Short-term outlook

In 2006 and 2007, the Austrian economy grew by almost 3 ½ percent per year. Despite the global financial turmoil, economic growth and employment continued to be buoyant in the first 5 months of 2008 and the economy expanded by 3 ½ percent in the first quarter. However, the ongoing financial downturn will also affect Austria and GDP growth is expected to decelerate to an annual growth about 2 ¼ percent in the second half of 2008. The authorities are concerned about the rising consumer price inflation, which was at 3 ½ percent in the spring of 2008. Two thirds of the increase is due to high world prices of food and energy.

Fiscal policy

At 1.5 percent of GDP, the general government deficit for 2006 was higher than assumed at the time of establishing the fiscal consolidation path for the current legislative period. This deterioration originated primarily from the one-off measures taken by local and state governments. The original target for 2007 was a deficit of 1.1 percent of GDP. The preliminary outcome showed an improvement of 1 percent of GDP as compared with 2006 and thus a deficit of only 0.5 percent of GDP. While planned public expenditures were under firm control, the significantly higher economic growth and a strong increase in employment were used for deficit reduction. Also, the public debt ratio fell below 60 percent for the first time since 1992.

For 2008, the fiscal target is a deficit of 0.6 percent of GDP, which is likely to be met despite some first steps taken to alleviate the tax burden for incomes of up to € 1,350 per month and the advancement of the next pension adjustment to November 2008. The latter measure reflects the currently high inflation, which has affected the purchasing power of pensions, while the first will be counted towards the volume of the envisaged tax reform in 2010, tentatively set at 1 percent of GDP and still in line with the goal of a balanced budget. The tax reform will be finalized at the time of adopting the 2010 budget.

In the coming three years, the Austrian economy is expected to grow close to its potential. According to the government agreement, public households should be moving to a structural balance in 2010. Fiscal consolidation will inter alia benefit from the phasing out of the purchase of fighter planes. The government has agreed upon a package of health sector reforms, which will gradually trim expenditures and exploit efficiency gains until 2012. Also, the government intends to introduce an automatic procedure for the adjustment of the parameters driving public pension expenditures, if life expectancy at age 65 increases by more than 6 months in the future, contributing to the financial sustainability of the public pension system.

In the coming years, the authorities will continue with the fiscal “Three-Pillar-Strategy” of Austria:

• Balanced budget by 2010 and stable, sustainable public finances.

• Expenditures focusing on “investments for the future” to further improve growth and employment at a sustainable level.

• Continuing structural and budgetary reforms, to foster the growth potential and simultaneously reducing strains on public expenditures. This should enable the implementation of a tax reform in 2010.

In order to strengthen the structural fiscal balance and avoid slippages from the budget path, a multi-year budget plan, set for four years in advance and updated on a rolling basis with fixed expenditure ceilings, will be implemented from 2009 onwards. The expenditure ceilings will have to be agreed by parliament and only the parliament will be able to change them. In this way, policy will be able to react flexibly to changing priorities, while simultaneously – due to the parliamentary procedures – a sufficient degree of expenditure discipline will be achieved. Flexible budget components will allow the automatic stabilisers to work and thereby react to cyclical conditions. Nevertheless, the final decision on the federal budget will continue to be in the realm of the national parliament.

Perspectives on the reform of fiscal federal relations in Austria

The agreement of the federal government includes commitments concerning state and local levels. To coordinate the responsibilities and financing schemes between the different levels of government, the fiscal revenue sharing agreement was concluded in October 2007. The new scheme is structured into two periods of three years each. It will be implemented starting January 1, 2008 and will end on December 31, 2013. At the level of states, the sustainability of the health sector was a key issue. From the perspective of the federal government, structural reforms in fiscal revenue sharing and the need to follow up with pension reforms at the state and local levels were stressed.

Challenges to the financial sector in Austria

The Austrian authorities consider the FSAP-update to be very useful as it presents a balanced view of the state of the Austrian financial sector. As rightly noted in the assessment, many of the main recommendations correspond to the priorities that have been identified by the authorities as well and are already being implemented.

The FSAP-update points to the robustness of the financial system, which has inter alia been proven by the comprehensive stress tests conducted during the Fund missions. The further integration of the CESE activities of Austrian banks in the stress testing framework, as recommended by the mission team, is an issue that is already on the agenda of the supervisory authorities. In this context, the authorities appreciate that the FSSA report explicitly notes that CESE countries are diverse, a fact that is often not appropriately recognised in discussions.

Moreover, there is also a need to continue raising awareness of borrowers regarding the risks inherent to foreign currency lending and to ensure that banks remain vigilant to the risks stemming from these activities. In this respect, the Financial Market Authority (FMA) and the OeNB have launched a number of activities in the last few years, some of which have been adopted by other countries that face the foreign currency loan phenomenon.

The IMF staff also rightly points out that to date the current global financial market turmoil has not had a major direct effect on Austrian banks. The most recent available data endorse this assessment. In 2007, the value adjustments in the structured product portfolios of the 30 largest Austrian banks approximately amounted to € 1.1 billion, with only a very limited part related to US-subprime securities. For the first quarter of 2008, these banks expect additional value adjustments in structured credit products in the range of € 550 million to € 750 million. Given this background and taking into account the robust capital base and refinancing structure of Austrian banks, a credit crunch or any adverse developments are not expected as a consequence of the recent international turmoil.

Also in the regulatory and supervisory areas, the issues at stake are evident: For the time being, one of the key priorities is the implementation of the recent reform of financial market supervision in Austria, maintaining the FMA as integrated supervisory authority, but assigning the responsibility for comprehensive risk assessment by means of on-site inspections and bank analysis to the OeNB. The two institutions are firmly committed to cooperating closely and have publicly acknowledged their common commitment. It should be emphasized that the practical implementation process of the new approach to inspections and analysis as well as the setting-up of supporting infrastructures – e.g. in terms of the a joint data base – is on track. This goes hand in hand with the enhancing of available staff resources in order to further intensify the depth and frequency of on-site inspections and to develop further the risk-based off-site analysis framework, followed by consistent supervisory measures, if necessary.

In this context, the authorities appreciate the clear opinion provided by the assessment team with regard to the need to limit the extensive public liability provisions being applied to financial sector supervision, not least with a view to the political debate such an issue necessarily implies.

At the same time, the authorities are giving further emphasis to cross-border banking cooperation, building on the extensive efforts made in this respect over the last few years. Preparations for a regional crisis management exercise are also in the pipeline.