ECONOMY REPORT - AUSTRALIA

ECONOMY REPORT - AUSTRALIA (Extracted from 2001 Economic Outlook) The Australian economy continued to perform strongly in the first half of 2000, before slowing in the second half of the year, with the downturn flowing somewhat on to employment later in the year. Ongoing inflation has remained low and within the Reserve Bank of Australia s target range over 2000. REAL GROSS DOMESTIC PRODUCT Real Gross Domestic Product (GDP) increased 3.8 percent in 2000 following growth of 4.7 percent in 1999. The slowing in the rate of growth was due to the weakness experienced in the second half of the year, arising, in part, from the negative impact of higher world oil prices, a decline in the world economy and the past effects of higher interest rates. The profile of growth through 2000 was heavily influenced by transitory factors such as the Sydney Olympics stimulus and the introduction of The New Tax System (TNTS). Following the abatement of these one-off factors the Australian economy is expected to continue its strong record of growth over the next 12 months. Household consumption rose by 3.4 percent in 2000, following growth of 5.2 percent in 1999. The moderate growth in household consumption in 2000 is likely to have reflected the effect of higher fuel prices, subdued employment growth, and less-rapid growth in household wealth. Following three years of solid growth, dwelling investment experienced slow growth in 2000. During the first half of the year dwelling investment rose strongly as a result of consumers bringing forward construction ahead of the introduction of The New Tax System (TNTS). This build-up in activity was subsequently unwound in the second half of 2000. Total business investment rose slightly in 2000. This result is due to a decline in non-residential construction following the completion of Olympics-related construction projects, which largely offset growth in machinery and equipment investment. Underlying public final demand (i.e., after adjusting for second hand asset sales) rose by 3.5 percent in 2000 after rising 6 percent in 1999. Slower growth in public final demand in 2000 reflects the unwinding of strong increases in both public consumption and public investment in 1999. The external sector had a positive impact on growth over the course of 2000. Net exports contributed 0.3 percentage points to GDP growth in 2000, after detracting 1.1 percentage points from GDP growth in 1999. INFLATION

The 5.8 percent increase in the Australian Consumer Price Index (CPI) through the year to the December quarter 2000 includes the one-off impact from the introduction of TNTS (which is likely to have contributed a little less than 3 percentage points in the September quarter 2000) and the temporary effect of higher world oil prices on domestic fuel prices. Abstracting from these influences, the CPI is estimated to have increased by around 2 percent through the year to the December quarter 2000, placing it at the lower end of the Reserve Bank of Australia s inflation target band. Moderate wage outcomes and intense competitive pressures contributed to the low outcome, which occurred despite a fall in the value of the Australian dollar. EMPLOYMENT Employment grew by 3.0 percent in 2000, with the unemployment rate falling to 6 percent in September and October 2000 before rising slightly to 6.3 percent in December 2000. Wages, as measured by average weekly ordinary-time earnings for full-time adults and average weekly earnings (all employees), rose 5.1 percent through the year to the December quarter 2000. In contrast, the wage cost index rose by 3.4 percent through the year to the December quarter 2000. CURRENT ACCOUNT The current account deficit fell to A$26.5 billion or 4 percent of GDP in 2000, down from A$35.7 billion or 5.8 percent of GDP in 1999. Exports in current prices increased 24.9 percent in 2000, while export volumes increased 10.2 percent in 2000. Imports increased 14.8 percent in current prices in 2000, while import volumes increased 7.3 percent in 2000. The terms of trade increased 5.9 percent in 2000, following a 0.4 percent fall in 1999. Overall, the trade deficit fell A$9.0 billion in 2000 to A$7.7 billion. FOREIGN INVESTMENT Net foreign debt was 44.6 percent of GDP (or US$162.2 billion) at the end of December 2000. Gross foreign debt was 69.6 percent of GDP (or US$252.0 billion) at the end of December 2000, and the public sector accounted for approximately 15 percent of this total, with the remaining 85 percent of Australia s gross foreign debt owed by private sector borrowers. Net foreign liabilities were 56.4 percent of GDP (or US$205.2 billion) at the end of December 2000. Foreign direct investment in Australia was 31.2 percent of GDP (or US$113.6 billion) at the end of December 2000. EXCHANGE RATE Since 1983, Australia has had a floating exchange rate. The Reserve Bank of Australia may undertake foreign exchange market operations when the market threatens to become excessively volatile or when the exchange rate is clearly inconsistent with underlying economic fundamentals. However, these operations are invariably aimed at stabilising

market conditions and are not undertaken in accordance with a specific exchange rate target. During 2000, the Australian dollar depreciated (in nominal terms) by 15.3 percent against the U.S. dollar and 5.0 percent against the Japanese yen. These depreciations contributed to a 8.5 percent fall in the trade-weighted index, despite rises in the Australian dollar against many Asian currencies. FISCAL POLICY Total general government net lending returned to surplus in financial year 1997 98 on a cash basis and has remained in surplus since then. (Data are not available on a calendar year basis.) This improvement has been mainly due to the elimination of the large Commonwealth Government fiscal deficits recorded in the first half of the 1990s. In financial year 2001 02, the Commonwealth Government is expecting to achieve a fiscal surplus of 0.2 percent of GDP on a cash basis (or a deficit of 0.1 percent of GDP on an accrual basis). This is lower than the fiscal surplus of 0.5 percent of GDP (or 0.2 percent of GDP on an accrual basis) forecast in the 2000 01 Budget, reflecting the downward revision to the economic growth forecasts for 2000 01 and 2001 02, and new policy decisions. MONETARY POLICY The Reserve Bank of Australia has the primary responsibility for the conduct of monetary policy. The formal objectives of monetary policy require the Reserve Bank Board to conduct monetary policy in a way that will best contribute to currency stability, the maintenance of full employment, and the economic prosperity and welfare of the people of Australia. Price stability is regarded as a critical element in achieving these objectives. In pursuing the goal of medium-term price stability, the Reserve Bank of Australia has adopted, with agreement from the Treasurer, the objective of keeping underlying inflation between 2 and 3 percent, on average, over the cycle. In pursuit of this objective, the Reserve Bank of Australia targets a publicly announced overnight cash rate that is determined by the Reserve Bank Board. The Reserve Bank Board does not target intermediate financial aggregates. In response to emerging inflationary pressures, the Reserve Bank of Australia tightened monetary policy by 125 basis points taking the target cash rate to 6 percent between February and August 2000. The Reserve Bank of Australia had earlier increased the cash rate by 25 basis points in November 1999. By the end of April 2001, the Reserve Bank of Australia had reduced the cash rate by 125 basis points. MEDIUM-TERM OUTLOOK Economic growth in Australia in 2001 02 is forecast to rebound quite strongly, having slowed sharply in the second half of 2000, driven by a turnaround in residential construction. The stronger growth in 2001 02 is expected to be accompanied by declining inflation.

In 2001 02, economic growth in Australia is forecast to be around 3.25 percent in year-average terms and a strong 4 percent through the year to the June quarter 2002. Residential construction is expected to contribute strongly to growth in 2001 02, with moderate growth in household consumption, business investment, and net exports. Average unemployment rates are forecast to be slightly higher than recent levels, with inflation declining and the current account deficit well below its average of the 1990s. Given the weakness in the second half of 2000 and subdued growth expected in the first half of 2001, economic growth is now expected to be around 2 percent in 2000-01 in year-average terms, and around 1 percent in through-the-year terms. Despite the slower world growth expected in 2001, net exports are estimated to contribute strongly to overall economic growth in Australia in 2000 01, with a further modest positive contribution expected in 2001 02. The exchange rate has helped boost the competitiveness of many of Australia s export and import competing industries. Australia s current account deficit (CAD) is forecast to be around 3 percent of GDP in both 2000 01 and 2001 02. At these forecast levels, the CAD will be down markedly from 5.3 percent of GDP in 1999 2000 and well below its 1990s average. In addition to reflecting the stronger balance of trade, the lower CAD also reflects a decline in the net income deficit in response to lower world and domestic interest rates and reduced margins between Australian and world investment returns. Domestic demand is forecast to grow at a moderate rate of around 3 percent in 2001 02, compared with less than 1 percent in 2000 01. Residential construction is expected to grow by around 5 percent in year-average terms in 2001 02, following a marked decline of around 25 percent in 2000 01, with the turnaround supported by recent reductions in interest rates and the Government s more generous First Home Owners Scheme. The recovery in this sector is expected to gather strength as 2001 02 proceeds, with through-the-year growth of around 14 percent. Modest growth is also expected to resume in non-residential construction, particularly in engineering construction, following several years of decline since the recent peak in 1998 99. Household consumption expenditure is forecast to increase by around 3 percent in 2001 02, a little faster than in 2000 01 but well below the very rapid growth experienced in the latter part of the 1990s (which was buoyed by strong growth in asset prices and household wealth). Household consumption will be supported by lower interest rates and a forecast gradual easing in fuel prices. Employment growth in 2001 02 is expected to be slower than in recent years but to grow at around 1 percent in year-average terms, and around 1.5 percent through the year. This largely reflects the lagged effects of slower overall economic growth in 2000 01, particularly the downturn in the labour-intensive construction sector. The unemployment rate is expected to increase slightly, to average around 7 percent in 2001 02. This follows a period of declining unemployment which reduced the unemployment rate to near-decade lows. Prospects are sound for a resumption in the downward trend in unemployment over

the medium term as the construction sector recovers and overall economic growth strengthens. Inflation is forecast to decline in 2001 02, with the headline CPI rising by around 2 percent in both year-average and through-the-year terms. The abolition of Financial Institutions Duty and other elements of TNTS will put downward pressure on consumer prices in 2001 02 of between 0.25 and 0.5 percentage points. The forecasts also incorporate an allowance for a slight easing in fuel prices in line with an expected downward trend in world oil prices. Wages growth is expected to remain moderate, at around 3.75 percent, helping to ensure that growth in labour costs remains well contained. The inflation forecasts also make an allowance for some impact on consumer prices of the decline in the Australian dollar over recent quarters. Ongoing inflation, that is, inflation excluding the impact of TNTS, is expected to be around 2.25 percent in the year to the June quarter 2002. POLICIES, STRATEGIES AND ADJUSTMENT MEASURES One of the major reforms undertaken in 2000 was the re-structuring of Australia s taxation system. On 1 July 2000 The New Tax System came into effect. This package reformed income tax, indirect tax, family assistance, business tax and Commonwealth-State financial relations. Key elements of TNTS included the abolition of a multi-rate wholesale sales tax (WST) and the introduction of a broad-based 10 percent goods and services tax (GST). Australia has entered the 21 st Century with an efficient and modern taxation system that will aid long-term economic growth. Prior to tax reform WST was a hidden tax applied at a number of rates to a narrow range of goods, thereby creating distortions and inefficiencies within the economy. Unlike the WST, which was a cascading tax, the GST is only applied to goods and services entering final consumption. Because it is only levied once and at a uniform rate across most goods and services, it removes unwarranted distortions of relative prices that were a feature of previous indirect taxes. As such it will promote the efficient allocation of resources within the economy. All revenues collected from the GST are transferred to the States and Territories to aid them in funding their own expenditures. As the GST is a broad-based tax with a secure revenue base, it will provide a growing source of revenue to State and Territory governments. This will go some way toward addressing vertical fiscal imbalance and should reduce State and Territory reliance upon revenues from inefficient, narrowly based indirect taxes. The increased indirect tax burden that results from the GST has been more than offset by substantial reductions in personal income tax. Personal income tax cuts worth $12 billion per annum have been implemented; this constitutes around one-fifth of the Commonwealth s individual income tax revenues prior to the reforms. These measures are expected to more than compensate taxpayers for the introduction of the GST; consequently they will experience a reduced tax burden.

Further, those in receipt of government income assistance have had their benefits increased to take into account the GST price effects. All pensions and allowances were increased by 4 percent; this includes a real increase of 2 percent. Other elements of TNTS include improvements to the administration of the taxation system, which will make the collection of taxes simpler and less costly. A comprehensive Pay-As-You-Go system, which replaces a number of separate payment systems, was introduced for income tax instalments. In addition, the reforms introduced the Australian Business Number system, which will facilitate the collection of tax and reduce the capacity to evade tax. The company tax rate is also being progressively reduced to make Australia a more attractive place to invest and conduct business. A cut in the company tax rate from 36 percent to 34 percent has been instituted, and a further cut to 30 percent took effect from 1 July 2001. In addition to tax reform the Federal Government has made a strong commitment to developing Australia s research and development capacity. On 29 January 2001 the Prime Minister launched the Government s Innovation Action Plan Backing Australia s Ability. Over the next five years this programme will commit $3.0 billion of Government resources to aid research and development through the provision of tax concessions, research grants, investment in research infrastructure, and additional university places. The broader economic reforms that have taken place in recent years will facilitate the effectiveness of these programmes. Annex I AUSTRALIA: OVERALL ECONOMIC PERFORMANCE 1995 1996 1997 1998 1999 2000 GDP and Major Components (percent change from previous year, except as noted) Nominal GDP (level in billion US$) 363.7 407.4 407.1 364.2 395.3 381.0 Real GDP 4.4 3.7 3.8 5.6 4.7 3.8 Consumption 4.6 3.1 3.4 4.5 5.1 3.8 Private Consumption 5.0 3.3 3.9 4.6 5.2 3.4 Government Consumption 3.6 2.6 1.6 4.0 4.8 4.9 Investment 4.0 5.1 10.8 6.6 6.2 1.3

Private Investment 4.8 6.5 13.8 10.6 5.1 0.5 Government Investment 1.2 0.3 0.4-8.1 14.5 4.6 Exports of Goods and Services 5.1 10.6 11.5-0.3 4.5 10.2 Imports of Goods and Services 8.1 8.2 10.3 5.9 9.3 7.3 Fiscal and External Balances (percent of GDP) Budget Balance (financial year) -2.8-2.0-1.0 0.2 0.7 2.0 Merchandise Trade Balance -1.0-0.6 0.4-1.8-2.6-2.5 Current Account Balance -5.4-3.9-3.1-5.0-5.8-4.0 Capital Account Balance 0.2 0.2 0.2 0.2 0.2 0.2 Economic Indicators (percent change from previous year, except as noted) GDP Deflator 1.8 2.1 1.3 0.3 0.9 3.2 CPI 4.6 2.6 0.3 0.9 1.5 4.5 M3 7.4 9.1 9.0 6.3 9.1 7.1 90-Day Bank Accepted Bill 7.7 7.2 5.4 5.0 5.0 6.2 Real Effective Exchange Rate (level, 1997=100)* 92.3 101.0 100.0 91.5 91.8 87.3 Unemployment Rate (percent) 8.2 8.2 8.2 7.7 7.0 6.3 Population (millions) 18.1 18.3 18.6 18.8 19.0 19.2 * Source: OECD Main Economic Indicators. Annex II AUSTRALIA: FORECAST SUMMARY (percent change from previous year) 2001 2002 Official * IMF Link OECD Official * IMF Link OECD Real GDP 2 2.3 0.8 2.0 3? 3.8 2.8 3.8

Exports Imports CPI 6 N.A. 2.0 7.0 5 N.A. 5.0 7.1 0 N.A. 2.8 3.7 4 N.A. 4.1 7.5 6 4.2 4.6 ** 3.0 ** 2 2.0 3.6 ** 2.3 ** Notes: * Official forecasts are given on a financial year basis (i.e., July to June). ** Private consumption deflator. N.A. Not available. Sources: IMF forecasts, The World Economic Outlook Database (September 2001). LINK forecasts, Project LINK World Economic Outlook (April 2001). OECD forecasts, OECD Economic Outlook (June 2001). Annex III AUSTRALIA: MEDIUM-TERM TREND FORECAST (percent) 2002 03 Real GDP 3.5 CPI* 2.5 Note: * The Consumer Price Index (CPI) projections are set as the mid-point of the medium-term inflation target and as such make no allowance for any further impact of The New Tax System. Source: http://www.apecsec.org.sg/ 2002