Keep lifting rates and tighten budget spending, says IMF

The International Monetary Fund has urged the Reserve Bank to keep lifting interest rates to stop high inflation from becoming entrenched while calling on the federal government to embrace major tax reform to help cover the costs of increasingly expensive programs such as the NDIS.

In a report on the economy released this morning, the IMF said it was likely Australia would avoid recession but housing prices were on track to fall “significantly” with the chance their current rate of decline would accelerate.

The IMF has urged the Reserve Bank to keep lifting interest rates to prevent inflation becoming entrenched in the economy.Credit: Mark Baker/AP

The Reserve Bank is in the midst of its most aggressive tightening of monetary policy since 1994, lifting official interest rates from 0.1 per cent to 2.85 per cent since May. Markets expect another rate rise at the RBA’s December meeting with the cash rate tipped to reach 3.6 per cent by the middle of 2023.

The fund said the Australian economy had been among the strongest in the developed world, but growth would likely slow next year to about 1.7 per cent because of global and local headwinds.

Despite the slowdown, the IMF said the Reserve needed to keep lifting interest rates while the federal government needed to bring down the size of the budget deficit which is expected to increase from $36.9 billion this year to $44 billion in 2023-24.

“Continued monetary and fiscal policy tightening is needed to rebalance domestic demand and keep inflation expectations well anchored,” it said.

“The RBA should continue to raise interest rates, and fiscal policy should support it in moderating domestic demand growth through judicious budget execution and saving of any revenue over-performance.

“Risks to the outlook are pointing firmly to the downside amid significant uncertainty. In (our) staff’s baseline scenario, Australia is expected to steer clear of a recession, but with significant downside risks.”

The fund said if inflation and wage pressures lifted or persisted for longer than expected, the RBA may need to take interest rates even higher.

It said one issue was the housing market, urging governments to look at ways to boost supply to help alleviate ongoing affordability problems.

“Amid rising interest rates, high inflation, and increasing housing supply, the earlier surge in housing prices has reversed, and housing prices are expected to continue declining significantly,” it said.

“Yet, affordability concerns are increasing given strongly rising rents and lower borrowing capacity amid much higher mortgage rates.

“A strong focus on boosting housing supply remains essential, supported by well-targeted support for lower-income households.”

In the October federal budget, Treasurer Jim Chalmers warned of large, ongoing financial pressures due to the surging cost of programs including the NDIS, aged care, health and defence.

The IMF backed Chalmers’ decision to save almost all of the extra revenue that flowed into the budget due to high commodity prices and the stronger economy. It also said reviews of programs such as the NDIS were a step towards reducing their impact on the budget.

But it said new specialist funds, including the National Reconstruction Fund, the government’s Rewiring the Nation program and the Housing Australia Future Fund, should be phased in “judiciously” to avoid adding inflationary pressures to the economy.

The fund said major tax reform needed to be on the government’s agenda so it could lift economic growth and take pressure off the budget.

“Tax reform could strengthen economic efficiency and public revenue. This should include a transition from currently high direct taxes to underutilised indirect taxes, with the regressive impacts mitigated by targeted cash transfers to vulnerable households,” it said.

“Longstanding recommendations include broadening the goods and services tax (GST) base to limit exemptions for healthcare spending, and restricting the capital gains tax exemption for the sale of main residences.”

The IMF noted the stage three personal income tax cuts, which start in mid-2024 and favour high income earners, should not be the only reform.

Rather, tax brackets should be increased “periodically” as this would help to reduce the impact on low income earners and women.

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