The federal government and Reserve Bank should stand ready to provide further stimulus to support the economy, the International Monetary Fund says.
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In its annual report on Australia, the IMF warns the risks to the economic outlook are tilted to the downside with subdued domestic confidence, heightened global policy uncertainty and a potential faster slowdown in China.
"If downside risks materialise, stronger fiscal and monetary stimulus would be warranted," the Washington-based institution said in the report released on Friday.
The warning comes just days out from Treasurer Josh Frydenberg handing down his mid-year budget review.
Economists doubt the government is about to loosen the federal purse strings, with its focus remaining on returning a budget surplus.
The IMF said while economic growth has gradually improved from the lows in the second half of 2018, it has remained below potential.
Following growth of about 1.8 per cent in 2019, the IMF expects the economy to expand by 2.2 per cent in 2020.
Economists put Australia's long-term trend rate at around 2.75 per cent.
"With below-potential growth, weakening inflation expectations and continued downsides risks, the macroeconomic policy mix should remain accommodative," the IMF said.
The Reserve Bank has cut the cash rate three times this year to a record low 0.75 per cent, with financial markets predicting a possible further reduction in February and after its board's summer recess.
The IMF noted the drought has been a drag on economic growth. Wage growth has remained sluggish and inflation remains below the Reserve Bank's two-to-three per cent inflation target band.
It expects inflation will likely stay below target until 2021.
It says Australia has "substantial fiscal space" it can use if needed.
"Commonwealth and state governments should be prepared to enact temporary measures such as buttressing infrastructure spending, including maintenance, and introducing tax breaks for SMEs, bonuses for retraining and education, or cash transfers to households," it said.
If stimulus is required, budget repair should be delayed and unconventional monetary policy measures such as quantitative easing may also become necessary as the cash rate is already close to the effective lower bound, it added.
Australian Associated Press
