The International Monetary Fund (IMF) has upgraded its economic growth forecasts for Australia, but warns that output will remain below potential for a number of years.

In a report on Australia, the IMF says the downturn has been milder than in most other countries.

“This is because of strong commodity exports, a flexible exchange rate, a healthy banking sector, and a timely and significant macro policy response,” it said.

Federal Treasurer Wayne Swan said this is “another clear endorsement” of the government’s economic strategy.

The IMF expects gross domestic product to contract by a modest 0.5 per cent in 2009, before growing 1.5 per cent in 2010.

Previously, the IMF had forecast a 1.4 per cent contraction this year, and slim 0.6 per cent recovery next year.

Both this IMF statement and an the latest Economic Outlook from Organisation for Economic Co-operation and Development released on Wednesday, had a common theme, Mr Swan said,

“That the Australian economy is the strongest performing economy of all major advanced economies with lower borrowings and lower deficits,” he told ABC Radio.

The IMF said the Reserve Bank of Australia’s early and substantive reduction the cash rate helped support domestic demand as the external environment deteriorated.

It also welcomed the quick implementation of targeted and temporary fiscal stimulus, saying this will provide a sizeable boost to demand in 2009 and 2010 that will cushion the impact of the global recession.

“There is scope for further fiscal stimulus if the outlook for growth weakness, although we would advise using monetary policy as the first line of defence,” the IMF said.

It also said that the RBA should be more cautious than normal in raising the cash rate in the future, given the still fragile state of the global economy.

But it said the outlook for the Australian economy is balanced.

“On the downside, the world economy could take longer to recover, with significant spillovers to Australia through commodity sector incomes, external demand and international capital markets,” it said.

A sharper than expected deterioration in banks’ asset quality, possible stemming from lower house prices, could constrain credit and deepen the downturn.

One the upside, it said a key risk is stronger than expected demand from China, while both the domestic and foreign economies could be more responsive than expected to the considerable stimulus in place.

It also said Australia’s decision to go into a large budget deficit is “appropriate” in current circumstances.

“The government’s commitment to return to surpluses and achieve a positive budget balance on average over the medium term is commendable,” it said.

“Few other advanced countries have adopted such a clear commitment.”

Mr Swan rejected suggestions the government need not have handed out billions of dollars in cash payments so early.

“The IMF report makes it absolutely clear that the Australian government put the stimulus packages in place at the right time and was the right strength.”

AAP