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International Monetary Fund sees strong Australian growth, but global risks – 20 November 2018

Australian Financial Review

The International Monetary Fund says Australia’s strong economic growth is expected to continue in the near term, gradually leading to an uptick in wages and inflation.

The IMF’s review of the Australian economy also welcomed the cooling housing market, urged a higher goods and services tax to fund lower corporate taxes and told the government to stick with its budget surplus plan.

But the fund warns of “downside” risks from the global economy, due to a slowing China and the US-China tariff fight, which could delay Australia’s economy soaking up spare capacity.

“A sharp tightening of global financial conditions could spill over into domestic financial markets, raising funding costs and lowering disposable income of debtors, with the impact also depending on the response of the Australian dollar,” the IMF said in a report published Tuesday.

“On the domestic side, a stronger pickup in the non-mining business sector, larger spillovers from public infrastructure investment, and the Australian dollar depreciation in real effective terms over the past year could boost near-term growth more than projected. Domestic demand may equally turn out weaker if wage growth remained subdued or investment spillovers were smaller.”

Keep rates on hold

An IMF team of economists has spent the past two weeks in Australia talking to government economic officials, business and academic economists, to produce an initial Article IV concluding statement, before a more detailed report is released in February.

The IMF has lent support to the RBA’s reluctance to raise interest rates from 1.5 per cent, despite the unemployment rate falling to a six-year low of 5 per cent and robust annual economic growth of 3.4 per cent in the June quarter.

The Washington-based fund said now is “not yet time to withdraw macroeconomic policy support” given the remaining slack in the economy.

“The strong economic momentum has resulted in further improvements in labour market conditions,” the IMF said.

“Nonetheless, wage growth has remained weak, suggesting some remaining labour market slack.”

It praised the government’s fiscal plan to return to a balanced budget in 2019-20 and to run surpluses thereafter, given the economy was “expected to return to full employment.”

Regulators need to hold the course

The IMF is not overly concerned about the recent declines in Sydney and Melbourne house prices, describing the recent “cooling” as a welcome development that can be weathered in a strong economy.

Though it is a source of risk, the IMF said: “In the absence of a sharp rise in unemployment, interest rates, or housing inventories, an orderly correction in housing prices will help contain macro-financial vulnerabilities.”

Given interest rates are likely to remain low and with high levels of household debt creating financial vulnerabilities, the IMF said regulators need to “hold the course” with regard to macroprudential policy, such as restrictions on interest-only loans and investor loans, and suggested regulators could prepare other measures in case they were needed in future.

It ramped up pressure on state and local governments, saying housing supply reforms will be critical to restore housing affordability. It listed planning and zoning reforms as priorities.

The IMF renewed its push for Australia to embark on major tax reform to boost productivity and inclusive growth, noting that revenue raised from direct taxes – such as personal and corporate tax – was above the average of advanced economies.

Increasing or broadening the 10 per cent goods and services tax, reducing tax concessions and cutting the company tax rate should be priorities, it said.

“To offset the regressive element from higher GST revenue, an income tax-based rebate scheme to reduce the negative impact on lower income groups should be considered,” the fund noted.

Treasurer Josh Frydenberg said the IMF had delivered a positive economic report card “welcoming our budget management, strong economic growth, improved labour market conditions and housing affordability reforms.”

“Importantly, the IMF notes that this ‘strong economic momentum has resulted in further improvements in labour market conditions’ and they see gradual upward pressure on wages,” he said.

“It also says the cooling of the housing market is welcome and contributes to improving housing affordability, noting that measures introduced by APRA have reduced the share of investor and interest-only borrowing and lowered the risks to financial stability.”

Article appeared in The Australian Financial Review on 20 November 2018.

Article written by John Kehoe & Jonathan Shapiro

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