IMF warns Australia to cut spending as rate hike looms, downgrades growth forecast

The International Monetary Fund has a straightforward message for Australia: governments need to spend less money. The warning arrived this week in a formal statement following the fund's annual review of the Australian economy, and it comes with a darker forecast attached. The IMF has trimmed its prediction for economic growth in 2027 down to 1.6 percent, a cut of 0.1 percentage points from its previous estimate. The reason, the fund says, is a rising likelihood that the Reserve Bank will need to push interest rates higher still in its struggle to bring inflation under control.

Inflation remains the central problem. The IMF's statement names it plainly: price pressures are not yet beaten, and weak productivity growth is dragging on the economy's potential. There is a particular worry about global energy costs. Brent crude oil has climbed above $108 a barrel this week, a 35 percent jump since early August, driven by deteriorating conditions in the Middle East. Financial markets are now pricing in an 80 percent chance that the Reserve Bank will raise rates on September 29. If energy prices keep climbing, the IMF warns, those costs could spill into domestic inflation expectations, forcing the central bank to tighten monetary policy even further.

This assessment lands at a difficult moment for Jim Chalmers, the treasurer, who is already working to convince Australians that living standards are improving and prosperity is within reach. The IMF's message undercuts that narrative. The fund did offer some praise for the government's recent budget changes to investor taxes, which Paulo Medas, the IMF's mission chief, described as creating a more balanced set of incentives. The previous tax settings, including negative gearing, had encouraged people to borrow more heavily and invest in housing, adding to price pressures. The new approach, Medas suggested, might redirect investment toward other parts of the economy and help with the housing affordability crisis. But the IMF also noted that falling house prices have done little to solve the underlying problem of unaffordable homes, and it called on both state and federal governments to do more to increase housing supply.

The real fiscal problem, though, is broader. The combined deficit of federal and state governments has widened over the past two years as states spent heavily on infrastructure and social services, particularly healthcare and the national disability insurance scheme. Governments also committed taxpayer money to cushioning the initial shock of rising global energy prices, most notably through cuts to the fuel excise. The result is visible in state balance sheets. New South Wales and Queensland are now spending more than twice as much on debt interest as they did before the pandemic, according to analysis by Challenger. While the IMF acknowledges that Australia's overall public debt remains relatively low compared to other advanced economies, it has flagged the rising debts and interest costs in state governments as a concern that demands attention.

The fund's core recommendation is that restraining government spending, even amid strong private demand, would help the Reserve Bank's efforts to bring inflation down. But there is a longer-term structural problem beneath these immediate pressures. Poor productivity growth is, in the IMF's assessment, Australia's key structural challenge. Reversing the slowdown of recent years will be crucial to improving living standards and making both public and private debt obligations sustainable over the long run. The government is preparing to release its latest intergenerational report on Monday, which is expected to paint a challenging picture of Australia's economy and budget over the decades ahead.