IMF REPORT CARD: Australia's outperformance is fading and the risks are rising

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“After years of rapid growth, Australia’s outperformance is fading with a soft real economy, a maturing financial cycle and slowing potential growth,” the International Monetary Fund said in its latest report on the state of the Australian economy released overnight.

The IMF highlighted that while Australia has grown around twice as fast as its peers for the last two decades and not had a “technical recession” for 25 years the “waning resource investment boom and sharp fall in the terms of trade have brought this to a halt”.

While it believes a cyclical recovery is under way, the IMF also says the risks to the outlook are skewed to the downside.

The fund does point out that while Australia’s overall vulnerabilities are low, “several distinct downside risks could interact and exacerbate the impact on the economy”.

Key here are risks around the housing market and China.

The IMF noted that APRA and the RBA have be warning and are actively seeking to restrain the current housing boom which had driven house prices into over-valuation territory and warns there is a risk of a housing hard landing.

A sharp correction in house prices, possibly driven by Sydney, could be triggered by external conditions (e.g., a sharper slowdown in China or a rise in global risk premia) or a domestic shock to employment. This might have wider ramifications if it affects confidence. The house price cycle could be amplified by leveraged investors looking to exit the market and a turning commercial property cycle.

They warn that Australia’s banks could come under pressure if the downturn becomes serious enough and face ratings downgrades.

When it comes to China, the IMF holds the same concerns that many investors and observers have previously articulated. That is, “a sharp growth slowdown accompanied by market volatility, and/or fall in property investment, could lead to a further large fall in demand for Australia’s commodity exports”.

That would effect national income, impact on GDP growth and dull foreigners’ appetite to continue to fund the Australian banking system the IMF warns.

It’s not all bad news though with the IMF noting the RBA, with a cash rate of 2%, still has room to drop rates to offset these risks should the economy move in this direction.

The fund says that Australia should continue to re-energise growth by “sustaining demand through the resources boom transition”.

That, the IMF says, means:

  • Monetary policy should remain accommodative given the sizeable output gap and subdued inflation, and stand ready to ease further should the recovery fall short of expectations and provided financial stability risks remain contained.
  • A small surplus should remain a longer-term anchor of fiscal policy. But the planned consolidation is somewhat more frontloaded than desirable. Increasing public investment would support demand and insure against downside growth risks.
  • Maintaining income growth at past rates requires higher productivity growth. There are few low-hanging fruit, but a range of reforms have been identified. Addressing infrastructure needs would relieve bottlenecks and housing supply constraints.
  • The tax system should shift towards more efficient taxes, while ensuring fairness, including by preventing personal income tax bracket creep and reducing the corporate tax rate, paid for by higher GST revenue—while compensating those on lower incomes.

As the Prime Minister and his economic ministers sit now with business, welfare and union leaders for a mini-summit today, that looks like a pretty good shopping list to start with.

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