Australia: Selected Issues

This Selected Issues paper reviews how Australia’s economy has adapted to a flexible Australian Dollar. The paper provides a background on the float and the initial policy challenges. It discusses the main elements of the Future Fund proposal, and estimates how much Australia and other countries in the Asia-Pacific region would gain from greater financial integration. The results suggest that these welfare gains are large, giving an argument in favor of a progressive capital account liberalization across the region, once the needed supporting measures are in place.


This Selected Issues paper reviews how Australia’s economy has adapted to a flexible Australian Dollar. The paper provides a background on the float and the initial policy challenges. It discusses the main elements of the Future Fund proposal, and estimates how much Australia and other countries in the Asia-Pacific region would gain from greater financial integration. The results suggest that these welfare gains are large, giving an argument in favor of a progressive capital account liberalization across the region, once the needed supporting measures are in place.

II. The Proposed Future Fund: An International Comparison11

A. Introduction and Summary

34. The 2005/06 budget announced that a Future Fund (FF) would be established to cover the liability of the Commonwealth from the unfunded public sectorsuperannuation schemes. It is envisaged to contribute to increased savings and government net worth and to help provide resources to cover a part of future fiscal spending, there by helping to address the challenge of an ageing population. The full details of the FF and the associated legislation are expected to be released later this year.

35. This chapter discusses the main elements of the FF proposal and compares itwith similar programs in other countries. A number of useful lessons can be drawn from international experience regarding the governance structure and investment options for the FF. In particular, to ensure proper governance, it will be critical to establish legislation that provides market-based and objective criteria to gauge the FF performance, operational independence from the government, and adequate reporting and accountability mechanisms. The investment policy should take into account the implications for the government's balance sheet and the impact on the domestic capital market. While portfolio limits on foreign investments do not seem warranted for the FF, restrictions on holding controlling stakes in domestic entities and domestic government bonds may be appropriate.

B. Main Elements of the Future Fund Proposal Purpose

36. The aim of the FF is to accumulate sufficient financial assets by 2020 to fullycover the unfunded public sector superannuation liabilities of the Commonwealth Government. While superannuation of private sector employees and that of most new public sector employees are covered by funded superannuation plans,12 superannuation of public servants—most of which is owed to past government workers—is the largest financial liability of the Australian Government.13 This liability, which is estimated at around $A 91 billion in 2005 (10½ percent of GDP) and is expected to grow to $A 140 billion by 2020, is currently met on a pay-as-you-go (PAYG) basis. Under the proposal, the FF will set aside capital to finance these unfunded liabilities.

37. The FF is part of a broad effort to meet the challenges of an ageing populationby reducing the call on the budget in future years. It is estimated that a fiscal financing gap of about 6V2 percent of GDP will emerge by 2042 due to rising healthcare costs and population ageing if policies remain unchanged.14 Although the ageing process in Australia is relatively gradual, allowing the government to address the long term fiscal gap through structural reforms to enhance productivity and increase labor participation, fiscal measures to increase public savings can also make a valuable contribution. In particular, the FF will narrow the fiscal gap by ½ percent of GDP by providing resources to cover superannuation payments which would otherwise be met from current revenues.

38. The FF also provides a vehicle to invest government surpluses in an environment of low public debt. Reflecting fiscal surpluses and asset sales over the past several years, net debt of the Commonwealth Government has almost been eliminated (3 percent of GDP in 2003/04). The Government has decided to maintain the domestic debt market to facilitate private sector interest rate risk management, and fiscal surpluses in recent years have been deposited with the Reserve Bank of Australia. The FF would enable the investments of budget surpluses in a range of financial assets that yield higher returns than bank deposits.

Source and Use of Funds

39. The FF will be financed mainly by the realized budget surpluses and can only be used to meet public sector superannuation payments. The Government plans to provide seed capital of about $16 billion—including the 2004/05 budget surplus once it is realized and Government deposits at the Reserve Bank. Each year the Government will allocate part or all of the realized fiscal surpluses to the FF, and will reinvest the earnings from the FF.15 There is also a possibility that privatization proceeds, for instance those from the sale of the Government's shares in the telecommunication company Telstra, will be placed in the FF. The funds cannot be withdrawn until the unfunded superannuation liability is fully covered, and can then only be used to meet the superannuation payments. To achieve the scheduled asset accumulation, it is estimated that an average contribution of about ¼ percent of GDP will be needed each year (Figure II. 1).16

Figure II. 1.
Figure II. 1.

The Future Fund: Illustrative Asset Accumulation to Cover the Unfunded Liability17

Citation: IMF Staff Country Reports 2005, 330; 10.5089/9781451802078.002.A002

Management—Governance and Investment

40. The FF will be governed by an independent statutory board, with day to dayasset management contracted out to private fund managers. The Board members will be selected by the Government for their expertise in investment and corporate governance, and will set investment strategies guided by a broad investment mandate to be issued by the Government. Annual reports will be submitted to the Parliament and the public, and auditing will be conducted regularly by external auditors, including by the Australian National Audit Office.

41. The details of the investment mandate will be announced before the end of the year. The FF will invest in a range of financial assets, but not directly in projects, including infrastructure projects.18 Work is ongoing regarding investment options available to the FF, which will likely address the following issues: To what extent will the FF be allowed to invest in Australian government securities? Should the FF be allowed to own controlling shares in domestic entities? And will there be any limit on holding foreign securities?

C. How Does the Future Fund Compare Internationally?

42. Other countries are also taking steps to build up reserves to cover future pension payment obligations. The old-age dependency ratio is projected to rise across the industrial countries, and so is the projected fiscal spending associated with an ageing population. In countries where the public pension has been financed on a PAYG basis, in particular New Zealand, Canada, and Ireland, new initiatives have been launched to shift towards at least partial funding of the system to avoid large tax increases for future generations or a significant reduction in pension benefits. These initiatives have entailed the establishment of the New Zealand Superannuation Fund (NZSF), the National Pension Reserve Fund (NPRF) of Ireland, and the new funding approach for the (Canada Pension Plan (CPP)). In Sweden, the National Pension Fund (NPF) underwent substantial reforms to strengthen the management of the pension reserves. Although not a pension fund, the Norwegian State Petroleum Fund (SPF) was established in part as a savings vehicle to manage the rising expenditures from population ageing.

43. While most other funding schemes aim to cover the basic national pension, Australia's FF covers only the occupational pension of civil servants. In other countries public pension funds have mainly sought to offset the government liability of the basic national schemes (NZSF, CPP, and NPF in Sweden), although the NPRF of Ireland covers civil service pensions as well. As noted, the coverage of the Norwegian SPF is broader—it is intended as reserves for the rising fiscal costs without being earmarked for pension purposes alone.

44. Nevertheless, the FF shares similar policy issues with these other public pensionfunds, given the sponsorship by the government and the impact on the government's balance sheet. There are a set of unique issues facing public pension funds compared to their private counterparts, due to the institutional relationship with governments concerning the funding arrangements, governance, and investment policies. Public pension funds are potentially more vulnerable to political interference, and their investments have direct impact on the government balance sheet. The discussion below compares the FF with other public pension funds in these aspects (Table 1).


45. Governments have mostly committed to a level of transfers or a revenue sourceto achieve the targeted funding. The New Zealand government will allocate an average of $NZ 2.3 billion per year (1.2 percent of GDP on average) during 2003–20. The Irish government is required by law to set aside 1 percent of GNP annually by 2025 to be invested in the NPRF. In both cases the contributions are expected to be met through fiscal revenues or privatization proceeds. The Canadian government adopted a “steady-state financing” approach, which increased the contribution rate from 5.6 percent in 1996 to 9.9 percent in 2003, with the additional contributions to be transferred to the CPP for investment. While there is no pre-announced path of asset accumulation for the Norwegian SPF, the source of the funding has not been an issue of concern as most of the revenues from North Sea oil will be directed into the fund. The funding of the FF, in contrast, is not based on a prior commitment of budget allocation nor an earmarked revenue source; rather, it will rely on future ex post budget surpluses.

46. However, the risks to FF funding are mitigated by the relatively small size of the liability, the commitment to reinvesting the FF earnings, and the expected strong fiscal position. The strong public finance position, underpinned by the principles of the 1998 Charter of Budget Honesty, places the Australian Government in a more favorable position than many others to fund its public service pension liabilities. The Commonwealth government's net asset position is expected to turn positive in a few years, and the underlying cash balance is projected to be in surplus in the medium term even with the investment earnings of the FF excluded from revenues. In contrast, with significant public debt and large fiscal deficits, other countries frequently find it difficult to set aside funds to meet future obligations.

Governance Arrangements

47. Transparency, accountability, and independence are the key governance issuesfor public pension funds. As the funds are sponsored by the state, the governments could potentially direct the money to achieve political popularity, for instance by investing in infrastructure and housing projects, at the cost of higher risk or lower returns.19 Funds in other countries have set up governance mechanisms to limit political influences in the investment process.

  • The operation of the funds is benchmarked against market-based objective criteria, with the role of social investment removed or limited. The legislation provides that the funds aim to maximize returns for the benefit of the plan members subject to a certain level of risk tolerance, with the performance gauged against certain portfolio benchmarks. The CPP and the NPRF of Ireland are explicitly disallowed from making investments for social objectives, while there are some requirements for taking into consideration social and reputation impacts for the NPF of Sweden and the NZSF.20

  • An arm's length relationship of the fund management from the government isimportant to reduce the scope of political influence. All the funds are governed by an independent body not directly under the control of the government. The NZSF is governed by a separate Crown entity called the Guardians of the New Zealand Superannuation. The Minister of Finance is required by law not to give any direction that is inconsistent with the duty to invest the NZSF on a prudent, commercial basis. Similarly in Canada, the CPP is governed by an independent Board of professional members. In both cases the selection of the Board members are based on the recommendation of an independent nominating committee. While the members of the governing body for the NRSF of Ireland—the National Pension Reserve Fund Commission—are selected by the Finance Minister, the Commission operates independently of the government. In Norway, the Central Bank directly manages the SPF. Moreover, a large share, if not all, of asset management, is contracted out to external managers with their performance monitored according to market-based benchmarks. This helps to further reduce the scope of political interference.21

  • Transparency and accountability are ensured through accounting and auditingrequirements. In all these countries, annual reports are provided to the public and the Parliaments, combined with more frequent publication of financial statements and periodic external audits.

48. The FF proposal has set out the key elements to achieve good governance. The governing board will operate independently from the government, although an extra buffer of having an independent nominating committee (such as the case in the NZSF and the CPP) might be desirable to further insulate the FF operation from the government. Alternatively, the independence could be strengthened through legislation that establishes the FF's purpose, function, and accountability mechanisms. Therefore, it will be important to have a clear commercial objective for the FF, and suitably strong disclosure requirements will enable close scrutiny of FF operations by the public.


49. Governments have often imposed some restrictions on the investment optionsavailable to these funds. These restrictions have been justified from the perspective of risk to the government balance sheet, the potential for political influence, and the impact of investments on the domestic capital market.

  • There are explicit limits on holding domestic assets in some cases. The NPSF of Ireland is prohibited from investing on domestic government securities to resist the temptation of financing government spending. The NZSF and the NPF of Sweden are prohibited from taking controlling stakes in domestic entities in order to ensure that investments are for portfolio purposes only, and to prevent the funds from becoming “excessively” large players in the domestic stock market. In practice, this means that NPF can not have more than 10 percent of voting rights in listed companies or more than 30 percent in unlisted venture capital firms, and the NZSF can not hold more than 20 percent of any entity's voting shares.

  • In other cases the regulations are with regard to outbound investment due to concerns for the exchange rate. For instance, the CPP has a 30 percent limit on foreign securities, and the NPF is subject to a 40 percent limit on the unhedged foreign currency exposure. In contrast, all the investment of the Norwegian SPF is made abroad to prevent a rise of the real exchange rate resulting from the inflows of oil revenues. While funds are often subject to the political pressure of “keeping public funds at home,” it is also recognized that such investments are an integral part of optimal portfolio allocation and help to manage the potential impact of the funds on the domestic capital market.

50. These practices may help shed light on the choice of investment policies for the FF. First, there appears to be no compelling economic reason to impose portfolio limits on foreign investments by the FF. The asset size of the FF is small compared with that of private superannuation funds—which stood at around $650 billion or 77 percent of GDP at the end of 2004. Thus the location of the investment of the FF is unlikely to have a significant impact on the exchange rate given that there are already large cross boarder capital flows from the private fund activities. Moreover, purchases of foreign securities will help diversify the FF portfolio. Second, FF investment in Australian government bonds may potentially affect the relative price of the securities, given the small size of the government debt market. Limits on buying government bonds should, therefore, be considered. Third, it might be desirable to prohibit the FF from having a controlling stake in any domestic entity, given the implicit conflict of owning a company that the government also regulates and taxes, although the risk of the FF being used as a government instrument is mitigated by close public scrutiny. Finally, the implications for the government balance sheet should be carefully weighed. Given the nature of shocks to the Australian economy, it has been argued that the investment of the FF should include a broad range of financial assets including nominal domestic debt and foreign equities so as to reduce the impact of macroeconomic shocks on the financial position of the government (Au-Yeung, McDonald, and Sayegh, 2005).

Table II. 1.

Selected Public Pension Funds

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The projected peak level of assets for Australian FF, CPP, NPRF of Ireland, and NZSF. The CPP figure is based on the projected asset size in 2050 in the 2002-03 CPP annual report and the projected nominal GDP, the NPRF figure is based on Palacios (2002), and the NPZF figure is based on IMF (2004). For NPF of Sweden the figure is as of end-2001, and the Norwegian SPF figure is as of end-2003.

Proposed as in the 2005/06 budget.


  • Australian Productivity Commission, 2005, “Economic Implications of an Ageing Australia,” Research Report.

  • Au-Yeung, Wilson, Jason McDonald, and Amanda Sayegh, 2005,, “Australian Government Balance Sheet Management,” Australian Treasury Conference Paper, available at

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  • Canada Pension Plan, Annual Report 2002-03, available at

  • Carey, David, 1999, “Coping With Population Ageing in Australia,” OECD Economics Department Working Paper.

  • Commonwealth of Australia, 2005, “Budgetary Strategy and Outlook 2005-06.

  • Department of Parliamentary Services, Australian Parliament, 2005, “The Future Fund,” available at

  • Iglesias, Augusto and Robert Palacios, 2000, “Managing Public Pension Reserves, Part I: Evidence from the International Experience,” World Bank Social Protection Discussion Paper, No. 0003 (Washington: World Bank).

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  • New Zealand Superannuation Fund, 2004 Annual Report, available at

  • National Pension Reserve Fund of Ireland, 2003 Annual Report, available at

  • Norges Bank, The Government Petroleum Fund Annual Report, 2004, available at

  • Palacios, Robert, 2002, “Managing Public Pension Reserves, Part II: Lessons from Five Recent OECD Initiatives,” World Bank Social Protection Discussion Paper No. 0219 (Washington: World Bank).

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  • Salgado, Ranil, 2004, “New Zealand Superannuation Fund: International Comparison and Economic Implications,” in “New Zealand—Selected Issues,” IMF Country Report No. 04/127 (Washington: International Monetary Fund).

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Prepared by Li Cui (Ext. 36539).


Superannuation is financed by employment related contributions. This differs from the non-contributory age pension which provides a safety net for the elderly and is financed out of general taxation. See Carey (1999) for further discussion.


In particular, superannuation liability accruing under the Commonwealth Superannuation Scheme (CSS) and the Defense Force Retirement Benefit Scheme (DFRDB) are completely unfunded. Liabilities accruing under the Military Superannuation and Benefits Scheme (MSBS) and the Public Sector Superannuation Scheme (PSS) are partly funded. These schemes account for about 95 percent of the Commonwealth's superannuation liabilities. The Commonwealth Government has closed these schemes, with the exception of the MSBS, to new entrants, so that the Government will pay the superannuation obligation for new public servants as they accrue rather than adding to the superannuation liability further. Nonetheless, the superannuation liability is expected to rise due to the growth in the MSBS and the entitlements accumulated for existing workers in the other schemes.


The Australian Productivity Commission (2005) estimates that about two-thirds of the gap is accounted for by the increase in healthcare costs, and about a quarter is accounted for by the increase in age pensions.


The investment earnings of the FF are excluded from the government underlying cash balance and can not be used for budgetary spending.


This estimate assumes that the average investment return on FF assets is about 7 percent each year.


Budget Overview, Commonwealth Government, May 2005.


Treasurer Costello, Budget Lock-up Press Conference, May 10, 2005.


Investments for political objectives have been shown to be associated with lower returns, such as the case in Korea and Japan. See Iglesias and Palacios (2000) for further discussion.


The former is required to state how environmental and ethical considerations are taken into account without relinquishing the overall goal of high return on capital, and the latter is asked to “avoid prejudice to New Zealand's reputation as a responsible member of the world community.”


It perhaps also reflects the recognition that privately-managed funds on average outperform publicly-managed funds in achieving higher returns. See Iglesias and Palacios (2000) and Palacios (2002).

Australia: Selected Issues
Author: International Monetary Fund