2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Australia
Australia has completed its 26th year of economic growth. This record of solid economic growth has been achieved despite the recent challenge of adjusting to both one of the largest terms of trade booms (and subsequent falls) and the largest mining investment boom in our history. Economic adjustment has been supported by an open economy with a flexible exchange rate regime, liberalized capital account, and flexible labor and product markets, backed by adaptive macroeconomic policies and strong institutional arrangements.
Economic growth is expected to return to around trend levels in the near term and to be above potential from 2019-20, closing the output gap. Authorities agree that near-term risks to growth are broadly balanced and are continuing to pursue policies to boost potential growth. They remain committed to open trade, foreign investment and immigration for future economic growth.
Since the time of the 2017 IMF Article IV consultation in November 2017, the Australian economy has continued to perform strongly. Notably, strong employment growth continued in December 2017, with employment now increasing in each of the past 15 months, equaling the longest consecutive streak of increases since records began. Underlying inflation in the December quarter 2017 was 0.4 percent, to be 1.8 percent higher through the year. Both underlying and headline inflation remain subdued reflecting weak wage growth and continued strong retail competition. The Government also released its Mid-Year Economic and Fiscal Outlook (MYEFO) update in December 2017, which forecast a smaller fiscal deficit in 2017-18 than that forecast in the 2017-18 Budget. Most recently, Australia worked closely with trading partners to successfully reach agreement on the final Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).
The Australian economy is expected to grow at a solid pace in 2017-18 supported by public final demand, in particular the Government’s investment in infrastructure; non-mining business investment which is growing at a stronger pace than expected; household consumption; and exports, including the ramp up in capacity from iron ore and LNG projects coming online. The unemployment rate has fallen slightly over 2017 to 5.5 percent, accompanied by a near record participation rate of 65.7 percent. The female participation rate has reached a record high of 60.6 percent. However, the underemployment rate, while having fallen, remains elevated indicating some additional spare capacity in the labor market which is contributing to slow wages growth.
Australia remains firmly committed to an open economy in trade, foreign investment and immigration and underscores its commitment to a cooperative multilateral trading framework, promoting openness over protectionism. Australia remains well placed to benefit from its diversification and integration into Asia, and continues to benefit from recent FTAs with China, Japan and South Korea. Australia is also working to develop new trade agreements with major trading partners as this forms part of the Government’s broader strategy to maximize economic opportunity by extending Australia’s FTA network with the countries that account for 80 percent of Australia’s two-way trade by 2020.
In January 2018, Australia together with important trading partners reached an agreement on the CPTPP. The CPTPP will significantly increase market access for Australia’s exporters of goods and services to a regional free trade area with a combined GDP of A$13.7 trillion. In 2016-17, one quarter of Australia’s total exports, worth close to $87 billion, went to CPTPP countries. The CPTPP will provide more opportunities for Australian exporters and considerable gains for Australian consumers with new trade agreements with Canada and Mexico and greater market access to Japan, Chile, Singapore, Malaysia, Vietnam and Brunei.
The accommodative stance of monetary policy is appropriate and consistent with achieving the inflation target of 2–3 percent, on average, over time. Inflation is expected to pick up gradually, underpinned by wage growth as the economy strengthens and as excess capacity in the labor market is reduced. The current stance of monetary policy balances the need to support the economy in the final days of the transition to lower levels of mining investment against the risks stemming from rising household debt. The Reserve Bank of Australia (RBA)’s flexible inflation-targeting framework ensures that it remains well-placed to respond to future developments. The RBA notes staff’s suggestion to consider forward guidance. The RBA will continue to ensure that the public understands its reaction function, allowing them to form their own views on the potential path of interest rates.
Australia’s current account deficit continues to reflect that Australia’s strong investment outcomes are not able to be fully met by domestic savings. While Australia has a net foreign liability position, it has a net foreign currency asset position, meaning that the bulk of Australia’s foreign liabilities are issued in or hedged back into Australian dollars. The banking sector not only hedges its foreign currency liabilities but does so in a way that generally matches the duration of its hedges with the underlying liabilities. Additionally, over the last decade Australia has tended to issue debt with longer term maturities reducing risks associated with rollover or refinancing. For these reasons, Australia’s net external liabilities have a relatively robust structure, minimizing exposure to exchange rate and other macro-financial risks. The current account deficit is expected to remain towards the low end of the range in which it has fluctuated over recent decades, and net foreign liabilities have been stable as a share of GDP over the past decade.
The Australian Government continues to maintain a responsible fiscal stance, while implementing its plan to support the economy’s transition to broader-based sources of growth. Consistent with the Government’s commitment to responsible budget repair, the fiscal position is projected to maintain an improving trajectory with a return to surplus in 2020-21. The Government is focused on containing recurrent expenditure, projecting real payments growth of 1.9 percent of GDP on average over the forward estimates, while prioritizing sustainable, growth friendly spending and tax measures aimed at boosting potential output.
The Government’s economic strategy seeks to boost jobs and growth through tax cuts for Australian businesses and government investment in areas that will improve long-run productivity. As a capital importing economy, Australia’s company tax regime needs to remain competitive. Data released by the Oxford Centre for Business Tax indicate that Australia’s average and effective corporate tax rates are currently in the upper third among advanced economies. My authorities consider that the recent US company income tax package only increases the need for Australia to address its relatively uncompetitive company tax. The Enterprise Tax Plan will reduce the company tax rate to 25 per cent for all businesses, supporting investment, employment and wage rises. The Government is continuing its ten-year A$75 billion investment in transport infrastructure, a comprehensive investment in our defense industry, as well as increasing incentives for research & development, skills development, enhanced competition, support for innovation and incentives for new start-up businesses.
Australian authorities note staff advice that more infrastructure investment could be undertaken given the identified infrastructure gaps. But the quality of investment in infrastructure is as important as the quantity of investment to deliver a boost to potential growth. The Australian Government has processes in place to facilitate high quality investment in infrastructure. Infrastructure Australia works to prioritize and progress nationally significant infrastructure projects that are underpinned by robust business cases. The authorities consider they have the balance right between rebuilding fiscal buffers to provide policy space in the event of a future crisis, while supporting initiatives that will increase potential growth.
Household debt is elevated relative to incomes, and has been rising as moderate growth in debt has outpaced the very low growth in household incomes in recent years. Authorities have been concerned that as the household sector takes on ever-more debt relative to its income, the sector’s vulnerability to shocks increases. This is especially so when this debt is taken on in a low-interest rate environment. While some segments of the overall housing market have experienced rapid price gains, housing credit growth is not unusually strong, and many households have built significant mortgage buffers. Further, the distribution of debt is skewed towards high income households with households in the top two income quintiles holding over 60 percent of Australian household debt. To the extent that higher income households are comprised of high skill workers that may be less vulnerable to unemployment, this distribution enhances debt sustainability.
That said, the authorities also agree with staff that there is the potential for a large external shock to interact with, or even trigger, domestic risks. The Australian Prudential Regulation Authority (APRA), with strong support from the Council of Financial Regulators1, has taken action to maintain strong lending standards and responded to rising household indebtedness by introducing new supervisory measures and by requiring credit standards to be tightened for new borrowers. The Australian Securities and Investments Commission (ASIC) has targeted responsible mortgage lending practices. As a result, there has been a reduction in riskier types of lending, growth in lending to housing investors has slowed, fewer loans are being made with very high loan-to-valuation ratios, debt-servicing tests have been tightened and fewer interest-only loans are being made. Recently house price growth appears to have moderated. These are positive developments but it is an area the Council of Financial Regulators will continue to closely monitor.
As the staff note, recent strong house price growth in the eastern states of Australia reflects an excess of housing demand over supply. In response to concerns about property market risks, Australia has implemented a range of policies aimed at promoting housing affordability and safeguarding financial stability into the future. This has predominantly involved domestically-oriented microprudential and macroprudential policies, while broader policy settings have sought to promote housing supply growth over time.
However, the macroprudential interventions that have been put in place are ineffective with respect to non-resident investors that use foreign sources of finance. Given Australia’s jurisdictional inability to regulate the lending practices of banks operating in foreign countries, Australia has chosen to implement a number of additional policy measures that have demand-side implications for individual non-resident investors.
A number of recent measures of the Australian Government and some of the eastern State governments that are directed at non-residents have nevertheless been labelled by the IMF as capital flow measures (CFMs). My authorities dispute this representation.
The ‘Annual charge on foreign owners of under-utilized residential property (on vacant properties only)’ does not seek to limit foreign investment in Australian residential property. Instead, it is to give effect to the long-standing policy intent that foreign investment in Australian residential property adds to housing supply. Property that is neither lived in by the owner nor made available for rent is not adding to the supply of housing. This measure does not seek to target only new capital flows, it applies to the stock of housing owned by foreign persons.
The measure ‘Prohibition of property developers to sell more than 50 percent of new residential housing development to foreigners’ has been mischaracterised. The measure only applies to the pre-approvals granted to property developers to sell new dwellings in a specified development to non-residents, without each non-resident purchaser seeking their own foreign investment approval. Previously, no cap applied to these pre-approvals. The pre-approval for property developers is now capped at 50 percent. This policy does not act to limit foreign investment in Australian residential property and is not intended to limit the flow of capital. Foreign investment in excess of 50 percent in new developments will still be possible through individuals seeking independent approval for a given development outside of a developer pre- approval.
Using the Capital Gains Tax (CGT) withholding regime for the collection of nonresident tax liabilities is consistent with global norms. A withholding tax does not impose a higher final tax liability on non-residents compared with residents—it merely seeks to ensure tax owing is paid. The CGT withholding regime seeks to address the low levels of compliance by non-residents with their Australian tax obligations. As it is a non-final withholding tax, a non-resident can lodge an Australian income tax return to recover amounts withheld in excess of their Australian tax liability. The non-resident may also be eligible for a tax credit in their home jurisdiction. Similarly, the denial to non-residents of the main residence CGT exemption is a tax integrity measure, not a capital flow measure.
In regard to the foreign investor surcharge on stamp duty and land tax imposed by the New South Wales state government, the then NSW Treasurer noted that ‘These new measures will ensure NSW’s property market continues to be an attractive destination for international investors while making sure that we are able to fund vital services into the future.’ The measure is therefore clearly intended to raise revenue and is not expected to impede the flow of capital into the NSW residential home market.
My authorities remain supporters of the Institutional View on Capital Flows (IV). However, they consider that the purpose for which the IV was intended has been ill-served by its application. The use of a rule that deems all measures that discriminate between residents and non- residents to be a capital flow measure does not reflect a key plank of the IV that the intent of the measure matters. The application of the IV needs to address the underlying substance of the measure not merely the form, and its materiality, and for this staff will need to be able to exercise judgement. We share the concern expressed by several Chairs that application of the IV under the current guidance could undermine the credibility of Fund advice and undermine support for the IV.
In addition, the resources both of staff and the authorities have been spent on a discussion of how to categorize housing affordability measures that touch upon foreign investors rather than a discussion of whether or not the policies implemented are effective at addressing the risk that rising household debt poses to the future strength of the Australian economy. We would have strongly preferred a focus on the effectiveness of the policies to achieve their stated intent.
My authorities therefore repeat the call for a review of the application of the Institutional View on Capital Flows, including an assessment of current implementation experience in the context of the original intent of the IV which was to guide the IMF’s policy advice to members on how to harness the benefits while managing the risks of capital flows. Finally, we note that similar policies in place are not being assessed as CFMs as they existed prior to the Institutional View being established in 2012. They highlight this as a matter of consistency that staff should consider further.
On the recommended changes to the tax treatment of housing we note that investment in housing (other than owner-occupied housing) is treated the same as investment in other assets. The ability to deduct expenses incurred in generating income is part of the normal operation of the Australian tax system and applies to a wide range of investments and business activities. Indeed in the 2017-18 Budget there were some limitations imposed on the expenses that can be deducted from returns on housing investment. The 50 percent capital gains tax discount is also applied to all assets held for more than one year. We also note that stamp duties and land tax are levied by the state governments not the Australian Government.
The Australian authorities appreciated the ability to discuss with the mission team the outlook for the Australian economy and the policy mix to address the opportunities and risks it faces. We thank staff for the highly relevant analysis in the Selected Issues Papers and for the constructive and open dialogue.
The Council of Financial Regulators is the coordinating body for Australia’s main financial regulatory agencies. It comprises the Reserve Bank of Australia, the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission, and The Treasury.