Australia: Staff Report for the 2003 Article IV Consultation

Australia's economy has continued to perform remarkably well, despite encountering major adverse shocks. Fiscal policy, with an objective of maintaining a balanced budget, will help support the economy. Maintaining a sound and stable macroeconomic environment is essential. Reforms of the personal income tax system are critical elements. A comprehensive reform of the complex system of income support payments would provide stronger incentives for labor force participation. Maintenance of competitive product markets will contribute to faster innovation and productivity and income growth. The financial system is sound.

Abstract

Australia's economy has continued to perform remarkably well, despite encountering major adverse shocks. Fiscal policy, with an objective of maintaining a balanced budget, will help support the economy. Maintaining a sound and stable macroeconomic environment is essential. Reforms of the personal income tax system are critical elements. A comprehensive reform of the complex system of income support payments would provide stronger incentives for labor force participation. Maintenance of competitive product markets will contribute to faster innovation and productivity and income growth. The financial system is sound.

I. Economic Developments and Outlook

A. Introduction

1. Australia’s economy has outperformed most other advanced countries in recent years, reflecting adherence to a credible macroeconomic policy framework and continued progress in implementing structural reforms. At the conclusion of the 2002 Article IV consultation on September 16, 2002, Executive Directors commended the authorities for the foundation that had been established by sound economic policies, including fiscal consolidation, the adoption of an inflation-targeting framework, and structural reforms. On fiscal policy, Directors considered that reforming the personal income tax system should be a major priority to enhance incentives to work, save, and invest. They also agreed that further reforms were needed to simplify the income support system and to enhance labor market flexibility. In general, there has been agreement between the authorities and the Fund on macroeconomic policies over the years. The authorities also have long recognized that continued progress in implementing structural reforms would be required to maintain and enhance Australia’s growth performance, which would help in addressing Australia’s longer-term challenges. In particular, they consider additional reforms of the industrial relations, income tax, and welfare systems to be among their top priorities, and they have actively pursued policy actions in all of these areas.

B. Recent Developments

2. Real GDP growth picked up from 2¾ percent in 2001 to just over 3½ percent in 2002, as buoyant domestic demand more than offset a weaker external environment and the onset of a severe drought.1 The strength of domestic demand reflected an easing of monetary policy in 2001 (which was only partially reversed in 2002), further moderate fiscal stimulus during 2001/02, an improvement in the terms of trade, and a competitive exchange rate. Growth in household demand was particularly strong, with private consumption growth picking up from around 3 percent in 2001 to 4 percent in 2002. Low interest rates and government incentives to first-time homeowners contributed to a 25 percent rise in residential construction. Rapidly increasing real property prices may also have contributed to strong demand in the investor segment of the housing market. Business investment rebounded in 2002, led by a 24 percent increase in nonresidential construction and a 10 percent rise in equipment purchases. In contrast, net exports declined sharply due to the divergent cyclical positions in Australia and other major economies, and the impact of the 2002 drought. As a result, the external current account deficit widened from 2.4 percent of GDP in 2001 to 4.4 percent in 2002. Employment growth picked up, bringing the unemployment rate down from 6.8 percent at end-2001 to 6.1 percent at end-2002.

uA01fig01

Contribution of Demand Components to Growth

(In percent)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

1/ Quarterly 12-month percent change

3. GDP growth slowed to 2.7 percent in the first quarter of 2003, as weak foreign demand, appreciation of the currency, and the drought placed a substantial drag on exports and consumption softened. Business investment continued to post strong gains, although it grew more slowly than in 2002. Subsequently, indicators of economic activity have been relatively mixed. Consumer confidence and retail sales, which dipped prior to the Iraq war, have recovered, and the unemployment rate, at 6.2 percent in July, remains close to its historical low; however, employment has declined in recent months. While lending to the housing sector has continued to expand at a rapid pace (21½ percent in June 2003 on a year-on-year basis), rental vacancy rates have risen, and rents and new construction approvals have fallen.

4. Inflation has remained in check. CPI inflation picked up to an annual rate of 3.4 percent in March 2003 reflecting a temporary run-up in petroleum prices and the drought-related food price increases, but it eased to 2¾ percent in June 2003, as oil prices subsided and the Australian dollar appreciated. Measures of core inflation have remained relatively stable within the Reserve Bank’s 2–3 percent official target range. Housing prices have continued to post strong gains, with the index of real property prices in major cities rising by 18½ percent in 2002 and some 46 percent over the past three years (Box 1).2

uA01fig02

REAL HOUSING PRICES

(l990–100)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Source: Data provided by the Australian authorities
uA01fig03

CONSUMER PRICES

(Four-quarter percent change)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Source: Data provided by the Australian authorities

5. The Australian dollar, which weakened during 2000–01, has strengthened markedly over the past year and a half. From its low of US¢ 50.7 in February 2002, the Australian dollar appreciated by 11¾ percent against the U.S. dollar and by 2½ percent on a real effective basis by end-2002. During the first half of 2003, it appreciated by an additional 17¾ percent against the U.S. dollar and by 9¾ percent on a real effective basis. During July, the Australian dollar moved off its recent high of US$ 68.4, settling at around US¢ 65 in August. Currently, the exchange rate is about 1¼ percent higher on a real effective basis than its ten-year average and 7¼ percent lower than its previous peak in December 1996. Given the strength of the Australian currency over the past year, the Reserve Bank of Australia (RBA) purchased U.S. dollars. Official reserves, net of swaps commitments, were $A 11.2 billion in June 2003, up from $A 8 billion in April 2002.

uA01fig04

BILATERAL EXCHANGE RATES

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

6. Monetary policy has been used effectively for countercyclical purposes. In response to slowing growth, the RBA cut the short-term cash rate six times during 2001 to a post-war low of 4¼ percent. Monetary conditions also eased as a result of the depreciating Australian dollar. As domestic demand recovered, the RBA raised the cash rate by a total of 50 basis points in May–June 2002 to 4¾ percent, where it has remained. As the Australian dollar has appreciated against the currencies of the major trading partners, monetary conditions have tightened somewhat further over the past year.

7. The May 2002 Budget was intended to withdraw some of the fiscal stimulus that had been injected in the previous two years.3 With the domestic and international economic environment expected to strengthen, the Commonwealth budget and the state and local government sector were projected to be in approximate balance in 2002/03. In the event, Australia’s participation in the war in Iraq resulted in some unanticipated defense and security expenditures, while growth was slightly weaker than had been expected. Nevertheless, revenues proved to be surprisingly robust, and the Commonwealth budget is estimated to have recorded an underlying cash surplus of ½ percent of GDP in 2002/03.

8. The May 2003 Budget contains a combination of tax cuts and modest expenditure increases which would leave the Commonwealth budget balance with small underlying cash surpluses in 2003/04 (0.3 percent of GDP) and over the medium term. On the spending side, the budget maintains a focus on upgrading defense and domestic security and addressing weaknesses in health care and higher education. In all, the expenditure measures in the budget are slated to cost $A 1.7 billion (0.2 percent of GDP) in 2003/04 and $A 4.3 billion over three years. On the revenue side, the new budget raises the thresholds for the three marginal personal income tax rates. These tax cuts and other smaller revenue measures are estimated to cost $A 2.5 billion (0.3 percent of GDP) in 2003/04 and $A 8.1 billion over three years.

C. The Outlook

9. Real GDP growth is expected to slow to 3.0 percent in 2003, reflecting less buoyant domestic demand, subdued global demand, and the ongoing effects of the drought. Private consumption growth and residential construction are expected to moderate from their very rapid pace in 2002. Rising vacancy rates and softness in rents, along with reduced fiscal incentives for first-time home owners should contribute to a cooling of price pressures in the housing markets, although to date there is little evidence of this occurring. Business investment would continue to rise, but at a slower rate, after a surge in mining sector construction in 2002 and as capacity pressures generally ease across the economy. Net exports would decline further, reflecting weak foreign demand, the effects of the drought, and the appreciation of the Australian dollar during the first half of the year. As a result, the current account deficit is projected to widen further to 5¼ percent of GDP in 2003. Softer demand and the strong exchange rate are expected to keep underlying inflation around the middle of the RBA’s 2–3 percent official target range.

10. The short-term outlook is subject to considerable uncertainty. The international environment poses significant risks. Although there are some signs that growth in the major industrial countries may be picking up, if external demand does not rise as expected and/or the Australian dollar appreciates further, the decline in net exports could be exacerbated and contribute to a scaling back of business investment. Near-term prospects could also be adversely affected by a continuation of the drought. Moreover, a rapid decline in housing prices could have significant adverse effects across the economy (Box 2).4 Booms in housing prices in Australia have historically been followed by periods of relatively stable nominal prices, instead of declining ones.5 However, a key difference in the current price run-up is the important role played by investor demand for housing, and it is not known whether investor behavior in a softening housing market could contribute to a sharp fall in housing prices.

11. Medium-term prospects remain favorable. The existence of transparent monetary and fiscal policy frameworks, the absence of fiscal imbalances, and the government’s commitment to carry forward the program of structural reforms should enable Australia to sustain growth in line with the economy’s currently estimated potential of around 3¾ percent per year over the medium term. This would be consistent with a further modest reduction in the unemployment rate to about 5½ percent. A post-drought recovery in agricultural production would boost exports and reduce the current account deficit to around 4 percent of GDP over the medium term.

II. Policy Discussions

12. The authorities and the staff generally agreed on the appropriate settings for macroeconomic policies in the short-to-medium term and on the key elements in the authorities’ strategy to deal with Australia’s longer-term policy challenges. The discussions centered on: (i) the uncertainties surrounding the economic outlook and implications for the near-term stance of monetary and fiscal policy; (ii) longer-term pressures on the economy and the budget arising from the aging of the populations; and (iii) implementation of the authorities’ strategy to deal with these longer-term pressures and the fiscal resources that are likely to be required to finance it.

A. Monetary Policy and the Exchange Rate

13. The Reserve Bank of Australia has kept monetary policy on hold since June 2002. Initially, despite strong domestic demand growth, concerns about the weak international economic environment and the drought influenced the RBA’s decision. In early 2003, the situation changed as signs of slowing domestic demand emerged and monetary conditions tightened with the sharp appreciation of the Australian dollar. In June 2003, the RBA indicated publicly that it was considering lowering interest rates. The Bank, however, remained concerned about continued strong housing demand and rapid growth in housing prices and the effects a cut in interest rates might have on this market. The authorities and the staff agreed that, while the timing of a decision to lower interest rates was uncertain and complicated by the situation in the housing market, the Bank should move to ease monetary policy if indicators pointed to a marked deterioration in economic prospects. Subsequent to the mission, the RBA left policy unchanged at its regular reviews of the short-term cash rate in July and August as momentum in the economy held up, housing demand remained strong, and the exchange rate eased off of its late June high. In the August 2003 Monetary Policy Statement, the RBA indicated that, while the situation is still subject to considerable uncertainty, the external risks to the economy have receded, at least for the time being, with global prospects looking slightly better and the exchange rate no longer rising as quickly as it had in the first half of the year. At the same time, the risks posed by developments in credit and asset markets have not diminished. Given these considerations, and the current assessment of the economic outlook, the case for an easing was judged to have weakened since June 2003.

14. In general, the authorities and the staff agreed that the sharp increase in housing prices in recent years appears to have been largely driven by fundamental factors. A significant decline in long-term interest rates, robust employment and immigration, and increased availability of financing were all important contributing factors. The sharp rise in household mortgage debt resulting from the housing boom was not seen by the authorities as potentially posing significant balance sheet risks for the financial sector. The authorities, nonetheless, were generally concerned about the unsustainable rate at which housing prices were rising and were particularly concerned by the behavior of individuals purchasing housing for investment purposes. Further changes in fundamental determinants were not seen as supporting continued rapid increase in housing prices. The rapid rise in housing prices, coupled with low returns on alternative investments and the fact that housing in the past has tended to hold its value in market slumps, prompted a sharp rise in investor demand. Moreover, investor housing demand in the major cities has remained very strong, despite declining rents and rising vacancy rates. Since investors had not previously played as large a role in the housing market, the authorities were unsure how investors would behave if the rise in housing prices slowed appreciably or prices began to decline. Clearly, however, increased selling in a slowing housing market could precipitate and perpetuate a fall in prices. Hence, the authorities expressed some reluctance to reduce rates at this time to avoid fueling additional housing demand and a further substantial run-up in prices, which could simply set the stage for a sharp correction in housing prices and in economic activity in the future. As events have unfolded, the RBA’s caution in reducing interest rate appears to have been justified.

15. The appreciation of the Australian dollar over the past year appears to have been primarily linked to portfolio capital flows attracted by the relative strength of the Australian economy, interest rate differentials that favor investment in Australian dollar securities, and recent upgrades of Australia’s credit ratings. In part, the widening interest rate differential reflected the fact that, while monetary policy in Australia has been on hold, policies in other major economies have been eased. The authorities noted that the level of the real effective exchange rate in mid-2003 was basically in line with its ten-year average.6 The sharp rise in the currency’s value was one factor contributing to a growing external current account deficit. This was not expected to be a major problem if the exchange rate stabilized. However, if it appreciated substantially further, the near-term outlook for the economy could be materially worse. In the discussions, both the authorities and private sector representatives pointed out that the historically close relationship between the terms of trade and the real effective exchange value of the Australian dollar appears to have broken down in recent years. This was seen as suggesting that the Australian economy had become more balanced and might be less subject to cyclical shocks from the rest of the world via commodity prices than it had been in the past.

B. Financial Issues

16. Australia’s banking system remains financially very healthy, with high levels of profitability and capital adequacy. The authorities did not envisage any systemic risks in the sector, even though bank exposure to the housing sector had increased significantly in recent years. Mortgage debt was still viewed favorably by the banks, since the delinquency rate on mortgage loans remains very low (below 1 percent), and such debt represents about one-third of bank assets. Given the relative importance of mortgage debt, the Australian Prudential Regulation Authority (APRA) is conducting stress tests to ascertain how individual banks could weather a sharp decline in housing prices. Preliminary results of these tests suggest that, while a fall in housing prices could significantly affect the net income of individual institutions, bank capital was viewed as sufficiently robust and that this would not pose a serious risk of failure by any major institution. APRA representatives also indicated that close supervision of the banks’ lending standards would have to be maintained.

17. The nonbank segments of the financial sector also are generally sound, although some individual firms have faced difficulties; however, in light of recent developments, supervision is being strengthened. APRA has already taken steps to improve supervision of the insurance industry and to strengthen its risk management practices, capital adequacy, and corporate governance, and it will implement other key recommendations of the Royal Commission investigating the failure of the insurance company HIH. In the superannuation industry, the Treasury and APRA are working on draft legislation that will further enhance the safety of the industry, based on the key recommendations of the Superannuation Working Group.7 In particular, licensing would be required to ensure that all superannuation trustees have the capacity, competency, and means to look after the interests of superannuation fund members.8 Trustees will also be required to provide to APRA a Risk Management Strategy as part of the trustee’s application. In addition, a proposed standard will deal with the fitness and propriety of trustees.

18. Australia’s vulnerability to adverse external shocks is considered to be low (Annex I).9 Although net foreign liabilities remain high, their level has broadly stabilized. Foreign debt has become more concentrated in private financial corporations, and its maturity has shortened, reflecting increased intermediation of flows by banks. The foreign currency component of external debt has risen, although the associated currency risk is mitigated through substantial hedging. Corporate and banking sector balance sheets remain strong, and they have proven in the recent past to be resilient to swings in exchange and interest rates. Household balance sheets also are reasonably sound, and they, too, have been resilient to past interest rate swings. Housing debt, which has risen rapidly in the last few years, is the sector’s major liability and the largest single component of bank lending. Although the value of housing assets has increased more rapidly than housing debt due to the run-up in prices in recent few years, household balance sheets would weaken in the event of a major price reversal (especially in the investor housing segment of the market). This, alone, is unlikely to threaten bank solvency, given the banks’ income positions and high capitalization, unless it was also accompanied by significant increases in both interest rates and unemployment.

19. Australia is in full compliance with the recommendations of the FATF on money laundering, following the passage of the Suppression of the Financing of Terrorism Act 2002. Australia has also ratified and implemented the OECD Convention on Combating the Bribery of foreign officials in international transactions.

C. Fiscal Policy

20. The stance of fiscal policy as laid out in the May 2003 Budget remains fundamentally sound. It is consistent with the authorities’ primary goal of balancing the budget on average over the course of the business cycle.10 Pursuit of this objective provides the authorities with flexibility to deal with a possible deterioration in economic prospects by allowing the automatic fiscal stabilizers to function. Moreover, Australia’s very sound budgetary position affords the scope to take discretionary fiscal policy actions if need be, and the policy framework—as embodied in the Charter of Budget Honesty Act—would help to ensure that such a discretionary response would be appropriate in size and duration. The authorities noted that the Australian public was wary of budget deficits, now that budget surpluses were viewed as the norm, and that they would be reluctant to take discretionary actions except in very special circumstances. If discretionary measures were taken, they would favor “high quality” ones, measures that would make a more lasting contribution to raising output rather than providing just a temporary boost to demand.

21. Owing to the strength of the economy and buoyancy of revenues at the time that the May 2003 Budget was prepared, potential fiscal surpluses going forward were envisaged to be greater than required to meet the government’s fiscal objective. Accordingly, the Budget allocated part of these fiscal resources to meet high priorities in the areas of defense and health care. Part also were directed at the government’s objective of raising the growth performance of the economy further over time by improving human capital through an increase in funds allocated to education and by enhancing incentives to work, save, and invest through cuts in personal income taxes by raising the income thresholds at which marginal tax rates apply.

22. Over the medium to long term, Australia—like most of the advanced economies—faces significant fiscal pressures and major challenges in trying to maintain a satisfactory pace of economic growth, owing in part to the aging of the population. The InterGenerational Report published as part of the May 2002 Budget sought to identify the sources and potential magnitude of fiscal pressures 11 Statement 4 in the May 2003 Budget lays out a strategy to try to compensate for the negative effects of an aging population on economic growth and to help close prospective long-term fiscal gaps through measures to raise labor force participation and sustain strong productivity growth (Box 3). The strategy involves the continuation of sound and stable macroeconomic policies, further improvements in labor market flexibility, the maintenance of competitive product markets, more investment in education and training, personal income tax reductions to provide greater returns to working and to maintain an internationally competitive personal income tax system, and reforms in the income support system to remove impediments and encourage recipients of income assistance to take up work. The staff commended the authorities for this well-conceived and comprehensive strategy.

23. Health care already is exerting substantial pressure on government spending and this pressure will intensify over time. In assessing the situation, the authorities indicated that they thought that the basic structure of the health care system with its public and private elements was appropriate, and they were focused on dealing with sources of cost pressures. Adjustments to the Pharmaceutical Benefits Scheme (PBS) proposed in the May 2002 Budget would be useful steps in controlling costs and encouraging more efficient use of resources in an area of health spending which was growing very rapidly. Although, this proposal has run into strong opposition and has not yet passed the upper house of Parliament, the authorities indicated that they would continue to press strongly for its passage. At the same time, steps have been taken to tighten up on the types of ancillary services offered as part of health insurance policies that qualify for the health insurance premium rebate. Improvements were also made in the delivery of health care services by the public sector. As a key first step, the government was requiring significant improvements in the reporting on the performance of the public hospitals in the context of a new funding agreement with the states. In addition, consideration was being given to a range of other measures to make compensation to doctors more equitable, to provide incentives for preventative care, and provide an ample supply of doctors in areas facing shortages.

24. To meet its health care obligations and to implement its longer-term strategy to raise labor force participation and maintain strong productivity growth, the government will need significant fiscal resources. In turn, the size and availability of these resources will be an important factor in dictating the design and timing of policy actions to implement the strategy. Over the past few years (including the May 2003 Budget), the authorities have used potential fiscal resources going forward that were expected to be greater than those required to meet the basic fiscal objective of a balanced budget over the cycle to fund a number of relatively small tax and spending initiatives. Use of these resources for some of these tax and spending initiatives has precluded the possibility of building-up a larger stock of fiscal resources that could be used to finance more comprehensive reforms in line with the government’s longer-term strategy. To obtain sufficient resources to fund this strategy, discipline over spending will have to be maintained, efforts will need to be made to pare expenditures and to limit tax reductions in lesser priority areas, and the government may have to run larger budget surpluses for longer periods of time (rather than quickly using potential surpluses in excess of those needed to meet the primary fiscal objective to satisfy more immediate needs). The next step in the reform process is to identify the specific policy measures to be taken in all of the key areas identified in the government’s strategy.

D. Structural Policies

25. Far-reaching structural reforms over roughly the past decade and a half have significantly improved Australia’s resilience to shocks and have contributed to the economy’s solid growth and productivity performance. Nevertheless, the authorities as part of their longer-term economic policy strategy recognize that there remains a number of areas—including the personal income tax system, the income support system, and the industrial relations system—where reforms need to be pushed further to strengthen incentives to work, save, and invest. Additional support and reforms are also needed in the education system, and the competitiveness of product markets needs to be expanded both domestically and internationally. The next step in the reform process is to identify the specific policy measures to be taken in all of the key areas identified in the government strategy.

26. The authorities stressed that additional changes in the personal income tax system are needed to strengthen incentives to work and to maintain an internationally competitive tax system. In particular, the top marginal income tax rates are applied at relatively low income levels. Measures introduced in the May 2003 Budget modestly raised the income thresholds at which marginal tax rates apply, and the authorities noted that they were prepared to take further measures to cut personal income taxes, if the fiscal position allows.12 The staff suggested that additional increases in income thresholds be implemented and that it would be useful in time to bring down the top marginal tax rates to enhance incentives to work and to acquire skills and to reduce distortions created by opportunities for high-income individuals to exploit the difference between personal and corporate income tax rates. The authorities pointed out that reductions in personal income taxes also might be necessary to ensure that Australia has an internationally competitive tax system so as to retain its best and brightest workers.

27. The government is seeking to simplify the income support system in order to provide stronger incentives for participation in the labor force and to better tailor assistance to individual needs.13 The authorities recognize that the income support system has evolved over time in an ad hoc fashion. The result is a system that is complex, costly, and structured in ways that may discourage movement from income support to work. The government has just concluded a public consultation process on overhauling the system based on the December 2002 discussion paper, Building a Simpler System to Help Jobless Families and Individuals, and recommendations on the next steps in the process are expected by the end of 2003. In formulating reform proposals, the staff stressed the importance of finding means of significantly reducing the high effective marginal tax rates that income recipients tend to face when they move from welfare to work. It also stressed the importance of tightening eligibility for income support programs, like the May 2002 Budget’s proposals to tighten eligibility for the Disability Support Pension, and uniformly applying to all recipients of unemployment benefits strong activity tests and penalties for breach of obligations. At the same time, more could be done to provide support services for income support recipients (including employment, job training, and child care services) and that longer phase outs (tapers) could be applied to the withdrawal of some income support benefits, like assistance with health care expenses, to strengthen incentives to enter the labor force. The authorities indicated that all of these possibilities would be explored in putting together a comprehensive reform plan.

28. While the authorities have taken significant steps over the past several years to address labor market rigidities, further reforms are needed to improve the market’s flexibility and to promote greater labor force participation. In particular, the wage bargaining system should be simplified by reducing the overlap of the federal and state awards systems, and the role of the award system in setting minimum wages should be diminished in order to reduce barriers to employment for low-skilled workers. The government favors a faster pace of labor market reform. While it has secured passage of some new industrial relations legislation, much of the reform agenda has encountered substantial political resistance, with a number of proposals still pending before Parliament.14

29. The government is implementing reforms in education as part of its longer-term strategy to enhance economic performance. The May 2003 Budget included a $A 1½ billion increase in support to universities over four years, steps to allow the universities greater flexibility in setting fees, and additional financial support to students. The government also is seeking significant improvements in governance and workplace relations within the sector, as well as improvements in courses and curricula to make university training more responsive to the economy’s needs for skilled workers.

30. The authorities have taken a pragmatic, multi-tracked approach to trade liberalization aimed at strengthening the competitiveness and efficiency of domestic industries, while improving market access opportunities for Australian exporters.15 Agriculture is Australia’s highest priority in the Doha Round, and the authorities stressed the importance of achieving progress in this area for the success of the round. The authorities have concurrently pursued bilateral negotiations, where possible, to achieve faster market openings. Australia signed a free-trade agreement with Singapore in February 2003, which eliminates tariffs on all goods and significantly liberalizes trade in services through the use of a short negative list. Negotiations on free-trade agreements with Thailand and the United States and preliminary research on an economic and trade agreement with Japan are under way. The authorities are also continuing to implement structural adjustment programs in the passenger motor vehicles (PMV) and the textiles, clothing, and footwear (TCF) sectors, which remain the more heavily protected sectors in Australia’s economy. Tariffs in the PMV sector will be reduced through 2010, with government assistance declining progressively over this period. Tariffs in the TCF sector will be reduced through 2005, with post-2005 tariff arrangements to be considered shortly. In addition, to foster economic development in the poorest countries, Australia unilaterally granted tariff- and quota-free access on all products to the least developed countries effective July 2003.

III. Staff Appraisal

31. Australia’s economy has continued to perform remarkably well over the past year, despite encountering major adverse shocks, including persistent weakness in the global economic environment and a sustained, severe drought at home. Australia’s ability to generate strong growth outcomes in an increasingly inhospitable environment is testimony to the economy’s enhanced resilience stemming from the implementation of stable macroeconomic policies within transparent frameworks and the continued implementation of structural reforms.

32. As regards monetary policy, the significant appreciation of the Australian dollar over the past year has tightened monetary conditions and bolstered expectations that underlying inflation will decline in the period ahead. Consistent with its policy framework, the Reserve Bank of Australia has indicated that it would consider lowering interest rates. The RBA remains concerned, however, that lower rates might fuel a further, sharp rise in housing prices. While such considerations could complicate a decision on the precise timing of a cut in interest rates, the Bank would be expected to ease monetary policy should there be clear indications of a deterioration in economic prospects.

33. In such circumstances, fiscal policy, with its objective of maintaining a balanced budget over the cycle, would allow the automatic stabilizers to work to support the economy. If need be, Australia’s sound fiscal position would provide scope for discretionary policy action, and the policy framework would help to ensure that such a discretionary response would be appropriate in size and duration. However, the staff supports the authorities’ cautious view that such discretionary actions should be taken only in exceptional circumstances and that measures enacted should attempt to make a more lasting contribution to raising output rather than providing just a temporary boost to demand.

34. Notwithstanding the impressive economic performance of the past decade, the authorities are fully aware that over the medium to longer term they are likely to face significant fiscal pressures and daunting challenges in trying to maintain a satisfactory pace of economic growth, owing in part to the aging of the population. The staff supports the well-conceived, comprehensive strategy to raise labor force participation and sustain strong productivity growth that the authorities have adopted to deal with this situation. The strategy includes the continuation of sound and stable macroeconomic policies, further improvements in labor market flexibility, the maintenance of competitive product markets, more investment in education and training, personal income tax reductions to provide greater returns to working and to maintain an internationally competitive tax system, and reforms in the income support system to remove impediments and encourage recipients of income support to take up work.

35. Maintaining a sound and stable macroeconomic environment is essential. Doing so will help to ensure that relative prices provide clear information about where scarce resources can be put to their most productive uses and that the fruits of today’s labors can be safely saved and invested for future consumption. The fiscal and monetary policy frameworks currently in place should provide this environment if they continue to be prudently implemented.

36. Further reforms of the personal income tax system also are critical elements of the government’s strategy. Additional reductions in income taxes would improve incentives. In particular, the income thresholds at which different marginal tax rates apply should be raised further. Moreover, it would be useful over time to bring down the top marginal tax rates and to reduce a distortion in the tax system created by arbitrage opportunities for high-income individuals between the top marginal rate and the corporate tax rate. Reductions in personal income taxes may be needed as well to maintain an internationally competitive system.

37. A comprehensive reform of the complex system of income support payments would provide stronger incentives for labor force participation. The interplay of the current income support system and the personal income tax system creates high effective marginal tax rates when individuals move from welfare to work; finding means of significantly reducing these rates is an important consideration in formulating reform proposals. The transition to work also would be facilitated by continuing efforts to improve employment and job training services and the provision of other supporting services, such as child care and a tapered (phased) reduction in health care assistance. Tightening eligibility for some income support programs and maintaining strong activity tests and penalties for breach of obligations for unemployment benefits and applying them uniformly to all recipients would provide stronger incentives to return to employment.

38. The government continues to push for changes in the industrial relations system that will increase labor market flexibility. The staff believes that further simplification of the award and wage bargaining system is needed to bring the unemployment rate over time significantly below 6 percent and to raise the economy’s potential output on a sustainable basis. Simplification of the awards system is needed to reduce the overlap of federal and state awards and the multiplicity of awards in the same workplace. In addition, the role of the award system in setting minimum wages should be diminished in order to reduce what could be a significant barrier to the entry of low-skilled individuals into employment.

39. Investment in education and training also is important in raising productivity and participation levels throughout the economy. In turn, the demand for education and training can be enhanced by improving the return on individuals’ investment in acquiring skills through changes in the personal income tax system.

40. Implementation of the government’s strategy to raise labor force participation and sustain strong productivity growth could entail significant initial fiscal costs. The availability of fiscal resources will be an important factor in determining both the design and pace of policy actions. The process of raising public awareness of the long-term challenges facing Australia and building political consensus to address them started with the InterGenerational Report and was extended by Budget Statement 4. In the period ahead, efforts will need to be directed at exploring specific options for reforms to implement the government’s strategy, their fiscal costs, tradeoffs in establishing priorities for reforms, and how resources might be raised to finance them such that the burden is equitably shared across generations. To obtain needed fiscal resources, expenditure discipline has to be maintained and budget priorities set strictly in line with the government’s strategy. It is also likely to entail the government running larger budget surpluses to build up a sufficient stock of fiscal resources to finance comprehensive reforms, particularly in the areas of the personal income tax and the income support systems.

41. Maintenance of competitive product markets will contribute to faster innovation and productivity and income growth. Accordingly, given the relatively small size of Australia’s domestic market, the authorities have long recognized the importance of an open international trade regime in promoting a competitive economy. The staff fully supports their approach to trade liberalization based on strict adherence to a rules-based multilateral framework and their efforts to improve market access through the Doha Round. The staff recognizes the importance of achieving a significant reduction in agricultural trade barriers in these negotiations. Australia’s pursuit of bilateral free trade agreements are seen as being consistent and supportive of the country’s multilateral efforts. These agreements may provide helpful opportunities to promote trade liberalization. In order to minimize trade diversion, however, partners in these agreements should avoid raising barriers to other countries and at the same time ensure comprehensive product coverage. In addition, the staff commends the authorities for the recent unilateral decision to provide least developed countries with complete duty- and quota-free access to the Australian market.

42. The financial system is generally sound. The staff welcomes the steps already taken, as well as measures that are under consideration, to strengthen the supervision of the system. The banking system as a whole has a high level of profitability and capital adequacy, making it highly resilient to shocks. While the system’s large exposure to the housing market has prompted some concerns, the preliminary results of APRA’s comprehensive stress test exercise suggest that the banks could manage a sharp decline in housing prices without endangering the safety of system, although bank profitability and capital would be adversely affected. Nevertheless, the staff agrees with the authorities that close supervision of the banks’ lending standards and systems will need to be maintained. Steps that APRA has already taken, along with implementation of the key HIH Royal Commission recommendations, should strengthen supervision and risk management practices, capital adequacy, and corporate governance in the insurance industry. In addition, efforts to improve corporate governance in the management of superannuation funds are welcomed.

43. It is proposed that the next Article IV consultation with Australia take place on the standard 12-month cycle.

Australia: Developments in the Property Market

Property price inflation has accelerated during the last few years, propelled by low mortgage rates, poor returns from alternative investments, strong employment and immigration, and tax incentives. Low interest rates and the First Home Owners grant reduced the cost of housing for owner-occupiers. Investor demand has also driven housing prices, particularly in the central business districts of the major cities, as increased expected returns on housing far outstripped returns on other assets. Consequently, by the end of 2002, investor housing accounted for 30 percent of the stock of housing loans, compared to 18 percent a decade ago.

Table 1.

Property Price Inflation

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Source: Australian Bureau of Statistics

The recent run-up in housing prices is largely explained by economic fundamentals. While housing prices have increased rapidly during the last 5 years, they have not deviated significantly from their long term trend (Figure 1). Furthermore, the estimation results of an econometric model show that movements in real Australian housing prices over the last two decades are well explained by movements in real mortgage interest rates, real disposable income, real returns on equities, and population growth (Figure 2). In particular, the real mortgage rate decline of 4½ percentage points during the last five years alone accounted for about 30 percent of the increase in real property prices during the period.

Figure 1.
Figure 1.

Median Price of New and Established Houses (in log)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Figure 2.
Figure 2.

Median Price for New and Established Houses Deflated by the CPI (in log)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

The recent rapid rate of housing price increases does not, however, seem sustainable. The fact that property prices are well explained by economic fundamentals suggests that there may be no speculative bubble in the overall market at present. Nevertheless, the absence of a bubble does not imply that the current rapid rise in housing prices will continue. Further changes in fundamentals would not appear to support additional sharp increases in prices. In particular, mortgage rates are not expected to decline significantly. Moreover, in the investment segment of the market, the sharp rise in housing prices over the past 5 years and more recent indications of declining rents have led to a large increase in the price/earning ratio for new and established houses—computed as the ratio of the median price for new and established houses to the yearly rent for similar type of housing—although some of the increase reflects declining mortgage interest rates (Figure 3).1 Signs of over-supply of rental housing are beginning to emerge. For example, in Sydney, the vacancy rate increased from 1.2 percent in mid-1999 to 4.4 percent in the fourth quarter of 2002.

Figure 3.
Figure 3.

P/E for New and established Houses

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Source: Australian Bureau of Statistics, Real Estate Institute of Australia, and staff calculations.1 For an explanation for why the ratio of housing price to the yearly rent can be interpreted as the “P/E” ratio for real estate assets, see Edward Leamer, June 2002, “Bubble Trouble? Your Home Has a P/E Ratio Too”, UCLA Anderson Forecast.

Australia: Housing, Consumption, and Output

In recent years, housing investment has made an important contribution to swings in economic activity in Australia. Strong GDP growth in 1999 reflected a surge in housing investment in advance of the introduction of the goods and services tax; GDP slowed sharply in 2000 as this investment plunged after the tax was imposed (first figure). However, after the government introduced the First Home Owners Scheme, the resulting boost to housing investment contributed to a pick up in GDP growth in Australia and to maintaining growth at a high level since 2000, even as economic activity in other advanced economies softened.

uA01bx02fig01

GDP and Housing Investment

(Constant prices in percent SAAR)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Housing activity also has had a strong influence on consumption. Directly, the rise in housing investment has affected consumption of housing-related durable goods and services (see figure). The consumption of these goods and services is highly correlated with housing investment, and they have made a significant contribution to the growth in consumption since 2000.

uA01bx02fig02

Consumption and Housing Related Durable Goods and Services

Constant prices in percent SAAR)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Housing also has influenced consumption indirectly through the effects of the rise in housing prices on net wealth of households. According to this “traditional” wealth effect, an increase in permanent wealth will induce households to consume more (save less) out of current income. Various studies of consumption and saving in Australia suggest that consumption expenditures rise (saving falls) by 3 to 5 cents for every dollar increase in net housing wealth. Over the period since 2000, housing wealth has risen by approximately $A 670 billion, suggesting that consumption could have been increased by as much as $A 33 billion, if households considered this rise in wealth to be permanent.

Beyond the traditional wealth effect, housing has played a role in stimulating consumption owing to innovations in credit markets which have allowed homeowners to more easily and less expensively borrow against the equity in their houses. The impact of this improvement in household access to credit may have had a more significant influence on consumption than the traditional wealth effect. During the period 2001 to March 2003, net housing equity withdrawals are estimated to have been around $A 165 billion. The proportion of these funds used to finance consumption or for other purposes is not known, but it is likely that a substantial part was used for consumption.

The rapid increase in housing prices in recent years has raised concerns about a bubble developing and the potential consequences for economic activity if a sharp correction in prices were to occur. In the event, housing investment would be expected to fall, and along with it, consumption of housing-related consumer durables and services. Traditional wealth effects would reduce consumption further. However, although net equity withdrawals (and the consumption they would have financed) would decline, households would not be expected to make substantial repayments of previous housing equity withdrawn which would lead to a further fall in consumption.

1 A more detailed analysis of wealth effects associated with housing is provided in the forthcoming Selected Issues paper.2 According to an ABS survey, about 20 percent of borrowers used excess funds from home refinancing during 1997–99 to finance consumption, particularly purchases of cars.

Australia: May 2003 Budget–Statement 4

Budget Statement 4, Sustaining Growth in Australia’s Living Standards, lays out a strategy to compensate for the negative longer-term effects of an aging population and increasing health and aged care costs. The strategy focuses on the interaction between population, labor force participation, and productivity. Various scenarios presented in the 2002 Intergenerational Report (IGR) showed population aging would slow growth in real GDP per person to about 1½ percent per annum by the next decade, if recent trend toward lower labor force participation continued and productivity growth fell back to the average of the last 30 years (about 1¾ percent). Not only would the economy grow more slowly than currently, public expenditures, primarily because of age-related spending, would raise sharply, opening up a budget gap that would reach about 5 percent of GDP in 2041–42 if government services are maintained at current levels.

To address this fiscal gap, one alternative that the government is considering is to increase GDP growth above the rate projected in the IGR. Drawing lessons from other countries’ experiences and building on the policy reforms of the past years, the government suggests that stronger GDP growth could be attained by sustained efforts to remove obstacles or disincentives for individuals to participate in the labor force and to maximize productivity growth rates.

The basic types of policies that make up the government’s strategy include:

  • Macroeconomic policies. Stable and sound macroeconomic policies are a necessary backdrop. Australia’s fiscal and monetary policy frameworks produce stable low inflation and contribute to stabilizing the business cycle. The certainty and credibility of these policies would contribute to an environment conducive to investment and innovation.

  • Education and training policy. Improving education and training outcomes can increase productivity directly by increasing the skills and abilities of individual workers and indirectly by raising the flexibility of the labor force. It also could foster more rapid utilization and transmission of new skills and production technologies, having a dynamic effect in increasing productivity.

  • Labor market policy. A flexible labor market can assist workers in avoiding periods of involuntary unemployment by making it easier for workers to change jobs and occupations, and facilitate the hiring of workers by (small) firms in areas of growth in the economy, thereby enhancing job creation, innovation, the deployment of new technologies, and productivity growth.

  • Maintaining competitive product markets. Product market competition contributes to enhancing employment and productivity outcomes. It promotes higher investment in R&D, innovation, and creates incentives for workers to upgrade their skills.

  • Taxation policy. Productivity and participation are affected by the level of taxation and the design of the taxation system. Taxes on returns to capital can affect savings and investment behavior, while taxes on returns to workers can affect labor force participation decisions. Maintaining internationally competitive personal income taxes arrangements also will be an important factor in Australia’s ability to retain skilled workers in increasingly globalized markets for such individuals.

  • Welfare and health policy. Australia’s welfare system is highly targeted, providing a reliable safety net for those in need. However, different rates of assistance and means testing arrangements for various social security benefits for people of working age may discourage labor force participation and job search.

FIGURE 1.
FIGURE 1.

AUSTRALIA COMPARISONS OF MACROECONOMIC PERFORMANCE, 1990-2002

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Sources: National authorities; IMF, International Financial Statistics and World Economic Outlook; OECD, Economic Outlook.1/ Gross fixed capital formation.2/ Fiscal year.
FIGURE 2.
FIGURE 2.

AUSTRALIA SELECTED REAL ECONOMIC INDICATORS, 1995-2003

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

1/ Contribution to GDP growth.2/ Net household saving as a percent of household disposable income.3/ Adjusted for sale of second hand assets between sectors.
FIGURE 3.
FIGURE 3.

AUSTRALIA INFLATION AND LABOR MARKET INDICATORS, 1995-2003

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Sources: Australian Bureau of Statistics; and Fund staff estimates.1/ The “Trimmed mean” is calculated as the weighted mean of the central 70 per cent of the quarterly price change distribution of all CPI components, with the annual rates based on quarterly calculations.2/ Weighted average of 8 capital cities; established houses.3/ The Wage Cost Index is only available from September 1997.4/ Output per hour worked; non-farm market sector.5/ Staff estimates.
FIGURE 4.
FIGURE 4.

AUSTRALIA FISCAL INDICATORS, 1994/95-2005/06 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Source: Data provided by the Australian authorities.1/ Revenue, expenses, and fiscal balance are on accrual basis.2/ Fiscal balance is equal to revenue less expenses less net capital investment.3/ Data only available to 2002/03.
FIGURE 5.
FIGURE 5.

AUSTRALIA SELECTED MONETARY INDICATORS, 1995-2003

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Sources: Australian Bureau of Statistics; Reserve Bank of Australia; and staff estimates.1/ Melbourne Institute Survey, expectation of inflation over next year (median response).2/ Calculated as the spread between long-term non-indexed and indexed government bonds.
FIGURE 6.
FIGURE 6.

AUSTRALIA BALANCE OF PAYMENTS AND EXTERNAL LIABILITIES, 1995-2003

Citation: IMF Staff Country Reports 2003, 337; 10.5089/9781451802054.002.A001

Sources: Australian Bureau of Statitics; and Reserve Bank of Australia.1/ June 1997 exports includes the sale of gold by the Reserve Bank equivalent to 1 1/2 percent of June 1997 quarter GDP.
Table 1.

Australia: Selected Economic and Financial Indicators, 1997-2003

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Sources: Data provided by the Australian authorities; and Fund staff estimates and projections.

Includes public trading enterprises.

Fiscal year ending June 30.

The sharp drop in 2001 reflects tax reform, including income tax cuts, the removal of the Wholesale Sales Tax, and the reduction in grants to States.

Underlying expenditure and balance exclude asset sales and other one-off factors; cash basis.

May 2003.

March 2003.

July 2003.

IMF, Information Notice System index (1990 = 100).

Table 2.

Australia: Selected Fiscal Indicators, 1997/98-2006/07 1/

(In percent of GDP)

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Sources: Commonwealth of Australia: Budget Strategy and Outlook. 2003/04; Final Budget Outcome, 2001/02.

Fiscal year ends June 30.

Projections as presented in the Budget Strategy and Outlook- 2003/04.

Accrual data are reported on a consistent basis with Government Financial Statistics (GFS). GST related transactions are excluded since the Commonwealth government conducts them on behalf of states and territories.

The drop in 2000/01 reflects tax reform, including income tax cuts, the removal of the Wholesale Sales tax, and the reduction in grants to States.

The fiscal balance is equal to revenue less expenses less net capital investment and measures the government’s net lending.

The Commonwealth, state, and public enterprise balances may not add up to the public sector balance due to the effect of consolidation.

Due to a break in the series following the introduction of the new accrual accounting standards, cash receipts and payments data from 1999/00 are not directly comparable with earlier years.

The cash equivalent of the fiscal balance.

The fiscal surplus exceeds the underlying cash surplus in 2000/01 due to abnormally high (ax liabilities from the move to a pay-as-you-go system for company tax.

Assumes the sale of the government’s remaining shareholding in telstra.

Includes financial and non-financial assets and liabilities, including unfunded superannuation liabilities to public employees.

Table 3.

Australia: Balance of Payments, 1997-2003

(In percent of GDP)

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Source: Data provided by the Australian authorities; and Fund staff estimates and projections.
Table 4.

Australia: Medium-Term Scenario 2002-08

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Sources: Data provided by the Australian authorities; and staff estimates and projections.

Includes public trading enterprises.

Fiscal year basis.

Assuming the sale of the government’s remaining shareholding in Telstra.

Table 5.

Australia: External Debt Sustainability Framework, 1998-2008

(In percent of GDP, unless otherwise indicated)

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Sources: Data provided by the Australian authorities; and staff estimates and projections.

Derived as [r - g -ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as ρ[(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stockp increases with an appreciating domestic currency ε(> 0) and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium and long-term debt, plus short-term debt at end of previous period

ANNEX I Australia—Economic Vulnerability Assessment

1. Australia’s vulnerability assessment remains broadly unchanged from the last assessment, and the economy remains well placed to manage adverse external shocks.1 Although net foreign liabilities remain high, their level has broadly stabilized. Foreign debt has become more concentrated in private financial corporations, and its maturity has shortened, reflecting increased intermediation of flows by banks. The foreign currency component of external debt has risen, although the associated currency risk is mitigated through substantial hedging. Corporate and banking sector balance sheets remain strong, and they have proven to be resilient to large swings in exchange and interest rates in the recent past. Household balance sheets also look to be reasonably sound, and they too have been resilient to past interest rate swings. However, housing remains the biggest household asset, and housing debt, which has risen rapidly in the last few years, is the major household liability and a major asset of the banking system. With higher indebtedness and given a rapid rise in housing prices over the past few years, households could be at risk to a major price correction (especially in the investor housing segment of the market), and there could be spillover effects on profitability and capital position of the banking system, although these effects are not expected to pose a systemic threat.

A. External Position

2. Net external liabilities have remained largely unchanged at around 55 percent of GDP over the last five years, although their composition changed significantly in 2000, as net foreign holding of Australian assets shifted from equity to debt (Table 1). Net external debt rose to 47 percent of GDP at end-2000 from around 41 percent during the previous three years, and subsequently, it has stayed at roughly that level. Financial corporations account for a growing proportion of both gross external debt and claims. Gross external debt increased from 61 percent of GDP in 1997 to 73 percent at end-2000 and has since risen more modestly to 76½ percent in 2002. The private sector accounts for 87 percent of total external debt, of which financial corporations are the biggest component. Public sector debt declined significantly between 1997 and 2000, and has since remained stable at 10 percent of GDP. The ratio of net interest payments to exports has declined steadily over the last few years, reflecting the relatively lower interest rate environment.

3. The maturity profile of the external debt has been shortening, and there has been an increase in the foreign currency component. As the financial sector raises most of its funds at shorter maturities than the government and corporate sectors, the rise in the share of the financial sector’s external debt has caused a shortening in the maturity profile of Australia’s external debt. At the same time, the share of gross debt denominated in foreign currency has risen slightly to around 64 percent in 2002. Australia’s foreign currency exposure is mitigated by a high degree of hedging. A 2001 survey by the Australian Bureau of Statistics (ABS), showed that foreign currency assets of Australian entities exceeded foreign currency liabilities at end-June 2001.2 Private corporations appear to have relatively minimal direct exposure to exchange risk; a significant portion of their overseas borrowing is hedged naturally. Banks, in contrast, made substantial use of derivatives to hedge their foreign currency exposure. The market for these instruments appears to be reasonably deep and has proven to be resilient given the large swings in the value of the Australian dollar over the past several years.

Australia: External Debt Statistics

(In percent of GDP)

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Sources Australian Bureau, of Statistics and RDA.

Australian Total Foreign Currency Expenses

(In billions of Australian dollars as of June 30, 2001)

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Source: Australian Bureau of statistics.

B. Sectoral Balance Sheets

Corporate Sector

4. Financial indicators suggest that the nonfinancial corporate sector in Australia remains sound. The debt-to-equity ratio in the nonfinancial corporate sector has been gradually increasing over the last few years to nearly 80 percent in end-June 2002. While this increase raises some concerns, it is noteworthy that the ratio is about half its level in the early 1990s. Moreover, debt was reduced significantly in 2002. The operating margin remains sound and the interest cover ratio indicates a good position. The return on permanent capital has declined over the last two years primarily due to debt-funded acquisitions or investments.

Households

5. The recent boom in the property market has been associated with a significant increase in household debt. Lower interest rates, lower inflation, and financial deregulation are the main factors behind the rise in household debt, which jumped from 90 percent of disposable income in 1997 to about 125 percent by the end of 2002, slightly higher now than the debt level in the United States, although the overall gearing ratio (ratio of liabilities to assets) is still relatively low.3 At the same time, interest payments on mortgages declined to around 5½ percent of disposable income and principal repayments are estimated at about 2½ percent of disposable income.4 The share of nonfinancial assets to disposable income increased as dwellings (mainly housing) and land increased in value. In contrast, financial assets declined as a share of the total and pension funds lost value. Household liabilities increased substantially with housing debt accounting for a large part of this increase.

Australia Non-Financial Corporate Financial Indicators

(In percent)

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Sources: Australian Bureau of Statistics, ICS, S&P’s Australia and New Zealand CreditStats, June 2003, and Fund staff estimates.

Survey median ratios based on Standard and Poor’s, survey of Australian and Zealand companies. Australian companies comprise around 85 percent of the survey.

Australia: Household Balance Sheet

(As percentage of gross disposable income)

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Source: Reserve Bank of Australia.