The Australian economy continued to perform strongly in 1999, and is entering its ninth calendar year of uninterrupted positive growth. The strong economic growth in 1999 was accompanied by solid gains in employment and continued low inflation.

GROSS DOMESTIC PRODUCT

Real GDP increased by 4.4 percent in 1999 following a growth of 5.2 percent in 1998. Growth has been consistently strong, with Australia recording its 11th consecutive quarter of through-the-year growth in the fourth quarter of 1999 at more than 4 percent.

Business investment rose by a 0.2 percent in 1999, representing a relatively flat level that reflected the maturity of the investment cycle after seven years of uninterrupted growth, with Olympics-related construction nearing completion and uncertainty in the resources sector caused by low commodity prices.

Following two years of strong growth, dwelling investment increased by 5.4 percent in 1999, reflecting continuing high levels of affordability, moderately supportive demographic factors and ongoing expenditure on alterations and additions.

Private consumption rose from 4.1 percent in 1998 to 4.6 percent in 1999, the growth of which is likely to have reflected the effects of low interest rates, solid employment growth and rising household wealth.

INFLATION

Robust productivity growth, moderate wages increase, heightened competitive pressures and a rise in the value of the Australian dollar all contributed to an exceptionally good inflation performance in 1999, with the consumer price index (CPI) rising by 1.8 percent through the year in the last quarter of 1999 (and by 1.5 percent in year average terms).

EMPLOYMENT

Employment grew by 2.9 percent in 1999, with the unemployment rate continuing to fall and reaching 7.0 percent by December 1999.

Wages, as measured by average weekly ordinary-time earnings for full-time adults, rose by 3.0 percent through the year up to December 1999 but the average weekly earnings (all employees) grew by a mere 1.6 percent in the same period.

CURRENT ACCOUNT

The current account deficit increased from 5.0 percent of GDP in 1998 to 5.7 percent of GDP in 1999 at A$34.9 billion. This reflected a fall in the balance of trade despite moderate export growth, a slight fall in the terms of trade (after a significant fall in 1998) as well as a continued strength in imports given strong domestic demand. Export demand remained subdued until the second half of 1999 with Australian exports directed mostly away from East Asian economies and toward faster-growing economies. This trend, however, appeared to have changed as the East Asian economies started to recover from the financial crisis by late 1998.

In the meantime, while the current account deficit rose as a percentage of GDP in 1999, the net income deficit remained stable at 3.0 percent of GDP.

FOREIGN INVESTMENT

Net foreign debt was 39.8 percent of GDP (or US$159.5 billion) at the end of December 1999, below the peak of 41.9 percent at the end of September 1998. By end of December 1999, the public sector accounted for approximately 11 percent of this total, with the remaining 89 percent owed by private sector borrowers. The build-up in foreign debt is a result of ongoing current account deficits reflecting a structural saving-investment imbalance. The Government¡¯s medium-term fiscal strategy of achieving fiscal balance on average over the course of the economic cycle is directed at addressing the issue of unsustainable government borrowing, one of the underlying contributors to continuing current account deficits.

Gross foreign debt was 61.3 percent of GDP (or US$245.4 billion) at the end of December 1999 while foreign direct investment in Australia was 29.6 percent of GDP (or US$118.6 billion) in the same period.

EXCHANGE RATE

Since 1983, Australia has had a floating exchange rate. The Reserve Bank may undertake foreign exchange market operations when the market threatens to become excessively volatile or when the exchange rate has clearly ¡®overshot¡¯ a level consistent 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.

The Australian dollar appreciated (in nominal terms) by 2.5 percent against the US dollar and depreciated by 10.7 percent against the Japanese yen in 1999. On a trade-weighted basis, the Australian dollar depreciated by around 0.9 percent in 1999, with falls against most major currencies, including those of Australia¡¯s Asian (non-Japan) trading partners.

FISCAL POLICY

Total general government net lending returned to surplus on a cash basis in the 1997-98 financial year and has remained so 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 2000-01, the Commonwealth Government is expecting to achieve a fiscal surplus of 0.8 percent of GDP on an accrual basis (0.4 percent of GDP on an underlying cash basis). This is lower than the fiscal surplus of 1.5 percent of GDP (1.2 percent of GDP on an underlying cash basis) expected to be achieved in 1999-2000, reflecting the budgetary cost of the major taxation reform package to be introduced in the coming year.

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 price (currency) stability, the maintenance of full employment, and the economic prosperity and welfare of the people of Australia. Price stability is regarded as a precondition for achieving the last two objectives and in pursuit of this goal, the Reserve Bank has agreed to a commitment with the government to hold inflation to between 2 and 3 percent over the cycle.

To fulfill this commitment, the Reserve Bank targets a publicly announced overnight cash rate (the intermediate objective) determined by the Reserve Bank Board. The Reserve Bank Board does not target intermediate financial aggregates.

The most recent interest rate cycle troughed at 4.75 percent in December 1998, with rates held steady at this level until November 1999. At this time, the Reserve Bank acted pre-emptively against inflationary pressures and tightened monetary policy by 25 basis points ¨C taking the target cash rate to 5 percent.

During calendar year 1999, real short-term interest rates (90-day bank bills adjusted for underlying inflation) rose by around 45 basis points, to end the year at around 3? percent. This reflected an increase in nominal short-term yields of almost 90 points (partly attributable to the official interest rate rise) and a modest rise in inflation. Real long-term bond rates (10-year bonds adjusted for underlying inflation) rose by some 120 basis points to end the year at around 4? percent, mainly reflecting an increase in nominal rates of around 160 points over the year.

MEDIUM-TERM OUTLOOK

The outlook for the Australian economy remains bright as it expects to experience a continued solid growth and relatively low inflation.

However, following a very strong economic growth over the past few years, growth is expected to be more moderate, from around 4? percent in 1999-2000 to 3? percent in 2000-01.

A significant rebalancing of the components of growth underpins the moderation in growth expected in 2000-01. Domestic demand is expected to grow at a slower pace than in recent years, reflecting a subdued consumption growth (as wealth effects from house price and share price movements stabilise), an unwinding of a net bring-forward of expenditure ahead of The New Tax System, and the impact of recent increases in interest rates (since November 1999, there have been four subsequent rises in the target cash rate, bringing it to 6.25 percent by August 2000).

Partly offsetting the slowing in some elements of domestic demand will be the stronger growth in business investment and a significant strengthening in exports. Increased business investment will be supported by the beneficial impact of The New Tax System on the price of investment goods and business costs, a stronger outlook for the world economy and relatively high levels of capacity utilisation. Faster world economic growth, combined with some moderation in domestic demand and a boost to services exports from the Olympics, will result in net exports making a positive contribution to growth in 2000-01. The overall decline in the Australian exchange rate during the course of 1999-2000 will also contribute to a stronger net export performance in 2000-01.

The current account deficit (CAD) is forecast to average 4? percent of GDP in 2000-01, down from 5? percent of GDP in 1999-2000. The expected decline in the CAD reflects the impact on net export volumes and the terms of trade of the stronger world economy, along with some moderation in the rate of growth of domestic demand.

Employment growth is forecast to remain robust at 2? percent in 2000-01, following a growth of around 2? percent in 1999-2000. The unemployment rate is expected to fall further, reaching 6? percent by the 2nd quarter of 2001.

Inflation is expected to be around 2? percent in year-average terms in 1999-2000. The slight increase from the very low outcomes of previous years mainly reflects the impact of higher world oil prices over calendar year 1999 and in the early months of 2000. In 2000-01, ongoing inflation (that is, leaving aside the impact on prices of the changes in indirect taxes) is forecast to be around 2? percent until the 2nd quarter of 2001.

Taking together the estimate of ongoing inflation and the impact of The New Tax System on prices, the CPI is forecast to rise by around 5? percent through the year up to the 2nd quarter of 2001. Households will be more than compensated for the one-off price impact of indirect tax reform via income tax cuts and increases in welfare payments. The changes to indirect tax arrangements are therefore not expected to have any significant impact on wage settlements or ongoing inflationary pressure.

POLICIES, STRATEGIES AND ADJUSTMENT MEASURES

To be sure, Australia¡¯s ability to ¡®weather the (Asian financial crisis) storm¡¯ was the result of the sound macroeconomic policies and structural reforms that have been gradually put in place over time rather than an element of luck. The key aspects of Australia¡¯s reform process, which supported the economy through the crisis, include:

• The credibility of Australia¡¯s fiscal policy has been improved by the adoption of a clearly articulated and demonstrated medium-term framework¨Cto achieve underlying balance, on average, over the economic cycle¨Cin addition to the legislated Charter of Budget Honesty. Consistent with this objective, the budget is forecast to remain in surplus, the fourth surplus in a row. This outcome has been achieved while delivering landmark tax reform, including income tax cuts, and a range of high priority spending initiatives.

• The Government has also strongly supported the Reserve Bank¡¯s low inflation target and its independence in setting monetary policy. Monetary policy credibility, together with a more competitive Australian economy, has kept inflation low despite the significant decline in the Australian dollar that accompanied the crisis in Asia.

• During the period of considerable uncertainty in the regional financial markets, the stability, integrity and efficiency of the Australian financial sector was critical to the performance of the economy. Recent reforms, including those that are being implemented through the Wallis Inquiry and the Corporate Law Reform Program, are aimed at maintaining a sound regulatory foundation for well-functioning markets, without compromising efficiency or consumer protection.

• Ongoing structural reforms, including those in labour and financial markets, have produced a more flexible and productive economy capable of responding to the Asian crisis. This improved flexibility was demonstrated by the capacity of Australian exporters to diversify their sales outside of the major export markets in Asia to other more strongly growing economies during the Asian crisis.

This policy framework was fundamental to the economy¡¯s resilience against the backdrop of the Asian financial crisis. It allowed foreign investors¡¯ confidence in Australia to be maintained, facilitating an orderly depreciation of the dollar and allowing interest rates to remain low.

One major lesson stemming from the Asian crisis is the importance of sound macroeconomic policies and ongoing structural reforms. In view of this, Australia is pushing ahead with a range of reforms even as it had enjoyed very good economic outcomes in recent years. These reforms include:

• Through the historic the New Tax System legislation passed in June 1999 and announced business tax reforms, the Government is reforming the tax system to make it fairer and simpler. The reform of Australia¡¯s taxation system will contribute to raising the economy¡¯s growth potential through more efficient resource allocation and better incentives. The existing tax system is a significant impediment to improving Australia¡¯s economic position. The GST package will thus significantly lower income tax rates, thereby improving incentives to work and save. The Wholesale Sales Tax system will be replaced with a tax regime that reduces business costs and encourages productive investment.

Business tax reform will be directed at achieving a taxation system that reduces distortions to business decisions and provides a competitive regime for attracting international investment. Overall reform of the tax system will contribute to raising the economy¡¯s growth potential through improved resource allocation and providing better incentives.

• Continuing reform of the labour market. Despite recent falls in the unemployment rate, Australia is continuing to reduce the barriers to job creation and active participation in employment.

AUSTRALIA: OVERALL ECONOMIC PERFORMANCE