The Austrian authorities welcome the consultation with the Fund and commend the staff for the high quality of its staff report. They broadly agree with the staff’s assessment of Austria’s economic situation and its general recommendations on economic and financial policies. They welcome the Selected Issues study, which sheds light on the specific Austrian phenomenon of foreign exchange borrowing of households.

The staff report again highlights Austria’s good economic performance relative to its European peers in terms of GDP-growth, unemployment, competitiveness and public finances.

Short-term outlook

The most recent data show that real GDP grew by 2.4 percent in 2004, revised upward from the 2.2 percent estimate quoted in the staff report.

In the first quarter of 2005, GDP growth was only 0.2 percent, but reached 2.1 percent year-on-year. The lagged effects of the appreciation of the Euro on exports, low investment due to the expiration of a temporary tax allowance and continued weak growth of private consumption were responsible for the outcome. On the positive side, dependent employment expanded at a rate of 1 percent in the first half of 2005. Further, the increase in both disposable income and after-tax profits as a result of the recent tax reform will gradually support private consumption and investment. Yet, signals of a strong upswing are currently absent. In view of high oil prices and the declining momentum of world trade, high growth is not very likely.

Fiscal policy

In 2003, the current fiscal policy strategy was adopted for the period until 2008. It aims at a balanced budget over the cycle and at reducing the tax burden to 40 percent by 2010. A major step to reduce the tax burden has been implemented in 2004/2005. In the short-run, tax cuts are not fully financed by expenditure cuts, resulting in a temporary deviation from a balanced budget (cyclically-adjusted) in the years 2004-2007.

Since then, fiscal policy has stayed broadly on track, but has been adjusted to a somewhat weaker economic environment. The latter prompted several actions, aimed at enhancing the supply-side of the economy and providing a growth stimulus. Over the period 2003-2005, the cumulative growth stimulus amounted to some 3/4 percentage points and helped to contain the still widening output-gap. The particularly strong fiscal impact contributed to the 2.4 percent GDP growth in 2004.

The 2005 budget is dominated by the tax reform aimed at reducing the tax burden of private households and further strengthening the growth potential of the economy. Recently, the economic research institutes revised downwards the GDP forecast for 2005 to around 1.9 percent. Yet, the authorities are confident to keep the overall budget balance at 1.9 percent of GDP, owing to better than expected tax revenues so far in the year. The estimated deficit is still comfortably within the cyclical safety margin of the EU’s Stability and Growth Pact (SGP).

Taking into consideration the moderate economic developments in 2005, the authorities see no danger in the pro-cyclicality of the tax reform, especially as the output gap will remain negative, at least until 2006. Previous investment incentives were phased out and reductions in public expenditure will be phased in. Thus, the tax reform will support the Austrian economy on its recovery to potential output, but will not lead to any overheating.

The government is strongly committed to achieve a balanced budget by 2008. Austria will continue its reforms of public administration at the national and regional levels. The efficiency of general government is to be increased further. In 2004, the new fiscal revenue sharing scheme was agreed upon by the federal, regional and local governments. At the same time, the Austrian domestic stability pact was re-instated for the years until 2008. For the fiscal revenue sharing agreement in the period after 2008 it is planned to put special emphasis on the expenditure side. The federal and provincial levels have recently begun discussing the inclusion of civil servants at the sub-national levels into the harmonised pension system.

Taking into consideration the remarks made by Directors during last year’s Board meeting, the Ministry of Finance has intensified and recently finalized a proposal for a medium-term expenditure framework. This proposal is due to be discussed in Parliament and a final decision should be expected this year. It would be implemented in 2007, as the federal budget for 2006 has already been approved by Parliament.

Other structural policies

In early July, Parliament adopted another set of policies to foster growth and employment. This package forms part of the Austrian National Action Plan to reach the targets of the EU-agreed Lisbon strategy. It includes efforts to increase the ratio of R&D expenditures to GDP from 2.35 percent in 2005 to 3 percent in 2010 by additional public spending and by broadening the income tax allowance of 25 percent to outsourced R&D and unincorporated companies. The housing savings-promotion scheme (”Bausparen”) will be extended to cover also credits for education and nursing.

Infrastructure investment will be speeded up and procedures for project approval streamlined. The package also includes measures against moonlighting and tax fraud. In addition, the labour market authority will dedicate a special premium to additional apprenticeships.

According to expert estimates, the total package will create some 20,000 new jobs (0.6 percent of the work force). The measures will not significantly affect the general government budget balance for 2005/2006.

Foreign exchange borrowing of households.

The Austrian authorities are well aware of the increase in foreign currency loans of households. They have time and again pursued campaigns to inform the public about the risks involved in such borrowing.

While one can certainly point to the potential risks of household indebtedness in foreign currency, the reasons for its popular appeal are obvious: some households saved substantial amounts by switching from yen to Swiss franc. Moreover, the Swiss franc is less volatile and less likely to appreciate further. In terms of the domestic market, borrowing in foreign currency has had a dampening effect on interest rates of loans, and on the interest rate spread, which both are now among the lowest in the Euro-area.

Linkages to Germany and Central and Eastern Europe

While the business cycle in Austria was for many years strongly linked to the business cycle in Germany, these close ties have weakened as a result of significant foreign direct investments in Central and Eastern Europe by Austrian Banks and manufacturing industries in recent years. This is welcome from a risk-diversification strategy point of view. The staff’s paper hints at the possibility of a more volatile cycle in Austria. In our view, this scenario seems rather remote. More fundamentally, the staff’s study on the regional linkages of Austria supports a positive outlook for the Austrian economy.