with greater than A$1 billion of term loans.

3 month Money Market Spreads

(In bps)

Source: Bloomberg.

Mortgage Rates

Source: Haver Analytics.

B. Outlook

9. The economy is expected to adjust toward potential growth, full employment, and inflation well within the target range, but the process will be gradual.

  • Growth should gradually moderate to that of potential output. The rebound in non-mining private business investment and public infrastructure spending, as suggested by a strong pipeline of capital projects, is projected to offset the expected contraction in dwelling investment in the near term. Mining investment is projected to increase at a rate consistent with capital stock maintenance, removing a major drag on domestic demand growth. Private consumption growth is predicted to remain close to potential output growth, supported by employment gains and gradual wage increases but tempered by pressures from debt reduction and higher saving rates, given tightening lending standards and conditions. Net exports will contribute less to growth, reflecting drought-related supply declines, the end of the ramp-up in liquified natural gas (LNG) exports, and lower growth in China and the global economy. Macroeconomic policies are assumed to adjust, with growth moderating towards that of potential output in the medium term.

  • Inflation is forecast to return to the midpoint of the target range over the next two to three years. With growth above or close to potential, the output and unemployment gaps will be closing and underemployment will decline, leading to upward pressure on wages and prices. In the near term, disinflationary effects from continued strong retail competition and the recent one-off declines in some administered prices will weigh on inflation.

  • The housing market correction should be mild and short-lived. The correction is assumed to continue over the next year or so, with some contraction in dwelling investment and further price declines, as in previous episodes (Box 2). In the context of continued strong growth and improving labor markets, the negative feedback effects on banks’ asset quality and the real economy (including through wealth effects) should remain modest. At the same time, the underlying demand for housing should hold up because of robust population growth, which should eventually lead the way for a house price rebound. The negative credit supply shock is also expected to ease, as banks have already responded with stricter enforcement of existing lending standards in anticipation of the recommendations from the banking royal commission due in February 2019. With this correction, house price overvaluation should decrease, while household debt ratios should stabilize and then decline.

10. After declining over the past decade, potential output growth is forecast to stabilize at 2.6 percent in the medium term. Productivity has recovered somewhat, even with diminishing capital deepening since the end of the mining investment boom. Trend total factor productivity (TFP) is assumed to remain broadly stable, with a small increase over the projection period on account of increased infrastructure investment and higher spending on research and development (R&D). Labor input is projected to grow steadily, as immigration is assumed to maintain population growth and there is scope for higher labor force participation by female and older populations.

Potential Output Decomposition

(Percent or Percentage Points)

Sources: ABS, Authorities’ data, IMF staff calculations

Population Growth and Key Drivers

(Contributions to population growth, in percent)

Sources: Haver Analytics and IMF staff calculations.

C. Risks

11. Downside risks to economic growth have increased with a less favorable global risk picture, the housing market downturn, and uncertainties about domestic demand (Annex II).

  • On the external side, given Australia’s reliance on exports to China—coal, iron ore, tourism, and education services—it is particularly exposed to the downside risks from the ongoing trade tensions between China and the United States, and China’s economic rebalancing, potentially reinforcing each other.1 These risks could delay the closure of the output gap, although there are also upside risks to the terms of trade in the near term. A sharp tightening of global financial conditions could spill over into internationally integrated domestic financial markets, raising funding costs in the economy and lowering disposable income of debtors, with the impact also depending on the response of the Australian dollar.

  • On the domestic side, the housing market correction may be deeper and longer than anticipated, especially if banks are overly cautious in extending credit. While households’ incomes are relatively resilient to smaller interest rate increases, larger negative shocks, domestic and external alike, would likely interact with and amplify the housing correction. Domestic demand would also turn out weaker if wage growth remained subdued or investment spillovers were smaller. On the other hand, a stronger pickup in the non-mining business sector, larger spillovers from public infrastructure investment, and the Australian dollar depreciation over the past year could boost near-term growth more than projected. Over the medium term, potential output growth could either be lower if TFP weakens as elsewhere or higher with effective structural reforms.

Estimated Impact of Interest Rate Changes on Household and Housing Debt
Household DebtHousing Debt
Baseline Dec-17Alternate 1/Baseline Dec-17Alternate 1/
Interest payment (quarterly, A$Bil)28,03433,94122,82327,253
Implicit interest rates (percent)4.75.75.26.2
DSTI (interest payment only, quarterly, percent)8.910.77.28.6
Sources: RBA, ABS, and IMF staff calculations.

Alternate scenario assumes a 1 percentage point increase in interest rates.

Sources: RBA, ABS, and IMF staff calculations.

Alternate scenario assumes a 1 percentage point increase in interest rates.

D. Authorities’ Views on Outlook and Risks

12. The authorities expected near-term growth to remain around 3 percent, a little above estimates of potential growth. Solid growth in employment, corporate profits, and public demand would support household incomes, consumption, and business investment in a low interest rate environment. By 2020, housing investment was expected to slow and LNG exports were expected to reach capacity. Remaining slack in the labor market would diminish steadily, with the unemployment rate expected to decline further. Nonetheless, the pickup in wage growth and inflation was expected to be gradual, given remaining labor market slack and continued increasing competition in the retail sector.

13. The authorities emphasized that the correction in the housing market has been orderly, in the context of a strong economy. The declines in house prices, particularly in Sydney and Melbourne, must be seen against the large price increases previously. The correction was taking place in a strong economy, including low unemployment, and few pockets of excess housing supply.

14. Downside risks from the housing market correction are a concern. Officials noted that these risks include an excessive moderation in credit flows, possibly from banks overreacting to the banking royal commission and the housing correction, unexpected strong caution by market participants in response to the correction, or from the interaction with other negative surprises shocks in the context of high levels of household debt. The authorities expected the impact of the housing correction on consumption through wealth effects to be small, but highlighted uncertainty around prospects for private consumption, given continued low wage growth amid household debt.

15. The authorities agreed that downside risks to economic growth had increased with a less favorable global risk picture. While the impact of US-China trade tensions on the Australian economy had been muted so far, partly because of policy stimulus in China, their escalation could weaken global growth and economic activity in Australia, particularly through commodity market and services trade channels. A sharp tightening of global financial conditions could spill over into domestic financial markets, raising funding costs and lowering disposable income of debtors. The impact would be mitigated by exchange rate flexibility, with the Australian dollar typically depreciating in those circumstances.

Macroeconomic Policies

Context

16. The monetary policy rate has been on hold at 1.5 percent since August 2016. The monetary policy stance is accommodative, with the current cash rate setting implying a slightly negative real policy rate relative to estimates of the real neutral interest rate in the range of 1–2 percent. Financial conditions have remained broadly unchanged in 2018, while a small steepening of the domestic short-term yield curve has been broadly offset by the depreciation of the Australian dollar. The RBA has recently signaled that the next move in the cash rate will likely be an increase, but that the currently accommodative policy stance will be needed for some time, given weak inflation.

17. The fiscal policy stance has remained supportive. General government expenditure has grown faster than potential output since 2016, partly owing to an infrastructure investment boost. Nevertheless, the Commonwealth and general government budget deficits have narrowed, primarily reflecting strong revenue growth with the economy’s improving cyclical position, stronger terms of trade, and, until recently, the housing boom. With stronger revenue collection in the current fiscal year, the Commonwealth’s Mid-Year Economic and Fiscal Outlook (MYEFO) of December 2018 incorporated higher spending on education, health care, and aged care, with some matching at the state level, as well as increased infrastructure spending.

Staff’s Views

18. Continued macroeconomic policy support is essential for completing the economic rebalancing after the end of the mining investment boom. While the unemployment rate is approaching NAIRU, labor market slack is likely to be larger than indicated by the implied cyclical unemployment rate. Relatively high underemployment corroborates this view, consistent with a greater role of adjustment along the hours-worked dimension in this recovery. At the same time, labor force participation has been increasing, especially for females and older workers, groups which tend to have stronger responses to cyclical changes in labor market conditions (Box 1). Cyclical upward pressure on wages will likely emerge only with a substantial and uncertain lag once full employment is reached. At the same time, the infrastructure investment boost has been a catalyst for the economic rebalancing, with continued uncertainty about whether the nascent rebound in private business investment is strong enough to offset the drag from balance sheets constraints on private consumption and an expected decline in residential investment.

19. The monetary policy stance should be accommodative until evidence of more substantive upward pressures on wages and prices emerges. Staff concurs with the RBA that the policy stance is sufficiently accommodative for inflation to return gradually to the 2–3 percent target range. A tightening bias is premature at this point, given the labor market slack and downside risks to the near-term outlook and inflation. With unusually persistent inflation undershooting and continued uncertainty about the timing and magnitude of cyclical upward pressures on prices, the monetary policy stance needs to emphasize commitment to the inflation targets and clear guidance on when labor market conditions will merit policy normalization. With the recent increase in the share of households with high debt in Australia, normalization would likely have to be gradual.2 In these circumstances, the cash flow channel (through the impact of interest payments on households’ disposable income) will likely be relatively more important in the transmission of monetary policy, which, everything else equal, should also increase its effectiveness.

Unemployment Gap and Core Inflation

(%)

Source: Haver analytics and IMF staff calculations.

1/ Defined as actual minus HP filtered unemployment rate.

Policy Rate Expectations 1/

Source: Bloomberg.

1/ Based on future contracts for 30-day Federal Funds rate for the US and 90-day Bank Bill rate for Australia.

20. The infrastructure investment boost has provided welcome aggregate demand support. With further increases in spending envelopes, real expenditure growth is projected to remain above that of potential output in 2019, owing to continued high growth in public investment. Australia has substantial fiscal space and could, therefore, consider further increases in infrastructure spending. At the same time, capacity constraints appear to have held back implementation. The appropriate sequencing of projects between levels of government and regions, especially Melbourne and Sydney, will thus remain important in ensuring a steady growth impetus from the infrastructure investment program in the near term.

Fiscal Impulse

(% GDP)

21. The government’s medium-term fiscal strategy appropriately aims to reach a balanced budget by FY2019/20 and run budget surpluses thereafter. This fiscal path is predicated on a further cyclical revenue recovery and would still be consistent with the Commonwealth and state governments continuing to run ambitious infrastructure investment programs and structural reforms in support of higher growth under the baseline outlook. The principle of running budget surpluses in good times has been a core element of the medium-term fiscal strategies under Australia’s fiscal framework. This principle has helped in preserving fiscal discipline. Looking forward, the projected surpluses under the baseline outlook should not be cut short prematurely through permanent tax cuts or increases in current spending. Some of the recent revenue strength may well turn out to be more temporary than expected. In this respect, a rigid interpretation of the cap on Commonwealth tax revenue of 23.9 percent of GDP formalized in the FY2018/19 budget might not be consistent with the principle of running sustained budget surpluses in good times.

22. A role for medium-term debt anchors could be considered as a complementary element in medium-term fiscal strategies. As Australia’s recent experience demonstrates, there can be considerable upward drift in debt ratios from shocks with protracted effects, a medium-term budget balance anchor notwithstanding. While Australia has substantial fiscal space and current debt levels are still relatively low, the drift might make meeting the principle of low debt levels set out the in the Charter of Budget Honesty Act more challenging over the medium term. In the context of increased downside risks to the outlook and an environment in which discretionary fiscal stimulus might be needed more frequently, and given the limited conventional monetary policy space, some role for a debt anchor in the medium-term fiscal strategy might be considered. Options include the occasional resetting of the budget balance anchor based on recent debt developments or replacing the budget balance anchor with a debt anchor, with flexibility over the economic cycle.3

23. If downside risks to the economic growth outlook materialize, macroeconomic policy responses will need to be flexible. Monetary policy has been the primary policy tool for macroeconomic stabilization, while the fiscal policy response has been to let automatic stabilizers play out. But with more limited conventional monetary policy space, a fiscal stimulus would likely need to be a part of an effective overall policy response if major downside risks were to materialize. Australia’s substantial fiscal space allows for fiscal policy to respond as necessary.

Authorities’ Views

24. The RBA expected to keep the policy rate on hold in the near term given its forecast of gradual progress in meeting its dual employment and inflation objectives. A pickup in wage growth was likely to be necessary for inflation to be sustainably within the target range. RBA officials noted that this would require an economy that has been in full employment for some time, but also emphasized the considerable uncertainty around these developments. Private consumption in an environment of high household debt and housing price declines was another source of uncertainty. Officials also noted that mortgage lending rates remained low in general and for high quality new mortgage loans in particular, despite some increases in bank funding costs on the back of higher money market rates.

25. The government highlighted the stronger budget outturn and the earlier return to budget surpluses by the Commonwealth. The Commonwealth government expects a return to budget surpluses as of FY2019/20. The FY2018/19 budget already incorporated an improved fiscal outlook, which provided the space to cancel the 2019 increase in the Medicare levy put in place last year and to cut PIT for middle and lower income households over the next seven years. The government also formalized a speed limit on tax collection, which should remain below 23.9 percent of GDP, the average in the 2000s before the GFC. The FY2018/19 MYEFO showed a further improvement in the underlying cash balance of A$15.0 billion over the four years to FY2021/22. This budget balance path will enhance Australia’s fiscal space and allow for a flexible policy response in case of a downturn.

26. The infrastructure push will continue. Revenue and spending outcomes for the states have been better than expected as well, with most states intending to increase infrastructure spending further, and run surpluses if possible. Both levels of government are concerned about risks of capacity constraints slowing the pace and increasing the cost of the ongoing infrastructure push. New South Wales and Victoria are already discussing how to coordinate schedules to help address these risks.

27. The authorities agreed that a severe negative shock might require a combined monetary and fiscal policy response. With the nominal policy rate at 1.5 percent, the RBA still has space for further rate reductions, although the effective lower bound on nominal policy rates would more likely be a constraint. Officials emphasized, however, that the policy response would depend on the nature of the shock. If the latter were country-specific, for example, the Australian dollar would likely depreciate in real effective terms, raising expected inflation and nominal interest rates, everything else equal. As for unconventional monetary policy responses, there were several options for the RBA to use its balance sheet within the current institutional and legal framework.

Macrofinancial Policies4

Context

28. The authorities have pursued a two-track approach to manage structural financial vulnerabilities. This approach distinguishes between issues related to the asset and the liability side of bank balance sheets.

  • The regulatory emphasis on banks applying strong lending standards remains, but caps limiting investor and interest-only lending were removed by end-2018. Prudential interventions introduced by the Australian Prudential Regulation Authority (APRA) sought to lower systemic risks from rapid household credit growth and already high debt levels at the outset of the recent housing boom (Annex IV). Besides stronger lending standards, the interventions have also limited higher-risk investor and interest-only lending through caps (“benchmarks”). More recently, APRA removed the caps restricting a bank’s annual investor lending growth to 10 percent (effective as of July 1, 2018) and its interest-only lending to 30 percent of new loans (effective as of January 1, 2019). The removals were motivated by the measures having reached their goals. Implementation has been bank-specific, conditional on a bank’s assurances to APRA with respect to the strength of its lending standards.

  • The capital adequacy framework for banks was further refined in 2018. Since the GFC, APRA has raised capital adequacy requirements in several steps and introduced tighter liquidity requirements, including a net stable funding ratio in line with Basel III requirements. In 2018, APRA established a framework and timeline for introducing a minimum leverage ratio for Australian banks and proposed changes to the capital adequacy framework to increase banks’ loss absorbing capacity.

29. FSAP stress test results found banks’ solvency and liquidity to be relatively resilient to stress, but the tests also highlight banks’ continued vulnerability to external funding shocks. The tests examined the resilience of the ten largest banks in Australia to a combined shock involving a significant slowdown in China, a sharp correction in real estate valuation, and marked tightening of global financial conditions. While the tests revealed some pressure on capital, the banks examined would still be meeting regulatory minima. Liquidity stress tests revealed some vulnerabilities to severe stress given continued reliance on wholesale funding. Cross-border analysis revealed banks’ exposure to potential credit and funding shocks from several advanced countries, notably the United Kingdom and the United States, the regional financial centers of Singapore and Hong Kong SAR, as well as from parent-subsidiary linkages with New Zealand.

30. AUSTRAC has taken several steps to strengthen its AML/CFT supervision. These include increasing its focus on institutions’ inherent ML/TF risks and prioritizing higher risk institutions. Initial work has also been undertaken to bring designated non-financial businesses and professions (DNFBPs) under the AML/CFT regime. There is however scope to increase the number of onsite inspections and further improve the sanctioning regime.

Staff’s Views

31. Financial vulnerabilities from household debt and house price overvaluation will stay elevated. Under the orderly correction in the baseline scenario, house price overvaluation diminishes and average household debt ratios decline over time. Even so, household debt ratios will remain high over the next few years, as will related vulnerabilities. While lower shares of higher-risk household debt (e.g., interest-only mortgages or high LTV mortgages) should have lowered aggregate default probabilities on household liabilities held by banks, those probabilities are also related to debt levels, debt distribution, and the value of assets at risks. At the same time, the amplification of the economic impact of shocks through household debt channels and the possibility of adverse feedback loops between real estate values, bank credit, and economic activity remain a concern.

32. Against such vulnerabilities, macroprudential policy should hold the course on implementation of stricter lending standards. The prudential caps restricting investor loans and interest-only mortgages have contributed to slowing household credit growth and cooling the housing market. With the end of the housing boom, the benchmark on investor lending growth had not been binding prior to its removal, and investor loan growth has moderated further since. The removal of the cap on interest-only mortgages will provide more flexibility in the pace of conversions of interest-only loans to principal-and-interest loans, which would have been concentrated over the next three years with the benchmark still in place. The recent declines in the share of interest-only loans is a welcome development and should be maintained. Borrowers of interest-only loans are more exposed to adverse shocks given the higher balances they face over the life of the mortgage. If the lending standard assurances required for the removal of the caps prove insufficient in maintaining a lower share of interest-only loans, the authorities should stand ready to reintroduce caps on such loans.

33. The readiness of an extended macroprudential toolkit should be explored. The prudential measures used by APRA in the recent housing and credit boom have dampened growth in high-risk lending and reinforced sound lending practices. A further tightening is not warranted at this point in the cycle. Nevertheless, given the prospect of interest rates remaining low and household debt ratios remaining high for some time, and expectations of continued strong growth in housing demand, the authorities should prepare for a possibility of another house price boom or increased macrofinancial vulnerabilities for other reasons. Having a broad macroprudential toolkit ready for deployment would provide for a flexible and targeted response to systemic risks that could emerge. An extended toolkit relative to measures used recently could include borrower-based restrictions, such as loan-to-value caps, income-based ratios, such as limits on loan (or debt)-to-income, as well as refined debt-serviceability requirements. Readiness would require that data, legal, and regulatory requirements have been addressed.

34. The Australian authorities have developed a robust regulatory framework, but further reinforcement in two broad domains would be beneficial:

  • The systemic risk oversight of the financial sector could be strengthened. The parallel 2018 Financial Sector Assessment Program (FSAP) recommends buttressing the financial stability framework by strengthening the transparency of the work of the Council of Financial Regulators (CFR) on the identification of systemic risks and actions taken to mitigate them. Improving the granularity and consistency of data collection and provision would support the analysis of systemic risks and policy formulation.

  • Financial supervision and financial crisis management arrangements should be further bolstered. The FSAP’s specific recommendations include increasing the independence and budgetary autonomy of the regulatory agencies, strengthening the supervisory approach, particularly in the areas of governance, risk management, and conduct, and enhancing the stress testing framework for solvency, liquidity, and contagion risks. The FSAP also recommends strengthening the integration of systemic risk analysis and stress testing into supervisory processes, completing the resolution policy framework, and expediting the development of bank-specific resolution plans. Recent announcements of additional funding for the regulatory agencies are welcome (Annex V).

35. There is scope for further improvements to the AML/CFT regime ahead of the next FATF assessment planned for 2020. AUSTRAC should increase its supervisory resources and the number on onsite inspections, further strengthen the effectiveness of its sanctions regime, and expand the AML/CFT regime to cover all DNFBPs starting with trust and company service providers, lawyers and real estate professionals as they have been assessed as presenting higher ML/TF risk.

Authorities’ Views

36. The authorities noted that stricter enforcement of conduct and regulatory standards is already underway but voiced concerns about an excessive moderation in credit flows. They underscored that Australian banks remain strongly capitalized, have considerable liquidity buffers and on the whole manage credit risk effectively by global standards. Despite incidents of misconduct identified by the banking royal commission, non-performing loan ratios have been low. Officials also highlighted that lending and governance standards for banks have already been tightened and that the main challenge now is enforcement. While banks need to comply with standards and take responsible loan decisions, they should not be unduly constrained in taking and managing responsible risk.

37. The authorities are in broad agreement with the thrust of the FSAP’s findings and recommendations. The CFR is taking steps to enhance the transparency of its operations. It recently released its first quarterly statement following its December meeting. The statements will outline the main issues discussed at each CFR meeting. The authorities took note of shortfalls in the granularity and consistency of data to support the analysis of supervisory and systemic risks and the formulation of policy. The recommendation on the need for additional investment in data and in analytical tools will be useful in bringing about the change.

Housing Markets and Policies

Context

38. The housing market correction is helping housing affordability. Foreign and domestic investor demand has moderated, thereby enhancing opportunities for first-time home buyers and purchases by owner-occupiers more broadly. On the supply side, progress has been made in using City Deals, agreements across all levels of government that integrate planning and infrastructure delivery for new developments and redevelopments. A prominent example―the City Deal for western Sydney―encompasses the development of the urban area around the new airport. Two states (Western Australia and Tasmania) introduced or announced housing-related tax policy measures discriminating between residents and non-residents since the last Article IV Consultation.5

Staff’s Views

39. Housing supply reforms will remain critical to restoring housing affordability. While the housing market correction will help, it is unlikely to be sufficient for inclusive, broad-based affordability and growth. The underlying demand for housing is widely expected to remain strong with a robust economic growth outlook for and high population growth in urban areas. At the same time, broad affordability will also be a precondition for a significant reduction in related macro-financial vulnerabilities. As planning, zoning, and other reforms affect supply and prices with long lags, housing supply reforms should, therefore, not be delayed because of the housing market correction. City Deals are a useful catalyst for the large-scale development or redevelopment of urban areas. Nevertheless, this instrument has limited reach, although the Regional Deals envisaged by the government would provide for a welcome extension. Some states should still take the opportunity for further streamlining and consolidation in planning and zoning regulation.

Approvals for New Residential Property Purchases by Foreigners

(In billions of AUD)

Sources: Australian Foreign Investment Review Board, Annual Reports; and IMF staff calculations.

1/ All data are converted from fiscal year. For 2017, extrapolated from 2016/17.

40. Broader tax reforms that also address housing and land use would reinforce the impact of supply-side measures. Stamp duties should be replaced by broader land taxes, which would strengthen incentives for efficient land use. Within the context of a broader tax reform, gradual lowering of capital gains discounts and limits on negative gearing for investors would reduce structural incentives for leveraged investment by households, including in residential real estate. A more limited capital gains tax exemption for owner-occupiers should also be considered.

41. The housing policy measures discriminating nonresident buyers should be reconsidered. As the role of foreign buyers in residential real estate markets has started to decline, the discriminatory measures should be reconsidered, as they may no longer be needed to address housing market imbalances. They should be replaced by alternative and effective non-discriminatory measures where possible (e.g., a general surcharge on all vacant property).

Authorities’ Views

42. The state governments of New South Wales and Victoria noted that the fall in housing prices in Sydney and Melbourne was larger than originally projected in their budgets. Nevertheless, despite their limited progress on zoning and planning reform to reduce impediments to housing supply and affordability, they expected house prices to find support from both housing demand and supply factors. The authorities highlighted that City Deals could be important tools to foster urban housing supply. City Deals have allowed all levels of government to coordinate planning and construction decisions, thereby facilitating infrastructure provision which can in turn support housing supply expansion. Deals agreed on or announced in 2018 included Darwin, Geelong, Hobart, and Perth. There are also plans underway to pilot Regional Deals outside of the major urban areas.

Fostering Growth

Context

43. The government’s structural policy agenda targets areas identified by the Productivity Commission and the OECD. Australia’s multifactor productivity growth increased over the past few years but remains below that of some peers. Recent policy efforts have focused on addressing infrastructure gaps, strengthening innovation and R&D capacity, reducing the gender gap in labor force participation, and lowering corporate and personal income tax rates. The government has also implemented a strategy to reduce gender gaps in labor force participation and representation in senior positions, with the goal of lifting potential output.

44. Some tax policy and revenue sharing reforms have been passed. Personal income tax (PIT) cuts were announced in the FY2018/19 budget and approved by Parliament. The cuts will be phased in over seven years, starting this fiscal year, improving the progressivity of the system and favoring lower income groups. 6 The proposed company tax reform, which sought to reduce the statutory corporate income tax (CIT) rate gradually from 30 to 25 percent for all companies, has been implemented only partially. The rate reduction to 25 percent by FY2021/22 was legislated for small companies with a turnover below A$50 million, while a reduction in the CIT rate for larger companies was defeated in the Senate. Horizontal fiscal equalization (HFE) reform was also completed in November 2018, by revising the redistribution mechanism of goods and services tax (GST) revenue to states, which offsets differences in revenue raising capacity and costs of delivering services.

45. Energy policy has come to the forefront with recent increases in energy price volatility. With the opening of domestic natural gas markets to international trade (through LNG production) and closure of coal-based energy sources and exacerbated by difficulties in the distribution network (network reliability issues, lack of storage for some renewable sources, such as solar and wind power), energy prices soared in 2017. The higher prices also highlighted potential inconsistencies between state-level and Commonwealth renewable energy targets (RETs). These developments motivated the 2017 Independent Review into the Future Security of the National Electricity Market (the “Finkel review”), which led to reforms, including new and reform of existing energy institutions, involving both the Commonwealth and states. These reforms appear to have contributed to reducing electricity prices in 2018. Nevertheless, there is no agreement yet on nationally integrated policies needed to meet Australia’s commitment to reducing greenhouse gas emissions under the Paris Agreement.

Staff’s Views

46. Closing macro-critical gaps for infrastructure, gender equality, R&D, energy policy, and general tax reform should strengthen productivity growth. Progress has been made in all five areas in recent years and are currently being addressed by the authorities. The infrastructure gap, while a large contributor for stronger productivity growth, already has a stronger baseline position than the other areas. The government implementation for its gender equality strategy continues, as female participation rates continue to rise (Box 1). Staff sees scope for additional measures for the other three areas to stimulate productivity growth, by expanding R&D measures, undertaking broad tax reform, and ensuring an integrated national energy policy.

47. There is scope to further expand infrastructure spending to stimulate productivity. Australia is a relatively fast-growing economy supported by high population growth, and its infrastructure needs have also been increasing rapidly. The country has a notable infrastructure gap compared to other advanced economies, the closing of which could raise GDP by about one percent in the medium term.7 In the last round of budgets, the Commonwealth and state governments expanded infrastructure spending planned over the coming years. There is an average forecasted annual infrastructure gap of roughly 0.35 percent of GDP through 2040 for basic infrastructure (roads, rail, water, ports), and an additional gap in social infrastructure (schools, hospitals, prisons), likely of a lesser magnitude.8 The latest budget spending has greatly reduced the gaps in the near term, but there is scope to go further. Planning for additional spending should be expedited, as infrastructure projects require long-term planning and zoning. Gaps may also be opening faster than expected, given the greater-than-expected rapid population growth in Sydney and Melbourne.

Announced Infrastructure Spending

(% GDP)

Sources: Commonwealth FY2018/19 Mid-Year Economic and Fiscal Outlook (MYEFO); FY2018/19 mid-year budget reviews from the states; FY2018/19 budgets from the territories.

48. Further reforms to encourage innovation would reinforce progress made to date. Spending on R&D has increased in Australia over the past decade. While the main phase of National Innovation and Science Agenda (NISA) is ending in FY2018/19, funding for new research infrastructure over the next 12 years has been increased by A$1.9 billion. There has been R&D tax credit reform, focused on reducing potential abuses of the current system by larger firms. Instead of focusing only on reducing costs, providing larger tax credits and incentives to further benefit young firms (usually SMEs), perhaps targeted to specific sectors, could also be implemented.9 Further work on innovation in the education sector would be welcome along the lines of the Australia 2030: Prosperity through Innovation report, as well as the Productivity Commission’s Shifting the Dial: 5 Year Productivity Review from 2017.

R&D Expenditures

(Percent of GDP)

Sources: OECD Main Science and Technology Indicators, IMF staff calculations

49. Broad tax reform would support productivity and inclusive growth.10 The share of direct taxes in Australia’s federal tax revenue is higher than the OECD average, partly reflecting relative high effective tax rates in international comparison and shifting from direct to indirect taxes would lower tax distortions and enhance productivity. The Commonwealth government has to date lowered CIT for SMEs and introduced PIT cuts. If these reforms were to be combined with reforms to raise GST revenues and a new attempt to cut CIT for all firms, it could complete the rebalancing of the tax system in a revenue-neutral manner towards indirect taxation. To increase GST revenues, it would be efficient to first broaden the tax base, and then consider the appropriate tax rate to reach the targeted level of revenue. To offset the regressive element from a broader GST coverage, an income-based tax rebate scheme to reduce negative impacts on lower income groups could be included. Such a scheme could be funded in part by a reduction in overly generous tax concessions. Shifting from land transfer stamp duties to a general land tax is also advisable on efficiency grounds.

50. Continued progress on energy policy should further reduce uncertainty for investment decisions. Governments have already made substantial progress on pricing and reliability issues. The clarification in due course of policies to achieve Australia’s greenhouse emissions target commitments will also help reduce uncertainty.

51. Staff welcomes the authorities’ continued commitment to working actively with international partners to promote the global multilateral trading system. Australia has maintained highly open trade and investment regimes. It has committed to agreements within the WTO, it is completing its accession to the 47-member WTO Government Procurement Agreement, and it has completed domestic ratification of (and is now subject to the commitments under) the WTO Trade Facilitation Agreement. Outside the WTO, Australia has ratified the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (also known as CPTPP or TPP-11), sending a positive signal in a time of increasing global trade tensions.

Selected Trade Policy Indicators

(0 = least open country in G20; 1 = most open country in G20)

Notes: The indicators reflect no judgment as to WTO compliance of underlying measures, nor whether certain measures (such as trade defense) are an appropriate response to the actions of other countries. The “ease of starting a business” indicator is based on perceptions as part of an established IFC survey process.

Sources: Tariff data are from the WTO, World Tariff Profiles; the import licensing measure is based on UNCTAD TRAINS and COMTRADE data; the average trade facilitation performance, agricultural support measure, Services Trade Restrictiveness Index (STRI), and FDI Restrictiveness Index are from the OECD; WB STRI is from the World Bank; the post-GFC indicators are from Global Trade Alert.

1\ Import (export) coverage ratio, except for the case of FDI (number of measures )

Authorities’ Views

52. The authorities continue to pursue energy reform. The Commonwealth, with the states, has undertaken reforms to the gas market, networks, wholesale and retail electricity markets, and is pursuing further reforms as part of the Australian Consumer and Competition’s (ACCC) recommendations to improve competition and reduce electricity prices. Most of the recommendations of the Finkel review have been or will be implemented, including the establishment of the Energy Security Board comprising an independent chair and the heads of all relevant market bodies. The Commonwealth remains committed to reducing carbon emissions by 26 to 28 percent on 2005 levels by 2030 as in the Paris Agreement and is on track to meet its 2020 Kyoto target.

53. Policy reforms to foster innovation have been implemented. Through National Innovation and Science Agenda (NISA), R&D infrastructure has received additional funding. The R&D tax credit regime has been reformed to ensure more efficient and broader use by the private sector. The government is also implementing many of the recommendations from the recently released 2030 Strategic Plan for the Australian Innovation, Science, and Research System.

54. The authorities agreed with the merit of tax reform but noted the difficult political economy of such reform. Although the Commonwealth government’s CIT reform plan was defeated, it successfully passed PIT reform and reforms of the HFE mechanism associated with distributing the GST revenues among the states. Under the reform, from FY2021/22, GST will no longer be distributed to equalize all states’ fiscal capacity to that of the state with the strongest fiscal capacity but will transition over six years to equalizing to the fiscal capacity of the stronger of either New South Wales or Victoria. All states will be better off as a result of the HFE reform, at least until it is revisited in FY2026/27 by the Productivity Commission.

55. The government remains committed to free trade. Besides securing trade agreements with its major trading partners China, Japan and Korea and ratifying the CPTPP, the government continues to pursue negotiations for the Regional Comprehensive Economic Partnership (RCEP) and free trade agreements with other Asian economies such as Indonesia. It supports trade measures by the WTO, as well as initiatives to reform and enhance the effectiveness of the WTO.

Staff Appraisal

56. Australia’s economic rebalancing after the end of the mining investment boom advanced further. Economic growth picked up to rates above potential in the first half of 2018, supported by buoyant public demand and solid private consumption, but slowed somewhat in 2018Q3. Labor market conditions also improved, with strong employment growth and declining unemployment, although wage growth remained weak while inflation hovered just below the lower end of the RBA’s target range. With the current account deficit shrinking in 2017–18, the external position is broadly consistent with medium-term fundamentals and desired policies.

57. The economy is expected to reach full employment over the next two to three years, but downside risks to the growth outlook have increased. Strong growth in private and public investment should more than offset weaker dwelling investment, as the housing market correction continues. But the recent strong momentum in economic activity will not be sustained, as growth in resource exports will increasingly be constrained by capacity, while modest wage growth, high household debt, and declining house prices will weigh on private consumption growth in the near term. Upward pressures on prices and wages, however, should increase once the economy has been at full employment for some time. The balance of risks is tilted to the downside, with the deterioration in the global risk picture and risks of a deeper housing market correction.

58. Macroeconomic policy support should remain in place until full employment and inflation in the target range are firmly within reach. Domestic demand strength is likely becoming less broad-based in the near term, partly because of the unfolding housing market correction, while net exports will be constrained by resource sector capacity and a weaker global environment. In this situation, the return to full employment and stronger wage and price pressures will remain gradual, with continued risks of inflation remaining below the target range. The infrastructure investment boost will thus be a critical source of demand strength in the near term. With the cash rate at 1.5 percent, monetary policy remains appropriately accommodative, and its normalization should depend on firmer upward pressures on prices.

59. With the economy moving toward full employment, the government’s medium-term fiscal plans appropriately target budget surpluses from FY2019/20. The budget has benefited from revenue strength underpinned by progress in the economic rebalancing and stronger-than-expected commodity terms of trade. The principle of running budget surpluses in good times has been an important anchor of fiscal discipline in Australia. Given considerable uncertainty about how much of the recent revenue surge is cyclical, the expected run of consecutive budget surpluses reflecting the stronger economy should not be stopped through premature permanent tax cuts or expenditure increases. Moreover, with large medium-term swings in net public-debt-to-GDP ratios since the GFC, a complementary role for a debt anchor in Australia’s fiscal framework could be considered.

60. With limited conventional monetary policy space, the macroeconomic policy response needs to be flexible if downside risks to growth materialize. Discretionary fiscal stimulus may need to complement monetary easing in economic downturns more frequently than it has in the past. With substantial fiscal space, the effectiveness of the fiscal policy response will depend critically on the readiness for deployment.

61. Managing financial vulnerabilities from high household debt requires macro-prudential policy to hold the course on lending standards. Macroprudential interventions have helped reducing heightened credit risk and reinforcing sound lending standards. With a cooling housing market, household credit growth has moderated, and the need for temporary prudential intervention to manage risks to financial stability has declined. Nevertheless, significant structural financial system vulnerabilities are still present and household debt will remain high, with an orderly housing market correction. Maintaining improved lending standards and further strengthening of banks’ resilience through refining the capital adequacy framework will be essential. At the same time, macroprudential policy should focus on expanding and strengthening the toolkit, which will provide for more flexible responses to financial stability risks in the future.

62. The systemic risk oversight of the financial sector could be strengthened. The transparency of the work of the CFR on systemic risks should be strengthened, following FSAP recommendations. Supervision and financial crisis management arrangements should be further improved in several areas, including increased independence and budgetary autonomy of the regulatory agencies, a strengthened supervisory approach, and an enhanced stress testing framework. The authorities should also strengthen the integration of systemic risk analysis and stress testing into supervisory processes, complete the resolution policy framework, and expedite the development of bank-specific resolution plans.

63. Housing supply reforms are critical to restoring housing affordability. The ongoing price correction will help mitigate pressures on affordability. But with the baseline demand outlook for housing still robust and no signs of significant oversupply, meeting the needs of a growing urban population will require strengthening the supply response beyond the current cycle through continued reform. In the context of broader tax reform, changing key tax policy parameters affecting housing demand and land use, including replacing stamp duties with broad-based land taxes, would strengthen the effectiveness of supply-side measures. Housing policy measures discriminating between resident and nonresident buyers should be reconsidered as the role of the latter in residential real estate market has started to decline.

64. The structural policy agenda appropriately targets innovation, infrastructure gaps, tax reform, and energy policy, although progress has been limited in some areas. The infrastructure spending envelope could be further increased to close remaining gaps to relieve congestion and maintain existing infrastructure capital. Tax reform would benefit from a broader approach, focusing on a greater role in the tax system for more efficient taxes with stable bases, such as the GST and land taxes, while reducing tax concessions. Clarifying energy and greenhouse gas emissions policies would reduce policy uncertainty and catalyze investment in at least the energy sector, if not more broadly in the economy.

65. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

Box 1.Implications of Greater Female and Old-Age Labor Force Participation

Labor force participation plays a key role in Australia’s labor market dynamics. With stable demographic trends, it drives short- and long-term movements in labor supply. This box reviews developments in labor force participation and macroeconomic implications, focusing on females and older workers. As a key takeaway, cyclical and structural components in labor force participation would have macroeconomic implications. In particular, possible scope for labor force participation rate (LFPR) increases would constitute a labor market slack in the short term as well as contribute to steady labor supply growth that counteracts the impact of the ageing workforce.

Australia’s LFPRs have increased in recent decades, especially for females and older workers. The aggregate LFPR rose from 63.8 percent in 2000 to 66.3 percent in 2017. Prime-age female and old-age LFPRs increased by 7 and 12 percentage points over 2000–17, respectively, while the LFPR for prime-age men remained flat. A pickup in female and old-age LFPRs in 2017 contributed significantly to a rebound in labor inputs growth, as measured by total hours worked, to 3.2 percent (year-over-year) in 2017Q4.

Labor Force Participation Rate (LFPR)

(In percent)

Sources: Haver Analytics and IMF staff calculations.

Contribution to Changes in Total Hours Worked

(y/y percent change)

Sources: Haver Analytics and IMF staff calculations.

Greater female and old-age labor force participation has counteracted the effect of ageing. The population share of age 65 and above rose from 12.5 percent in 2000 to 15.6 percent in 2017. All things equal, this would bring the LFPR down as prime-age workers reach retirement age. The increase in female and old-age LFPRs, however, more than offset the ageing effect. The labor force grew by 1.9 percent annually over 2000–17, of which the LFPR increase contributed 0.2 percentage points, while working age population growth contributed 1.7 percentage points.

The LFPR is responsive to cyclical labor market conditions. The recent labor market cycle started in 2011, as the unemployment rate began to rise and peaked in 2014. The LFPR moved in tandem, declining over 2011–14 and rebounding since 2014 as the labor market tightened. The rebound in LFPR, especially for prime-age females and older workers, also followed with a lag a recovery in labor demand, as measured by job vacancy. This observation is consistent with an analysis by the RBA, which found that the LFPR has a significant cyclical component and its cyclical sensitivity is large for the young, prime-age females, and old-age males.1 Rising labor force participation by females and old-age people may have flattened Australia’s labor supply curve, possibly weakening the transmission channel from aggregate demand to wages.

Contributions to Changes in LFPR since 2000

(In percent)

Sources: Haver Analytics and IMF staff calculations.

LFPR and Unemployment Rate

(In percent)

Sources: Haver Analytics and IMF staff calculations.

LFPR and Job Vacancy

(In percent)

Sources: Haver Anarytics and IMF staff calculations.

1 “The Cyclical Behaviour of Labour Force Participation,” Reserve Bank of Australia Bulletin, September 2018.

Box 2.Australia’s Housing Price Correction in Perspective

Housing prices have declined since 2017Q4 as housing markets in Sydney and Melbourne have eased following a period of strong price growth. Is this round of house price corrections different from Australian historical and international perspectives?

National housing prices peaked in 2017Q3. Based on the price index released by the Australian Bureau of Statistics, housing prices have declined 2.3 percent in real terms since 2017Q3. The price correction has been led by declines in Sydney and Melbourne, which account for about 60 percent of the nation’s housing value.

Australia has experienced five national housing price downturns previously over the past 3 decades.

Real House Prices

(Index)

Sources: OECD and IMF staff calculations.

Real House Prices

(Percent change y/y)

Sources: OECD and IMF staff calculations.

In three episodes, housing prices fell by more than 5 percent in real terms (see Table below). The downturn in 1989–91 coincided with a recession. The other two major downturns occurred during the Global Financial Crisis (GFC) in 2008, and in the final stretch of the mining investment boom, during which monetary policy was normalized and Australian banks responded to the higher risk aversion in financial markets after the GFC by raising the level and quality of their capital.

Housing Price Cycles in Australia
Real House PricesReal ST Interest RateReal Housing CreditReal GDP %Real Household Net Worth %Household Deb to Income (%)
NationalMelbourneSydney
PeakTrough% Change 1/Duration 2/% Change 1/% Change 1/Peak 3/Trough 3/Peak 4/Change 1/Change 1/Peak
1989Q21991Q1-8.37-15.2-10.06.3-2.61.70.2-0.968.5
1995Q11996Q1-3.65-3.6-2.63.2-1.7-5.74.41.781.5
2004Q12005Q3-2.460.6-11.41.3-0.50.94.410.9143.4
2008Q12009Q1-7.44-7.7-9.30.4-4.45.51.5-11.4161.1
2010Q22012Q2-8.29-12.4-6.81.3-1.7-2.77.5-1.3165.2
2017Q32018Q2 5/-2.3...-3.8-6.5-0.30.9-1.72.81.6185.9
Sources: ABS; RBA; OECD; and IMF staff calculations.

Percent change from peak to trough.

Number of quarters of falling house prices in S capital cities.

Change in percent points compared to 4 quarters ago.

Annual growth in real housing credit to households compared to annual growth one year ago.

Correction is ongoing; trough shows quarter of latest data.

Sources: ABS; RBA; OECD; and IMF staff calculations.

Percent change from peak to trough.

Number of quarters of falling house prices in S capital cities.

Change in percent points compared to 4 quarters ago.

Annual growth in real housing credit to households compared to annual growth one year ago.

Correction is ongoing; trough shows quarter of latest data.

The current housing market downturn has several common and some unique features compared to past episodes. A first common feature is that the ongoing house price correction is taking place against a domestic environment of strong growth, relatively low interest rates, and low unemployment, as in 2010–12. Second, as in previous downturns, the price corrections in Sydney and Melbourne are sharper than that of the national average. However, an important difference is that the slowdown in mortgage credit growth, in particular, investor and interest-only loans, has not coincided with a monetary policy tightening, as in previous episodes. Instead, banks have strengthened their lending standards in response to the tightening of macroprudential measures.

Housing markets in several other advanced economies have started to cool after a boom. As in Australia, markets in Canada, Sweden, and the United Kingdom had been booming, reflecting in part common drivers, including low interest rates, relatively strong growth, and, to varying degrees, foreign investor interest. The bottoming out of global interest rates and tightening macroprudential policies were likely common factors contributing to the cooling in all four countries.

Real Housing Prices in Selected Advanced Economies

(2012Q1 =1)

Sources: OECD; and IMF staff calculations.

Figure 1.Australia on the Final Leg in the Adjustment and Rebalancing after the Mining Boom

Sources: ABS; Haver Analytics; EconData; and IMF staff calculations.

1/ Defined as unemployment rate minus the non-accelerating inflation rate of unemployment (NAIRU).

Figure 2.Current Account Improving After Rebalancing and a Terms of Trade Rebound

Sources: ABS; RBA; Haver Analytics; IMF, World Economic Outlook; and IMF staff calculations.

Figure 3.Housing Market Imbalances and Vulnerabilities after A Boom

Sources: OECD and Haver Analytics.

1/ Based on a limited number of countries due to the lack of data.

Figure 4.Monetary Policy Has Supported the Adjustment After the End of the Mining Boom

Sources: RBA; Haver Analytics; and IMF staff estimates.

Figure 5.Public Finances Focused on Infrastructure and Lowering Debt

Sources: Commonwealth and State/Territory Treasuries, FY2016/17 and FY2017/18 budgets; IMF, World Economic Outlook; and IMF staff estimates and projections.

Figure 6.Banking System Remains Strong

Sources: Orbis by Bureau van Dijk; FitchConnect; RBA; APRA; Financial Soundness Indicators; and IMF staff calculations.

1/ GSIBs stands for global systemically important banks. Simple average of 19 GSIBs.

2/ Adjusted for movements in foreign exchange rates.

3/ Includes deposits and intragroup funding from non-residents.

Figure 7.Financial Market Indicators: New Lows for Yields and Spreads

Sources: Bloomberg; RBA; and IMF staff calculations.

Figure 8.Interconnections and Spillovers

Sources: ABS; APRA; RBA; IMF, Direction of Trade Statistics; BIS; and IMF staff calculations.

1/ Measured on a consolidated, ultimate risk basis.

2/ Includes Hong Kong SAR, Japan, and Singapore.

Figure 9.Australia’s Macro-Structural Position

Note: The Global Competitiveness Index combines both official data and survey responses from business executives on several dimensions of competitiveness. This measure of competitiveness is a subjective depiction of competitiveness, particularly in comparison between Australia and its peer group.

Sources: OECD.Stat; World Economic Forum, The Global Competitiveness Report 2017–2018; OECD Main Science and Technology Indicators; Oxford Economics and G-20 Global Infrastructure Hub, Global Infrastructure Outlook; OECD Trade Facilitation Indicators, Department of Foreign Affairs and Trade, Trade in Services Australia, for 2014–15 and 2016–17.

Figure 10.Australia in International Comparison

Source: IMF, World Economic Outlook database.

Table 1.Australia: Main Economic Indicators, 2014–2024(Annual percent change, unless otherwise indicated)
20142015201620172018201920202021202220232024
Est.Projections
NATIONAL ACCOUNTS
Real GDP2.62.52.82.43.02.72.62.62.62.62.6
Domestic demand0.91.21.82.93.02.62.72.62.62.62.6
Private consumption2.52.42.72.42.62.52.72.62.62.62.6
Public consumption0.34.44.84.04.12.82.42.02.12.22.2
Investment-1.9-3.6-2.33.02.92.32.73.02.92.82.8
Public-3.3-1.813.39.10.25.41.50.60.40.40.4
Private business-6.1-9.6-11.23.24.03.74.94.34.34.24.3
Dwelling9.68.97.9-2.45.5-1.3-0.12.42.32.01.7
Net exports (contribution to growth, percentage points)1.60.91.3-0.80.30.20.00.10.10.10.1
Gross domestic income1.0-0.12.84.83.11.72.52.22.32.62.7
Investment (percent of GDP) 1/26.425.924.724.124.324.224.224.224.224.123.9
Public4.44.44.85.04.95.04.94.84.74.64.4
Private22.021.419.719.119.319.219.219.319.419.419.4
Mining investment7.15.43.93.12.82.72.72.72.62.62.6
Non-mining investment15.016.115.916.016.416.416.516.616.816.816.9
Savings (gross, percent of GDP)23.321.620.922.021.721.521.321.221.121.121.2
Potential output2.82.62.52.52.62.52.62.62.62.62.6
Output gap (percent of potential)-0.9-1.0-0.8-0.9-0.5-0.3-0.2-0.1-0.10.00.0
LABOR MARKET
Employment0.62.01.82.32.72.11.91.71.71.71.7
Unemployment (percent of labor force)6.16.15.75.65.34.84.84.84.84.84.8
Wages (nominal percent change)2.52.11.91.92.12.53.03.33.23.33.3
PRICES
Terms of trade index (goods, avg)1039090103104989795949494
% change-8.0-12.4-0.414.40.9-5.5-0.8-1.8-1.4-0.30.5
Iron ore prices (index)7744465655484747474747
Coal prices (index)81677510112010810299999999
LNG prices (index)9561424156494544444444
Crude prices (Brent; index)9148405065575756575758
Consumer prices (avg)2.51.51.32.02.02.12.42.52.52.52.5
Core consumer prices (avg)2.62.31.71.61.62.12.32.52.52.52.5
GDP deflator (avg)0.3-0.81.03.61.71.02.12.12.32.62.4
FINANCIAL
Reserve Bank of Australia cash rate (percent, avg)2.52.11.71.51.51.51.82.32.73.23.5
10-year treasury bond yield (percent, avg)3.72.72.32.62.83.23.54.04.55.05.1
Mortgage lending rate (percent, avg)6.05.65.45.25.65.66.16.67.17.67.6
MACRO-FINANCIAL
Credit to the private sector7.48.17.04.64.73.73.64.04.64.74.8
House price index120131141148141135136137141144148
% change6.78.77.75.0-4.4-4.10.31.02.52.52.5
House price-to-income, capital cities (ratio)4.24.54.74.84.54.13.93.83.73.63.5
Interest payments (percent of disposable income)8.98.88.68.99.79.29.910.611.311.911.8
Household savings (percent of disposable income)7.46.34.93.92.52.32.52.62.73.03.1
Household debt (percent of disposable income) 2/167173180187188176174171169167165
Business credit (percent of GDP)4851515050505050505050
GENERAL GOVERNMENT (percent of GDP) 3/
Revenue33.934.634.834.935.636.035.935.835.735.635.6
Expenditure36.837.437.436.436.737.536.635.935.635.635.6
Net lending/borrowing-2.9-2.8-2.6-1.5-1.2-1.5-0.7-0.10.10.00.0
Operating balance-1.6-1.5-1.1-0.10.40.41.11.61.71.61.6
Cyclically adjusted balance-2.5-2.4-2.1-1.1-0.9-1.3-0.60.00.10.00.0
Gross debt34.137.840.540.740.741.440.840.139.337.936.7
Net debt15.517.918.918.419.320.620.319.819.118.017.0
Net worth52.049.449.349.048.650.350.350.450.049.148.5
BALANCE OF PAYMENTS
Current account (percent of GDP)-3.1-4.6-3.3-2.6-2.4-2.7-2.9-3.0-3.1-3.0-2.8
Export volume6.96.56.83.55.32.42.52.93.13.23.2
Import volume-1.41.90.17.73.81.72.62.72.92.92.9
Net international investment position (percent of GDP)-52-56-57-54-50-51-52-52-53-53-53
Gross official reserves (bn A$)66637485
MEMORANDUM ITEMS
Nominal GDP (bn A$)1,6151,6411,7041,8081,8941,9652,0592,1582,2652,3852,506
Percent change3.01.63.96.14.83.74.84.85.05.35.1
Real net national disposable income per capita (% change)-0.8-2.11.12.71.20.20.40.10.20.40.6
Population (million)23.624.024.424.825.225.626.026.426.827.227.7
Nominal effective exchange rate99929294
Real effective exchange rate100939396
Sources: Authorities’ data; IMF World Economic Outlook database; and IMF staff estimates and projections.

Includes changes in inventories.

Reflects the national accounts measure of household debt, including to the financial sector, state and federal governments and foreign overseas banks and governments. It also includes other accounts payable to these sectors and a range of other smaller entities including pension funds.

Calendar year.

Sources: Authorities’ data; IMF World Economic Outlook database; and IMF staff estimates and projections.

Includes changes in inventories.

Reflects the national accounts measure of household debt, including to the financial sector, state and federal governments and foreign overseas banks and governments. It also includes other accounts payable to these sectors and a range of other smaller entities including pension funds.

Calendar year.

Table 2.Australia: Fiscal Accounts, 2013/14–2023/24(In percent of GDP, unless otherwise indicated)
2013/142014/152015/162016/172017/182018/192019/202020/212021/222022/232023/24
EstProjections
CONSOLIDATED GENERAL GOVERNMENT OPERATIONS 1/
Revenue33.734.234.834.435.535.936.035.835.835.635.6
Tax revenue27.227.428.027.728.729.029.229.329.529.329.3
Direct taxes19.420.020.220.221.121.521.421.621.721.621.6
Individual and withholding13.214.114.514.314.514.614.714.915.115.015.0
Corporate6.25.95.75.96.66.86.76.76.66.66.6
Indirect taxes7.87.47.87.57.67.67.87.77.77.77.7
Of which: GST3.53.53.63.63.53.63.53.63.63.63.6
Non-tax revenue6.56.86.86.86.86.86.86.66.36.36.3
Expenditure36.637.237.436.936.137.637.236.135.635.635.6
Expense35.335.936.135.434.935.735.334.434.034.034.0
Employee expenses9.59.79.99.89.69.79.49.29.19.19.1
Other operating expenses (excl. depreciation)9.29.69.810.010.511.011.110.710.710.710.6
Transfers12.712.612.311.710.710.910.810.510.410.410.4
Current12.112.111.911.310.510.610.510.310.210.210.2
Capital0.60.50.40.40.20.30.30.30.20.20.2
Interest (excl. superannuation)1.41.51.51.41.41.41.41.31.31.31.3
Other2.52.62.62.52.62.82.72.62.52.62.6
Net acquisition of nonfinancial assets1.31.21.31.51.21.91.91.71.61.61.6
Of which: Gross fixed capital formation2.92.92.93.23.43.83.63.53.33.33.3
Operating balance-1.6-1.7-1.4-0.90.60.10.71.41.81.61.6
Primary balance-1.6-1.5-1.2-1.00.8-0.40.31.01.51.31.3
Net lending (+)/borrowing (-)-2.9-2.9-2.7-2.4-0.6-1.8-1.1-0.30.20.00.0
CONSOLIDATED GENERAL GOVERNMENT BALANCE SHEET
Liabilities63.969.178.374.574.969.468.766.264.962.359.9
Gross debt32.435.839.541.040.441.341.440.240.038.637.3
Commonwealth23.026.330.432.332.231.430.528.828.126.424.8
States, territories and local governments9.59.59.18.78.29.910.811.411.912.212.5
Other liabilities31.533.238.833.534.528.127.326.124.923.722.6
Assets116.3120.9125.2125.5122.0119.6118.9116.7115.3111.8108.7
Financial assets47.749.450.852.651.249.950.149.449.447.746.2
Other assets68.571.574.372.970.869.868.867.365.864.162.5
Net financial worth-16.2-19.6-27.5-21.9-23.7-19.5-18.6-16.8-15.5-14.6-13.7
Net debt14.516.519.118.518.220.420.719.919.718.517.5
Commonwealth 2/12.714.918.118.418.518.316.815.014.012.511.1
States, territories and local governments1.81.61.10.2-0.32.13.94.95.76.06.4
Net worth52.451.946.951.047.250.350.150.450.349.548.8
Commonwealth-14.4-17.7-24.2-21.7-22.6-16.6-15.2-13.1-11.6-9.8-8.1
States, territories and local governments66.869.571.172.769.866.965.463.661.959.356.9
MEMORANDUM ITEMS
Cyclically adjusted balance (in percent of potential GDP)-2.6-2.5-2.2-2.0-0.3-1.6-1.0-0.20.20.00.0
Fiscal impulse (change in CAB; in percent of potential GDP)0.1-0.1-0.2-0.2-1.81.3-0.60.80.5-0.20.0
Change in real revenue (percent)1.41.42.53.45.73.52.51.72.02.22.5
Change in real primary expenditure (percent)4.11.31.02.8-0.55.50.60.71.92.82.6
Commonwealth general government 3/
Revenue20.119.920.220.121.121.821.921.922.122.022.0
Expenditure22.322.522.622.121.422.121.821.321.221.221.2
Net lending (+)/borrowing (-)-2.2-2.6-2.3-2.0-0.3-0.30.20.60.90.80.8
States, territories and local governments 4/
Revenue13.213.614.013.813.813.513.513.313.113.113.1
Expenditure13.613.714.113.913.814.614.613.913.613.613.6
Net lending (+)/borrowing (-)-0.4-0.1-0.1-0.20.0-1.1-1.0-0.6-0.5-0.5-0.5
Commonwealth transfers to subnational governments6.16.46.46.66.46.46.46.36.36.36.3
Of which: General revenue assistance3.33.63.63.63.63.63.63.63.73.73.7
Nonfinancial public sector capital stock95.899.4103.1100.1101.6101.1100.999.497.795.593.6
GDP (in billion A$)1,5991,6241,6631,7651,8481,9282,0112109.32208.22325.12444.6
Sources: Authorities’ data and IMF staff estimates and projections.

Accrual basis; GFS. Comprises the Commonwealth, and state, territory, and local goverments.

Includes Future Fund assets.

Excludes general revenue assistance to states and territories from revenue and expenditure.

Excludes Commonwealth payments for specific purposes from revenue and expenditure.

Sources: Authorities’ data and IMF staff estimates and projections.

Accrual basis; GFS. Comprises the Commonwealth, and state, territory, and local goverments.

Includes Future Fund assets.

Excludes general revenue assistance to states and territories from revenue and expenditure.

Excludes Commonwealth payments for specific purposes from revenue and expenditure.

Table 3.Australia: Balance of Payments, 2014–2024(In percent of GDP, unless otherwise indicated)
20142015201620172018201920202021202220232024
Est.Projections
BALANCE OF PAYMENTS (% GDP)
Current account-3.1-4.6-3.3-2.6-2.4-2.7-2.9-3.0-3.1-3.0-2.8
Balance on goods and services-0.6-2.3-0.80.50.90.0-0.1-0.3-0.5-0.4-0.3
Exports of goods and services20.619.719.721.422.821.721.220.620.019.619.3
Exports of goods16.615.315.216.717.816.716.315.815.214.814.6
Of which: Resources10.58.88.710.511.610.710.29.89.39.08.8
Exports of services4.14.54.64.75.05.04.94.94.84.74.7
Imports of goods and service21.222.020.620.921.921.721.321.020.520.019.6
Imports of goods16.416.815.716.016.816.716.416.215.815.515.2
Imports of services4.95.24.94.95.15.04.94.84.74.54.4
Primary income, net-2.3-2.3-2.4-3.0-3.3-2.7-2.7-2.6-2.5-2.5-2.4
Interest payments-1.3-1.3-1.2-1.1-1.2-1.2-1.3-1.2-1.2-1.2-1.2
Equity income-0.6-0.7-0.8-1.5-1.7-1.3-1.3-1.3-1.2-1.1-1.1
Secondary income, net-0.2-0.1-0.1-0.1-0.1-0.1-0.1-0.1-0.1-0.1-0.1
Capital and financial account
Capital account, net0.00.00.00.00.00.00.00.00.00.00.0
Financial account, net3.24.83.12.72.52.72.93.13.13.02.8
Direct investment2.83.13.62.93.12.41.71.71.71.71.7
Equity2.11.23.02.93.22.41.71.71.71.71.7
Debt0.62.00.60.00.00.00.00.00.00.00.0
Portfolio investment1.32.4-2.20.7-0.70.40.50.60.70.70.7
Equity-0.80.8-0.3-1.0-1.0-0.5-0.3-0.10.00.00.0
Debt2.21.6-1.91.70.40.90.80.70.70.70.7
Financial derivatives-0.2-0.10.4-0.70.3-0.10.0-0.1-0.1-0.1-0.1
Other investment-0.5-0.92.00.5-0.90.20.80.80.80.70.5
Reserve assets-0.30.2-0.6-0.70.70.00.00.00.00.00.0
Net errors and omissions0.00.00.2-0.1-0.20.00.00.00.00.00.0
BALANCE SHEET
Net international investment position-52-56-57-54-50-51-52-52-53-53-53
Equity, net55225310-2-3-5
Assets6567697280808080818181
Liabilities6062677075777981828485
Debt, net-58-61-59-56-55-54-53-52-51-50-49
Assets6068676262626262636263
Liabilities118129126118117117116115114112111
External assets (gross)126135137134142143143143143143143
Equity6567697280808080818181
Debt6068676262626262636263
External liabilities (gross)178191193187193194195195196196197
Equity6062677075777981828485
Debt118129126118117117116115114112111
Of which: foreign currency, hedged4050433638383837373736
A$-denominated5454585856555554545353
Short-term4043443938383737373636
MEMORANDUM ITEMS
Gross official reserves (bn A$)66637485
In months of prospective imports2.22.12.42.5
In percent of short-term external debt10.28.810.012.0
Net official reserves (bn A$)53585857
Iron ore prices (index)7744465655484747474747
Coal prices (index)81677510112010810299999999
Oil prices (Brent crude; index)9561424156494544444444
Sources: Authorities’ data and IMF staff estimates and projections.
Sources: Authorities’ data and IMF staff estimates and projections.
Table 4.Australia: Monetary and Financial Sector, 2014–2024
20142015201620172018201920202021202220232024
Projections
BALANCE SHEETIn billions of A$
Total assets 1/3,7194,0234,2304,1874,3874,5534,7765,0045,2525,5405,849
Currency and deposits273275310255267277290304319337356
Securities other than shares566607626624653678711745782825871
Loans2,6092,8943,0433,1003,2453,3653,4963,6413,8123,9994,196
Claims on government1212111213131415151617
Claims on MFI345382391366383398417437459484511
Claims on non-MFIs20402,2042,3592,4662,5812,6762,7732,8843,0183,1613,311
o/w private sector2,0402,2042,3592,4662,5812,6762,7732,8843,0183,1613,311
Claims on non-residents213295282255267278291305320338357
Shares and other equity5956495052545760636670
Other (w/o residual)211192202185194201211221232245258
Other211192202160170178221253276313357
Total liabilities 1/3,7194,0234,2304,1874,3874,5534,7765,0045,2525,5405,849
Capital and reserves224256254270283293308322339357377
Borrowing from RBA73737887919499103109115121
Liabilities to other MFIs67375979276379982987091295710091066
Deposits of non-banks2,1662,3592,5032,4932,6112,7102,8432,9793,1273,2983,482
Debt securities381385405422442459481504529558589
Other liabilities202191198153161167175183192203214
In percent of GDP
Total assets (w/o residual) 1/230245248232232232232232232232232
Loans162176179171171171170169168167166
Claims on MFI2123232020202020202020
Claims on non-MFIs126134138136136136135134133132131
Percent change
Credit non-bank private sector 2/5.56.85.65.24.73.73.64.04.64.74.8
o/w Housing credit6.76.96.46.84.93.83.23.74.84.94.9
o/w Owner-occupied housing4.710.77.88.47.05.14.35.06.56.56.5
o/w Investor housing10.10.84.13.80.90.90.90.90.90.90.9
Personal credit0.55.1-0.4-0.5-1.71.01.01.01.01.11.1
Business credit4.46.95.23.35.34.04.84.94.85.04.9
Sources: IFS (Other Depository Corporations, Table ODC-2SR) , RBA, APRA, and IMF staff projections.Notes:1/ IFS (Other Depository Corporations, Table ODC-2SR).2/ RBA (Table D2 Lending and Credit Aggregates).
Sources: IFS (Other Depository Corporations, Table ODC-2SR) , RBA, APRA, and IMF staff projections.Notes:1/ IFS (Other Depository Corporations, Table ODC-2SR).2/ RBA (Table D2 Lending and Credit Aggregates).
Table 5.Australia: Selected Financial Soundness Indicators of the Banking Sector(Year end unless otherwise noted, in percent)
2012201320142015201620172018Q3
Capital Adequacy
Regulatory capital to risk-weighted assets12.111.812.413.913.814.714.7
Regulatory Tier I capital to risk-weighted assets10.810.410.711.911.612.512.7
Capital to assets6.16.05.96.06.66.97.0
Large exposures to capital73.772.276.082.082.376.575.8
Nonperforming loans net of loan-loss provisions to capital16.313.29.87.97.87.37.8
Asset Quality
Nonperforming loans to total gross loans1.81.51.10.91.00.90.9
Sectoral distribution of loans to total loans
Residents94.994.192.990.592.293.393.1
Deposit-takes0.10.10.10.10.10.20.1
Central bank0.00.00.00.00.00.00.0
Other financial corporations2.62.72.83.13.33.43.7
General government0.30.30.30.30.30.20.2
Non-financial corporations24.123.423.222.723.023.022.9
Other domestic sectors67.867.766.664.365.566.666.2
Nonresidents5.15.97.19.57.86.76.9
Earnings and Profitability
Return on assets1.11.21.21.40.81.21.4
Return on equity17.720.120.823.812.116.719.7
Interest margin to gross income68.067.366.959.482.571.363.9
Noninterest expenses as a percentage of gross income49.847.447.942.853.847.544.9
Liquidity
Liquid assets to total assets16.917.016.417.017.617.817.2
Liquid assets to short-term liabilities42.842.040.239.741.240.140.4
Sources: APRA and IMF, Financial Soundness Indicators (FSI) database.
Sources: APRA and IMF, Financial Soundness Indicators (FSI) database.
Annex I. External Sector Assessment
AustraliaOverall Assessment
Foreign asset and liability position and trajectoryBackground. Australia has a large negative net international investment position (NIIP), reaching -54 percent of GDP at the end of 2017. Liabilities are largely denominated in Australian dollars, while assets are in foreign currency. Foreign liabilities are composed of around one quarter of FDI, one half of portfolio investment (principally banks borrowing abroad and foreign holdings of government bonds), and one quarter of other investment and derivatives. The NIIP improved in 2017 (by 3 percent of GDP relative to 2016), partly driven by a narrowing of the current account deficit and partly by strong nominal economic growth. The NIIP to GDP ratio is expected to remain around -53 percent of GDP over the medium term.

Assessment. The NIIP level and trajectory are sustainable. The External Stability (ES) approach suggests that the NIIP would be stabilized at around current levels over the medium term with a CA deficit between 2¾-3 percent. The structure of Australia’s external balance sheet reduces the vulnerability associated with its high negative NIIP. Since Australia’s external liabilities are mainly in Australian dollars and there is a net foreign currency asset position, a nominal depreciation tends to strengthen the external balance sheet, all else equal. The banking sector’s net foreign currency liability position is hedged. The maturity of banks’ external funding has improved since the Global Financial Crisis, and even in a tail risk event where domestic banks suffer a major loss, the government’s strong balance sheet position allows it to offer credible support.
Overall Assessment: The external position of Australia in 2018 is projected to be broadly consistent with medium-term fundamentals and desirable policies, although the Australian dollar remains somewhat overvalued. The CA deficit in 2018 is projected to shrink slightly to 2.4 percent of GDP. Some REER-based models suggest continued overvaluation.

Potential policy responses: The Australian dollar remains moderately overvalued, and if growth was on the weak side, or commodity prices fell again, further monetary accommodation would be warranted.
Current accountBackground. Australia has run CA deficits for most of its history, reflecting a structural saving-investment imbalance with very high private investment relative to a private saving rate that is already high by advanced country standards. Since the early 1980s, deficits have averaged around 4 percent of GDP. The CA deficit in 2017 narrowed to 2.6 percent of GDP primarily reflecting stronger terms of trade, because of higher coal and iron ore prices in response to measures restricting domestic supply in China, and a ramp-up in new resource exports. The CA deficit is expected to shrink slightly to 2.4 percent of GDP in 2018, as strong terms of trade and the ramp-up in new resource exports continued, offsetting the negative impact of drought on rural exports. Over the medium term, the CA deficit is expected at a level lower than the historical average of around 4 percent, given the end of the prolonged import intensive mining investment boom and a lower interest differential on Australian bonds relative to foreign bonds compared to longer-term averages. With over half of Australia’s exports going to emerging Asia, a key risk is a sharper than expected slowdown in China resulting in a further sharp decline in commodities prices.

Assessment. Preliminary estimates from the 2018 EBA model suggest a CA norm of -0.6 percent of GDP. Taking the relative output gaps and the cyclical component of the commodity terms of trade into account, the cyclically adjusted CA for 2018 is estimated to be around -2.6 percent of GDP, indicating a CA gap of around -2.0 percent of GDP. However, in staff’s view, the CA norm of Australia is closer to -1.6 percent of GDP, reflecting traditionally large investment needs due to its size, low population density, and initial conditions. Therefore, the adjusted 2018 CA gap for Australia is assessed to be in the range of -0.5 to -1.5 percent of GDP.
2018 projectionProjected CA-2.4Cycl. Adj. CA-2.6EBA CA Norm-0.6EBA CA Gap-2.0Staff Adj.-1.0Staff CA Gap-1.0
Real exchange rateBackground. In 2017, Australia’s REER appreciated by 2.9 percent relative to the 2016 average. As of December 2017, the REER was some 11 percent above its thirty-year average, consistent with the strengthening of the terms of trade in that period. Estimates up to November 2018 show that the REER depreciated by 4.8 percent relative to the 2017 average.

Assessment. Considering estimates of the staff-assessed CA gap, the estimated REER gaps, and the gaps implied by the ES approach, staff assesses the 2017 REER to be 0 to 17 percent above the level implied by medium-term fundamentals and desirable policy settings. Real depreciation in 2018 have narrowed the range of overvaluation to 0 to 13 percent. 1/
Capital and financial accounts: flows and policy measuresBackground. The mining investment boom has been funded predominantly offshore. Net FDI inflows into this sector have partially offset the reduced need for the banking sector to borrow abroad. As investment in new mining projects winds down, related demand for imports will decrease, buffering the impact on the overall balance of payments. Australia also received large inflows in recent years into bond markets. The weighted average maturity of government bonds is 6.6 years, and has lengthened over time, with 90 percent of the issue maturing by 2027. Assessment. Credible commitment to a floating exchange rate and a strong fiscal position limit the vulnerabilities.
FX intervention and reserves levelBackground. A free-floater since 1983. The central bank undertook brief but large intervention in 2007–08 when the market for Australian dollars became illiquid (bid-ask spreads widened) following banking sector disruptions in the U.S. The authorities are strongly committed to a floating regime, which reduces the need for reserve holding. Assessment. Although domestic banks’ external liabilities are sizable, they are either in local currency or hedged, so reserve needs for prudential reasons are also limited.
Technical Background Notes1/ For 2018, the REER index and level models imply an overvaluation of 2 and 13 percent respectively, while the CA gap is consistent with an overvaluation of 5 percent (applying an estimated elasticity of 0.2) and the ES approach suggests the REER is broadly in line.
Annex II. Risk Assessment Matrix
Source of risksLikelihoodTime horizonImpactPolicies to reduce impact
Domestic risks
Stronger recovery momentumMShort termM Non-mining business investment could recover faster with higher public infrastructure investment, which would boost domestic demand and growth.The Australian dollar would likely appreciate; monetary policy tightening if output gap closes faster than expected and inflation is above the target range mid-point.
Slowing of economic recoveryMShort to medium termM Consumption growth could be weaker with continued low wage growth and a higher incidence of part-time work, leading to weaker growth and an economic downturn.Monetary policy easing; combined with easier fiscal policy if policy interest rates approaches the zero lower bound.
Severe Housing market downturnL/MShort to medium termH A sharp housing market correction would lower residential investment and private consumption, and thereby growth. A negative feedback loop of declining house prices, higher non-performing loans, tighter bank credit, and lower activity could amplify the downturn.Monetary policy easing; fiscal policy stimulus; measures to facilitate mortgage debt restructuring, including selected fiscal intervention.
External Risks
Weaker growth in China S-T disorderly deleveraging or M-T insufficient progress in rebalancing and deleveragingL (disorderly deleveraging) / M (insufficient progress in deleveraging, rebalancing)Short to medium termH A disorderly deleveraging and insufficient progress in rebalancing in China resulting in large commodity price declines would lead to a downturn in Australia. Could be exacerbated by an acceleration in the trade dispute with the United States.Combined monetary policy and fiscal policy easing if the policy interest rate approaches the zero lower bound; structural fiscal measures to facilitate adjustment in commodity sectors and regions, including active labor market policies.
Weaker-than-expected global growthMMedium termM Lower growth in these economies would result in lower commodity prices and commodity consumption, and thereby lead to a downturn in Australia.Monetary policy easing; combined with easier fiscal policy if policy interest rate approaches the zero lower bound. Structural and fiscal reforms to raise productivity.
Sharp tightening of global financial conditionsMShort termM Australia would be affected through direct asset price channels, their impact on international funding conditions of Australian banks, and spillovers from their broader effects on global growth and commodity prices. Much would depend on investor sentiment toward Australia.The exchange rate would likely act as a shock absorber and dampen the impact; monetary policy easing as needed.
Unsustainable macroeconomic policiesMShort to medium termM A sharp tightening of global financial conditions could spill over into internationally integrated domestic financial markets, raising funding costs and lowering disposable income of debtors, with the impact also depending on the response of the Australian dollar.The exchange rate would likely act as a shock absorber and dampen the impact; monetary policy easing as needed.
Rising protectionism and retreat from multilateralismHShort to medium termH Australia would be negatively affected as a rise in protectionism in large economies would reverse trade liberalization and regional integration, reduce global growth and commodity prices and increase financial market volatility. If China faces a strong impact, it would work directly through trade in commodities, tourism and education services.Monetary policy easing; combined with easier fiscal policy if policy interest rate approaches the zero lower bound. Continued pursuit of open market policies for trade.
Intensification of the risks of fragmentation and security dislocationHShort to medium termM Escalated tensions in parts of the Middle East, Africa, Asia, and Europe could lead to some small decrease in external demand for Australia. It could experience safe-haven capital, leading to a stronger Australian dollar, which could result in a slower pickup in economic activity and inflation.Monetary policy easing; combined with easier fiscal policy if policy interest rate approaches the zero lower bound.
Sizable deviations from baseline energy pricesMShort to medium termL If oil prices increase sharply due to steeper-than-anticipated export declines, real consumer income would be lower. Prices could drop significantly if downside global growth risks materialize or supply exceeds expectations. Coal and LNG sectors would be hurt, as would the coal mining states.The exchange rate would likely act as a shock absorber and dampen the impact; monetary policy response if needed.
Annex III. Debt Sustainability Analysis

Figure 1.Australia: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2018 and 80 percent of fx denominated external debts are assumed to be hedged to local currency.

Figure 2.Australia: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as general government.

2/ Based on available data.

3/ Long-term bond spread over U.S. bonds.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r – π(1 +g) – g + ae(1 +r)]/(1 +g+π+gπ)) times previous period debt ratio, with r – interest rate; π – growth rate of GDP deflator; g – real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1 +g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 3.Australia: Public DSA – Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Annex IV. Selected Key Macroprudential Policy Measures, 2014–18
DateAuthorityMeasures
Dec 2014APRA
  • Speed limit curtailing annual growth in a bank’s investor housing lending to 10 percent;

  • Serviceability assessments for new mortgage lending to include interest rate buffers of at least 2 percentage points above the effective variable rate applied for the term of the loan, and a minimum floor assessment rate of at least 7 percent to allow borrowers to accommodate future increases in interest rates; and

  • Supervisors would be alert to high levels of higher-risk mortgage lending with:

    • high LVR and/or loan-to-income ratio

    • owner-occupier loans with lengthy interest-only periods

Dec 2014ASICA review of interest-only home loan was undertaken to determine whether lenders’ lending practices complied with responsible lending obligations.
2015APRATo assess and compare lending standards across ADIs, in early 2015, APRA request a number of the larger ADIs to complete a Hypothetical Borrower Exercise (HBE), providing serviceability assessments for four hypothetical mortgage borrowers — two owner-occupiers and two investors — using their policies in place as at December 31, 2014. In a second HBE conducted in late 2015, ADIs that were the least conservative in December 2014 generally reported a significant drop in calculated net income surplus using their September 2015 policies.
Jul 2015APRAAnnounced an increase in capital adequacy requirements for residential mortgage exposures for ADIs accredited to use the internal ratings-based (IRB) approach to credit risk, effective from July 1, 2016. This change requires an increase of average risk weights to at least 25 percent from about 16 percent, equivalent of increasing minimum capital requirements for major banks by approximately 80 basis points.
Jan 2016APRACountercyclical capital buffer (Basel III) was incorporated into the capital standards for locally incorporated ADIs. APRA has determined that the Australian jurisdictional countercyclical capital buffer applying from January 1, 2016 will be zero percent of risk-weighted assets. This rate will remain in force until APRA determines otherwise.
Oct 2016APRAReleased for consultation a revised draft of Prudential Practice Guide APG 223 Residential Mortgage Lending to incorporate measures announced or communicated to ADIs since 2014.
2016APRAConducted a thematic review of commercial property lending over 2016.
2016ASICReviewed the lending practices of 11 large mortgage brokers to promote responsible lending and consumer confidence in the credit industry.
Mar 2017APRA
  • Limit the flow of new interest-only lending to 30 percent of new residential mortgage lending1, and within that:

    • Strict internal limits on the volume of interest-only lending at loan-to-valuation ratios (LVRs) above 80 percent; and

    • Strong scrutiny and justification of any instances of interest-only lending at an LVR above 90 percent; and

  • Restraint on lending growth in higher risk segments of the portfolio, e.g. high LTI loans, high LVR loans and very long-term loans.

Apr 2018APRAThe 10 percent investment lending growth benchmark will no longer apply from July 1, 2018 where an ADI has been operating below it for at least the past 6 months, and the ADI’s Board has provided the required assurance to APRA on both lending policies and practices:
  • Interest rate buffers above 2 percentage points over the loan product rate, and interest rate floors above 7 percent;

  • application of these interest rate buffers and floors to both a borrower’s new and existing debt commitments;

  • discounts on uncertain and variable income, with haircuts of at least 20 percent for most types of non-salary income and expected rental income;

  • for interest-only loans, an assessment of serviceability for the period over which the principal and interest repayments apply;

  • prudently managing overrides to lending policies, with risk tolerances set by the Board on the extent of exceptions to serviceability policy (negative serviceability) and serviceability verification waivers; and

  • developing internal risk appetite limits on the proportion of new lending at very high debt to income levels (where debt is greater than 6 times a borrower’s income), and policy limits on maximum debt to income levels for individual borrowers.

Dec 2018APRAFor ADIs that have provided the necessary assurances on their lending standards and are no longer subject to the investor loan growth benchmark of 10 percent, the interest-only benchmark will also no longer apply, effective from January 1, 2019.

For other ADIs, it will be removed concurrently with the removal of the investor loan growth benchmark.

ADIs with levels of interest-only loans below the benchmark are expected to remain below it and not increase the share of new interest-only loans materially from current levels.

ADIs with levels of interest-only loans below the benchmark are expected to remain below it and not increase the share of new interest-only loans materially from current levels.

Annex V. Key FSAP Recommendations
Recommendations and Authority Responsible for ImplementationTime1
Banking and Insurance Supervision
Strengthen the independence of APRA and ASIC, by removing constraints on policy making powers and providing greater budgetary and funding autonomy; strengthen ASICs enforcement powers and expand their use to mitigate misconduct (Treasury, APRA, ASIC).ST
Enhance APRA’s supervisory approach by carrying out periodic in-depth reviews of governance and risk management (APRA).ST
Strengthen the integration of systemic risk analysis and stress testing into supervisory processes (APRA, RBA).I
Financial Stability Analysis
Commission and implement results of a comprehensive forward-looking review of potential data needs. Improve the quantity, quality, granularity and consistency of data available to the CFR agencies to support financial supervision, systemic risk oversight and policy formulation (CFR agencies).MT
Enhance the authorities’ monitoring, modeling and stress testing framework for assessing solvency, liquidity and contagion risk. Draw on the results to inform policy formulation and evaluation (CFR agencies).ST
Encourage further maturity extension and lower use of overseas wholesale funding (APRA).I
Systemic Risk Oversight and Macroprudential Policy
Raise formalization and transparency of the CFR and accountability of its member agencies through publishing meeting records as well as publication and presentation of an Annual Report to Parliament by CFR agency Heads (CFR agencies).I
Undertake a CFR review of the readiness to apply an expanded set of policies to address systemic risks, including data and legal/regulatory requirements; and address impediments to their deployment (CFR agencies).I
Commission analysis by the CFR member agencies on relevant financial stability policy issues, including: policies affecting household leverage; as well as factors affecting international investment flows and their implications for real estate markets (CFR agencies).MT
Financial Crisis Management and Safety Nets
Complete the resolution policy framework and expedite development of resolution plans for large and mid-sized banks and financial conglomerates, and subject them to annual supervisory review (APRA, Treasury).ST
Extend resolution funding options by expanding loss-absorption capacity for large and mid-sized banks and introduce statutory powers (APRA, Treasury).ST
Advance mutual understanding between the Australia and New Zealand resolution authorities on cross-border bank resolution modalities, through the Trans-Tasman Banking Council (CFR agencies).ST
Financial Market Infrastructures
Strengthen independence of RBA and ASIC for supervisory oversight, enhance enforcement powers and promote compliance with regulatory requirements (RBA, ASIC, Treasury).I
Finalize the resolution regime for FMIs in line with the FSB Key Attributes (RBA, ASIC, Treasury).ST
Anti-Money Laundering / Countering the Financing of Terrorism (AML/CFT)
Expand the AML/CFT regime to cover all designated non-financial businesses and professions (DNFBPs), and strengthen AML/CFT supervision by: improving data collection and risk analysis; increasing oversight of controls and compliance; and undertaking more formal enforcement action in the event of breaches (Department of Home Affairs, Treasury, AUSTRAC).I

I Immediate (within 1 year); ST Short term (within 1–2 years); MT Medium term (within 3–5 years).

I Immediate (within 1 year); ST Short term (within 1–2 years); MT Medium term (within 3–5 years).

The significant role of trade linkages between Australia and China were examined in Karam and Muir, 2018, “Australia’s Linkages with China: Prospects and Ramifications of China’s Economic Transition”, in Australia: Selected Issues, IMF Country Report No. 18/45 (also available as IMF Working Paper 18/119).

Loukoianova, E., Y. Wong, and I. Hussiada, 2019, “Riskiness of the Household Debt in Australia and Its Impact on Monetary Policy,” IMF Working Paper, forthcoming.

These issues are discussed further in the accompanying Selected Issues Paper, Muir, 2019, “Evaluating and Reinforcing the Commonwealth of Australia’s Fiscal Strategy.”

The Financial System Stability Assessment prepared by the FSAP mission is presented in Country Report No. 19/xx.

Western Australia announced in its FY2017/18 budget a foreign purchaser duty (stamp duty) surcharge of 4 percent on residential property acquired by foreign individuals, corporations, and trusts to be introduced on January 1, 2019. The FY2018/19 budget increased the rate to 7 percent. Tasmania announced in its FY2018/19 budget a foreign purchaser duty surcharge of 3 percent on residential property acquired by foreign residents with an additional 0.5 percent of the dutiable value for all purchases of primary production land by foreign residents, effective July 1, 2018. These measures would be assessed as capital flow management measures (CFMs) under the IMF’s Institutional View on Capital Flows, as are the existing foreign purchaser duty surcharges imposed by all other states (See also Australia: Article IV Consultation, IMF Country Report No. 18/44, p.15).

A more complete analysis can be found in Commonwealth of Australia, 2018, Budget 2018–19 Budget Strategy and Outlook Budget Paper No. 1, pp.1–12-1–15.

See Australia: Article IV Consultation, IMF Country Report No. 18/44 and Muir, “Infrastructure Investment in Australia: Gaps and Multiplier Effects,” Australia: Selected Issues, IMF Country Report No. 18/45.

See Muir (2018), cited in the previous footnote.

Other options exist and are laid out in “Chapter 2. Fiscal Policies for Innovation and Growth” in IMF, 2016, Fiscal Monitor: Acting Now, Acting Together, April 2016.

See for broad tax reform see Pitt, 2015, “Options for Tax Policy and Federal Fiscal Relations Reform” in Australia: Selected Issues, IMF Country Report No. 15/275; for the effects of rebalancing between indirect and direct taxes, see Dizioli, Karam, Muir and Steinlein, 2017, “Australia’s Fiscal Framework: Revisiting Options for a Fiscal Anchor,” IMF WP/17/286 (originally included in Australia: Selected Issues, IMF Country Report No. 17/43).

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