Australia: Staff Report for the 2004 Article IV Consultation

Australia’s 2004 Article IV Consultation reports that economic growth has rebounded, underpinned by continued buoyancy of domestic demand, an improvement in the external environment, and a gradual recovery from the drought. The main risk to the outlook relates to overheating in the housing market, but recent indicators suggest a soft landing is likely. Other risks include a re-emergence of drought, sustained high oil prices, or a weakening of external demand.

Abstract

Australia’s 2004 Article IV Consultation reports that economic growth has rebounded, underpinned by continued buoyancy of domestic demand, an improvement in the external environment, and a gradual recovery from the drought. The main risk to the outlook relates to overheating in the housing market, but recent indicators suggest a soft landing is likely. Other risks include a re-emergence of drought, sustained high oil prices, or a weakening of external demand.

I. Overview

1. Australia continues to reap the benefits of sustained implementation of appropriate macroeconomic policies and structural reforms. These benefits are apparent in strong economic growth, low inflation, and substantial declines in the unemployment rate and public indebtedness. Reforms, a transparent framework for macroeconomic policies, and a floating exchange rate have also made the Australian economy much more flexible and resilient, as demonstrated by the longevity of the current expansion despite a series of severe domestic and external shocks.

A01ufig01

Real GDP

(Annual percentage change)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

2. The expansion is now entering its 13th year, with unemployment falling to a level not seen since the early 1980s. Growth is expected to increase to about 3¾ percent this year, with inflation remaining comfortably within the official target range. The main risk to the outlook relates to overheating in the housing market and the associated build-up in household indebtedness, but recent indicators suggest a soft landing is likely. Although deposit-taking institutions have substantial exposure to the housing market, stress tests indicate that even a large decline in house prices would not have systemic implications for the banking system.

A01ufig02

Consumer Price Index

(Annual percentage change)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

3. Monetary policy has been kept on hold since the two 25 basis point increases in the policy interest rate late last year, and the public finances are sound. The Reserve Bank of Australia’s (RBA) wait-and-see stance is appropriate in light of subdued inflation pressures and remaining uncertainties in the housing market. The 2004 Budget projects continued small surpluses, while still having room for a package of tax cuts and expenditure initiatives. Over the longer term, the government intends to address fiscal problems stemming from population ageing through structural reforms to increase productivity growth and labor force participation.

A01ufig03

Unemployment Rate

(In percent)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

4. In the short run, Australia is likely to continue to outperform most OECD countries in terms of economic growth, as it has since the early 1990s. In the longer term, however, there is no guarantee that growth will remain strong, not least because of the prospective demographic transition to an older population. Just as structural reforms boosted the Australian economy out of the economic doldrums of the 1970s and 1980s, it is necessary in a world of rapid technological change and globalization to continue the reform process to maintain growth in the future. Indeed, there is no reason why Australia should not aspire to even higher growth to close the productivity gap with the most advanced economies.

5. The staff support the authorities’ ambitious agenda of reforms to raise productivity and labor force participation to meet the challenges of an ageing population. If successfully implemented, this would move Australia to the forefront of defining international best practice in the area of structural policies to address the economic implications of ageing, as it is now in the area of macroeconomic policies. There is a risk, however, that the comparatively strong recent economic performance will engender complacency, which will sap the political will and public support for further structural reforms.

6. Prime Minister John Howard is expected to call for federal elections before 2005. The governing Liberal-National Party Coalition was elected to its third consecutive term in November 2001 with a majority in the House of Representatives but not in the Senate.

II. Recent Economic Developments and Outlook

A. Recent Developments

7. After slowing in the first half of 2003, economic growth rebounded, underpinned by continued buoyancy of domestic demand and a gradual recovery from the drought. For the year as whole, real GDP growth was 3 percent, only moderately lower than the 3.8 percent in 2002. Buoyant domestic demand continued to offset weak net exports and a large decline in agricultural output, which dropped by 33 percent in the year to March 2003. The strength in domestic demand was broad based, with consumption, housing investment, and business investment all growing at above-trend rates. Domestic spending in 2003 was underpinned by supportive financial conditions, substantial increases in household wealth from the surge in dwelling prices—prices for established houses grew in real terms by about 16 percent a year in 2002 and 2003—and rising equity prices. A strong labor market—the unemployment rate fell to 5.6 percent in 2003—and a rebound in farm incomes in the second half of 2003 also boosted domestic demand. In contrast, net exports have been a drag on GDP growth over the past couple of years, reflecting the combined effects of strong domestic demand, a weak external environment, a substantial appreciation of the Australian dollar, and the drought. Notwithstanding the rebound in agricultural output and a firming of external demand in the second half of 2003, the current account deficit deteriorated from 4.4 percent of GDP in 2002 to 6 percent in 2003.

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Contribution of Demand Components to Growth

(In percent)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

1/ Quarterly 12-month percent change.Source: Data provided by the Australian authorities.
A01ufig05

Annual Housing Price Growth

(In percent)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: Data provided by the Australian authorities.

8. Despite a weaker-than-expected first quarter of 2004, the expansion retained significant momentum. Quarterly GDP growth slowed from 1.3 percent in the last quarter of 2003 to 0.2 percent in the first quarter of 2004. However, domestic demand remained strong with a seasonally adjusted annual rate of growth of 5 percent, only slightly lower than the 5¼ percent in the last quarter of 2003. The housing sector appeared to cool somewhat in late 2003 and early 2004, with declining prices in some markets and easing in the auction clearance rate, building approvals, and lending for housing. While exports firmed in the first quarter of 2004, reflecting a strong rebound in agriculture, a boost in imports pushed net exports to a record low, subtracting 3¾percentage points from GDP growth.

A01ufig06

Housing Finance Commitments

(In billions of dollars; seasonally adjusted)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: Data provided by the Australian authorities.

9. Australia’s recent inflation performance has been marked by contrasting influences from strong domestic demand on the one hand and a substantial appreciation of the Australian dollar on the other. After a temporary spike in March 2003, reflecting mainly a run-up in energy prices, overall CPI inflation gradually declined to the lower bound of the RBA’s target range of 2–3 percent in the first quarter of 2004, before edging up to 2½ percent in the second quarter due to the easing of the Australian dollar and a surge in oil prices. However, the overall inflation measure masks very different trends in tradables and nontradables inflation. While CPI inflation for nontradable goods has remained above 4 percent since March 2003, price increases for tradable goods have declined sharply since March 2003 due to the large appreciation of the Australian dollar. More recently, there has been a pick up in tradable good prices associated with the ongoing boom in commodity prices and easing of the Australian dollar.

A01ufig07

CPI: Tradables vs. Nontradable

(Annual percentage change)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Sourc e: Data provided by the Australian authorities.

10. The Australian dollar appreciated significantly during the past two years. From its low in April 2001 to its recent peak in February 2004, the Australian dollar strengthened by 65 percent against the U.S. dollar. On a trade-weighted basis, the currency appreciated by 41 percent, reflecting the weakness in the U.S. dollar, which dragged along closely-linked currencies of some of Australia’s trading-partners, a widening in interest rate differentials due to Australia’s more favorable cyclical position, and strong commodity prices. This appreciation also reflected a bounce back from the Australian dollar’s significantly undervalued level in 2001. Indeed, at the February 2004 peak, the Australian dollar was only 21 percent above its ten-year average against the U.S. dollar (20 percent above on a trade-weighted basis).1 From February to July 2004, the Australian dollar eased but remained 6 percent above its ten-year average against the U.S. dollar (9 percent on a trade-weighted basis). The RBA took advantage of the currency’s strength to rebuild its official reserves—which had declined to the unusually low level of US$3½ billion in early 2002—which increased by US$11¾ billion during the two years to February 2004, with little change in subsequent months. Official reserves net of swap commitments were US$17.1 billion in June 2004, equivalent to 1½ months of imports of goods and services.

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Bilateral Exchange Rates

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: International Monetary Fund.

11. Monetary policy has successfully managed the countervailing influences on inflation and the heightened uncertainty during 2003. The Official Cash Rate (OCR) remained unchanged during the first three quarters of 2003, reflecting the balancing of conflicting risks to the outlook at the time. The RBA had to contend with, on the one hand, the potential for protracted weakness in the external environment, further appreciation of the Australian dollar, and uncertainty about the recovery from the drought, and, on the other hand, continued rapid growth in housing credit (Box 1). While keeping interest rates unchanged, the RBA has actively sought to raise public awareness about the unsustainability of the housing market boom. By the end of 2003, however, with external risks to the Australian economy abating, domestic demand growing faster than expected, signs of recovery in the agricultural sector emerging, and the housing sector continuing to expand at an unsustainable rate, the RBA increased the OCR by 25 basis points in both November and December. The RBA kept the OCR unchanged at its policy meetings in the first half of 2004 based on emerging signs of easing domestic spending, a cooling in the housing market, and subdued inflation pressures.

A01ufig09

Nominal Interest Rates

(In percent)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: International Monetary Fund.

12. The December 2003 Mid-Year Economic and Fiscal Outlook (MYEFO) depicted a stronger outlook than in the 2003 Budget.2 The near-term economic outlook had improved with the global recovery taking hold, an easing in drought conditions, and continued strength in the domestic economy. As a result, increases in expenditure due to additional policy measures announced since the 2003 Budget were more than offset by higher than expected revenue, reflecting significantly higher estimated corporate tax revenue. Consequently, the 2003 Budget estimate of a Commonwealth cash surplus of $A 2.2 billion (0.3 percent of GDP) for 2003/04 was revised upward in the December 2003 MYEFO to $A 4.6 billion (0.6 percent of GDP). The projected medium-term Commonwealth fiscal surplus was also raised marginally.

13. The 2004 Budget contained a $A 37 billion package of additional tax cuts and new expenditure initiatives over five years (an average of about 0.9 percent of GDP each year), while maintaining a modest cash surplus through the medium term. The centerpiece of the Budget was the government’s More Help for Families package, which provides assistance to Australian families, continues the government’s ongoing structural tax reform, and enhances incentives to save for retirement (Box 2). An underlying cash surplus of $A 2.4 billion (0.3 percent of GDP) was estimated for 2004/05, compared with $A 3.8 billion in the December 2003 MYEFO. Small underlying cash surpluses of between 0.2 and 0.4 percent of GDP were projected to continue for the foreseeable future, and Commonwealth net debt was projected to turn negative in 2007/08.

B. Economic Outlook

14. Strong momentum in domestic demand, recovery from the drought, and an improving external environment are expected to boost real GDP growth to near potential of about 3¾ percent in 2004. The long awaited rebalancing of sources of growth is expected during the second half of the year, with domestic demand growth gradually returning to trend and net exports becoming an alternative engine of growth. The two interest rate increases in late 2003 seem to have dampened dwelling investment and household consumption, although recent data show an acceleration in retail trade due to the new Maternity Payment disbursed on July 1, 2004. And while business investment remains strong, surveys of investment intentions for 2004-05 suggest that the investment cycle has reached its peak. The gradual cooling of domestic demand is expected to be, at least partially, offset by a pick up in external demand for nonagricultural exports and a rebound in agricultural output. The recent moderation of the Australian dollar will further strengthen the contribution of net exports to economic growth.

15. There are a number of important risks to the near-term outlook. The main risk centers on the housing market and the associated build up of household indebtedness. The RBA has been very alert to this risk during the past few years and has taken a number of measures, including raising interest rates, to contain it. Scattered evidence in late 2003 and early 2004 suggests a soft landing in the housing market. There are other risks: a reemergence of drought; sustained high oil prices; a weakening of external demand, perhaps associated with a slowdown in China;3 and building inflation pressures from a tight labor market, a further depreciation of the currency, or a combination of both. But none of these, in isolation, is likely to pose a significant risk in the short term. A combination of external and domestic shocks, however, could shake confidence and spark a sharp increase in household saving rates that could severely weaken domestic demand; if this were to occur when the expected recovery in net exports fails to emerge, the impact on GDP growth could be marked. While such a worst-case scenario cannot be ruled out, it is not the most likely outcome. These downside risks are balanced by the upside potential of domestic demand remaining robust as net exports strengthen and fiscal stimulus comes on stream.

16. Medium-term prospects remain favorable. Australia’s transparent and effective monetary and fiscal policy frameworks, healthy public finances, and the government’s commitment to carry forward its pro-growth strategy should sustain growth around Australia’s potential of 3¾ percent. This suggests that the current, historically low unemployment rate of about 5½ percent may remain broadly unchanged. The current account deficit is projected to decline to 4 percent of GDP as the effects of the drought dissipate, the economy returns to its medium-term growth path, the pick-up in global economic activity takes hold, and favorable terms of trade developments continue (Box 3). However, the persistent current account deficit and relatively high household debt continue to be potential vulnerabilities to the Australian economy.

III. Policy Discussions

17. The authorities and the staff broadly agree 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 policy discussions focused on the uncertainties surrounding the outlook, the appropriate monetary and fiscal policy mix, and longer-term fiscal pressures on public spending associated with rapidly increasing healthcare costs and the ageing of the population.

A. Macroeconomic Policies

Monetary Policy and the Exchange Rate

18. The RBA has kept monetary policy on hold since the two 25 basis point increases in the Official Cash Rate late last year. With the economy continuing to grow at a brisk pace, even in the face of a cooling housing sector, pressures on underlying inflation may start to build during the second half of 2004 as the restraining influence from the earlier appreciation of the exchange rate fades. These considerations prompted the RBA to signal in its August Monetary Policy Statement that Australian interest rates would likely have to increase at some stage in the current expansion. This tightening could come soon if wage growth—which has been relatively subdued so far—increases, oil prices remain high, the Australian dollar depreciates further.

19. The authorities noted that exchange rate flexibility has cushioned the Australian economy from external shocks, with economic agents adapting well to large exchange rate swings, including through hedging practices. At the same time, they believe that intervention in the foreign exchange market may be warranted to help reverse an apparent overshoot in the exchange rate in either direction; or to calm a disorderly market, which could lead to significant ask-bid spreads and loss of liquidity.4 The foreign exchange reserves used to intervene had fallen to an unusually low level in early 2002. As noted, the RBA took advantage of favorable market conditions to rebuild its stock of reserves until mid-February 2004, but has remained on the sidelines subsequently as the Australian dollar eased. Looking ahead, conditions seem favorable for a gradual depreciation of the Australian dollar toward its long-term average value, with a global pick up in economic activity and the expected increase in world interest rates. While recent exchange rate cycles suggest considerable persistence, econometric evidence indicates that the exchange rate tends to converge to its equilibrium level rather quickly when hit by large shocks.5

Fiscal Policy

20. Although fiscal policy remains fundamentally sound, the new package unveiled in the 2004 Budget could pose some risk to the medium-term outlook. Owing to the strength of the economy and buoyancy of revenue, the underlying cash balance is projected to remain positive for the foreseeable future despite the package of tax cuts and new expenditure initiatives in the budget. However, this relatively favorable outlook hinges on significantly stronger revenue than projected in December 2003, by a cumulative $A 29 billion over five years, which is expected to largely offset the cost of the new package. The authorities are cognizant of the risks to the fiscal outlook and would take appropriate measures if revenue turns out weaker than projected. The mission noted that the short-term stimulatory effect of the $A 37 billion package, of which $A 14 billion is earmarked for 2004/05 and 2005/06 (an average of about 0.9 percent of GDP each year), could complicate monetary policy formulation if it comes into play when growth of domestic demand is still significantly above potential. The authorities believe that the stimulus from the package will be relatively small,6 and, in any case, that is appropriate in view of the downside risks.

B. Structural Policies

21. Notwithstanding the relatively positive medium-term outlook, Australia faces significant long-term spending pressures due to increasing healthcare costs and population ageing. The IntergenerationalReport published as part of the 2002 Budget identified the sources of these fiscal pressures and estimated their potential magnitude to be a financing gap of about 5 percent of GDP in the Commonwealth budget by 2042, assuming no policy or behavioral changes. Compared with other industrialized countries, Australia is well placed to respond to these intergenerational pressures, because of the strength of its fiscal position. However, a measured and timely response to the challenges highlighted in the Intergenerational Report will render them much more manageable.

22. While Australia has narrowed the productivity gap with respect to leading industrial countries, perseverance with structural reforms is needed to make further progress. The strong performance over the past decade arose from the concerted efforts of successive governments to improve both the microeconomic and macroeconomic environment in Australia.7 In particular, product and labor market liberalization has spurred competition, increased efficiency, and encouraged the adoption of productivity-enhancing information and communication technologies. As a result, competitiveness has improved, potential growth has increased—perhaps by as much as 1 percentage point8—and business cycle fluctuations have been dampened, keeping actual growth close to potential. In a world of rapid technological change and globalization, it is necessary to continue the reform process to close the productivity gap with the most advanced economies and maintain adequate rates of growth to face the long-term challenges of an ageing population.

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Labor Productivity Ratio: Australia vs. the United States

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: OECD

Labor and Productivity Indicators

(Average growth rates, in percent)

article image
Source: OECD productivity database.

GDP per hour worked.

Based on ‘harmonised’ price indices for information and communication technology capital goods.

Labor force as a percent of population aged 15-64.

23. The government has outlined five complementary policy areas that could lift labor force participation and promote productivity growth:9

  • Better incentives for work. The challenge is to redesign the tax and income support systems to encourage higher workforce participation while providing an adequate and well-targeted safety net. The current income support system remains complex and costly, and imposes high effective marginal tax rates (EMTRs) on individuals moving from income support to work. The system also needs to be better targeted by tightening eligibility for income support programs. In particular, the Disability Support Pension (DSP) program has grown rapidly, with 6¾ percent of the labor force in the program in 2003, exceeding the unemployment rate of 5½ percent. One of the criteria to qualify for the DSP is continuing inability to work 30 or more hours a week, which is almost twice as many hours as the 16 hours a week worked on average by part-time workers in Australia. A government proposal to tighten eligibility for the DSP continues to be blocked in the Senate. To avoid encouraging people to leave the workforce early, the government has also proposed to amend the superannuation laws to relax the requirement that workers between the ages of 55 and 65 must leave work before they can access their superannuation benefits. Finally, the 2004 Budget contains new measures to reduce disincentives to participation, including tax cuts in the form of a further increase in thresholds for marginal tax rates affecting medium- and high-income families (following a more modest increase last year),10 and reductions in taper rates on family tax benefits.

  • Enhancing flexibility in the workplace. The government agenda of proposed amendments to the Workplace Relations Act continues to simplify procedures, increase labor market flexibility, and link wages and work conditions to productivity. However, the wage bargaining system needs further simplification, including a reduction in the overlap of the federal and state award systems and a diminished role of the award system in setting the minimum wage, which has contributed to a relatively high unemployment rate for low-skilled workers.11 While the government has secured passage of some industrial relations legislation over the past few years, several of its proposals were blocked in the Senate.12 New government initiatives include enhancing the Job Network Program designed to help unemployed workers find a new job, extending the government’s childcare program, and introducing legislation to remove age discrimination for federal government jobs.

  • Improving the capacity for work. The government has aimed to reduce skill mismatch in the labor market by improving the education system, enhancing training, promoting a closer relationship between the education system and the business sector, and maintaining a competitive tax system to attract and retain talented people.

  • Investment in science, innovation, and infrastructure. The 2004 Budget extends the government’s Backing Australia’s Abilityx, a science and innovation program, by $A 5.3 billion (following a $A 3 billion package in 2001). The 2004 Budget also includes a new infrastructure investment program, AusLink, with an additional $A 1.9 billion over the next 5 years allocated to upgrade the Australian road and rail systems.

  • Enhancing competitiveness of product markets. Central, state, and territory governments agreed in 1995 to implement a range of competition reforms under the National Competition Policy (NCP) framework to boost long-run economic growth. There have been substantial benefits from the implementation of the NCP and other competition related reforms, including in the electricity, gas, road transport, and water sectors. The Government has recently asked the Productivity Commission to inquire into the impact of competition policy reforms undertaken to date, and to identify priority areas for further competition reform.

A01ufig11

Unemployed and on Disability

(In percent of Labor Force)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: Australian Treasury

24. Controlling government outlays on healthcare is also necessary to close the long-term fiscal gap. The interaction of an ageing population, technological innovation in the healthcare sector, and the “luxury goods” nature of healthcare services—which implies that the share of income spent on healthcare services increases with the level of income per capita—will boost demand for healthcare services and put significant pressure on public expenditure. The recent amendment to the Pharmaceutical Benefit Scheme (PBS), the fastest growing component of healthcare spending, will increase patient co-payment and safety net thresholds by 21 percent starting January 1, 2005,13 helping contain the growth of public spending. Although the 2004 Budget includes more resources for preventive health, which could reduce future healthcare costs, additional measures are needed to preserve the long-run viability of the healthcare system.

A01ufig12

Health Care Expenditure as a Share of GDP

(in percent)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: Australian Treasury

C. Financial Sector Issues

25. The financial system is sound, with a strong risk management culture. Banks, the most important financial intermediaries from a systemic risk perspective, are, in general, well capitalized, very profitable, and carry few bad debts. This reflects the long-running expansion of the domestic economy and the important improvements in risk management following the problems of the early 1990s. In the non-banking sector, the insurance and superannuation industries have also benefited from the robust economic environment, the recovery in equity markets, and a global increase in insurance premia due to heightened geopolitical uncertainties.

26. The financial system is well positioned to withstand a possible correction in the housing market. While there are indications of increased risk in mortgage portfolios, it is difficult to envisage scenarios in which developments in the housing market alone could pose a systemic risk to the financial system. Recent stress tests by the Australian Prudential Regulation Authority (APRA) indicate that even if house prices fell by 30 percent and mortgage default rates increased dramatically, more than 90 percent of deposit-taking institutions would continue to meet minimum regulatory capital requirements.14 For the small number of institutions that fell below the minimum, the breach was estimated to be small.

27. An abrupt consolidation of household balance sheets could be more damaging. This could be prompted by a combination of shocks triggering a significant increase in mortgage interest rates and high unemployment. In turn, this would have a negative impact on banks’ balance sheets. Assessing the likelihood of such a scenario is complicated by the fact that there have been few instances, either in Australia or elsewhere, in which balance-sheet adjustment by the household sector has been a major factor shaping an economic downturn. In previous episodes, adjustments by the corporate sector and by financial institutions have typically been the source of difficulties, and the risk of problems emanating from these sectors appears to be quite small.

28. Australia’s vulnerability to adverse external shocks remains low (Annex I). The external current account deficit has widened, mainly reflecting the sharp appreciation of the Australian dollar and the relatively strong cyclical position of the economy. The low and declining level of public debt, the relatively stable source of external financing, and the strong risk management culture in Australia’s financial institutions limit Australia’s external vulnerability.15 Nevertheless, sustained current account deficits and the build-up of external debt, although mainly held by the private financial sector, could leave Australia potentially vulnerable to shifts in market sentiment, suggesting the need for careful monitoring (Box 4). Corporate and banking sector balance sheets are generally sound and have proven to be resilient to large swings in exchange and interest rates. While debt servicing remains manageable, households could be subject to more stress than in the past in the event of a substantial increase in both interest rates and unemployment.

29. Key recommendations of the Royal Commission that investigated the collapse of Heath International Holdings Insurance Ltd. (HIH) have been implemented. In response to the HIH Report, the government amended the Australian Prudential Regulation Authority Act 1998 with the objective of strengthening the governance of APRA, clarifying its role in the financial system, enhancing its disclosure and conflict of interest framework, and promoting closer cooperation with other financial regulators, the Reserve Bank of Australia, and the Australian Securities and Investments Commission. In addition, the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004—which became law on July 1, 2004—aims to enhance auditor independence, achieve better disclosure outcomes, and improve enforcement arrangements for corporate misbehavior.

30. Preparations for the implementation of Basel II are underway. In 2003, APRA issued preliminary guidelines for the adoption of internal risk models to calculate regulatory capital requirements in accordance with the new Basel Accord proposals scheduled for implementation by 2007. APRA does not expect the different approaches for computing capital requirements in Basel II to change the current competitive environment. APRA intends to conform wherever possible to the international consensus on the new Accord, but will amend components when necessary to reflect unique Australian circumstances.

31. 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 Public Officials in International Business Transactions.

32. The authorities are interested in participating in a Financial Sector Assessment Program (FSAP). They indicated during the Article IV consultation in June 2004 that, pending the Treasurer’s clearance, Australia would likely participate in a FSAP in 2005-06. This is an opportune time given the consolidation trend in international financial markets and the structural shift in the Australian banking sector toward the housing sector.

D. Trade Policy and Official Assistance

33. Trade liberalization has been aggressively, and often unilaterally, pursued over the past two decades as an integral aspect of Australia’s growth strategy. Further liberalization is in the pipeline as tariffs are reduced to a maximum of 5 percent on passenger motor vehicles by 2010, and on textiles, clothing, and footwear, by 2015. Australia is a strong supporter of multilateral trade liberalization and seeks to play a constructive role in the Doha Round. With multilateral negotiations stalemated until recently, however, Australia has concluded negotiations for free trade agreements with Singapore, Thailand, and the United States, and is exploring possible agreements with China, ASEAN, and other countries. In addition, Australia has recently provided tariff- and quota-free access for all goods from least developed countries. The authorities are aware of the risks that bilateral agreements may contribute to a proliferation of regional trade blocs, reduce the political will for further unilateral trade liberalization, and dilute efforts on the multilateral front in the context of the WTO. They are determined, however, to only conclude high quality bilateral agreements, and may extend commitments in bilateral agreements to all trading partners.

34. Australia is the dominant regional power and has long enjoyed close political and economic relationships with the Pacific island countries (Box 5). This role has been enhanced over the past year with Australia’s involvement in Papua New Guinea and the Solomon Islands, which reflected increasing concerns about the lack of sustainable economic progress despite large amounts of external assistance. Australian aid allocations to the Pacific region increased by 60 percent in the 2004-05 Budget. About one-half of the total assistance to the region is expected to go to Papua New Guinea and about one-fourth is expected to be allocated to the Solomon Islands. Overall, Australia provided 0.25 percent of GNP for ODA in 2003, in line with the average for industrial countries but well below the 0.7 percent United Nations target, which Australia remains committed to achieve.

IV. Staff Appraisal

35. Australia continues to reap the benefits of sustained implementation of appropriate macroeconomic policies and structural reforms. These benefits are apparent in strong economic growth, low inflation, and substantial declines in the unemployment rate and public indebtedness. Reforms, a transparent framework for macroeconomic policies, and a flexible exchange rate have also made the Australian economy much more flexible and resilient to shocks.

36. The short-to medium-term outlook remains favorable. The expansion is now entering its 13th year, with unemployment falling to levels not seen since the early 1980s, and prospects for the expansion to continue are good. Growth is expected to become better balanced during the year, with a cooling in the strong momentum of domestic demand, primarily reflecting a welcomed slowing in dwelling investment and household consumption, and a pick up in net exports as the global economy strengthens and agricultural output rebounds from the drought. It is expected that inflation will remain comfortably within the official target range and that the current account deficit will narrow as a percent of GDP.

37. There is a broad consensus that the main risk to the short-term outlook centers on the housing market and the associated build up of household indebtedness. The RBA has been alert to this risk for some time, and has taken a number of steps, including jaw boning and a couple of taps on the monetary brakes to bring the market off the boil. Scattered evidence suggests a soft landing in the housing market, which is what most observers now expect. While no single risk appears to pose a significant threat in the short term, a combination of external and domestic shocks could shake confidence and spark a sharp increase in household saving rates that could severely weaken domestic demand; if this happened when the expected recovery in net exports failed to emerge, GDP growth could decline sharply. While such a worst-case scenario cannot be ruled out, it is not the most likely outcome. Balancing these downside risks is the upside potential of domestic demand remaining robust as net exports strengthen and fiscal stimulus comes on stream.

38. In any case, macroeconomic policy is well placed to respond in either direction to unexpected conjunctural developments. For the time being, the RBA’s wait and see stance remains appropriate, given benign inflation and remaining uncertainties in the housing market. However, with a monetary policy stance still mildly accommodative and the dampening effect on inflation of the earlier exchange rate appreciation weakening, the stimulatory effect of the fiscal package may complicate monetary policy implementation if it comes into play when domestic demand growth is still robust and external demand is strengthening. On the other hand, if significant downside risks should materialize, fiscal policy has ample room to allow the automatic stabilizers to run their course, or to provide additional discretionary stimulus. There is also a risk that fiscal revenue turns out to be lower than projected in the budget, in which case the execution of the $A 37 billion package of tax cuts and new spending initiatives in the 2004 Budget should be reviewed.

39. Australia has demonstrated that a flexible exchange rate along with good risk management practices can significantly increase the resilience of the economy. The flexible exchange rate has helped the Australian economy weather severe external shocks, including the Asian crisis, a global recession, and wide fluctuations in commodity prices. Australia’s experience has also shown that large swings in exchange rates do not necessarily have adverse economic effects if foreign exchange risk is well managed. Accordingly, the staff supports the authorities’ policy to limit foreign exchange interventions to situations where the exchange rate is clearly misaligned or to calm disorderly market conditions.

40. Australia faces significant long-term spending pressures due to increasing healthcare costs and population ageing. The fiscal package in the 2004 Budget is consistent with the government’s long-term objective of lifting labor force participation and promoting productivity growth. In addition, the recent passage of changes to the Pharmaceutical Benefit Scheme will help contain healthcare cost. Future budgets and legislation will need to continue to target areas expected to deliver the highest boost to long-term growth, including: measures to further improve labor market flexibility; reforms to the welfare system to improve work incentives; measures to enhance the competitiveness of product markets, based in part on the forthcoming review of national competition policy by the Productivity Commission; and investment in education, training, research and development, and infrastructure.

41. The authorities are right to place higher productivity and labor force participation at the center of their strategy to achieve higher growth and close the long-term fiscal gap. Measures have been taken recently to address some of these issues, including a reduction in effective marginal tax rates for low income families returning to work, and allowing older workers to start drawing down certain superannuation income streams without having to cease work. These are important steps that should be complemented with stronger incentives to remain in the labor force through tighter eligibility requirements for the Disability Support Pension and other income support programs. Further broad-based measures to increase labor market flexibility are also needed, including a reduction in the overlap of the federal and state award systems and a diminished role for the award system in setting the minimum wage, which has contributed to a relatively high unemployment rate for low-skilled workers.

42. Trade liberalization has been aggressively, and often unilaterally, pursued over the past two decades as an integral aspect of Australia’s growth strategy. Further liberalization of the more protected sectors is in the pipeline. Australia is a strong supporter of multilateral trade liberalization and its pursuit of bilateral free trade agreements is consistent with and supportive of its multilateral efforts. The authorities are aware of the risks that bilateral agreements may contribute to a proliferation of regional trade blocs, reduce the political will for further unilateral trade liberalization, and dilute efforts to conclude successfully the WTO negotiations. IMF staff is encouraged by the authorities’ determination to only conclude high quality bilateral agreements, and urge the authorities to extend commitments in bilateral agreements to all trading partners.

43. The financial system is sound, with a strong risk management culture. Banks are generally very profitable and well capitalized. Although deposit taking institutions have a substantial exposure to the housing market, APRA stress tests indicate that even a substantial decline in housing prices would not have systemic implications for the banking system. The IMF staff commends APRA for actively preparing the Australian financial system for the implementation of Basel II, and welcomes the authorities’ interest in participating in a future Financial Sector Assessment Program.

44. A hallmark of Australia’s recent economic management has been the comprehensiveness of structural reforms and the consistent implementation of stable macroeconomic policies conducted in a transparent framework. Reforms have been complementary and mutually reinforcing, and hence more likely to succeed. Trade liberalization, for example, has been a catalyst for improved competition, paving the way for reforms in competition policy. Similarly, the RBA’s inflation targeting framework and the government’s prudent fiscal policies have created an environment of low and stable inflation that has made industrial relations less contentious and eased labor market reforms. Low and stable inflation has also helped to ensure that relative prices provide accurate signals about where resources can be put to their most productive uses. It is important to continue this comprehensive approach in coming years to meet the medium-term challenges of an ageing population.

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

The House Price Surge in Australia

House prices have increased rapidly in Australia. From the end of 2001 through the first quarter of 2004, prices of established houses surged at an average annual rate of 17¾ percent in nominal terms (14½ percent in real terms). Over the longer term, prices have increased by almost 125 percent (85 percent in real terms) since the last housing cycle trough in March 1996. According to estimates by the Reserve Bank of Australia (RBA), the ratio of housing asset values to incomes is now relatively high in Australia by international standards, whereas a decade ago the ratio was comparable to that observed in other countries.1

While there have been previous pronounced house price cycles—including in the early and late 1970s and a very sharp increase in the late 1980s—the current cycle has several unusual features. First, it has occurred in a period when overall inflation was low and continued over a longer period than previous upswings. Thus, the cumulative increase in both real and nominal terms has been much larger.2 Second, the current boom is nationwide, unlike earlier ones that were specific to regions. Third, the current upswing has been focused on residential properties (including apartments), whereas previous episodes had included commercial properties, where prices have not yet recovered to peaks reached in the late 1980s. Fourth, very strong demand by household investors to buy rental residential properties has played an important role in the current boom, despite low rental yields and high vacancy rates. Loans for investment properties now account for over 40 percent of new housing loans approved by financial institutions and about one-third of banks’ outstanding loans—both high by international standards—compared with about 15 percent of new and outstanding loans in the early 1990s.

The recent house price boom in Australia is not unusual compared to booms in other countries. Since 1996, house prices have increased sharply in several other advanced countries, led by Ireland and the United Kingdom. Around 70 percent of Australians own their homes, which compares with house ownership rates in other industrial countries, ranging from 40 percent in Germany to over 80 percent in Spain.

A01ufig13

Nominal House Prices

(1996Q1=100)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

A recent report by Australia’s Productivity Commission concludes that house prices have risen more than would be explained by longer-term fundamentals, which include population growth, smaller household size, land supply constraints, household income and wealth gains, the structural reduction in inflation and interest rates, and financial innovations that have eased household access to credit.3 The report suggests that factors such as negative gearing (that is, for income tax purposes, the ability to deduct expenses on investment properties, including comparatively favorable depreciation charges, against all forms of income), changes to capital gains and other income taxes since 1999, the First Home Owners Scheme (designed to offset the impact of the introduction of the Goods and Services Tax in 1999), and expectations of further price appreciation by households (including investors) have interacted to boost demand for residential properties.

1 See RBA, “Submission to the Productivity Commission Inquiry on First Home Ownership,” Occasional Paper No. 16, November 2003.2 For comparison, the cumulative increase in the late 1980s was 53 percent in nominal terms and 36 percent in real terms, based on data from the Australian Bureau of Statistics.3 See Productivity Commission, First Home Ownership, Inquiry Report No. 28, March 2004, which also proposes policy changes that could reduce price pressures. See also IMF, “The Determinants of Property Prices in Australia,” Chapter I in Australia—Selected Issues, Country Report No. 03/336, October 2003.

The 2004 Budget

The Budget forecasts continued growth for the Australian economy, with low unemployment and low inflation. GDP growth is projected to moderate slightly from 3¾ percent in 2003/04 to 3½ percent in 2004/05. The fiscal outlook for Australia remains positive, with a forecast underlying cash surplus of $A 2.4 billion in 2004/05 and a small surplus for the following three years.

The centerpiece of the 2004 Budget is the government’s More Help for Families package which provides assistance to Australian families, continues the government’s ongoing structural tax reform, and enhances incentives to save for retirement. The total package amounts to $A 36.7 billion over five years (an average of about 0.9 percent of GDP each year) and consists of three elements:

  • Family Package

    • The More Help for Families package costs $A 19.2 billion over five years. The package increases assistance to families and rewards work by relaxing the income test to qualify for family tax benefits. In addition, a new Maternity Payment of $A 3,000 was introduced on July 1, 2004, which will be increased to $A 4,000 on July 1, 2006 and to $A 5,000 on July 1, 2008.

  • Tax Cut

    • Building on the tax cut provided last year, the 2004 Budget seeks to reduce the disincentive of high marginal tax rates through a two-step reduction in personal taxes worth $A 14.7 billion over the next four years. The tax cut increases the thresholds above which incomes are taxed at 30 percent, 42 percent, and 47 percent. This will ensure that over 80 percent of taxpayers face a top marginal tax bracket of no more than 30 percent.

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  • Incentives for Retirement Saving

    • The 2004 Budget also improves incentives for low- and middle-income people to save for their retirement through superannuation, with a total cost of $A 2.7 billion. The maximum benefit under the superannuation co-contribution scheme was increased to $A 1,500 to match a $A 1,000 personal contribution. The superannuation surcharge rate for high-income earners will be progressively reduced from 15 percent to 7½ percent in 2006-07.

What Accounts for the Turnaround in Australia’s Terms of Trade?

The conventional wisdom, suggested first by Raul Prebisch in 1950, has been that there is a secular decline in the prices of primary products relative to the prices of manufactured goods, implying a secular decline in the terms of trade of commodity exporting countries. During the past decade or so, however, there is some evidence of a break in this trend for some commodity exporting countries. One reason for this could be the increased importance of trade in intermediate goods and the rising importance of low-wage countries such as China as major exporters of manufactured products. This could effectively lead to a “commoditization” of some manufactured products that may subject them to the same forces determining commodity price trends.

The terms of trade (TOT) for Australia, a commodity producer, have turned around after following a declining trend until 1986. Since 1987, the TOT have improved by 40 percent. Does this improvement represent a temporary deviation from the declining trend, or a turnaround that could last for a long time?

Several explanations have been suggested for the TOT improvement. First, the world demand for commodities has increased dramatically in recent years in part due to the rapid industrialization in China that has fanned its voracious appetite for raw materials. Second, the prices of the manufactured products that Australia imports have been declining rapidly, perhaps reflecting “commoditization” or faster-than-average productivity gains in the manufacturing of telecommunication equipment and computer hardware, which are important components of Australia’s imports. The two explanations for the import price decline need not be mutually exclusive as China is a major exporter of these products.

A01ufig14

Australia’s Terms of Trade

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

The improvement in the Australian TOT can be decomposed into the change in export prices relative to the change in import prices. The export price change can be further decomposed into changes in the prices of commodity exports (XPCOM), the prices of exported products that involve only a simple transformation of raw materials (XPSTP), and the prices of elaborately transformed manufactured products (XPETP). Similarly, the import price change can be decomposed into changes in the prices of those products of which China is a major world exporter (MPChina) and the prices of all other products (MPOthers). The figure describes the percentage contributions to the improvement in the Australian TOT from each of the five components.1

The rapid decline in the prices of Australia’s imports of goods at which China is a major world exporter is the single most important contributing factor to the steady improvement in the TOT. The rise in the world market prices for the commodities that Australia exports is the second most important factor. On the other hand, two factors have dampened the improvement in its overall terms of trade: a decline in the export prices of the elaborately transformed products, and a rise in the import prices of those products which China does not export on a large scale.

A01ufig15

Decomposing the Improvement in the TOT

(1987 Q1 - 2004 Q1)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Factors affecting terms of tradeA: Rise in XPCom B: Rise in XPSTPC: Rise in XPETP D: Fall in MP China E: Fall in MPOthers

A number of factors suggest that the improvement in Australia’s TOT may continue for some time. Given its vast rural population, China’s industrialization and urbanization process is likely to last for a sustained period, feeding into a steady demand for raw materials and a prolonged downward pressure on the prices of the manufactured products that China exports or will soon export on a large scale. In addition, other currently poor economies, especially India, are poised to repeat the Chinese experience and become more important trading nations.

1 Details are in a forthcoming IMF Working Paper, “Accounting for the Turnaround in the Terms of Trade for Australia,” by Shang-Jin Wei.

Current Account Reversals in Industrial Countries

Some economists and policy makers have argued that an increase in the current account deficit that results from decentralized (optimal) decisions on private saving and investment made by private agents should not matter or be a concern, including for public policy. Often called the “Lawson Doctrine,” this view, however, has come into question owing to a number of currency crises and sharp current account reversals that have occurred in emerging market and industrial countries in recent years.1 The issue is of particular relevance to Australia in the current conjuncture with the current account deficit around 6 percent of GDP, a government fiscal surplus, and low and declining public sector debt.

The average characteristics of industrial countries that have experienced large current account reversals can be summarized as follows: 2

  • Typically, the reversal involves a cyclical slowdown with decreasing income and GDP growth (possibly, related to monetary tightening) and a real exchange rate depreciation. There is no significant evidence that the current account deficit itself triggers the cyclical slowdown.

  • Although countries that suffered a reversal had a fiscal deficit on average, a number of these countries maintained fiscal surpluses, and fiscal balances on average were not deteriorating prior to the reversal. Subsequent to the reversal, however, fiscal balances deteriorated.

  • Interest rates increased before the reversal and subsequently fell back following the reversal.

  • The increase in the current account deficit prior to the reversal reflected on average decreased national (and private) saving with a stable domestic investment rate. The current account adjustment during the reversal was on average due to a sharp fall in investment with saving only rising slightly.

  • Net exports recovered substantially during the current account reversal, owing to increasing exports as a share of GDP. Imports also increased, but to a lesser degree, as a share of GDP.

Possible explanations for breakdown of the “Lawson Doctrine” include:

  • Private saving and investment decisions could be distorted, including due to policy or market failures. Examples of these include excessively optimistic expectations about changes to permanent income that lead to over-consumption and over-borrowing after major policy regime changes (such as from financial sector deregulation) and/or from asset market bubbles (through the associated wealth effects); and the Harberger externality—private borrowers may not internalize the increasing marginal social cost of external borrowing that arises from the upward-sloping supply of foreign capital.

  • Private sector liabilities are often contingent public sector liabilities, either because creditors force governments to absorb private sector debts in the aftermath of a crisis or through fiscal policy that may need to be used in the event of a current account adjustment for counter-cyclical purposes or to resolve financial sector crises.

  • In a Ricardian equivalence (or forward-looking rational expectations) framework, current account deficits are always the result of private sector decisions, independent of fiscal policy.

  • A worsening current account deficit may be a reflection of, or lead to, an unsustainable appreciation in the real exchange rate. An overvalued exchange rate, in turn, could be distortionary.

1 The “Lawson Doctrine” is generally attributed to Nigel Lawson, the British Chancellor, who commented on the current account deficit in the United Kingdom in the late 1980s. However, it was also expressed earlier by others, including Jeff Sachs and Max Corden.2 Characteristics cited in this box are based on Caroline Freund, 2000, “Current Account Adjustment in Industrialized Countries,” International Finance Discussion Paper 692, Board of Governors of the Federal Reserve System, and Sebastian Edwards, 2004, “Thirty Years of Current Account Imbalances, Current Account Reversals, and Sudden Stops,” NBER Working Paper 10276. Current account reversals are defined in several ways in the literature but primarily refer to current account deficits that were reduced substantially during one to three-year periods with lower levels of the deficits sustained for a number of years afterwards.

Australia and the Pacific Island Countries

Australia has long enjoyed close political and economic relationships with the Pacific island countries and is the dominant regional power. This role has been enhanced over the past year as a result of its involvement in Papua New Guinea and the Solomon Islands. Short-term economic developments in Australia mainly affect the Pacific island countries through tourism. More important medium-term issues are trade liberalization, external assistance, and a possible currency union. In this regard, a prosperous Australian economy benefits the island countries.

Foreign Trade: Australia accounts for a major share of exports and imports of the island economies, based on well established trading relationships. Over the medium term, a major factor will be the impact of the Pacific Agreement on Closer Economic Relations, one aim of which is to develop trade among the island countries with Australia; this will be crucial for the Fiji garments sector. With regard to island imports, there are indicators that, in light of the Australian dollar appreciation over the past two years, a few traders have been seeking cheaper Asian sources.

Tourism: This is the main area in which Australian economic developments could have an impact on the Pacific island economies. Australia is the main source of visitors to the region, especially for Fiji and Vanuatu, and as passengers on cruise ships. The perception of the region as a safe haven has helped the tourist industry since 9/11.

External Aid: Australian aid allocations to the Pacific region increased by 60 percent to ($A 569 million) in the 2004 budget; Papua New Guinea accounts for 53 percent and the Solomon Islands for 24 percent of the total. Taking into account the importance of the recent Enhanced Cooperation Program with Papua New Guinea and the Regional Assistance Mission in the Solomon Islands, it is unlikely that the aid program will be reduced in the short run.

Foreign Direct Investment: Pacific island investments in Australia are extremely small and limited primarily to equity holdings by superannuation funds and property purchases from Papua New Guinea sources. Australian investments in the region are mainly related to mineral projects in Papua New Guinea, including the prospective but uncertain Queensland gas pipeline.

Currency Issues: Provided that the economic policies of the Pacific island countries converge and their overall resilience to external shocks is enhanced by appropriate fiscal and monetary policies, structural reforms, and trade diversification, there could be scope to strengthen financial links between Australia and the island region. At least for the next several years, it seems improbable that there will be radical moves toward regional financial integration; there appears to be no strong view among the island authorities that monetary union would promote the growth of output, employment, and productivity. However, the possible adoption of the Australian dollar as the regional currency has been raised by some island Finance Ministers and Central Bank Governors, and by a 2003 Australian Senate Inquiry.

Figure 1.
Figure 1.

Australia: Comparisons of Macroeconomic Performance, 1990-2003

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Sources: Data provided by the Australian authorities; IMF; IFS; WEO; and OECD.1/ Gross fixed capital formation.2/ Fiscal year.
Figure 2.
Figure 2.

Australia: Selected Real Economic Indicators, 1995–2004

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: Data provided by the Australian authorities.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, 1995–2004

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Sources: Australian Bureau of Statistics; and Fund staff estimates.1/ The “trimmed mean” is calculated as the weighted mean of the central 70 percent of the quarterly price change distribution of all CPI components, with the annual rates based on quarterly calculations. The jump in 2000 CPI reflects the introduction of the Goods and Services Tax.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, nonfarm market sector.
Figure 4.
Figure 4.

Australia: Fiscal Indicators, 1998/99-2007/08 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Source: Australian budget for 2004/05.1/ Revenue, expenses, and fiscal balance are on accrual basis.2/ Fiscal balance is equal to revenue less expenses less net capital expenses.3/ Data only available to 2003/04.
Figure 5.
Figure 5.

Australia: Selected Monetary Indicators, 1995–2004

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Sources: Australian Bureau of Statistics; Reserve Bank of Australia; and Fund 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, 1995-2004

Citation: IMF Staff Country Reports 2004, 353; 10.5089/9781451802009.002.A001

Sources: Australian Bureau of Statistics; and Reserve Bank of Australia.1/ June 1997 exports includes the sale of gold by the Reserve Bank equivalent to 1.5 percent of 1997QII GDP.
Table 1.

Australia: Selected Economic and Financial Indicators, 1999-2005

Nominal GDP (2003): $A757 billion (US$514 billion)

Population (2003): 19.94 million

GDP per capita (2003): US$ 25,777

Quota (in millions): SDR 3,236

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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 2004.

July 2004.

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

Table 2.

Australia: Selected Fiscal Indicators, 1998/99-2007/08 1/

(In percent of GDP)

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Sources: Commonwealth of Australia: Budget Strategy and Outlook, 2004/05.

Fiscal year ends June 30.

Projections as presented in the Budget Strategy and Outlook, 2004/05.

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.

Staff estimate; adjusted to exclude the above-normal dividend from the RBA in 1999/2000.

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

Table 3.

Australia: Balance of Payments, 1998-2004

(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 2004-09

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

Includes public trading enterprises.

Fiscal year basis ending June 30.

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

Table 5.

Australia: External Debt Sustainability Framework, 1999-2009

(In percent of GDP, unless otherwise indicated)

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Derived as [rgρ(1+g)+ɛα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; p = 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)+ɛα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, p increases with an appreciating domestic currency (ε> 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

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

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

The implied change in other key variables under this scenario is discussed in the text.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and both non-interest current account and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

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.16 While net foreign liabilities remain high, external debt has become more concentrated in private financial corporations with 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. Although household balance sheets have expanded in recent years, net worth is comparatively high, and households have proved resilient to past interest rate swings. 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 the banking system.

A. External Position

2. Net external liabilities have increased from 55 percent of GDP to 60 percent of GDP over the last five years (Table 1). During this period, the composition of liabilities shifted more toward debt, and financial corporations accounted for a growing proportion of both gross external debt and claims. The private sector now accounts for 88 percent of total external debt, of which financial corporations are the biggest component. Public sector debt declined significantly in recent years, and the ratio of net interest payments to exports has declined steadily, reflecting the relatively lower interest rate environment.

Table 1.

Australia: External Debt and Reserve Indicators

(In percent of GDP)

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Sources: Australian Bureau of Statistics, Reserve Bank of Australia, and Fund staff estimates.