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Speech to the Australian Bankers Association, Sydney

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COMMONWEALTH P ARLIAMENTARY LIBRARYMICAH••n ••••• nn •n ••n•••• nn •• n • n •• n •.....ft

It is a pleasure to be here tonight.

It seems to have become something of a tradition for the Treasurer of the day to address your annual dinner

this is a tradition I am more than happy to be able to continue.

A year ago, when my predecessor spoke to you, he did so against the background of an incipient but still patchy economic recovery.

In the intervening year the economic situation has changed dramatically.

The incipient recovery has become an unambiguously strong recovery with growth of 3 1/2 per cent over the last two quarters and 5 % growth over the year to the March Quarter. Even allowing for some special factors in these numbers, the underlying trend rate of 4.3% over the past year gives us a growth rate at the pinnacle of the OECD scale.

Concern about job-less growth has also substantially abated. Employment growth of 230 000 over the past year and the fall in the employment rate from 10.8% to 9.8% have restored confidence in our capacity to return to a substantial job growth path and to make headway against high unemployment.

In the face of these outcomes our resident doomsayers, such as the Federal Opposition, have changed their tune from predicting a double dip recession to dire warnings of boom and bust. This is despite the fact that the element usually associated with such a phenomenon, substantial or high inflation, is conspicuously absent.

In fact, inflation has now been below 21/2 per cent for almost 3 years and is currently 1.4 per cent - hardly evidence of a 'boom-bust' cycle!

Fiscal policy was tightened significantly in last year's budget, and we have since accelerated the medium term deficit reduction strategy, with the Budget deficit now forecast to fall to below 1% of GDP by 1996-97, from a peak of 3.6% of GDP in 1992-93.

This however has not satisfied some critics who have called for a faster rate of deficit reduction.

Such comments ignore the fact that Australia's fiscal policy is in far better shape than that of most other OECD countries. A recent National Australia Bank publication showed that of 17 countries for whom data are available only 4 will have a lower deficit as a proportion of GDP than Australia in 1994. For those with larger deficits the range is from 4.4% of GDP to 12.5%!



For those countries that have announced a Deficit Reduction Program (effectively Australia and the G7 minus Japan), only Australia is expecting to reduce its deficit to below 1% of GDP by 1996-97.

And the size of the planned fiscal consolidation will go a long way towards facilitating the increase in business investment that will ultimately be required to underpin sustained growth.

Because new housing investment is likely to be coming off in this period, and non-residential construction investment is unlikely to grow to the extent seen in past cycles, much of the fiscal consolidation will be available to fund the necessary lift in plant and equipment spending.

In other words, the fundamental saving and investment forces which bear on the current account balance - and the cost of finance - are likely to be much more benign than in past recoveries.

Financial markets have also changed significantly over this year. Starting around last October in some. countries, long term bond rates have been edging up around the world, a process which gained real momentum after US official rates started increasing last February, and has moved in startling fashion in the last couple of weeks.

The broad "rational" expectation for all this is that the markets are fearful of rising inflation following some signs of increasing inflation in the US, signs of an improved outlook for some European countries and Japan, and rising world commodity prices.

Apparently pursuing the simplistic logic that increased growth means more inflation, any sign of strengthening activity has been taken to be an omen of increased inflation, and therefore higher interest rates.

Thus, good news becomes bad news! No sooner did we reach the point where we had clearly moved to strong growth than the money markets started seeing adversity in each announcement of more prima-facie "good news"!

The possibility that "good news" might really be just that seems not to have dawned.

It is worth recalling in this context that Australia has, in its not too distant past, been able to achieve prolonged periods of high economic and employment growth with low inflation. Following the recession at the beginning of the 1960s, our annual growth for the rest of that decade averaged 6 per cent, while inflation averaged only 2 1/2 per cent.

So strong growth does not necessarily mean we must forego low inflation.



Indeed, if we are now to have a sustained period of high economic and employment growth it is essential that we are able to keep our inflation at around the level of our major trading partners. Not to do so would clearly lead to downward pressure on the

$A with consequent inflationary pressures and so require measures to substantially slow the growth - as was the case in the late 1980s.

The Government is therefore determined to keep inflation under control. As the Governor of the Reserve Bank has said, the aim should be to keep the underlying rate of inflation around 2-3% over the cycle.

Notwithstanding financial markets' current preoccupation with inflationary shadows, it is worth emphasising that the available evidence does not support such fears.

On the costs side, right now, nominal unit labour costs are falling. Low nominal wage growth is being more than matched by productivity growth. Real unit labour costs are currently at similar levels to the late 1960s. Yet, workers are actually benefiting from real wage gains because they are sharing in part of the productivity growth.

So there are no obvious inflation forces in recent wages developments.

And fears of a future wage break-out ignore a number of important points.

Accord VII includes a commitment by the union movement to ensure wage claims are consistent with keeping Australia's inflation comparable with our trading partners;

Australia still has relatively high unemployment and over the 1980s, when unemployment was at comparable levels, inflation trended down; and

The outlook for wages continues to be subdued with the safety net wage rise being contingent upon attempting to bargain at the enterprise level first and with bargained rises increasingly linked to productivity.

With ongoing productivity growth we can have the best of both worlds, with rising real wages but little inflationary pressure and increasing international competitiveness.

Meanwhile, the continued strength of the exchange rate is acting to dilute any potential inflationary pressure from import prices

The trend in the exchange rate has been up since the end of last year and the risk of the $A falling significantly seems remote, given the outlook for commodity pnces.

This underscores, yet again, the strength of international confidence in Australia's economic fundamentals - and in the current policy mix.



On the demand side there is, presently, a reasonable degree of capacity slack in the economy and, while capacity utilisation is rising, there is no danger of hitting some capacity wall in the short term.

Moreover, the current low inflation is not merely a reflection of a lack of pressure on capacity and scarce resources

It is also tangible evidence of the success of the Government's structural reform efforts over the last decade.

Enterprise bargaining, broad based deregulation and the progressive opening up of the Australian economy to competitive pressures have combined to significantly improve the operation of domestic markets

It is no longer possible for producers to painlessly pass cost pressures onto the consumer

So it remains difficult to see the substance in the current market concerns.

To maintain low inflationary growth, it will be necessary to employ all arms of policy, as appropriate . In this regard we will continue to pursue a program of productivity enhancement through micro-economic reform. Contrary to the claims of some commentators, the Government has not dropped the ball on micro-economic reform.

It will vigorously pursue new reforms such as those contained in the Hilmer Report, to bring about an even more competitive economy. It will continue to pursue reform in areas where major advances have already been achieved such as telecommunications, the waterfront and shipping, Government Business Enterprises, aviation and rail freight services.

It will also continue to give high priority to reform of the labour market, by continuing to encourage and facilitate the move to enterprise bargaining, and by implementing the major reforms outlined in the Working Nation Statement which will do much to improve the motivation, job readiness and employability of the unemployed.

The Government is also prepared to adjust its macro-economic policies as the circumstances require.

The circumstances that would justify a tightening of policy would be where there are incipient signs of rising inflation. So far, there are no such signs. We must expect however that such signs will emerge as recovery becomes more robust.



Developments which may affect the inflation outlook and will therefore need to be monitored closely include:

• Wage agreements taking into account the duration of agreements and likely productivity offsets;

• Price increases and price setting behaviour by firms which of course continues to remain very competitive;

• Changes in inflation expectations; and

• Movements in the $A, which influence import prices and the ability of the traded goods sector to agree to wage increases not supported by productivity improvements. As I have said, the recent increase in the $A will of course help to put downward pressure on domestic prices.

In addition, a major factor in determining the likely course of inflation will be the behaviour of business investment. Too late a response by business to emerging capacity restraints could stimulate both inflationary pressures through shortage of

supply, and accelerated imports.

In the other - and in my view the much more likely - situation, a timely response by business to rising rates of capacity utilisation will put us on the virtuous cycle of enhancing growth, keeping inflation pressure at bay and minimising current account


The behaviour of business investment is therefore fundamental to our capacity to ensure a sustained period of high economic and employment growth.

In making their investment decisions, businesses should be fully aware that these are the choices they collectively will be making for the nation.

In doing so, they can be assured that the Government will act responsibly to keep inflation low. To do so, it will not shrink from tightening either monetary or fiscal policy, as appropriate, to achieve that objective.

On the other hand, we will not be pitchforked into it by money markets which are in very large part reacting to events outside Australia.

Rising inflationary pressures in the US, with its higher rates of capacity utilisation and markedly lower levels of unemployment than Australia, may well justify increased interest rates in that country, but it does not follow that Australia needs to follow

immediately on the heels of the US when it is in an earlier stage of its economic cycle.



We should, and will, do so when it is appropriate to our overall circumstances.

Furthermore, when interest rates do rise it should not be seen as action that is adverse to economic recovery, as the Opposition continually loudly proclaims.

Rather, it would be part of the necessary process of moderating economic activity in order to ensure that we are able to have a more prolonged period of substantial economic and employment growth than would otherwise be the case.

Those who assert any increase in interest rates at any time is bad news for Australia are essentially saying that the Government should put monetary policy permanently on ice. The naivety, stupidity, or plain dishonesty implicit in this position is quite extraordinary.

Nor should the community fear that any movement in. official rates heralds a return to the high interest rates of the late 1980s. The high levels of speculative activity which marked the latter years of the 1980s no longer exist and we will ensure that counterproductive inflationary pressures from such activity do not re-emerge.

With low inflation, and without a speculative 'bubble' to puncture, there is no prospect of our experiencing a re-run of monetary policy from the last economic cycle. Indeed, a timely response to genuine inflationary pressures is vital to minimising the extent of interest rate increases over the course of the cycle.

The fact is, Australia has not been so well placed to enjoy a substantial period of economic prosperity for a number of decades.

And the Government is determined to turn this hard-won potential into reality.

This is the environment in which the banking sector will need to operate

In the remainder of my comments, let me focus more specifically on banking policy issues.

The Government is committed to fostering a banking system which is, at the same time, both dynamic and secure.

The need for a stable and secure banking system has been recognised from the very earliest days of banking - and rightly so;

Australia's prudential supervision of the banking system is of the highest order and we can be justly proud of our record in this area.



However, this evening I want to concentrate on the other side of the equation: the need for a dynamic, innovative and forward looking banking sector.

this has really only come into prominence in the last decade or so;

but, increasingly, this objective is being recognised as every bit as important as stability.

The Government has sought to foster a more dynamic and efficient banking sector through financial deregulation and through foreign bank entry, both of which have greatly increased the level of competition in the banking industry

and in the financial sector more generally.

There is, I think, considerable evidence that the Australian banking system is now more competitive than ever before;

certainly, I am constantly being told this by industry participants.

As in other areas of the economy, heightened competition in the banking sector brings real benefits:

— banks are forced to find new and more efficient ways of conducting their business;

— clients have access to higher standards of service and more flexible forms of financing;

— depositors receive higher returns on their savings; and

— the cost of finance to borrowers is lower.

The Banking Policy Statement released by my predecessor a year ago highlighted several issues which the Government considered to be of importance to continuing this process of transformation.

and considerable progress has since been made on a number of these.

The Statement clarified the prudential supervision and taxation arrangements relevant to the implementation of the One Nation announcement regarding foreign bank branch operations in Australia.

We have since seen a number of foreign banks applying to operate in Australia on a branch basis:

eight branch banking authorities have been issued to date and a considerable number of further authorities are expected to be issued over the next year or so.


The Government welcomes this development and believes it will continue to enhance

the efficiency and dynamism of the banking sector.

Another area highlighted in the Statement, in which we have since seen considerable progress, is the area of consumer relations.

This is an area where the banks' record has not always been a happy one.

Finalisation of the drafting of the ABA's Code of Banking Practice late last year therefore represented a substantial milestone

not only in respect of the provisions of the Code itself but also because it represented formal recognition by the industry of the importance of improved consumer relations

and represented the fulfilment of a significant Government commitment in response to the report of the Martin Inquiry.

I am confident that the Code, and the change in attitude of which it is a part, will see a substantial improvement in bank/customer relations in future.

The Government recognises that it will not be possible to implement the Code fully before the proposed uniform State credit legislation and related regulations are settled:

Nonetheless, there are significant parts of the Code which are not directly affected by the credit legislation.

In this context, I welcome the recent commitment by your Association that banks will act consistently with these sections of the Code by the end of 1994 and that industry is committed to adopting the full code at the earliest opportunity.

I also note your Association's judgement that it will take a minimum of 12 months from the time the credit legislation and regulations are finalised, to implement both these requirements and the Banking Code.

I accept the need for some lead time, but at the same time I urge you to press toward full implementation of the Code as quickly as possible.

As I think you recognise, such an approach is in the best interests of both the industry and consumers.

One further word on consumer matters: having negotiated the Code, I urge the industry not to be tempted to rest on its laurels.

I would hope that competitive forces will continue to promote further improvements in banks' relations with their customer.



I urge you to keep these issues under continuous review: meeting legitimate consumer interests must become an integral part of banking culture. As you know, the Government will also be reviewing the experience with the Code in due course, and will seek any improvements which prove necessary.

Recent financial results for the major banks, and for a number of the regional banks, have been encouraging:

bad debt expenses are down, operating costs are being reduced, profits are increasing, and capital ratios are at historically high levels.

All of this is very welcome and reflects the rewards for a lot of hard work by the banking industry over the past few years.

As reassuring as these results undoubtedly are to bank employees and shareholders, their real significance is that they mean that banks are now well placed to finance the growth in investment in prospect over the coming year.

As this audience is well aware, the bulk of banks' lending over the past two years has been for housing.

I recognise that business lending has been constrained in recent years by subdued demand, reflecting the level of economic activity, a process of corporate balance sheet repair following the experiences of the late 1980s and increased resort to direct financing by larger businesses.

But things are changing and it is now time to shift the focus more towards business lending:

Banks have an important role to play in supporting Australian business as it faces up to the challenges and opportunities of the coming years.

Indeed, banks' ability to do this is critical to the sustainability of the present recovery and to continued progress in providing employment opportunities.

In particular, the Government is concerned to ensure that there is an adequate level of finance for small and medium sized businesses which have the potential to generate growth in employment and export income.

As highlighted in last year's Statement, small business finance has been a vexed question for many years.

While it would be wrong to accept at face value all the criticisms which small businesses have levelled at the banks, I think it is fair to say that in the past banks have not always given their full attention to small business lending:



small business lending seemed to get lost somewhere between personal lending and corporate lending.

But there are now clear signs that this problem is starting to be addressed:

we have seen specifically tailored lending products for small business, often with competitive interest rates;

banks have been retraining staff, revising approval procedures and restructuring to better understand small business and to develop stronger ongoing relationships with their small business clients; and

banks, in conjunction with other professional groups, have been seeking to educate small business operatives on financing issues more generally.

The banking community is to be applauded for these initiatives and I encourage you to continue and extend them.

To my mind, these very welcome developments are a clear result of the enhanced level of competition which we now enjoy in the banking sector.

The recent Working Nation statement announced a number of initiatives designed to further strengthen progress in this area.

With respect to debt finance, these announcements included measures to improve the finance skills and knowledge of small business operatives and capital providers, an extension of EFIC facilities and promotion of the Commonwealth Development Bank's role as a specialist small business financier.

On the equity side, the statement announced a highly concessional 15 per cent tax rate for profits earned by Pooled Development Funds on investments in small and medium sized businesses and supported a pilot "business angels" scheme designed to match potential investors and small businesses requiring equity finance.

In addition, the statement announced that the Government would seek to facilitate a constructive dialogue between banks and small business representatives to address the concerns of small business.

I am currently pursuing this initiative with the ABA and I am hopeful that there will be a further announcement on this issue in the not too distant future.

This initiative, and a number of the other measures outlined in the Working Nation Statement, reflected the Government's view that much of the perceived problem in the area of small business finance was an information problem rather than any inherent deficiency in the structure of the financial market.

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As noted earlier, banks are already moving to address this issue:

I urge you to persist with these efforts;

Small business lending is undoubtedly resource intensive, but small and medium sized businesses will continue to play a major role in the economy and I have little doubt that the rewards are there for the banks which can successfully tap

this market.

There is one further consequence of a competitive and innovative banking system which I would like to touch on before closing.

Financial deregulation and competition have seen a steady erosion of the traditional divisions in the financial sector.

The distinctions between banks, insurance companies, fund managers and other financial institutions are breaking down as individual players seek to offer a wider spread of financial services to their clients.

Banks have been particularly active players in this area and the corporate strategy of all the major banks now clearly includes the objective of offering a full spectrum of financial products.

This development poses challenges for our existing regulatory regime, based as it is on four separate, institutionally focussed, regulators: the RBA, ISC, ASC and ARC.

If the financial sector is to remain competitive and efficient then we cannot have identical financial functions subject to substantially differing prudential and supervisory arrangements simply on the basis of the institutional classification of the provider.

At present, the Government has sought to ensure consistency across the spectrum of financial products by requiring close consultation between the regulators.

This requirement was formalised with the establishment of the Council of Financial Supervisors in 1992.

To date the Council has worked well, establishing closer contact between the member regulators and allowing consultation on matters on common interest. And I am confident that these arrangements will continue to serve us well for some time to come.

Nevertheless, we need to consider whether more substantial changes to our underlying regulatory structure may be required to continue to keep it abreast of the rapidly changing financial market.



This is clearly a major topic and one which is likely to require extensive consideration In the years ahead.

Ladies and Gentlemen, the outlook for the economy and for the banking system is strong. After a decade of substantial change, and, on occasions, considerable discomfort, a far more efficient and dynamic banking sector and economy have emerged.

In both cases, the outcome is not attributable to good luck.

It is the result of careful judgements and hard work by all involved.

We can rightly be pleased with our achievements, but we cannot relax. Both the Government and the banking industry will continue to face a rapidly changing environment and constantly emerging challenges.

And we both have an obligation to continue to meet those challenges in the best interests of all Australians.

For its part, the Government has laid the foundation for sustainable, low inflationary economic growth

it's up to you to take full advantage of the opportunities this will present.

Thank you.