A. Near-Term Policy Mix: A Tightening Stance Across All the Policy Levers to Support the Inflation Objective, Ensure Price Stability, and Maintain Financial Sector Buffers

13. Near-term policies should focus on managing the final phase of returning inflation to target while nurturing growth. The baseline policy mix should be calibrated carefully to achieve these objectives and ensure price and financial stability. The current restrictive monetary policy stance is essential to address risks of prolonged inflation. Fiscal policy should avoid adding to excess demand as the economy continues to grapple with supply capacity constraints. Additionally, macroprudential policies should maintain a stringent stance to mitigate the risk of excessive vulnerabilities in household balance sheets, particularly in the context of rising housing prices. Should disinflation stall, monetary policy should be the first line of defense and may need to be further tightened, supported by tighter fiscal policy while nurturing growth, and preserving targeted support to vulnerable households amid rising living costs. This contingent policy mix should ensure monetary and fiscal authorities complement each other to avoid overburdening any single policy instrument. Should downside risks to growth materialize, Australia has substantial fiscal space to deploy further policy support, targeting affected sectors and households. In the face of external shocks, Australia’s commitment to a flexible exchange rate, will allow monetary policy to focus on domestic policy objectives.

Authorities’ Views

14. The authorities broadly concurred with the staff’s recommendations for the near-term baseline policy mix but noted that fiscal and monetary policy may need prudent recalibration if disinflation stalls or growth falters. They generally agreed on the importance of ensuring that monetary and fiscal policy tools complement each other to support growth and bring inflation sustainably back to target. The authorities noted that work was under way to respond to the RBA Review recommendation to promote a better understanding of the relative roles of fiscal and monetary policy.

B. Monetary Policy and Managing the Last Mile of Disinflation

15. The need for a longer period of higher rates remains necessary due to persistent inflation and emerging upside risks. Monetary policy tightening since May 2022 has transmitted through the economy via tighter financial conditions, notably for households and more leveraged firms (see Selected Issues Paper, Chapter 1). However, significant upside inflation risks persist (¶10). In this context, the RBA has kept the policy rate unchanged and retained a tightening bias by effectively ruling out rate cuts in the near-term, pointing to more evident excess demand and persistent labor market tightness. Experience from other countries underscores the importance of labor market adjustments in the final stages of disinflation, while a nonlinear relationship between inflation and unemployment suggests that disinflation process may slow in the final phase. In addition, staff analysis finds transmission via the corporate balance sheet channel may be softer in the current tightening cycle due to firms’ large cash buffers and robust funding structures, which may weaken the drag on investment.² In this context, maintaining the current restrictive stance is warranted until clear signs emerge of easing labor market tightness and wage pressures consistent with inflation sustainably falling toward the target range. Staff projections indicate this may not occur until the first half of 2025. While a soft-landing scenario remains plausible, where labor demand (reflected in job vacancies) gradually returns to pre-pandemic levels to rebalance the labor market without sharp increase in unemployment, this path is narrowing with prolonged inflation above target risking expectations becoming de-anchored. The RBA should stand ready to tighten policy further if signs emerge that the disinflation process is stalling.

16. Monetary policy communication is important for anchoring market expectations particularly in an environment of elevated global policy uncertainty. Following the independent RBA review, the Reserve Bank has adapted its meeting schedule and format and started to hold regular press conferences to communicate its monetary policy decision. Its press statements and the quarterly Statement on Monetary Policy (SMP) now provide greater clarity in its decision-making process. In an era with important monetary policy divergence among major central banks and heightened global economic and policy uncertainty, clear communication of the RBA's data-dependent decision-making process and particularly how incoming data will be interpreted to inform monetary policy adjustments is essential for guiding market expectations. An option would be for the RBA to consider augmenting the scenario analysis in the risks section of its quarterly SMP by including a qualitative discussion of the potential responses of monetary policy, in each alternative scenario. This nuanced approach could provide the market with a clearer understanding of the central bank’s monetary policy reaction function and avoid the intricacies of conditional forward guidance in an environment with large uncertainties.

17. Reforms to the monetary policy framework and arrangements, and the operations of the Reserve Bank will enhance the effectiveness of monetary policy.

• Transition toward an ample reserves system can enhance monetary policy implementation. This shift announced in April 2024 aims to ensure banks can access enough liquid assets without relying heavily on central bank funding. The move reflects a broader trend among central banks globally towards more flexible and resilient monetary policy frameworks in response to economic challenges. The transition should be coordinated closely with the RBA’s ongoing quantitative tightening (QT; although not a primary tool of the RBA to contain price pressures), through close monitoring, by thoroughly assessing reserves demand to help inform the QT strategy and pace. Regular communication with the market, coupled with developments in the repo market will strengthen liquidity management infrastructure.

• The RBA reform should be carried through with a focus on strengthening and clarifying its mandate, further bolstering the RBA’s operational independence, reinforcing its governance and accountability, and enhancing monetary-fiscal policy coordination. In this regard, the Statement on the Conduct of Monetary Policy has been updated by the Treasurer and the RBA’s Board to confirm the Reserve Bank’s dual mandate of price stability and full employment and clarify its responsibility in safeguarding financial stability. Most other recommendations from the 2023 independent RBA review that do not require legislative changes have already been implemented or are in the process of being implemented. The proposed bill to formally repeal the Treasurer’s power to overrule the RBA’s monetary policy decisions and establish a new Monetary Policy Board (MPB) separated from the Governance Board remains under legislative review. It will be important to ensure a transparent and merit-based process for appointing MPB’s external members. Additionally, the Treasury Secretary, as an ex officio member at the MPB (as recommended by the independent review, which, however, does not align with international leading practices), should be clearly defined to act in an individual capacity, not at the direction of the Treasurer. Furthermore, strengthening the institutional framework for monetary-fiscal policy interactions—currently characterized by close communication between senior policymakers, and frequent information sharing and joint forecasting at the staff level—without undermining the RBA’s operational independence is also crucial. This can be achieved through continued information sharing, joint scenario analysis, shared research agenda, and a framework for the use of additional monetary policy tools in the future, as recommended by the independent review. Additionally, the RBA could benefit from a Central Bank Transparency review by the Fund (2023 IMF staff report).

Authorities’ Views

18. The authorities reiterated their commitment to reducing inflation while preserving employment gains. With labor market indicators and model-based estimates continuing to suggest excess demand in the economy, the Reserve Bank of Australia (RBA) has kept the cash rate unchanged since it was last raised in November 2023 to maintain a tight monetary policy. Amid significant uncertainties, the RBA remains data-driven, agile, and prepared to tighten policy as necessary if upside inflation risks materialize. They also emphasized the potential downside risks to inflation arising from a quicker-than-expected adjustment in the labor market, particularly if the current strength proves localized and the margin of adjustment shifts from hours to employment. In this context, the RBA has enhanced its policy communication to help anchor inflation expectations and is actively exploring ways to improve this further, including through more detailed scenario analysis to better inform policy discussions and decisions. Finally, the authorities remain dedicated to executing the RBA review recommendations, many of which are well progressed or already implemented. However, several recommendations require new legislation, which has not yet been passed. They also acknowledged the positive impact of the Treasury Secretary's role on the RBA board, a point that was corroborated by the independent review.

C. Fiscal Policy, Supporting Disinflation and Safeguarding Long-term Sustainability

19. The 2024/25 Commonwealth Budget will affect growth and inflation through a positive fiscal impulse. Following two consecutive surpluses, it is expected that the Commonwealth budget will record a fiscal deficit of 1.2 percent of GDP in FY2024/25, including through implemented changes to personal income tax brackets and expanded near-term cost-of-living relief measures. Aimed at alleviating the regressive effects of high inflation and enhancing the participation benefits, the preannounced PIT cuts were adjusted in a revenue-neutral way to provide greater tax relief to low- and middle-income earners, who also tend to have higher propensity to spend. The AU$300 per household energy rebate, if spent, has the potential to boost aggregate demand, thereby mitigating its direct effect on reducing energy prices (with subsidies captured in headline inflation). Staff analysis shows that while the untargeted cost-of-living support measures will mechanically lower the price level (CPI) on a temporary basis, these measures will inject additional stimulus into the broader economy, which, together with higher disposable income from permanent PIT cuts, will stimulate aggregate demand (Annex VI). However, it remains too early to assess the extent to which they will be saved or spent and therefore the extent and timing of any impulse to demand. Additionally, the projected increase in public infrastructure spending in FY2024/25 will bolster strong public demand in already-tight labor markets, which may in turn contribute to wage pressures and potentially complicate the disinflation process.³ It could also further worsen construction bottlenecks and crowd out the residential construction projects (and particularly high-density developments), where existing capacity constraints have led to substantial supply-demand imbalances and persistent price pressures.

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Commonwealth Revenue Windfalls Drove Second Consecutive Commonwealth Surplus and Continued Post-Covid Budget Repair

Citation: IMF Staff Country Reports 2024, 360; 10.5089/9798400297120.002.A001

Sources: Haver Analytics; and IMF staff calculations.1/ Based on cyclically adjusted primary balance (CAPB). A positive (negative) difference in CAPB shows fiscal expansion (contraction). 2024 is estimated from partial data.

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The Commonwealth Budget Outlined New Spending Priorities and Revised Tier 3 Tax Cuts

Citation: IMF Staff Country Reports 2024, 360; 10.5089/9798400297120.002.A001

Sources: Authorities’ data; and IMF staff calculations.

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20. The consolidated government fiscal balance remains in deficit as states budget repair lagged the Commonwealth.⁴ Constituting 39 percent of total government expenditure and 24 percent of net debt in 2023/24, Australia’s state, territories and local governments are active users of fiscal policy. Compared to the Commonwealth government, they have experienced slower budget repair, with fiscal deficits of 1.6 and 1.4 percent of GDP in 2022/23 and 2023/24, respectively. This slow repair, coupled with high interest costs, has resulted in escalating net debt levels from 1.4 percent of GDP in 2018/19 to 6.9 percent of GDP in 2023/24. Outcomes have diverged across states: VCT and NSW ran large budget deficits during the pandemic contributing toward credit rating downgrades (VCT, NSW), which in turn, further inflated interest costs. Conversely, other states benefited from robust commodity prices (WA, QLD) and substantial migration inflows (ACT, QLD, WA), boosting revenues but also increasing demands for amenities. For FY2024/25, states have adopted relatively loose fiscal policy with new spending commitments on cost-of-living relief measures (QLD, NSW, VCT, WA, SA), subsidies and tax breaks for new housing (NSW, QLD, VCT, SA, NT), and continued strong infrastructure investments across all states and territories. By contrast, a significant fiscal consolidation is projected for FY2025/26 due to a removal of these temporary measures and a normalization of infrastructure spending. The varying pace of fiscal consolidation across states reflects differences in growth performance.

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State-Level Fiscal Positions Vary Substantially, Underscoring need for Coordination

Citation: IMF Staff Country Reports 2024, 360; 10.5089/9798400297120.002.A001

Sources: Authorities’ data and IMF staff calculations.

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21. Should disinflation stall, a tighter fiscal stance would be warranted, while better targeting of transfers could more efficiently support vulnerable households. Both Commonwealth and State budgets have been more expansionary than anticipated, and the overall positive fiscal impulse risks potential setbacks in disinflation (see Annex VI for details). Should inflation continue to prove persistent, expenditure rationalization at all levels of government could help lower aggregate demand and support a return of inflation to target without large losses to output. In particular, infrastructure spending could be carefully prioritized to avoid aggravating capacity constraints. However, expanding the productive capacity of the economy and supporting the green transition remain key priorities. Additionally, transfers should be targeted where possible. If targeted transfers are not feasible, an alternative to universal energy rebates would be to institute block pricing for electricity.

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Consolidated Government Fiscal Stance Loosening as Output Gap Narrowing

Citation: IMF Staff Country Reports 2024, 360; 10.5089/9798400297120.002.A001

Sources: Authorities’ data; and IMF staff calculations.1/ Based on the calculation of cyclically adjusted primary balance in percent of potential GDP.

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22. Over the medium term, broader tax and expenditure policy reforms could boost productivity and safeguard long-term fiscal sustainability.

• Tax policy reforms should aim at improving the efficiency, equity, and sustainability of the tax system. Australia’s heavy reliance on direct taxes and its relatively high effective cost of capital hinders investment and productivity growth. In addition, stamp duty on housing transactions has failed to fully capture capital gains, hinders mobility, and exacerbates housing affordability issues. To address these issues, the Commonwealth government could consider a revenue neutral increase in Goods and Services Tax (GST) offset by Corporate Income Tax (CIT) reforms aimed at promoting investment and productivity growth. Options include implementing an allowance for corporate equity and/or lowering the CIT rate, possibly alongside compensatory measures (e.g., adjustments to resource rent taxes) to maintain the corporate tax system's integrity. Tax breaks, including from superannuation concessions (to be scaled back starting July 2025) and capital gains tax discount, could be phased out to generate a more equitable and efficient tax system. At the state and territory level, implementing recurring property taxes in lieu of stamp duty would promote housing affordability, more efficient use of the housing stock, labor mobility, and a more stable tax base over the medium term.

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• Expenditure policy reforms should focus on improving spending efficiency, promoting sustainability, and improving outcomes including a focus on coordination across Commonwealth and Federal State governments. Implementing policies outlined in the national disability insurance scheme (NDIS) review and aged care reforms will help contain expenditure growth. Similar approaches could be adopted for other large and growing items identified in the 2023 Intergenerational Report including health and climate related spending. Infrastructure governance remains a perennial issue and intergovernmental coordination continues to be a high priority to heighten spending efficiency and avoid spending overlap.

23. As long-term spending pressures rise, the authorities can consider bolstering their fiscal policy framework with clearer anchors. Although government debt levels are low and sustainable, they remain well above pre-pandemic levels. Moreover, climate-change spending and demographic shifts present upcoming headwinds. The 2023 Intergenerational Report forecast increasing expenditure needs in health, aged care, NDIS, defense, and debt interest payments, expected to grow by 5.6 percent of GDP by 2062/63 and account for half of the Commonwealth budget. The authorities can consider supplementing the Commonwealth government’s existing principle-based fiscal strategy “to limit growth in spending until gross debt as a share of GDP is on a downward trajectory, while growth prospects are sound, and unemployment is low” with clearer fiscal anchors. Such a reform to the fiscal policy framework would help guide discussions around long-term spending pressures and necessary policy reforms. Successful examples from peer countries include a medium-term debt target, often paired with an operational rule on fiscal balance to guide the annual budget process. These fiscal anchors should be calibrated to country-specific circumstances and designed with enough flexibility to respond to business cycle fluctuations, including by providing clearly circumscribed ex ante escape clauses for exceptional circumstances.

Authorities’ Views

24. The authorities emphasized that current fiscal policy settings are consistent with a sustainable return to the inflation target. They noted that the second consecutive Commonwealth surplus has helped monetary policy in bringing inflation down and lowered debt. They view the existing cost-of-living relief to be helpful for supporting vulnerable households and not sufficient in scale to influence aggregate demand. They agreed that infrastructure bottlenecks could lead to cost pressures, and are continuously reviewing the infrastructure pipeline. Overall, they emphasized that fiscal policy is not the optimal tool for fine tuning demand to short-term macroeconomic fluctuations in Australia and that much of the recent increased infrastructure spending is aimed at facilitating the energy transition or boosting productivity. They agreed with staff that growing expenditure pressures, most notably due to demographic headwinds and responding to climate change, necessitate careful fiscal reforms, but indicated that the existing system-wide fiscal framework has served them well. In particular, the fiscal strategy has guided the saving of revenue upgrades, the Intergenerational Report has helped to inform policy on medium term structural reforms including in the NDIS and aged care sectors, and the fiscal institutions provide transparency and clear guidance. Tax reforms, including changes to superannuation system, petroleum resources rent tax, and the reprofiling of the PIT cuts are argued to already be addressing the equity and efficiency of the tax system.

D. Financial Stability and Housing Affordability

25. The Australian financial system is generally robust, with systemic financial risks contained, but localized vulnerabilities exist. Banks continue to demonstrate resilience with high capital levels, strong liquidity positions, and healthy profits. While strong labor market conditions and large savings buffers (including in mortgage offset and redraw accounts) have provided cushions against increased mortgage payments, arrears have risen (to 1.6 percent in March 2024), around pre-pandemic levels. Pressure on firms' profitability continues amidst tight financial conditions, subdued demand, and lingering wage pressures, though delinquency rates remain manageable. The recent stress test by the Australian Prudential Regulation Authority (APRA) finds major banks to be resilient to a severe (but plausible) economic downturn. However, sectors with weaker balance sheets, such as low-income households (in particular those with mortgages originated during low interest periods which have yet to be refixed to higher rates) and small-medium enterprises, remain vulnerable. The commercial real estate (CRE) sector, while not currently posing systemic risks with the financial positions and funding arrangements of CRE owners well managed and the share of non-performing CRE loans very limited, is exposed to possible withdrawal of foreign lenders and investors amid international market uncertainties.

Selected Financial Soundness Indicators of the Banking Sector

(Year-end unless otherwise noted, in percent)

Source: IMF, Financial Soundness Indicators (FSI) database.

Selected Financial Soundness Indicators of the Banking Sector

(Year-end unless otherwise noted, in percent)

	2022	2023	2024Q1
Regulatory capital to risk-weighted assets	17.8	20.0	20.4
Regulatory Tier 1 capital to risk-weighted assets	13.4	14.7	14.7
Nonperforming loans to total gross loans	0.7	0.9	0.9
Return on assets	1.3	1.0
Return on equity	14.1	11.3
Liquid assets to short-term liabilities	41.2	42.8	41.6

Source: IMF, Financial Soundness Indicators (FSI) database.

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Selected Financial Soundness Indicators of the Banking Sector

(Year-end unless otherwise noted, in percent)

	2022	2023	2024Q1
Regulatory capital to risk-weighted assets	17.8	20.0	20.4
Regulatory Tier 1 capital to risk-weighted assets	13.4	14.7	14.7
Nonperforming loans to total gross loans	0.7	0.9	0.9
Return on assets	1.3	1.0
Return on equity	14.1	11.3
Liquid assets to short-term liabilities	41.2	42.8	41.6

Source: IMF, Financial Soundness Indicators (FSI) database.

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Credit Growth Is Normalizing and Banks are Well Placed to Manage Risks

Citation: IMF Staff Country Reports 2024, 360; 10.5089/9798400297120.002.A001

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26. Financial supervisory and regulatory reforms are aimed at enhancing the resilience of the financial sector. The Council of Financial Regulators has adopted a revised framework to identify systemic vulnerabilities, focusing on assessing factors that could potentially cause or exacerbate instability in the Australian financial system. This includes hidden leverage, cyber-attacks, geopolitical events, climate change impacts, and the adoption of new technologies. This is expected to be further supported by a new post-pandemic system-wide stress test design, which would help improve corporate sector surveillance. With China being Australia’s largest trading partner, the authorities should strengthen its systemic risk analysis of China-related exposures (both direct and indirect) and credit risks. Meanwhile, APRA is consulting on targeted adjustments to liquidity and capital requirements to bolster the banking sector’s resilience to future stresses. Legislation mandating climate disclosures has been passed by Parliament, with requirements to be phased in starting in 2025. Moreover, Australia is also actively engaged in global initiatives to address corresponding banking relationship (CBR) issues in the Pacific. Finally, further progress in implementing 2019 Financial Sector Assessment Program (FSAP) recommendations has been made, in the areas of financial sector risk monitoring and management, macroprudential policy analysis, resolution policy framework, financial market infrastructure regulations, and the AML/CFT regime (Annex X).

27. Data gaps on Non-Bank Financial Institutions (NBFIs) impede effective risk oversight and management. Australia’s NBFI sector, excluding prudentially regulated superannuation funds, is relatively small, and its interconnections with banks are diminishing. This said, NBFI credit growth has picked up recently which signals potential leakages from the banking sector during the monetary policy tightening cycle. In addition, competition with banks has led non-bank lenders to relax lending standards, favoring riskier borrowers, which has resulted in deteriorating asset quality. Despite overall manageable risks, significant data gaps can complicate timely identification of potential vulnerabilities in the NBFI sector, including its exposure to CRE. Regulatory agencies are actively addressing these gaps to enhance the visibility into the activities of less-regulated NBFIs.

28. Housing in Australia remains undersupplied compared to many other advanced economies. Australia’s 420 dwellings per 1,000 people (2022) is about 90 percent of the OECD average. Persistent structural impediments such as planning, zoning, and building restrictions, high costs of land for development, and infrastructure gaps, continue to escalate the cost of housing supply and cause significant delays. Building activities are currently at their lowest in a decade, with delays and difficulties in obtaining approvals from local councils persisting, compounded by community resistance to increased density. Additionally, high interest rates, rising costs, and labor shortages further challenge the profitability of starting construction even after securing development approval, leading to a substantial backlog and a slow response in housing supply to robust demand, exacerbating price pressures. As a result, about 176,000 new dwellings were added in FY2023/24, significantly below the 240,000 a year needed to meet the authorities’ target of 1.2 million new homes (over 5 years) announced in 2023.

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29. Housing affordability challenges pose significant threats to inclusive growth and more broadly intergenerational equity; thus, a holistic strategy is needed to unlock new housing supply. Recent increase in housing prices have significantly exacerbated housing affordability issues, particularly affecting younger generations. With the price-to-income ratio nearing historical highs and surpassing that of many comparable economies, concerns about the potential overvaluation of housing prices are growing stronger. Key policy priorities in the near-term policy could include (i) ensuring an adequate supply of construction workers through training initiatives and skilled migration; (ii) providing more effective financial incentives to state governments and local authorities to support infrastructure, relax stringent zoning and building restrictions, and expedite approval and land release process for housing development (drawing from successful practices in Canada and Auckland); (iii) further supporting the built-to-rent sector by incentivizing investment, including from superannuation funds and foreign institutional investors; (iv) expanding public and affordable housing—which have declined as a share of total housing stock—to bolster support for low-income families; (v) reviewing tax concessions for property investors (such as capital gains tax discounts) to curb property speculation, improve housing affordability, and reorient potential fiscal savings to support new housing supply; and (vi) considering replacing stamp duty levied by state governments with a recurring property tax to promote more efficient land use.

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Rising Interest Rates Made Home Ownership More Challenging

Citation: IMF Staff Country Reports 2024, 360; 10.5089/9798400297120.002.A001

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30. Macro-prudential policy stance remains broadly appropriate and should be agile to preempt an excessive buildup in household indebtedness amidst increasing housing prices. APRA tightened its mortgage serviceability buffers requirement from 2.5 to 3 percentage points in October 2021 and has kept it, along with the 1 percent countercyclical capital buffer, unchanged since then. Together with higher mortgage rates, this has led to a sharp decrease in the proportion of mortgages with high Debt-to-Income (DTI) and high Loan-to-Value Ratio (LVR). The recent swift rebound in housing prices seems to be driven more by fundamental supply-and-demand imbalances than by excessive leverage. However, as housing prices continue to rise, risks of borrowers taking on unsustainable levels of debt relative to their income and from borrowing excessively against the value of their property may increase, posing challenges to financial stability. The authorities should continue to closely monitor mortgage lending standards and prepare to activate additional borrowers-based limits in their macroprudential toolkit to guard against further housing price acceleration and contain rising share of high-risk mortgage lending, including when monetary policy appropriately transitions to an easing cycle. The introduction of DTI and LVR measures have shown effectiveness in other countries (e.g., Canada, New Zealand). With no clear evidence of a recent and significant inflow surge in foreign capital to Australia’s residential property sector, the authorities should also consider phasing out the existing CFM measures (¶5), with due regard to market conditions, and replacing them with non-discriminatory measures to support new housing supply.

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Authorities’ Views

31. The authorities view financial sector risks as contained despite tightened conditions and global uncertainty. The latest Financial Stability Review (FSR) emphasizes the resilience of the Australian financial system, aligning with APRA stress tests that indicate banks are well-positioned to withstand severe downside scenarios, including significant declines in housing prices.⁵ They continue to prioritize strengthening operational resilience given the operational vulnerabilities stemming from increased complexity and interconnectedness in the digital economy. They have increased the frequency of their public communications regarding macroprudential assessments to inform the decisions regarding policy changes, including whether to activate additional borrowers-based limits, and are engaging with counterparts in other jurisdictions to share insights. They continue to monitor developments in nonbank lending and remaining data gaps in the NBFI sector but emphasized its limited scale and interconnectedness with the banking system. Additionally, they recognized the importance of monitoring new and emerging risks, including those related to geopolitical risk, climate change and digitalization, and noted their ongoing efforts to make progress on sustainable finance and climate data disclosures.

32. Like staff, the authorities remain concerned about the worsening in housing affordability. They concurred with staff’s assessment and policy recommendations, acknowledging the challenges of implementing reforms at the subnational level due to the heterogeneity across states and territories. The Commonwealth is engaging state governments through bilateral discussions, exploring financial incentives to relax zoning restrictions and expedite approval processes, alongside initiatives for training and skilled migration aimed at alleviating labor shortages in the construction sector. The Commonwealth Government’s $32 billion housing investment aims to address the underlying capacity issues constraining the sector more broadly, coupled with significant new investment in public and affordable housing. They also acknowledged the need to tackle labor productivity issues in the construction sector to improve efficiency.

E. Productivity and Climate Change

33. Reforms to capital and labor markets can help reverse the recent downtrend in productivity growth. Beyond slow labor productivity growth, recent research from the Treasury, RBA, and Productivity Commission also highlights weakening business dynamism and a waning in the reallocation of capital. While efforts to draft and implement productivity-enhancing reforms along the five pillars identified by the 2023 Productivity Inquiry are underway, steady and measured progress – especially in incentivizing innovation, leveling the playing field for firms, and boosting human capital – are critical to securing resilient medium-term growth.

• Leveraging new AI technologies and boosting innovation: Reforms that incentivize innovation and R&D to build up intangible capital are critical to bolster productivity. Proactive labor market policies are also needed to leverage AI benefits on productivity, while mitigating job displacement risks for those workers most exposed (Annex VIII). Staff analysis finds that in Australia, around 60 percent of occupations are highly exposed to AI (consistent with the evidence found in other AEs), with professionals facing the highest exposure and elementary occupations facing the least, but variation within each occupational category. Proactive policy measures, including training or upskilling, improving labor mobility, strengthening of the safety net for displaced workers, as well as public awareness and consultations programs, particularly in sectors most exposed to AI, are required to leverage AI's benefits, while mitigating its risks. Continuous reassessment and policy agility are crucial as new technologies evolve.

• Boosting competition and business dynamism: The establishment of a task force to identify priority reform areas in competition policy based on data-driven analysis and global best practices is a welcome step. Moving to a mandatory suspensory merger reporting regime should help reduce inefficiencies in the regulatory oversight of mergers. Reforms to reduce barriers to labor mobility including from the over-use of non-compete clauses and differential occupational licensing requirements across states could also boost business dynamism. Efforts to revitalize the national competition policy should continue to be data driven and focused on delivering productivity improvements.

• Labor markets: Despite high labor force participation – including of women, boosted by childcare reforms, efforts to reduce pay differentials, and policies to encourage women into male-dominated professions – Australia will continue to contend with skill shortages. The authorities’ efforts to harmonize skill recognition for qualified migrants, as well as dynamic updating of skills lists and requirements, are essential for ensuring migration can help address persistent labor market needs. Reforms to educational and training programs and the immigration system should continue to be closely aligned with medium-term structural changes in labor demand linked to the net zero transition and an aging population, drawing from independent advice from the recently established Jobs and Skills Australia.

34. To meet Australia’s decarbonization goals and mitigate risks associated with climate change and the global energy transition, additional policies are needed that leverage price signals and address market failures:

• Mitigation. Australia emitted around 1 percent of global GHG emissions in 2022 making it one of the twenty largest emitters. The country is making progress towards its ambitious 2030 goals of a 43 percent reduction in GHG emissions from 2005 levels and 82 percent renewables electricity share, and Net Zero 2050 target. IMF Staff expect that there will be a gap to the NDC under current policies (Figure 9).⁶ Alongside current policies, increasing the share of renewables to the 82 percent target would align Australia’s GHG emissions with its 2030 NDC target (SIP: Chapter 2).⁷ However, bottlenecks in construction, need for upgrading and expanding the grid and issues surrounding community engagement presents a threat of delays warranting reforms identified in the December 2023 Community Engagement Review.⁸ Additional policies would be needed to meet the long-term Net Zero target. The most efficient option to bridge any remaining gap would be a broad-based carbon price. However, if the implementation of such a measure proves to be politically challenging, strong sectoral policies using price signals could also prove effective. An option is to expand the safeguard mechanism (a baseline and credit system⁹) by lowering the threshold, including more sectors and tightening the emissions decline rate. Additional sectoral policies should prioritize addressing market failures identified in the forthcoming sector pathways. Australia has committed to deliver AU$3 billion over 2020-25 in climate finance focused on the Pacific region and is an active member of multiple international mitigation initiatives including the Global Methane Pledge.

• Energy transition risks. Australia’s shift towards renewable energy and the global move away from fossil fuels will affect jobs, exports, and tax revenues. As the largest coal exporter in value terms, Australia may face notable economic adjustment costs from a rapid global transition. Staff analysis suggests the speed of global energy transition will create wide ranging outcomes, including especially for the coal sector, which could see shrinking labor demand (-250 to -8800 jobs, relative to baseline), capital stock (-4 to -22 percent, relative to baseline), and export revenues (-4 to -12 percent relative to baseline). However, its low extraction costs and high-quality coal increase the sector’s resilience. Additionally, natural gas exports could increase as a transitional fuel and essential minerals like copper, lithium, and nickel will support global electrification efforts amid ongoing technological uncertainties (see Selected Issues Paper (SIP), Chapter 2).¹⁰ A resource rent tax could incentivize a faster phase-out of fossil fuels and provide revenues needed in the transition. Reforms identified in the Critical Minerals Strategy 2023-2030 and the related areas of the 2023 Intergenerational Report can help create an attractive investment environment alongside narrowly targeted green industrial policy that aims to address market failures and externalities (¶35). Clearly communicated and consistent government policy can help investors to make informed investment decisions, especially in the renewable electricity sector. Further strategies could include social assistance to impacted households and active labor market policies, including addressing any sub-national impacts. Monitoring financial sector vulnerabilities in impacted sectors is also crucial for bolstering resilience in this transition.

• Adaptation. Rising temperatures, wildfires, and other natural disasters have contributed to a rapid rise in insurance premiums over recent years. While climate stress tests show limited direct effects of climate risks on the financial system as a whole, geographically localized and sector-specific risks create a need for close monitoring and measures to build resilience. The National Adaptation Plan, scheduled for release in 2025, will help guide policy. Options include property-level mitigation measures, climate-stress testing of the financial system, data enhancement for location-based risks, investment in resilient infrastructure including flood defenses and forest firefighting sources, and strategic residential zoning in flood plains.

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35. Australia’s efforts to support multilateral solutions are welcome, including the rules-based international trading system and measures taken to address transnational aspects of corruption.

• Thus, in line with the authorities’ support for a multilateral approach, and to avoid undue distortions, both domestically and internationally, staff advised that the recently announced "Future Made in Australia (FMiA)”—Australia’s approach to green industrial policy (IP)—should be confined to narrow objectives where externalities or market failures prevent effective market solutions and be consistent with the country’s international obligations, including to the WTO¹¹. While the FMiA amounts to AU$23 billion over a decade (0.07 percent of annual GDP) and aims to enhance economic resilience and facilitate the net-zero transition (Annex IX), if not carefully designed with appropriate guardrails, it could mark an important deviation from Australia’s long-standing policy of preserving market-based principles, with attendant implied effects of "picking winners", provide a competitive advantage to domestic producers, and could encounter enormous administrative challenges beyond the capacity of the Treasury to manage.

• Australia also continues to address transnational aspects of corruption, but further efforts are needed to mitigate risk (Annex XI). On supply side, amendments to the criminal law strengthen the foreign bribery offence (in particular, penalizing the failure to prevent foreign bribery and removing impediments to foreign bribery enforcement). However, foreign bribery enforcement remains low and should be prioritized. On facilitation of corruption, the latest national risk assessment finalized in July 2024 provides updates on understanding of risks for laundering of foreign corrupt proceeds. Staff encourages the Treasury to accelerate the establishment of a publicly accessible beneficial ownership register to improve transparency of legal persons. Australia should also proceed with passing the recently introduced legislation that expands Australia’s AML/CFT framework to Designated Non-Financial Businesses and Professions (DNFBPs), especially high-risk ones such as accountants, lawyers, and real estate professionals.

36. Australia’s data provision is adequate for surveillance based on the Fund’s new data adequacy assessment (Annex XII). Australia has subscribed to the Special Data Dissemination Standard (SDDS) since April 1996. The Australian Bureau of Statistics (ABS) has taken several initiatives to further improve the quality of the data, including further progress is finalizing the compilation and dissemination of monthly inflation data, the addition of which to the suite of statistics would further strengthen data adequacy for surveillance purposes.

Authorities’ Views

37. The authorities emphasize a critical need to enhance productivity, including through competition policy and labor market reforms. They regard the findings of the 2023 Productivity Commission’s Advancing Prosperity Five Year Productivity Inquiry as helpful for guiding policy reforms and prefer a gradual approach to implementing changes. They highlight that reducing barriers to competition, including across states (such as from occupation licensing), could significantly improve productivity and raise growth. Building up on data-driven analysis and public consultations, the authorities are gearing up to introduce competition policy reforms expected to improve business dynamism and reduce inefficiencies, including moving to a mandatory suspensory merger reporting regime, reforming the use of non-competes, and revitalizing the National Competition Policy. The authorities are aware of the costs of persistent skill mismatches in the labor market. They highlight recent reforms responding to skill and labor shortages, including greater investment in domestic skills training and the reformed Temporary Skill Shortage visa. They acknowledge the potential productivity enhancement and labor displacement effects of AI, and consider that such a global technological transition warrants close monitoring, including its safe and responsible use.

38. The authorities are committed to achieving their 2030 emissions reduction target and net zero goal by 2050, and recognized the challenges and opportunities associated with the green transition. They agreed with staff on value of market-based solutions where possible and point to the success of the safeguard mechanism in mitigating emissions in the industrial sector. They are adopting a sectoral approach to decarbonization including the electricity and energy sector plan. They recognize the challenges inherent in the rapid speed needed to meet the renewable energy share target but consider that policy well placed to support this transition. Like staff, the authorities recognize the medium- to long-term challenges from a global transition away from fossil fuels, especially when coupled with policy and technology uncertainty and the risk of geoeconomic fragmentation, but emphasize Australia’s upside potential to becoming a renewable energy superpower. They are dedicated to fostering emerging sectors that can leverage Australia’s renewable potential and natural resources such as green metals, green hydrogen and critical minerals and being an indispensable part of the global supply chains in the energy transition. The establishment of the Net Zero Economy Authority is intended to promote an orderly and positive economic transformation.

39. The authorities see the Future Made in Australia proposal as a way to establish an enabling environment for the development of domestic green sectors and technologies. Like staff, the authorities agree that the Future Made in Australia agenda should adhere to market-based principles and should complement decarbonization strategies. They stated that it will focus on areas where Australia may have a future competitive advantage and where market failures exist, such as negative externalities from emissions and insufficient private investment without government support. Additionally, they noted the need for support to foster adequate early investments in nascent technologies essential for the net-zero transition, where positive externalities, like learning by doing, can be realized. Furthermore, the authorities highlighted that the National Interest Framework will provide suitable guardrails for time-bound and narrowly targeted interventions while minimizing the fiscal costs and ensuring alignment with the country’s WTO obligations.