IMF cautions Australia against austerity policies

SYDNEY Wed Feb 12, 2014 8:00am EST

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SYDNEY Feb 13 (Reuters) - The IMF has cautioned Australian policymakers against embracing fiscal austerity in the short term for fear of undermining growth at a time when the economy is getting over the hump of a long mining boom.

A report released on Thursday by the International Monetary Fund's executive board warned that the Liberal-National coalition government's plans for fiscal tightening should be carried out "without undue prejudice to growth".

The coalition government has foreshadowed that tough spending cuts would be needed in its annual budget in May to make up for a shortfall in revenue.

The IMF forecast economic growth would pick up only slightly to 2.6 percent this year from a projected 2.5 percent in 2013.

"Staff supported the broad aim of improving the budget position over the medium term...but cautioned that it should be done in a way that does not disrupt growth prospects in the near term," the report said.

The IMF has changed its tune on budget austerity in recent years, conceding that fiscal tightening had done more damage than it expected, especially in Europe.

The Fund noted that while Australia had outperformed many advanced economies in recent years, it was vulnerable now that a long boom in mining investment had peaked and as the local currency was "modestly overvalued" in real terms.

"With growth currently on the soft side, the real exchange rate still strong and efforts to reduce the budget deficit likely, monetary policy should remain accommodative and act as the primary macroeconomic tool for managing aggregate demand in the near term," the report concluded.

The Reserve Bank of Australia (RBA) recently signalled that interest rates were likely to stay at an historic low of 2.5 percent for some time amid signs of a recovery in housing and consumption and a pick-up in inflation.

A revival in home building would help support the economy in the short term, but it had also come with an acceleration in home prices. After a couple of years of softness, prices rose almost 10 percent over 2013.

"There is a risk that rapid house price growth could give rise to expectations-driven, self-reinforcing demand dynamics and price overshooting, and the authorities would need to be prepared to take preventative actions," the IMF said.

Then again, Australia's framework of intense and proactive supervision would limit the impact of swings in home prices on the financial system as a whole, the report noted. (Reporting by Wayne Cole; Editing by Eric Meijer)

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