1. Australia’s economic performance has been robust in comparison to other advanced economies despite the commodity price and mining investment bust. Growth has remained above 2 percent (annual rate) and increases in unemployment have been small. The moderate impact of the large shocks since 2011 reflects prompt monetary easing, a flexible exchange rate acting as a shock absorber, export orientation to the dynamic Asia region, relatively high labor force and population growth, and flexible labor markets. Another reason is the relatively small size of the commodity sector and continued strong mining export performance (Annex I: “Four Years After the Bust …”). In this setting, Australia’s long expansion without a recession has continued uninterrupted for 25 years.
Average Annual Real GDP Growth (2009-15)
Source: IMF, World Economic Outlook database.
2. Still, Australia has been confronted with symptoms of the “new mediocre.” The economy has experienced a slowdown since the global financial crisis (GFC), with average GDP growth about 0.8 percent lower (annual rate), which is indicative of lower potential output growth. As elsewhere, the adjustment to the shocks has been drawn out, and growth has fallen short of expectations in 2014 and early 2015, partly from weaker-than-expected partner country growth and partly from domestic demand weakness. In particular, growth in non-mining business investment has been slow despite declines in real interest rates and real exchange rate depreciation. At the same time, underemployment and long-term unemployment have been higher, while nominal wage growth has been low and inflation has fallen below target.
Sources: Haver Analytics and IMF staff calculations.
1/ Counterfactual is based on pre-GFC average growth (2003-07).
3. Housing-related and external macro-financial vulnerabilities are a concern. Real house prices and household debt ratios rose to high levels in tandem during the country’s economic boom of the 1990s and 2000s. While stabilizing after the global financial crisis, both house prices and household debt ratios have picked up again recently. The main concern is the large housing exposure (over 50 percent of total assets) of Australia’s highly concentrated banking system. On the external side, Australia has had long-running current account deficits and a relatively large net external liability position. Much of the related risks focus on the funding of Australian banks because they rely heavily on international wholesale markets.
Real House Prices
Sources: Haver; and IMF staff calculations.
Recent Developments, Outlook and Risks
A. Developments over the Past Year
4. Australia’s recovery advanced with a pickup in activity from mid-2015, but underlying demand growth remained closer to trend. Growth (at annual rates) increased to over 3 percent from mid-2015—above current potential output growth estimates of 2¾ percent—driven by higher government spending, LNG export capacity coming on stream, strong services export growth, and buoyant residential investment.1 That said, private business investment outside mining has remained more subdued than expected. And with the growth rebalancing toward non-mining activity, activity in states where such activity dominates has been buoyant, and disparities in economic performance between non-mining and mining states have widened. With hindsight, some of the growth pickup in early 2016 reflected one-off level increases in demand, particularly in government spending. Consequently, real GDP unexpectedly contracted by 2 percent annualized in 2016Q3 when these level effects wore off, with temporary, weather-related weakness in residential investment spending also contributing. The strength of underlying growth in aggregate demand, however, does not appear to have changed.
State Final Demand
Sources: Australian Bureau of Statistics; and Haver.
5. Labor market conditions have improved although the fall in the unemployment rate likely overstates the improvement in labor markets. Employment picked up with overall activity, and unemployment has decreased from its recent peak. Still, the underemployment rate—defined as the share of employed persons in the labor force seeking to work more hours—has remained almost 2 percentage points above average (7 percent of the active labor force over the past 20 years). Some 80 percent of the jobs created over the past year or so have been part-time jobs.2 At the same time, the share of long-term unemployment has remained above average. As of mid-2016, IMF Staff estimates the output gap at 1.7 percent and the unemployment rate gap at 0.5 percent (about 1¼ percent at the peak).
Unemployment and Underemployment Rate
Source: Haver Analytics.
Share of Full-Time Jobs in Total Employment
Source: Haver Analytics.
6. Both headline and core inflation have been below the inflation target range of 2-3 percent in 2016, and the Reserve Bank of Australia (RBA) responded promptly to an unexpected downshift in the inflation path. Initially, the disinflation that began in late 2014 had been driven by the declines in the prices of oil and other commodities. Over the past 12 months, however, the declines have been due to non-tradables inflation, with the RBA pointing to the temporary inflation impact from lower margins due to increased competition in the retail and other sectors. After a noticeable, unexpected decline of core inflation in the first quarter of 2016, and a downshift in the path of expected inflation, the RBA has lowered the policy rate by another 50 basis points to 1.5 percent in 2016 in May and August. Core inflation has since stabilized at around 1.6 percent. Wage growth has remained weak, with nominal unit labor costs running at less than 0.5 percent on average, and cost pressures have been virtually absent.
7. The current account balance has remained moderately weaker than its fundamental level and the Australian dollar has continued to be moderately overvalued. The commodity-currency adjustment mechanism that has come into play after the mining investment bust has supported the rebalancing of growth toward net exports, with investment weakness also weighing on imports. A renewed widening of the current account deficit in 2015 reflected temporary factors, including weather related export declines and exceptional imports, and the balance has since narrowed again. While currency depreciation in 2014-15 has reduced much of the overvaluation that had developed over the boom, the correction has stalled in recent months (Annex IV—External Sector Assessment). The latter has likely reflected the relative attractiveness of Australian assets, given their relatively high returns. Nonetheless, yields on longer-term Australian bonds have declined, and valuation effects from the resulting bond price increases, together with exchange rate appreciation, have contributed to a marked deterioration in the net external liability position over the past year, given the economy’s sizeable net short position in that asset class (Annex II). That said, the underlying risk profile has improved further, adding to improvements since the global financial crisis, as the share of longer-term external funding of Australian banks has increased over the past year or so, while that of short-term external funding has decreased.
8. By some metrics, housing market conditions have cooled and credit growth to households has slowed, but risks related to house price and debt levels have not yet decreased.
- ➢ Realhousepricegainshavemoderated. Indicators of current conditions such as sales volumes and the rate of turnover in the housing stock have moderated. The extent of cooling has varied considerably across capital cities. The strongest price increases continue to be recorded in Sydney and Melbourne, where underlying demand for housing remains strong. With house prices still rising ahead of income, standard valuation metrics suggest somewhat higher house price overvaluation relative to the assessment in 2015 Article IV consultation.
- ➢ Theflipsidehasbeenslowinggrowthinbanklendingtohouseholds. APRA prudential guidance requiring tighter lending standards by banks, which was introduced in late 2014, has curtailed growth in riskier mortgage loans in particular and credit growth to household more broadly. At the same time, there has been some upward pressures on mortgage rates, as banks have increased capital ratios and prepared for a higher risk weight on mortgage lending. That said, household credit gaps have not yet reversed.
- ➢ Onthesupplyside, residential investment has risen to some 0.5 percent of GDP above its long-term average (the ratio remains comparatively low given population and labor force growth). An above-average number of new apartments is expected to come on stream in the next year or so, mostly in the downtown areas of Brisbane, Melbourne, and, to a lesser extent, Sydney. Concerns about temporary oversupply have thus risen. But leading indicators, such as approvals of new houses and other dwellings or new residential construction starts, have started to level off after brisk increases in 2014-15. In commercial real estate, property price valuations have increased but are still within the usual range of variation over the cycle (Box 1).
New Residential Term Loan Approvals by Loan-to-Valuation Ratio (LVR)
New Residential Term Loans to Households Approved
9. Household sector leverage has been stable overall despite higher debt, and debt buffers have risen but not for all households. The household debt ratio rose to 186 percent of gross disposable income over the past year, but underlying vulnerabilities have not increased to the same extent. Mortgage buffers—balances in related offset accounts and redraw facilities, which are held for tax and precautionary reasons—have also risen, to some 18 percent of outstanding mortgage loans by mid-2016—the equivalent of around 2½ years of scheduled debt payments at current interest rates. And household leverage (liabilities as a percent of net worth) has been stable and low at around 25 percent.3 Yet there is considerable heterogeneity across households. With house values a rising multiple of income, first-time homebuyers and other new borrowers tend to have higher debt ratios and smaller buffers. Indeed, around 25 percent of all households in each income quintile had debt to income ratios above 3 in FY2013-14—the latest available year for income and wealth data across households. These households may well be liquidity-constrained in an economic downturn.
Household Leverage in the Flow of Funds
Sources: Haver Anaytics and IMF staff estimates
Household Leverage by Income Quantile
10. Banks have further strengthened their balance sheets, responding to regulatory change and market pressure. The large Australian banks have raised the CET1 capital ratio from 8.6 of risk-weighted assets (RWA) in June 2014 to 10 percent at the end of 2015, partly through raising fresh capital, and the ratios are expected to have improved further in 2016. According to APRA studies, after adjusting for stricter requirements in capital and RWA calculations, these capital ratios have placed the banks at the low end of the top quartile internationally. Bank funding conditions have also improved, with foreign currency funding continuing to be fully hedged. Nonperforming loans (NPL) have remained largely unchanged.4
CET1 Ratios of Major Banks
11. The baseline outlook is for the resumption of growth close to trend, a gradual return of inflation into the target range, and a slow stabilization of macro-financial vulnerabilities.
- ➢ Growthisexpectedtobeclosetotrend, withincreasingcontributionsfromdomesticdemandgrowthastheadjustmenttothecommodityandminingshocksadvancesfurther. With the contraction in 2016Q3 largely due to one-off factors, growth is expected to resume in the last quarter of 2016. Residential investment growth is expected to rebound, given a strong pipeline of building approvals and housing starts. The contribution of private business investment to growth should turn positive, as the correction in mining investment should run its course and non-mining investment should start to pick up. In addition, states that have experienced rapid growth in activity are expected to ramp up infrastructure spending in 2017-18. Private consumption should strengthen with the recovery continuing and labor markets improving further. On the export side, the rate of growth is expected to slow somewhat, as the initial boost from new mining capacity and new sources of demand (e.g., tourism from Asia) should moderate.
- ➢ Thedisinflationexperiencedin2015-16isexpectedtostartreversing. With the rebound of oil prices in 2016, an important source of disinflation has already dissipated. Other sources are expected to weaken gradually. The output gap is projected to decline, and the inflation effects from downward pressure on producer price levels from increased competition in the retail sectors should wear off with no major new market entrants.
- ➢ Themacro-financialoutlookisforastabilizationofhousing-relatedvulnerabilities. The main driver is a realignment of house price inflation with broader measures of inflation and robust growth. Recent increases in residential investment should result in higher supply over the next two years, especially in market segments that have seen higher prices increases, and lower affordability should constrain demand. Credit gaps and debt ratios should thus stabilize or decline. On the external side, the accumulation of net external liabilities should slow in the absence of valuation effects. As banks prepare to meet net stable funding ratio requirements by 2018, related vulnerabilities should improve further.
12. The balance of risks has improved but is still to the downside. The interaction of external and domestic downside risks must remain the main policy concern. The momentum of the recovery could be stronger, as recent terms-of-trade improvements could boost business confidence and commodity production if they are more persistent than expected. On the downside, growth could be slower, as consumption growth could remain lackluster with continued low wage growth and high incidence of part-time work, and profits could remain under pressure for longer with increased competition and relatively persistent slack. On the external side, there are risks to global trade from rising populism and nationalism in large economies and from tighter and more volatile global financial conditions. A major concern for macro-financial risk management is that external risks could hit both traditionally exposed sectors (commodity prices and exports) and new sources of growth (e.g., services exports), for example, a sharper growth slowdown in China (Annex V—Risk Assessment Matrix). If such external risks materialized, they could interact with or even trigger domestic risks, especially a sharp housing market correction, also given that annual approvals for all non-residents applying to purchase residential property have substantially increased to around 20 percent of overall turnover value, and they could lead to external funding pressure for banks.
D. The Authorities' Views on Outlook and Risks
13. The authorities emphasized that the transition to non-mining-based growth after the boom was well advanced. They acknowledged that some elements of the “new mediocre” were present, including weak private business investment. But they saw these as a reflection of the drawn out adjustment of the economy to the decline in the terms of trade and the large fall in mining investment rather than a cause. While many of the new jobs were part-time ones, this partly reflected preferences in the labor force. The rise in underemployment as well as in long-term and youth unemployment had remained small in historical comparison, and growth in output had remained close to trend. And while trend growth was lower, the decline was small, about a quarter of a percentage point, partly reflecting lower population growth, not lower capital intensity or productivity growth.
14. Robust broad-based growth was expected to continue. The authorities noted that the unexpected decline in GDP in the September quarter of 2016 was partly a result of falling mining investment and a series of one-off factors including weather-related falls in non-residential construction and dwelling investment. Looking forward, economic growth would be supported by household consumption; another wave of LNG capacity was expected to ramp up, in 2017 as well as in 2018; public investment growth would rise as States’ infrastructure spending was budgeted to increase further; residential dwelling investment growth, while moderating, would remain strong in the near term; and private business investment would no longer detract from growth in 2018 as the drag from mining investment would ease and non-mining investment would rise moderately. GDP growth would strengthen to around trend rates. The authorities indicated that the economy would thus return to full employment gradually, with underemployment declining and inflation moving back into the target range. While the balance of risks had improved, it remained tilted to the downside, with the possibility of a hard landing in China being a key medium-term concern.
15. The authorities noted that risks associated with high and rising household leverage had diminished. Tighter bank lending standards, encouraged by prudential measures, had led to slower mortgage credit growth, with improved risks profiles for new loans, and a moderation in housing price growth. Risks related to short-term demand-supply mismatches in housing markets were localized. There were some risks related to lending to real estate developers but those were being closely monitored. Households across all income brackets continue to accumulate deposits in offset accounts, implying that effective household debt was lower, and did not use mortgage borrowing to finance consumption. More resilient bank balance sheets were another factor contributing to diminished housing risks.
Economic Policy Priorities
16. Discussions focused on policy requirements to meet three broad objectives: Completing the economy’s transition to non-mining growth; containing macro-financial vulnerabilities; and enhancing longer-term growth potential.
A. Supporting Aggregate Demand
17. Australia’s transition to non-mining-based growth has advanced significantly with monetary policy support but the process is not completed. The lack of significant price and wage pressures suggests that some economic slack is still present, which, if prolonged in what has already been a drawn-out adjustment process, risks hurting medium-term supply potential.
18. The RBA cut the policy rate promptly in response to the unexpected downshift in the expected inflation path in early 2016. The easing also helped to realign the policy rate with interest rates elsewhere, which had declined in some other major advanced economies through September 2016. Staff background work suggests that the equilibrium real interest rate has declined from about 3 percent in the early 1990s to close to 1 percent in the second quarter of 2016 compared to an actual real rate of 0.2 percent, although there is substantial uncertainty around such estimates.5 Absent monetary easing, upward pressure on the Australian dollar would likely have been stronger, reinforcing the disinflationary impulse experienced early in the year.
19. Australia has substantial fiscal space. Standard metrics suggest that Australia has fiscal space under both the baseline and economic stress scenarios (Annex VI—External and Fiscal Debt Sustainability Analysis). For example, sovereign spreads over U.S. bonds have been relatively moderate in the past 12 months (at most 64 basis points); gross debt is still low at 40 percent of GDP compared with other major advanced economies.
20. The federal government has recently aimed for substantial near-term fiscal consolidation but budget targets have not been met because of weaker nominal income. Automatic stabilizers have been allowed to operate in response to weaker growth and lower inflation, and the fiscal stance in 2016 is estimated to have been broadly neutral. Against this backdrop, concerns about recent public debt increases and what they mean for Australia’s top-ranked sovereign debt rating have dominated fiscal policy discussions.
21. In the FY2016/17 budget, the government has projected a return to fiscal balance by FY2020/21. It has also renewed its commitment to a federal government surplus of 1 percent of GDP over the business cycle as a medium-term fiscal anchor, which would imply a cumulative adjustment of up to 3.4 percent of GDP. The Mid-Year Economic and Fiscal Outlook 2016-17 (MYEFO), released on December 19, 2016 foresees a cumulative adjustment of the fiscal balance of 2.1 percent of GDP by end of FY2019/20, as revenues strengthen in line with the economy, primarily related to stronger personal income tax collection because of bracket creep.
22. The RBA’s monetary policy stance should remain accommodative until the return of inflation to the mid-point of the target range is highly secured. Australia has not experienced the persistent low inflation problem of other advanced economies, and medium-term inflation expectations, while lower, have generally remained within the target range. But with economic slack expected to decline only gradually and taking into account downside risks, policy decisions should remain predicated on the possibility that the return of inflation back to target may take longer, consistent with recent international experience. And in current circumstances, there are asymmetric costs to inflation risks, given policy objectives. The risk of inflation rising faster than expected is less costly than risks of inflation being lower. Monetary policy can likely respond more effectively to positive surprises for some time, given that from current policy settings, policy rates may rapidly reach the effective lower bound if negative surprises reflect large shocks to demand.
23. The RBA could consider enhancing its policy communication given the inflation outlook and the risk of hitting the effective lower bound under a downside scenario. While increases of longer-term interest rates in advanced economies since October are suggestive of some increase in underlying equilibrium interest rates, policy rates in Australia may well stay low for some time. Under these conditions, risks of low inflation becoming entrenched could be reduced through clear guidance by the RBA on the horizon over which inflation is expected to return to the mid-point of the target range and on the likely policy measures should downside risks materialize. To lay the foundation, the RBA could consider lengthening the forecast horizon in its Statements on Monetary Policy. More clarity on the policy rate path, possibly through publication of the RBA’s projected policy rate path, could also enhance the RBA’s communication with markets and price setters.
24. The government should use its fiscal space for a gradual fiscal consolidation and structural fiscal reform. The conditions calling for more pro-active fiscal stimulus, including policy rates at the effective lower bound and impaired monetary policy transmission, are not present. Some fiscal consolidation remains desirable—not the least in view of a sizeable structural budget deficit and impending medium-term increases in ageing-related spending. However, Australia has the fiscal space to undertake budget repair gradually. Any remaining negative demand effects could be offset by continuing accommodative monetary policy, expenditure switching, and growth-friendly structural fiscal reform. In contrast, a front-loaded fiscal consolidation based on measures would pose too much of a risk to the on-going recovery. The MYEFO 2016-17 shows a fiscal improvement based on an economic recovery, broadly consistent with staff’s views on growth in the coming years.
25. Structural fiscal reform should focus on supporting growth through increased spending on infrastructure, innovation, labor market integration, and tax reform.
- ➢ Thereisroomforgreaterinfrastructureinvestment. While general government spending on infrastructure has increased in FY2016/17, this increase primarily reflects higher spending by States, not the Commonwealth. Indeed, capital spending is expected to increase by ½ of a percentage point of GDP in the current budget year, but these efforts are not expected to be sustained as spending is projected to level off in the next fiscal year and to decline thereafter. A more sustained, multi-year increase in spending on efficient infrastructure also at the Commonwealth level would be desirable, considering that Australia has infrastructure needs and fiscal space and the funding environment is favorable.
- ➢ Reformsthatsupportinnovationandproductivityshouldbestrengthened. These would include an upgrade of the R&D tax credits put in place last year and active labor market policies, to lower risks of hysteresis in labor markets and support human capital formation in an environment of rapid structural change, increased part-time employment, and higher long-term unemployment.
- ➢ Ataxshift, loweringcorporateandhouseholdincometaxeswhileincreasingthegoodsandservicestax(GST), couldboostinvestmentandliftGDP. Background work using the IMF’s G20MOD suggests that in Australia, the long-term multipliers for a 1 percent of GDP shift from corporate income taxes to the GST is roughly 0.6 percent of GDP, while that of labor income taxes to the GST is over 0.1 percent of GDP. A revenue-neutral tax shift should thus lead to a permanent increase in the level of real GDP. 6
26. Should downside risks materialize, fiscal stimulus may be needed to boost aggregate demand, as monetary policy may rapidly be constrained by the effective lower bound. If the shock is large, an effective macroeconomic policy response may well require expansionary fiscal policy. In a China downside scenario, model-based scenario analysis in background work by staff illustrates how a combined monetary and fiscal policy response ensures a faster recovery (Box 2). With some high-impact downside risks to the near- and medium-term outlook present, contingency plans for expansionary fiscal policy should be prepared, given the implementation lags involved in undertaking fiscal stimulus. Such contingency plans should include a revolving pipeline of ready-to-implement infrastructure projects, with coordination between the Commonwealth and State governments.
27. An IMF staff review of the fiscal anchor and framework suggests that the authorities consider changing to a long-term debt anchor.7 In 2010, the government raised the mediumterm anchor from a zero balance to a surplus of 1 percent, with a view to reverse the recent debt accumulation. In staff’s view, it is a strength of Australia’s fiscal framework that it requires governments to report against a medium-term fiscal strategy based on “principles of sound fiscal management.” But the authorities should consider replacing the current medium-term budget balance anchor with a longer-term debt anchor. The latter would provide certainty about debt and fiscal policy in the future. Once in place, the debt anchor would encourage the government to discuss the implication of unanticipated shocks on the fiscal position and the medium-term fiscal strategy. At the same time, if implemented over a 5- to 10-year horizon, the framework would remain sufficiently flexible to allow for countercyclical fiscal policy support if needed.
28. The RBA was concerned about the potential costs to financial stability from further monetary easing relative to the benefits of inflation returning to target faster. Against expectations of robust growth and improving labor markets, it considered risks of inflation becoming entrenched below target to be low. The undershooting of core inflation was recent. But the RBA was ready to ease further should the outlook for labor markets and inflation deteriorate materially. RBA officials saw costs and benefits to changing policy communication strategies. While RBA staff were working on extending the forecast horizon, they were concerned that conditional forecasts of the policy rate path could be misread as RBA commitment. RBA officials noted that they could use unconventional monetary policy measures should the need arise, with circumstances dictating the instruments to be used. However, they considered the risks of reaching the effective lower bound for policy rates to be low, partly because the Australian dollar usually depreciated in the case of adverse external shocks. This, in turn, could ease the burden on monetary policy in responding to a downturn.
29. The authorities were less sanguine than staff about the extent of available fiscal space and did not think that current circumstances required its active use. They noted concerns by rating agencies about the sizeable and persistent budget deficits and emphasized that being a capital importing country, which generally runs current account deficits, requires greater fiscal prudence than otherwise. In their view, the economy could absorb the proposed path of fiscal consolidation, noting that much of the expected increase in revenue was through household income tax bracket creep, rather than measures with higher multipliers. However, they agreed that, in the face of negative economic shocks, such as a sharp slowdown in China, increased fiscal spending would need to be considered, as the effectiveness of monetary easing might be diminished. Concerns about a widening current account deficit could be mitigated if it is driven by fiscal spending that encourages stronger domestic investment instead of only weakening saving ratios.
30. The authorities felt that the composition of fiscal adjustment was as important as the pace of consolidation. In this respect, they noted that past spending increases often focused on recurrent spending. Some of the spending had not been productive, while other spending could be reduced while maintaining or improving outcomes through increased productivity in the delivery of services. Restraining recurrent spending would help in increasing productive spending, on infrastructure investment, nurturing innovation, and on measures encouraging private investment, real wages and incomes in the private sector. This in turn would help on the revenue side as well, particularly for healthy labor income tax revenues, which depend on growth to induce bracket creep.
B. Managing Macro-Financial Vulnerabilities
31. Momentum in house prices and housing credit has moderated and bank balance sheets have strengthened with prudential and regulatory steps, but vulnerabilities have not yet decreased materially. Intrinsic housing market risks have become more localized. The escalation of APRA’s supervisory intensity, including guidance on lending standards, over the past year and a half has contributed to lowering growth in new, higher risk lending (e.g., with loan-to-value ratios of more than 80 percent), while housing market conditions have cooled broadly. Nevertheless, risks of renewed price acceleration remain, as mortgage and interest rates more broadly are still low, while foreign investment interest in residential property in the major cities continues to be strong. And high household debt could still amplify the negative impact of large shocks. Regulatory steps under the Basel III framework have contributed to banks’ stronger capital positions. As of January 2016, banks had to meet a capital conservation buffer of 2.5 percent of RWA, and a buffer for domestic systemically important institutions of 1 percent of RWA became effective. The counter-cyclical capital buffer is currently set at zero. In addition, in July 2016, a floor for mortgage risk weights for banks using the IRB approach took effect. Tighter prudential rules do not seem to have led to migration of credit activity to non-banks, and the shadow banking sector in Australia has remained relatively small over recent years.
32. With signs of a cooling housing market, the tightening of prudential measures should remain a contingency. Under the IMF staff’s macro-financial baseline outlook, tighter loan restrictions could accelerate a cooling in housing market, which would be pro-cyclical. In markets where a house price correction has already begun—in the mining states, for example—they risk delaying the recovery from the commodity bust, including by hindering labor mobility. But with continued upside risks to house prices and housing lending growth, APRA should stand ready with targeted prudential measures. Minimum amortization requirements for new loans could also be considered to rein interest-only lending further.
33. Banks’ should further strengthen their capital position, which would increase their resilience to housing and other macro-financial shocks. This approach would focus on strengthening banks’ ability to absorb losses from a more significant housing market correction. For instance, APRA could consider adjustments to the level of required capital, dependent on banks’ exposure to risky housing market segments and lending standards in those segments (pillar 2 adjustments). Alternatively, it could consider introducing higher minimum risk weights for some lending, notably higher-risk housing-related loans. With expectations of lower profitability in the sector, it will be important for banks to remain in a position to continue to generate sufficient internal capital to finance the growth of their balance sheets and maintain unquestionably strong capital ratios.
34. In the longer term, the macro-financial resilience of the economy to housing market shocks could be enhanced through tax reform. The Commonwealth tax system provides households with incentives for leveraged real estate investment that likely amplifies housing cycles. The incentives arise from the combination of tax concessions on capital gains and the possibility to apply losses from negative gearing to income from other sources. Reforms of capital gain tax concessions would need to be undertaken in a broader context, to avoid introducing new distortions in the taxation of different assets.
35. Broader progress in implementing the regulatory reform agenda would also help in lowering and managing financial sector risks. APRA’s efforts to develop an operational framework to assess whether Australian banks are “unquestionable strong” in international comparison will further reduce bank-related financial stability risks. Another priority are reforms recommended in the 2014 Financial Sector Inquiry for increasing the resilience of the banking system, such as the implementation of a framework for loss absorbing and recapitalization capacity and the introduction of a leverage ratio, in the context of international regulatory developments.
36. The authorities are taking steps to address the lack of adequate AML/CFT safeguards in the real estate sector. In 2015, the Mutual Evaluation Report of Australia’s AML/CFT regime by the Financial Action Task Force found that the real estate sector is exposed to significant money laundering risk and should be subject to AML/CFT safeguards in line with the international standards. In response, Australia has recently completed a statutory review of its AML/CFT regime and initiated a consultation process about regulating real estate professionals under the AML/CFT Act._The cost-benefit analysis of different regulatory models is expected to be completed by July 2017.
37. Remittance flows from Australia have remained broadly stable while regional correspondent banking relationships with Australian banks have continued. AUSTRAC’s tracking of international funds flowing through financial intermediaries registered in Australia suggests no significant change in patterns or magnitudes of remittance flows. That said, money transfer operators have been subject to structural change, given evolving financial technology, and regulatory change. While some operators have had their bank accounts closed, this has only affected a subset among them. However, money transfer operators have faced increased costs and complexities of doing business. At this stage, there is no evidence that Australian banks have stopped correspondent banking and other business with neighboring Pacific Islands. Nevertheless, recognizing the potential for negative spillovers, the authorities have formed a high-level interdepartmental committee to coordinate policies, intensified consultation with the industry, provided neighboring countries with technical assistance to deal with AML/CFT challenges, and actively engaged in the G20 Global Partnership for Financial Inclusion.
38. The authorities concurred that policies should focus on further strengthening resilience to housing market and other shocks with macro-financial implication. Regarding “unquestionably strong” capital ratio of banks, APRA stressed that a top quartile positioning relative to international peers is only one guidepost and that other benchmarks would be used as well. For example, capital positions against rating agency measures of capital strength would be assessed and the result of stress tests can also be informative. In terms of timing, APRA did not expect that final standards on unquestionably strong capital ratio would be released soon, given that 2017 will be a year of consultation. The standards would be unlikely to take effect until at least a year after that to facilitate an orderly build-up of capital. APRA indicated openness to the use of a range of prudential measures in case they are needed.
39. The Treasury continues its efforts to introduce new legislation to deliver on the Government’s financial system agenda. In its response to the recommendations of the Financial System Inquiry (FSI), the government announced 48 measures, including on the crisis management toolkit, banks resolution, and consumer protection, which require legislation to be prepared and worked through the legislative process.
C. Keeping Up Productivity Growth
40. Maintaining high productivity growth rates may be challenging. Aggregate labor productivity growth in Australia has remained stable over the past decade and a half, increasing at an annual average rate of around 1.5 percent. More recently, however, labor productivity growth has slowed, with weaker multifactor productivity especially in the services sectors, which have accounted for most of the growth in employment since the end of the mining boom. At the same time, weak non-mining investment has likely resulted in less capital deepening.
41. Moving ahead with a range of smaller reforms may nevertheless boost productivity. After a wave of reforms in the early 1990s, there are few low-hanging fruit in terms of large-scale structural policies. Australia generally ranks favorably compared to other OECD countries in key “ease of doing business” areas, although its relatively favorable position has eroded over time as other countries have also improved and progress on reforms in Australia has slowed. Policy priorities have been identified in commissioned expert Reviews and Inquiries, while the Productivity Commission provides the government with research and analysis. The reform agenda, including on the tax side, has been shaped by the 2015 Competition Policy Review (“Harper Review”) and the 2014 Financial System Inquiry (“Murray Inquiry”).
42. Recent structural reforms have appropriately focused on fostering innovation. Innovation is key to factor productivity growth, but there are sizeable gaps relative to the frontier in this dimension. Investment in knowledge capital is relatively low in Australia, partly reflecting low R&D spending relative to other advanced economies. The government’s National Innovation and Science Agenda (NISA) allocates $1.1 billion (less than 0.1 percent of GDP) over four years to boost innovation and entrepreneurship in the high-tech sector, including through tax breaks. Recognizing the difficulties in fostering innovation through policies, the authorities are closely monitoring outcomes to ensure policy effectiveness. The government plans to continue and expand the program if it proves to be effective.
43. Product market reforms can be expanded in targeted areas. The Harper Review has identified a number of reforms to boost competition and productivity in the services sectors, and to strengthen competition policy broadly. Some of the major benefits from the proposed measures arise from reforms to increase competition in the delivery of human services on behalf of governments, and in other markets including construction, retail trade, and transport. A number of these reforms will have to be implemented at the state level, which will require complex coordination between the Commonwealth and State governments, in legislation and through intergovernmental agreements. Legislation for key components are still under preparation, and efforts to expedite implementation of the Harper Review would be beneficial. In addition, efforts to increase competition in the financial sector, including through implementation of measures identified in the Murray Inquiry, should continue.
44. Trade liberalization is another means to increase competition and Australia intends to continue efforts towards further liberalization in regional and multilateral fora. Aside from benefiting from traditional lines of exports, Australia would also stand to gain from enhanced access to service export markets, which would also serve to strengthen service sector productivity in Australia. At the same time, active labor market policies and the social safety net would help to mitigate the cost to those who would bear the burden of adjustment.
45. Tax reforms appear challenging in the current political environment. The government managed to achieve passage of a tax cut for small business in the current Budget, but has yet to introduce similar measures for larger firms. Such a measure should be part of a package of broader reforms that remains to be accomplished, including reducing tax concessions, and the shift in the tax mix discussed above as part of structural fiscal reforms. Such reforms could enhance productivity.
46. Labor markets have performed well. The flexible labor market settings have contributed to a smooth adjustment from the mining boom with low unemployment. However, the elevated rate of underemployment, and persistent youth unemployment could lead to diminished incentives to accumulate human capital if not addressed. While the gradual elimination of economic slack should help to ease some of the potential for problems, the authorities should remain vigilant to prevent deepening skill mismatches and labor market hysteresis. In this context, the government’s $840 million Youth Employment Package, which seeks to increase employability of youth mainly through wage subsidies, is a welcome step.
47. The authorities agreed that the productivity growth environment is challenging. While labor productivity growth has been stable, it is expected to grow at a somewhat slower rate over the next few years. Moreover, half the aggregate labor productivity growth recorded recently was contributed by the mining sector, which has moved to the less labor-intensive production phase after a long investment phase.
48. The authorities aimed to improve productivity through targeted steps, with legislative steps under preparation. With key economy-wide reforms already implemented, future productivity gains would require specific measures, which include increasing contestability in markets for services, and boosting innovation capacity and absorption. Reforms identified in the Harper Review would primarily have to be implemented at the state level, and would require close coordination between the Commonwealth and State governments. The government is finalizing intergovernmental agreements and National Partnerships detailing funding for measures taken at the state level. These Partnerships are expected to be formed by mid-2017 to mid-2018. Other reforms proposed in the Harper Review can be implemented by the Commonwealth government and may be introduced as early as mid-2017.
49. Innovation was emphasized as a priority. The government’s NISA would help to boost innovation capacity by seeking to encourage entrepreneurship, and to enhance industry-science collaboration. Future waves of NISA would envisage building science capability in niche areas such as health or data analytics, encouraging private sector investment in innovation and making it easier for business to interact with Government.
50. The authorities were pressing ahead with trade liberalization. They were committed to the passage of the TPP. Even if it were not to come into force because some other signatories may not pass it, the authorities were committed to implementing as many of its provisions as possible by other means such as bilateral agreements - for example, the recent expansion of its 2003 free trade agreement with Singapore. They were also interested in continuing negotiations for the RCEP (Regional Comprehensive Economic Partnership), which includes China and the Asia-Pacific TPP signatories.
51. Context. Australia has experienced robust growth and low unemployment during the drawn-out adjustment to the commodity price and mining investment bust, highlighting the resilience of the economy and strong policy frameworks. But it has not been immune to symptoms of the “new mediocre.” Wage and price pressures have been weak, underemployment has risen, and private business investment outside mining has been lackluster.
52. Outlook and risks. After a growth pickup from mid-2015, real GDP unexpectedly contracted in 2016Q3, largely on account of one-off factors, so growth close to trend is expected to resume. The balance of risks to the growth outlook improved in 2016 but remains tilted to the downside. While recent terms-of-trade improvements provide for some upside, domestic demand could remain lackluster with continued weak wage growth and underemployment. A major concern is that high-impact external risks could interact with or even trigger domestic risks, especially a housing correction.
53. On the macro-financial side, prudential policies have contributed to a tentative stabilization of housing-related and external vulnerabilities. APRA’s prudential measures introduced in late 2014 have improved the risk profile of new loans. While household debt has remained high, risks to banks and to household balance sheets have been mitigated by the strong growth in mortgage buffers. The macro-financial risk outlook has also improved as banks’ balance sheets have become more resilient with higher capital ratios and a higher share of stable funding.
54. The economic policy agenda should center on three priorities: Demand support to ensure completion of the transition to non-mining-based growth; further reductions in macro-financial vulnerabilities, and reforms to enhance the longer-term growth potential.
55. The monetary policy stance should remain accommodative. Australia’s low inflation is more recent, but policy decisions should remain predicated on the possibility that inflation may return into the target range later than expected, given international experience. Prudential measures to address housing-related risks have mitigated risks to balance sheets and financial stability from lower policy rates.
56. Australia still has substantial fiscal space despite recent public debt increases, which allows for a gradual approach to fiscal consolidation and higher growth-friendly spending.
- ➢ Thegovernmentappropriatelyplanstobalancethebudgetoverfouryears, whilemakingtheexpenditurecompositionmoregrowth-friendly. Efforts focus on supporting longer-term inclusive growth, including by boosting innovation and tax reform.
- ➢ Theenvisagedfiscalconsolidationrisksbeingtoofront-loaded. Over the next two years, the budget targets reductions in the structural budget deficit of close to 1½ percent. This ambitious pace risks being counterproductive in the current phase of the recovery, especially if it does not provide for the increases in productive spending needed to support longerterm growth.
- ➢ Amoresustainedpublicinvestmenteffort. A multi-year increase in spending on efficient infrastructure beyond the planned current short-lived increase would be desirable, considering that Australia has infrastructure needs and fiscal space.
57. If high-impact downside risks were to materialize, fiscal policy should support aggregate demand, as monetary policy could be constrained by the effective lower bound. Developing contingency plans and a pipeline of infrastructure projects would help reduce implementation lags in undertaking fiscal stimulus.
58. With more acute risks concentrated in a few specific housing market segments, policies should focus on further strengthening resilience to housing market and other shocks with macro-financial implications.
- ➢ With continued upside risks to house prices, APRA should stand ready to intensify targeted prudential measures, if lending or house price growth were to re-accelerate.
- ➢ APRA should continue to actively encourage banks’ efforts to robustly anchor their capital position in “unquestionably strong” territory, given a highly concentrated banking sector where banks have similar business models.
- ➢ Treasury’s preparation of new legislation to further the regulatory reform agenda should continue to complete the implementation of the FSI recommendations. APRA should continue in its effort to implement prudential steps to strengthen the loss absorbing and recapitalization capacity of banks and introduce leverage ratios, in line with the international agenda.
59. The government’s structural reform agenda appropriately focuses on fostering innovation and strengthening competition, and the intention to push for trade liberalization is welcome. The NISA, is an important step forward. The efforts should continue, as currently envisaged, and, if effective, be expanded. The measures recommended by the Harper Review would strengthen services sector competition and productivity, but implementation will require determined effort. Expanding access to service export markets could also strengthen services sector productivity in Australia and elsewhere, while the social safety net and active labor market policies could mitigate the cost to those who bear the burden of adjustment.
60. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.
Box 1.Developments in Australia’s Commercial Real Estate Market
Signs of commercial real estate overvaluation have emerged. Commercial real estate (CRE) prices in Australia have increased rapidly since mid-2014. Rents have not followed at the same pace, and the price-to-rent (PR) ratio is now above average. Whether the latter is a good metric of fair value is difficult to assess. But the deviations from average are now close to levels last seen before the global financial crisis. Shortly thereafter, there was a sharp correction in CRE prices in the context of the crisis. Internationally, Australia’s CRE PR ratio is closer to the pre-crisis maximum than in almost all other countries for which data are available, with the notable exception of the United States and Canada. The valuation increases may in part reflect the strong interest of foreign investors in Australian CRE assets.
Price to Rent Ratio
Sources: MSCI; and IMF staff calculations.
Price to Rent Ratio
Sources: MSCI; and IMF staff calculations.
Approvals by Country of Investor on Real Estate in 2014-2015
Risks to financial stability from any potential CRE overvaluation appear manageable. The share of CRE lending in commercial banks’ total assets decreased in the past few years and has now stabilized at around 5 percent. Even so, banks’ lending growth to CRE has been rising recently, with increased contribution by Australian branches of foreign banks. The share of impaired CRE assets over total CRE assets has declined and the impaired assets are almost fully provisioned. While a downturn in the CRE market would likely not pose a major financial stability risk, it may still have important macroeconomic effects as Australia’s CRE capital expenditures as a percent of GDP are relatively high in comparison.
CRE Lending Growth Rate
Share of CRE
Impaired CRE Assets and Special Provisions
Share of CRE Related Capital Expenditure
Sources: MSCI; Haver Analytics; and IMF staff calculations.
Box 2.A China Downside Scenario with Monetary and Fiscal Policy Responses
Disappointing external environment may require a ‘low for longer’ strategy for monetary policy. We consider alternative simulations where China’s economic growth surprises on the downside. This has significant spillover effects on the rest of the world and a sizable impact on commodity prices. This downside scenario implies an opening up of the effective foreign output gap relevant for the Australian economy (defined as export-weighted output gaps for Australia’s main trading partners). Specifically, the effective foreign output gap is 2.3 percentage points lower and metal prices are 5.3 percent lower at the trough compared to the baseline. Under the blue line, in anticipation of the negative shocks, the policy rate declines to the effective lower bound (assumed to be 0.75 percent) and stays there for 2 years. This results in a further depreciation in the Australian dollar that helps support the economy. However, a sizable negative output gap remains for the Australian economy as largely dominated by the magnitude of the negative shock. Headline inflation slightly overshoots the 2.5 percent mid-point of the RBA’s 2-3 percent inflation target range.
A combined monetary-fiscal policy would provide a much-needed shot in the arm for the Australian economy if the downside shocks were to materialize. Under this case, a direct fiscal stimulus is used to help deal with the negative external shocks hitting the Australian economy. The direct effects of the fiscal stimulus are equal to 0.25 percent of GDP for 2017-18. Monetary policy provides the ‘supporting role’ to a much-welcomed fiscal expansion by cutting the policy rate aggressively to its lower bound faster than under the previous case. This helps raise inflation and generate a modest overshoot of inflation above the upper bound of the 2-3 percent target range over the medium term. This planned overshoot of inflation raises inflation expectations and reduces the real interest rates, which combined with more depreciated exchange rate helps close the output gap much faster. A faster recovery of the economy under this more accommodative strategy allows monetary policy to renormalize earlier than under the previous case.
Figure 1.Australia in International Comparison
Source: IMF, World Economic Outlook database.
Figure 2.Strong Advances in the Recovery from the Mining Bust
Sources: Haver Analytics; dxTime; ABS; and IMF staff calculations.
Figure 3.Current Account Improving After Rebalancing Toward Net Exports
Sources: Haver; IMF, World Economic Outlook; ABS; RBA; and IMF staff calculations.
Figure 4.Housing Risks Remain
Sources: OECD; RBA; APRA; RBNZ; Corelogic; BIS;Haver Analytics; and IMF staff calculations.
Figure 5.Monetary Policy Faces a Disinflationary Impulse
Sources: RBA; Haver Analytics; and IMF staff estimates.
Figure 6.Strong but Deteriorating Public Finances
Sources: Commonwealth and State/Territory Treasuries; 2016-17 Budget; IMF, World Economic Outlook and IMF staff estimates and projections.
Figure 7.Banking System Remains Strong
Sources: Bankscope; RBA; APRA; Financial Soundness Indicators; and IMF staff calculations.
Figure 8.Financial Market Indicators: New Lows for Yields and Spreads
Sources: Bloomberg; RBA; and IMF staff calculations.
Figure 9.Interconnections and Spillovers
Sources: ABS; APRA; RBA; IMF, Direction of Trade Statistics; BIS; and IMF staff calculations.
|Net exports (contribution to growth, percentage points)||−0.2||1.5||1.5||0.8||1.2||0.1||0.1||0.1||0.1||0.1||0.1|
|Gross domestic income||1.3||1.3||1.2||−0.1||2.0||2.2||2.0||2.7||2.8||2.8||2.9|
|Investment (percent of GDP)||29.0||27.6||26.9||26.3||25.1||25.1||25.4||25.5||25.6||25.6||25.6|
|Savings (gross, percent of GDP)||24.6||24.4||23.9||22.1||21.6||21.6||21.3||21.5||21.6||21.6||21.6|
|Output gap (percent of potential)||−0.5||−1.1||−1.3||−1.4||−1.7||−1.7||−1.3||−1.0||−0.7||−0.4||−0.1|
|Unemployment (percent of labor force)||5.2||5.7||6.1||6.1||5.7||5.7||5.6||5.4||5.3||5.3||5.1|
|Wages (nominal percent change)||3.7||2.9||2.5||2.1||2.0||2.1||2.5||2.6||2.8||2.9||3.0|
|Terms of trade index (goods, avg)||121||117||107||94||92||91||86||86||85||85||85|
|Iron ore prices (index)||101||107||77||44||46||55||45||39||39||39||39|
|Coal prices (index)||109||95||79||65||74||83||75||72||72||72||72|
|LNG prices (index)||102||97||95||61||43||48||48||48||48||48||48|
|Crude prices (Brent; index)||103||100||91||48||40||52||52||52||52||52||53|
|Consumer prices (avg)||1.7||2.5||2.5||1.5||1.3||2.0||2.4||2.5||2.5||2.5||2.5|
|GDP deflator (avg)||−0.2||1.3||0.2||−0.6||1.0||1.9||1.8||2.2||2.4||2.4||2.5|
|Reserve Bank of Australia cash rate (percent, avg)||3.7||2.7||2.5||2.1||1.7||1.7||2.0||2.3||2.6||2.9||2.9|
|10-year treasury bond yield (percent, avg)||3.5||3.7||3.7||2.7||2.1||2.0||2.5||2.8||3.1||3.4||3.5|
|Mortgage lending rate (percent, avg)||7.0||6.2||6.0||5.6||5.4||5.4||5.7||6.0||6.3||6.6||6.6|
|Credit to the private sector||5.4||−1.7||7.4||8.1||6.5||5.0||5.2||4.7||4.4||4.2||4.1|
|House price index||102||113||120||131||138||145||152||158||164||169||174|
|House price-to-income, capital cities||3.9||4.2||4.2||4.9||4.8||4.9||4.9||4.9||4.8||4.8||4.7|
|Interest payments (percent of disposable income)||9.8||8.8||8.8||8.6||7.8||8.5||9.1||9.6||10.0||10.1||10.2|
|Household savings (percent of disposable income)||8.0||8.3||8.1||6.4||6.1||6.2||5.9||5.6||5.4||5.2||5.0|
|Household debt (percent of disposable income) 1/||166||171||176||183||185||186||187||186||184||183.1||181.8|
|Non-financial corporate debt (percent of GDP)||49||48||49||51||52||51||52||52||52||52||52|
|GENERAL GOVERNMENT (percent of GDP) 2/|
|Cyclically adjusted balance||−3.1||−2.3||−2.3||−2.0||−2.0||−1.8||−1.0||−0.2||0.4||0.4||0.3|
|BALANCE OF PAYMENTS|
|Current account (percent of GDP)||−4.1||−3.2||−2.9||−4.8||−3.2||−3.5||−4.2||−4.1||−4.0||−4.0||−4.0|
|Net international investment position (percent of GDP)||−55||−54||−55||−59||−63||−63||−65||−65||−66||−67||−67|
|Gross official reserves (bn US$)||47||59||66||67||…||…||…||…||…||…||…|
|Nominal GDP (bn A$)||1,507||1,559||1,606||1,634||1,688||1,766||1,851||1,948||2,052||2,162||2,281|
|Real net national disposable income per capita (% change )||0.2||−1.0||−0.5||−2.4||1.0||−0.1||0.1||1.0||0.8||0.7||0.7|
|Nominal effective exchange rate||110||105||99||92||…||…||…||…||…||…||…|
|Real effective exchange rate||110||105||100||93||93||…||…||…||…||…||…|
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.
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.
|CONSOLIDATED GENERAL GOVERNMENT OPERATIONS 1/|
|Individual and withholding||13.0||13.4||14.2||14.6||14.7||14.6||14.9||15.1||15.1||15.1|
|Of which: GST||3.3||3.5||3.5||3.6||3.6||3.6||3.7||3.6||3.6||3.6|
|Other operating expenses (excl. depreciation)||9.4||9.4||9.7||10.1||10.3||10.0||9.9||9.7||9.7||9.7|
|Interest (excl. superannuation)||1.3||1.4||1.5||1.5||1.5||1.5||1.5||1.5||1.5||1.5|
|Net acquisition of nonfinancial assets||1.2||1.4||1.2||1.2||1.6||1.4||1.3||1.0||1.0||1.0|
|Of which: Gross fixed capital formation||3.0||2.9||2.9||3.0||3.7||3.5||3.1||2.9||2.9||2.9|
|Net lending (+)/borrowing (-)||−2.7||−2.9||−2.9||−2.6||−3.2||−2.1||−1.5||−0.3||0.0||0.0|
|CONSOLIDATED GENERAL GOVERNMENT BALANCE SHEET|
|States, territories and local governments||9||9||9||9||9||9||9||9||8||7|
|Net financial worth||−14||−16||−20||−28||−20||−19||−17||−15||−14||−13|
|States, territories and local governments||2||2||2||1||2||2||2||2||1||1|
|States, territories and local governments||68||67||70||68||68||68||68||67||65||62|
|Cyclically adjusted balance (in percent of potential GDP)||−2.3||−2.4||−2.3||−1.8||−2.4||−1.4||−0.9||0.2||0.3||0.3|
|Change in real revenue (percent)||4.4||1.6||1.0||1.9||1.6||3.1||3.1||4.2||3.2||2.8|
|Change in real primary expenditure (percent)||−2.0||4.2||1.1||0.4||2.8||0.0||2.8||1.8||2.3||2.8|
|Commonwealth general government 3/|
|Net lending (+)/borrowing (-)||−1.4||−2.3||−2.6||−2.3||−2.4||−1.3||−1.0||−0.4||−0.1||−0.1|
|States, territories and local governments 4/|
|Net lending (+)/borrowing (-)||−1.1||−0.3||0.0||0.0||−0.5||−0.5||−0.2||0.4||0.4||0.4|
|Commonwealth transfers to subnational governments||6.0||6.2||6.4||6.4||6.7||6.7||6.5||6.2||6.2||6.2|
|Of which: General revenue assistance||3.4||3.4||3.6||3.6||3.6||3.6||3.6||3.6||3.6||3.6|
|Nonfinancial public sector capital stock||96||97||98||99||99||98||97||95||93||0|
|GDP (in billion A$)||1,533||1,582||1,620||1,661||1,724||1,801||1,890||1,991||2,097||2,210|
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.
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.
|BALANCE OF PAYMENTS (% GDP)|
|Balance on goods and services||−1.4||−0.5||−0.5||−2.2||−1.3||−1.5||−2.3||−2 4||−2 4||−2 4||−2 3|
|Exports of goods and services||20.0||20.4||20.4||19.3||19.1||19.4||18.8||18.6||18.6||18.6||18.6|
|Exports of goods||16.5||16.9||16.6||15.3||14.9||15.0||14.4||14 4||14 4||14 4||14 4|
|Of which: Resources||10.3||10.8||10.6||8.8||8.5||8.6||8.2||8.2||8.4||8.4||8.5|
|Exports of services||3.4||3.5||3.7||4.0||4.3||4.4||4.3||4 2||4 2||4 2||4 1|
|Imports of goods and service||21.3||20.9||20.9||21.6||20.4||20.9||21.1||21.0||21.0||21.0||20.9|
|Imports of goods||17.1||16.4||16.5||16.9||15.8||16.1||16.3||16 2||16 2||16 3||16 2|
|Imports of services||4.3||4.5||4.4||4.7||4.6||4.8||4.8||4.8||4.8||4.8||4.7|
|Primary income, net||−2.6||−2.6||−2.3||−2.4||−1.8||−2.0||−1.8||−1 6||−1 5||−1 5||−1 6|
|Equity income||−0.9||−1.0||−0.6||−0.7||−0.2||−0.7||−0.6||−0 5||−0 5||−0 5||−0 6|
|Secondary income, net||−0.1||−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, net||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0 0||0 0||0 0||0 0|
|Financial account, net||4.7||3.7||2.9||4.4||3.5||3.6||4.2||4.1||4.0||4.1||4.0|
|Direct investment||3.3||3.6||2.8||3.1||3.0||3.0||2.8||2 7||2 5||2 4||2 3|
|Debt||1.4||2.3||0.6||2.3||1.5||1.8||1.6||1 6||1 5||1 5||1 4|
|Equity||−0.3||0.1||−0.8||1.1||−0.3||−0.3||−0.1||−0 4||−0 3||−0 3||−0 2|
|Financial derivatives||−0.5||−1.2||−0.2||−0.3||−0.8||−0.6||−0.7||−0 7||−0 7||−0 7||−0 7|
|Reserve assets||−0.2||−0.4||−0.3||0.2||0.1||0.0||0.0||0 0||0 0||0 0||0 0|
|Net errors and omissions||−0.5||−0.4||0.1||0.4||−0.3||0.0||0.0||0.0||0.0||0.0||0.0|
|Net international investment position||−55||−54||−55||−59||−63||−64||−65||−66||−66||−67||−68|
|External assets (gross)||98||111||123||131||133||131||132||132||132||132||132|
|External liabilities (gross)||153||166||177||190||195||195||197||198||198||199||200|
|Of which: foreign currency, hedged||30||37||40||52||43||43||43||43||43||43||43|
|Gross official reserves (bn A$)||47||59||66||67||…||…||…||…||…||…||…|
|In months of prospective imports||1.7||2.1||2.2||2.3||…||…||…||…||…||…||…|
|In percent of short-term external debt||9.5||10.3||10.3||10.0||…||…||…||…||…||…||…|
|Net official reserves (bn A$)||44||50||53||58||…||…||…||…||…||…||…|
|Iron ore prices (index)||101||107||77||44||45||41||35||30||28||27||25|
|Coal prices (index)||109||95||79||65||75||88||80||79||78||77||76|
|Oil prices (Brent crude; index)||102||97||95||61||43||48||48||48||48||48||48|
|BALANCE SHEET||In billions of A$|
|Currency and deposits||202||273||275||307||320||334||352||371||391||412|
|Securities other than shares||513||566||607||623||650||680||716||755||795||838|
|Claims on government||12||12||12||13||13||14||14||15||16||17|
|Claims on MFI||304||345||381||412||430||450||474||499||526||555|
|Claims on non-MFIs||1900||2040||2,205||2,356||2,466||2,595||2,718||2,837||2,956||3,076|
|Claims on non-residents||174||213||295||283||295||309||325||343||361||381|
|Shares and other equity||64||59||56||49||51||54||56||59||63||66|
|Capital and reserves||212||224||256||271||282||295||311||328||345||364|
|Borrowing from RBA||59||73||73||81||85||89||93||98||103||109|
|Liabilities to other MFIs||593||673||759||797||832||870||916||965||1016||1072|
|Deposits of non-banks||1,954||2,166||2,359||2488||2,595||2,714||2,858||3,011||3,171||3,346|
|In percent of GDP|
|Total assets (w/o residual)||214||232||246||250||250||250||250||250||250||250|
|Claims on MFI||20||21||23||24||24||24||24||24||24||24|
|Claims on non-MFIs||122||127||135||140||140||141||140||139||137||136|
|Credit non-bank private sector||−1.7||7.4||8.1||6.9||4.6||5.3||4.7||4.4||4.2||4.1|
|o/w investor housing||16.5||12.4||2.2||−2.1||5.2||4.7||4.1||3.5||3.3||3.0|
|Regulatory capital to risk-weighted assets||11.6||11.8||12.1||11.8||12.4||13.9||14.0|
|Regulatory Tier I capital to risk-weighted assets||9.7||10.3||10.8||10.4||10.7||11.9||12.0|
|Capital to assets||6.3||6.1||6.1||6.0||5.9||6.3||6.2|
|Large exposures to capital||69.6||68.1||73.7||72.2||76.0||49.8||47.4|
|Nonperforming loans net of loan-loss provisions to capital||19.3||18.2||16.3||13.2||9.8||7.8||8.4|
|Nonperforming loans to total gross loans||2.1||2.0||1.8||1.5||1.1||1.0||1.0|
|Sectoral distribution of loans to total loans|
|Other financial corporations||2.6||2.9||2.6||2.7||2.8||3.1||3.4|
|Other domestic sectors||68.9||67.6||67.8||67.7||66.6||64.3||65.2|
|Earnings and Profitability|
|Return on assets||1.1||1.2||1.1||1.2||1.2||1.2||…|
|Return on equity||17.7||19.7||17.7||20.1||20.8||18.6||…|
|Interest margin to gross income||59.1||68.3||68.0||67.3||66.9||67.0||…|
|Noninterest expenses as a percentage of gross income||54.7||48.7||49.8||47.4||47.9||48.4||…|
|Liquid assets to total assets||14.9||15.3||16.9||17.0||16.4||16.9||16.8|
|Liquid assets to short-term liabilities||38.9||39.2||42.8||42.0||40.2||39.7||40.6|
The sizeable bust in commodity prices and rapid decline in mining investment has been weathered well by the Australian economy. The decline in investment has been partly offset by rising resource exports, supporting value addition and employment linked to the resource sector in other industries. Household real incomes have been shielded from the commodity price bust as profits have absorbed much of the decline.
This annex examines some of the factors limiting the negative impact of a historic boom-bust cycle in mining investment and commodity prices on the economy. Over the boom period, mining investment rose from its average of around 2 percent of GDP to over 9 percent by 2013, net terms of trade doubled, and resource exports rose from 6 percent of GDP to 11 percent. Expansion of mining also increased demand for other industries, and the value added share of the broadly defined “resource sector” including directly extractive industries and support industries in aggregate nominal gross value added rose from 4¼ percent over 1990-2004 to 14¼ percent in 2011/12.1 The share of the resource sector in employment doubled from around 5 percent over 1990-2004 to just under 10 percent in 2011/12, mostly among support industries, while the employment share of the mining sector itself remained around 2 percent.
Four years into the bust, mining investment has declined sharply, but growing resource exports have dampened the negative impact of declining investment, and will continue to do so in the near term as new capacities ramp up and investment returns to more normal levels. Resource sector value added peaked at 15.5 percent of GDP in 2013/14, following the peak in mining investment. About half (8 percent of GDP) was value addition within the mining sector itself. The remainder was value addition in support sectors: 4 percent of GDP due to mining exports, and 3¼ percent of GDP due to investment (chart 1; table 1 lists the contribution of key support industries). Export-related value addition is expected to support a gradual decline in resource value added to around 11 percent of GDP by 2017/18.
Chart 1.Value Added Share of Resource Sector
Notes: Chart shows impact of final demand for mining exports and investment in the mining sector on gross value added in aggregated industry groups as a share of GDP. Export demand is projected to grow in 2017 and 2018 at 5% each year in 2013/14 prices. Investment is projected to decline to 1.8% of GDP by 2018, and nominal values are inferred from desk forecasts of GDP.
|Due to final|
Resource sector employment also peaked in 2013/14 at 10 percent of total employment (chart 2), of which only 2 percent was in direct mining activity and the rest was in support sectors. By 2015/16, resource employment declined only gradually, in line with the decline in resource sector value added. In addition, the investment decline has been cushioned by a strong housing sector, particularly for the construction sector which had a relatively higher exposure to mining investment.
Chart 2.Employment Share of Resource Sector
The impact of the decline in commodity prices on household incomes has been mitigated by declining profits. Australia had experienced a so called “income recession” in late-2015 (adjusting GDP for the terms of trade decline), but real producer wages have in fact risen sharply since the end of the boom despite weaker nominal wage growth (chart 3), indicating that the impact of lower output prices has not been transferred entirely to wages. Producer wages stayed relatively low during the boom, and the share of profits in income was rising, whereas it has steadily declined since the 2011 peak in commodity prices. Moreover, consumer wages rose faster than producer wages during the boom, due in part to exchange rate appreciation. Estimates of exchange rate pass-through to CPI prices in Australia suggest that a 10 percent appreciation is linked with a 1 percent decline in consumer prices, which would imply a sizeable impact given the large real appreciation. On the downswing, depreciation has not translated into retail inflation as expected, which may be attributed to both weaker import prices (as manufacturing shifts globally to cheaper locations) and more domestic retail sector competition.
Chart 3.Real Wages
Source: Staff estimates.
Australia’s net external liability position increased markedly over the past year. This annex documents that this increase largely reflected a set of atypical valuation effects and, for the ratio to GDP, exceptionally low nominal GDP growth that are atypical compared to usual patterns. The risk profile of Australia’s net external position, however, has remained broadly stable.
Net foreign liabilities amounted to 63 percent of GDP by the end of 2016Q3, about 7 percentage points higher than they were in mid-2015. This unusually steep increase occurred even though the current account deficit shrunk from around 5 percent of GDP to below 3 percent of GDP over the same period. Valuation effects—changes in the market value of external assets and liabilities—partly explain the contrasting behavior. Nominal GDP growth was exceptionally low because of sharply deteriorating terms of trade through the first half of 2016. Australia stands second to New Zealand among AAA-rated countries in relative size of net foreign liabilities to GDP.
Foreign Liabilities and Assets
Source: Haver Analytics.
Net International Investment Position
Source: Haver Analytics.
Valuation effects have mitigated the impact of persistent current account deficits on Australia’s net external liabilities. As of 2016Q3, the cumulated current account deficits since 1988Q3 (the period during which quarterly balance of payments statistics are available) amounted to about 72 percent of GDP. Offsetting this, valuation effects helped improve the net external liabilities by 10 percentage points of GDP over the same period. Analysis of the valuation effects following an approach reviewed by Gourinchas and Rey (2015) suggests that the return on external assets has been some half of a percentage point higher than that on external liabilities.1 Despite external liabilities being substantially larger than external assets, the rate of return on the net external assets has still been positive. But it has been smaller than the rate of growth. Australia’s debt-stabilizing current account deficit has thus been close to 4 percent of GDP.
Over the past year, negative valuation effects, especially losses on Australia’s equity assets, have resulted in a higher return on its net external liabilities. At the same time, the nominal GDP growth was exceptionally low because of the impact on the GDP deflator of the large terms-of-trade declines during the period. In the absence of valuation effects over the forecast horizon, the expected pickup in nominal GDP growth should result in a broadly stable net external liability position.
Net Foreign Liabilities
Source: Haver Analytics.
Note: Cumulated CA is calculated by adding cumulated CA balance to NIIP at the end of 1988Q2.
Net Equity and Net Debt
Source: Haver Analytics.
The structure of Australia’s net external liabilities has remained broadly stable in terms of currency and asset composition, but its sectoral composition has changed.
- Currency. As of mid-2016, 87 percent of liabilities were denominated in domestic currency, while 56 percent of assets are in foreign currencies. On net, Australia thus had a long foreign currency position equals to 49 percent of GDP. The implication is that depreciation of the Australian dollar against the currencies in which its external assets are invested in leads to improvements in the external balance sheet. In the aggregate, depreciation does not come with the adverse balance sheet effects it would have with a net short foreign-currency position. For individual firms or households, however, there could still be negative effects. But banks’ debt service obligations in foreign currency are fully hedged, while mining companies have natural hedges given commodity pricing standards.
- Maturity and Type. At the end of 2016Q3, 87 percent of net liabilities are in long-term debt instruments (exceeding 1 year in maturity) and 14 percent in short-term debt, the net long position in equity is broadly balanced. The share of short-term external debt liabilities has decreased in recent years, partly because of banks increasing the share of more stable, longerterm debt in their wholesale funding.
Composition by Currency
Sources: Haver Analytics; and RBA.
Composition by Maturity
Source: Haver Analytics.
- Sectors.2 With the mining investment boom, the mining sector’s net external liabilities have increased by some 20 percentage points of GDP. At about 40 percent, the sector accounts for the largest share of total net external liabilities. Banks now account for some 36 percent. With greater emphasis on stable funding sources, their net external liabilities as a share of GDP have decreased by about 3 percentage points of GDP since the global financial crisis. With the housing boom, the real estate sector has also posted an increase in its net external liabilities, increasing from 0.4 to 11.7 percent of GDP between 2006 and 2016.3 The other financial sector, which includes superannuation (the private second pension pillar), is the only private sector with a net foreign asset position. Its net position has increased by some 20 percentage points of GDP, reflecting the net accumulation of assets in the sector (contributions exceed withdrawals in the aggregate), some of which are invested abroad.
- Banks’ exposure by country. Banks heavily rely on the UK and the US for funding, with a combined share in net liabilities of 103 percent. Banks have net assets with China, New Zealand and France.
Net Foreign Liabilities
Source: Haver Analytics.
Banks’ Net Foreign Liabilities
Source: Haver Analytics.
- Australia’s labor markets were relatively little disrupted by the global financial crisis, and are adjusting smoothly to the sizeable commodity price bust and mining investment decline. Unemployment rose relatively little post-GFC compared to other advanced economies. After the commodity price bust, unemployment peaked at 6¼ percent in mid-2015 and has been declining since, and the unemployment gap is assessed to be small.
- However, some labor market indicators suggest persistent weakness. For instance, longterm unemployment remains elevated. Underemployment has also persisted above long run averages, and is a possible driver of weaker wage growth since the commodity price bust.
- In this context, the paper conducts a more detailed assessment of the labor market impact of the adverse shocks. It addresses the following key questions:
- Has the commodity price bust and mining investment decline led to a worsening in skills mismatch and other frictions?
- Have cyclical labor adjustment dynamics changed over time? What are the implications for assessment of labor market slack, and relatedly for wage growth?
- Has changing sectoral allocation of labor had an impact in the transition?
- What is the role played by migration in state level adjustment to shocks, particularly in the context of the commodity boom-bust cycle?
- Salient findings for policy analysis consideration are as follows:
- Beveridge curve analysis suggests that the increase in long-term unemployment does not indicate any significant worsening in structural unemployment since the commodity price bust.
- Average hours worked have adjusted more flexibly in downturns, with employment reductions smaller since the 2000s. However, rising part time employment and falling average hours worked are likely driving higher underemployment. A wage Phillips curve suggests that underemployment helps explain some of the recent weakness in wage growth.
- Aggregate labor productivity growth has on average remained stable in the 2000s, but more recently, the expansion of services employment has contributed to the weakness in labor productivity growth.
- At the state level, a VAR analysis suggests that changes in migration have played a key role in the supply side response to employment (demand) shocks, supporting a smooth adjustment particularly in the context of the mining boom-bust cycle.
|Foreign asset and liability position and trajectory||Background. Australia has a high negative net international investment position (NIIP) of -63 percent of GDP (as of mid-2016). The ratio has varied in a range between -40 and -60 percent of GDP since 1988. 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. With the current account deficit expected to rise to its long run average of around 4 percent of GDP over the medium term, the NIIP to GDP ratio would rise to around 68 percent of GDP.|
Assessment. The NIIP level and trajectory are sustainable. The structure of Australia’s external balance sheet reduces the vulnerability associated with its large negative NIIP. Since Australia’s NIIP 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 has a net foreign currency liability position but it is fully 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.
In 2016 the external position was assessed to be moderately weaker than the level consistent with medium term fundamentals and desirable policies. The widening of the current account deficit in 2015, notwithstanding substantial currency depreciation in 2014-15, was likely temporary, partly reflecting exceptionally large terms of trade declines in the context of commodity price declines and stronger-than-expected domestic demand growth in a weaker external environment. The Australian dollar has depreciated with the large deterioration in the terms of trade and supported expenditure switching, including by boosting services and non-resource exports. The depreciation in 2014-15 likely reduced the overvaluation of the Australian dollar, although the correction has stalled in recent months. Some remaining exchange rate overvaluation might be accounted for by the relative attractiveness of highly-rated Australian assets.
Potential policy responses:
If growth remains on the weak side, or commodity prices fall further driven by weaker global demand conditions, further monetary accommodation would be warranted.
The government’s planned gradual fiscal consolidation over the longer term should help improve the current account by boosting national savings.
|Current account||Background. Australia has run current account (CA) deficits for most of its history. Since the early 1980s, deficits have averaged around 4 percent of GDP. In 2015, the deficit widened by 1¾ percentage points to 4.8 percent, reflecting an unusually large decline in the terms of trade (iron ore prices fell by over 40 percent in 2015), stronger domestic demand in Australia, and relatively weaker external demand. The current account deficit is expected to narrow in 2016, partly reflecting the lagged effects of currency depreciation in 2014/15, which has boosted services and non-resource exports, and new resource export capacity coming on stream. Over the medium term, the deficit is expected to be around 4 percent of GDP, with a moderately larger trade deficit. However, with over half of Australia’s exports going to emerging Asia, a key risk is a sharper than expected slowdown in China which could result in a further sharp decline in commodities prices.|
Assessment. Australia’s persistent CA deficits reflect a structural saving-investment imbalance with very high private investment relative to a saving rate which is already high by advanced country standards. After accounting for Australia-specific factors driving investment, the staff assessment is that the cyclically-adjusted current account is some 0-2 percent of GDP below the level implied by medium-term fundamentals and desirable policy settings in 2015. This assessment is subject to uncertainty given that it depends on how non-oil commodity prices evolve. 1/
|Real exchange rate||Background. The real effective exchange rate (REER) depreciated 7 percent in 2015 relative to its 2014 average. As of June 2016, the REER depreciated by less than ½ percent compared to its 2015 averages. Compared to its thirty-year average, the REER is some 14 percent higher. Continued substantial capital inflows and favorable interest rate differentials may have contributed to the continued relative strength of the Australian dollar. Since mid-2015, the currency has been broadly stable in real effective terms.|
Assessment. Taking into account these factors including the attractiveness of highly rated Australian assets, staff assesses the REER to be 0 to15 percent above the level implied by medium-term fundamentals and desirable policy settings. 2/
|Capital and financial accounts: flows and policy measures||Background. 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 given its sound fiscal position relative to other advanced economies, and owing to relatively high interest rate differentials. Assessment. Credible commitment to a floating exchange rate and a strong fiscal position limit the vulnerabilities.|
|FX intervention and reserves level||Background. 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 with little or no counterparty risks, so reserve needs for prudential reasons are also limited.|
|Technical Background Notes||1/ The EBA CA regression approach for 2016 estimates a CA norm of -1.0 percent of GDP and a CA gap of -1.9 percent of GDP. Using estimated elasticities, the current account approach would be consistent with an exchange rate overvaluation of around 11 percent in 2016. However, the estimates of the CA norm may not capture Australia-specific factors such as the attractiveness of Australian assets to overseas investors. If such factors were considered, the current account norm might be for a deficit larger than 1 percent of GDP. The NFA stabilizing deficit is closer to 2½-3 percent of GDP. Our assessment is therefore that the current account gap is in the range of -2 to 0 percent of GDP.|
2/ The EBA REER regression approach, and the EBA REER level regression provide estimates of a gap encompassing a wide range from 5 to 15 percent in 2016.
|Source of risks||Likelihood||Time horizon||Impact||Policies to reduce impact|
|Stronger recovery momentum||M||Short term||M Business investment could recover faster amid favorable financing conditions and stronger terms of trade.||The Australian dollar would likely appreciate; monetary policy tightening if needed.|
|Slowing of economic recovery||M||Short to medium term||M Profits may remain under pressure for longer with external disinflation, while consumption growth could be weaker with continued low wage growth and a higher incidence of part-time work. Investment would remain weaker as a result, hurting medium-term growth prospects.||Monetary policy easing with minor slowing; combined monetary and fiscal policy easing if economy hits the zero lower bound.|
|Housing market downturn||L||Short to medium term||H A sharp housing market correction would lower residential investment and private consumption. A vicious 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.|
|Significant China slowdown||L/M||Short to medium term||H A hard landing in China would lead to lower growth and large commodity price declines would lead to a major downturn in Australia.||Combined monetary policy and fiscal policy easing as economy could reach the zero lower bound quickly; structural fiscal measures to facilitate adjustment in commodity sectors and regions, including active labor market policies|
|Structurally weak growth in major advanced and emerging economies||H/M||Medium term||M Lower growth in these economies would result in lower commodity prices and commodity consumption, thereby lead to a major downturn in Australia.||For temporary easing: monetary policy easing; combined monetary and fiscal policy easing if economy hits the zero lower bound. Structural reforms, including fiscal ones, to raise productivity.|
|Tighter and more volatile global financial conditions||M||Short term||M 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 how investor sentiment toward Australia changed.||Monetary policy easing; combined monetary and fiscal policy easing if economy hits the zero lower bound.|
|Economic fallout from political fragmentation||H||Short to medium term||M As an open economy depending on trade, Australia would be negatively affected if a rise in populism and nationalism in large economies would reverse trade liberalization, reduce global growth and commodity prices, and exacerbate financial market volatility.||Monetary policy easing; combined monetary and fiscal policy easing if economy hits the zero lower bound. Continued pursuit of open market policies.|
|Persistently lower energy prices||L||Medium term||L If fuel prices did not increase as expected, real incomes of consumers would be higher, but coal and LNG sectors would be hurt, as would the coal mining regions. The net effect on the economy would also depend on the global growth impact.||The exchange rate would likely act as a shock absorber and dampen the impact; monetary policy response if needed.|
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 2010.
Australia Public Sector Debt Sustainability Analysis (DSA) - Baseline Scenario
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 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.
Australia Public DSA - Composition of Public Debt and Alternative Scenarios
Source: IMF staff.
The Australian model of flexible inflation targeting has been a success, as evidenced by average inflation consistent with the target, and a substantial moderation in inflation and output volatility.
Belatedly, monetary policy in Australia has also faced some of the challenges that other central banks have faced after the global financial crisis, albeit not to the same extent.
- A slower-than-expected recovery, economic slack, and inflation declining below target in a difficult global economic environment.
- An increased probability of hitting the effective lower bound (ELB) on nominal policy rates, given declines in the real equilibrium interest rate (EIR) and some possibly large downside risks (e.g. China, European banks, geo-political uncertainty, etc.).
- Risk of more persistent deviations of inflation below target (“low inflation trap”) and prolonged slack.
Staff estimates of the real EIR in Australia suggest that it has declined from around two percent in mid-2008 to around 1 percent over the past two years. The policy rate has been below the equilibrium throughout most of the post-GFC recovery, indicating that monetary policy has been in a ‘loose’ stance.
In the current situation, the prudent policy strategy would be a “low for longer” monetary policy stance while preparing for coordinated monetary and fiscal policy easing if downside risks were to materialize.
- Around the current baseline outlook, a ‘prudent risk-management strategy’ would be to respond more strongly to negative inflation and output surprises than to positive ones.
- To lower risks of ‘dark corners’, an effective policy response would call for both expansionary monetary and fiscal policies in the event that large negative shocks were to materialize (e.g., lower global growth and commodity prices).
Enhancing policy transparency
- A more forecast-oriented communication policy which could include more explicit discussion of how the RBA intends to use its policy instruments over time to bring inflation back to target.
This paper reviews the Government of Australia’s approach to framing fiscal policy.
- Trying to meet its objectives of stabilization, long-term sustainability, and support of intergenerational equity. It aims for a medium-term balance anchor of 1 percent of GDP budget surplus, on average, over the economic cycle and to control debt accumulation.
- Amid long-term spending pressures from demographics – pensions, health care, aged care.
The analysis is based upon the use of the IMF’s model, G20MOD.
- Comprises the entire world, with a block specifically for Australia. It models households, firms, the government and the central bank, calibrated to match Australia’s macroeconomic and fiscal characteristics.
- The fiscal sector is fairly rich, with eight tax and spending instruments. Since government debt levels help determine global interest rates, long-term net foreign asset holdings and real exchange rates, fiscal policy plays a key role in both the short and long term.
Propose options for fiscal rules best suited to Australia to anchor fiscal policy.
- Based on IMF work on fiscal rules (IMF, 2009, “Fiscal Rules – Anchoring Expectations for Sustainable Public Finances,” IMF Staff Paper, December, 2009), with some of the methodology derived from the Canada 2014 Article IV paper (Kinda, 2014, “Anchoring Sustainable Fiscal Policy: A New Fiscal Rule in Canada,” in Canada: Selected Issues, IMF Country Report No. 15/23)
Short-term budget repair to achieve the medium-term balance anchor. The analysis shows that the Government should be cautious about the pace of budget repair.
- There is uncertainty on the required magnitude for budget repair.
- Relies on rebalancing away from the domestic to external sector, which may not be a desirable choice of fiscal authorities at this juncture.
- It can be very costly under the primary risk of the “new mediocre.”
Implement a long-term debt anchor to provide a stronger long-term fiscal framework.
- To achieve and maintain this, we propose an appropriate mix from three types of fiscal rules:
- An expenditure rule limiting spending growth from 2021-2030—quantifies existing government commitment to reduce the size of government and harks back to expenditure rules used in the past;
- Medium-term balance anchor (a flexible budget balance rule)—this is the target currently in force;
- Different configurations of debt rules – both strict and flexible, achieving a new debt target over either a 5- or 10-year horizon.
Compare strengths of the long-term debt anchor and the medium-term balance anchor.
- Both targets have to be met on average over the economic cycle (a degree of flexibility that is already present in the existing medium-term balance anchor) and communicated clearly through various vehicles such as the annual budget and the mid-year updates.
- A long-term debt anchor provides certainty about the level of the debt and its role in anchoring households’ and firms’ behavior.
- A long-term debt anchor provides greater stability for real GDP in both temporary and permanent shocks relative to a medium-term balance anchor.
The paper analyzes three different debt rules. It examines an example consolidation of 10 percent of debt under the benchmark scenario as well as a couple of possible alternatives - stronger aggregate demand and a boom-bust cycle driven by the terms of trade.
- A preferred mixed rule strategy combines an expenditure rule with the flexible debt rule aiming to reduce the debt over 10 years assessed against a number of stabilization and debt-control related indicators.
- The analysis also demonstrates that clear communications will ease the transition for the implementation of rule against the background of long-term spending pressures from demographics.