Abstract
Increasing integration to the East has benefited the Austrian economy, but also created vulnerabilities that came to a head with the global financial crisis. The crisis has highlighted old challenges and created new ones that need to be addressed. The banking sector’s return to more normal levels of profitability creates the conditions for a further build-up of high-quality capital and exit from government support. Policies to foster labor market participation by low-skill workers and human capital accumulation would increase long-term growth.
The Austrian authorities welcome the consultations with the Fund and appreciate the high quality of the staff report. They broadly agree with the staffs assessment of Austria’s economic and financial situation and its general recommendations on economic, fiscal and financial policies.
The staff report shows that Austria has weathered the crisis well and the recovery is on firm grounds. Supported by generous automatic stabilizers and targeted labour market policies, consumption and employment held up well during the crisis, contributing to economic stability and setting the stage for a quick rebound in output growth as external conditions improved. The fiscal position is favourable in international comparison, although public debt is expected to remain above 60 percent of GDP for some time. The Austrian authorities take note of the issues raised regarding public finances, the financial sector and the long-term growth strategy.
Short-term and medium-term outlook
On the back of strong external demand, output growth accelerated in the first half of 2011. With capacity utilization back to pre-crisis levels, the export-led recovery spilled over to investment, thus sustaining and broadening the recovery. Private consumption increased steadily but moderately, as high inflation and subdued wage growth weighed on real disposable incomes. The short-term outlook for the remainder of the year is positive, though output growth will slow down as the cyclical upswing will have run its course. The Austrian authorities concur with the staff’s view on the main risks to the outlook, which are external, but refer to the efficiency of the crisis-mitigation measures and the muted overall effect of the crisis in 2008-2010. It is also noteworthy that Austrian sovereign bonds were regarded as a safe haven in the most recent turmoil on financial markets.
The staff report points out areas which would benefit from reform in order to support medium- and long-term growth, such as the education system and the employment rate of low-skilled and older workers. The Austrian authorities have already taken steps in this direction and will continue to give priority to these issues in the formulation of the medium-term economic and fiscal strategies.
Fiscal policy
The government has put in place a consolidation package to reduce the deficit to below 3 percent of GDP by 2013 and bring the debt ratio back on a downward path. According to the projections in the report, staff expects the government to outperform on the deficit targets for the years 2011-2014 as set out in the Stability Program, thus underlining the credibility of the government’s consolidation strategy. The new budgetary framework in place at the federal level has proven successful in avoiding expenditure slippages. Moreover, the Domestic Stability Pact, which sets the deficit targets for the three levels of government, has benefited from a reinforcement of the sanctioning mechanism, thus reducing the risk of budgetary shortfalls at sub-federal levels. While taking note of risk factors to the public finance situation as outlined in the staff report, the authorities consider the currently planned pace of budgetary adjustment sufficient to forestall financing risks.
The staff report recommends reforms to improve public expenditure efficiency, in particular with regard to health care and pensions. In both areas, important reform steps have recently been taken and further consideration will be given to the issues referred to in the staff report.
Financial sector
Bottom-line profitability of the Austrian banking system benefited from the favorable macroeconomic conditions in Austria and the CESEE region during 2010 but banks continue to suffer from low interest margins in the domestic market. On the back of the economic recovery, the crisis-related growth in risk provisioning for non-performing loans decelerated in recent quarters and the overall NPL ratio of the banking system is now expected to reach its peak in 2011. Due to the focus of their foreign exposure in the CESEE region, the direct country exposure of Austrian banks to the Euro Area periphery appears manageable.
As evidenced by the latest Austrian National Bank (OeNB) stress test, the Austrian banking system features a reasonable risk-bearing capacity. Based on the framework of the EBA stress test 2011, the OeNB stress testing exercise of Spring 2011 includes an additional adverse scenario that focuses on the CESEE and CIS region. The results show a manageable decline in the core tier 1 ratio of the aggregate banking system with an increased dispersion of results on a single bank level that was also reflected by the recently published results of the EBA stress tests. The Fund’s assessment of existing weaknesses in a few medium-sized banks is shared by the authorities, who play an active role in the ongoing intense restructuring process in these institutions.
The strong commitment of Austrian banks to the CESEE region was a key ingredient in maintaining financial stability in the region during the financial crisis since end-2008 and supported the successful implementation of EU/IMF programs in several CESEE countries. While this positive role has to be acknowledged, the crisis also revealed vulnerabilities of the banks’ business models in the run-up to the crisis, in particular the significant level of foreign currency lending combined with an unsustainable credit growth in some markets, and the reliance on intra-group funding by many CESEE subsidiaries. Looking ahead, both the large Austrian banks and the Austrian sovereign would clearly benefit from the fostering of local sources of funding in the CESEE region and the further strengthening of the parent banks’ capital base. The authorities therefore agree with the Fund that the current recovery in profitability and the favorable market sentiment towards the CESEE region provides an opportunity for improvement in these areas. The forthcoming implementation of the CRD IV/CRR in the EU also supports the case for a quantitatively and qualitatively improved capital position of Austrian banks in the medium term.
In the wake of recent developments in FX markets, the high outstanding levels of Swiss franc-denominated loans in Austria and some CESEE countries have come into the spotlight once again. The total volume of outstanding Swiss franc loans by Austrian banks amounts to approx. 70 billion EUR on a consolidated basis. The authorities’ long standing skeptical view on Swiss franc-lending both in Austria and CESEE has resulted in supervisory initiatives that led to a stop in new Swiss franc lending both in Austria (since October 2008) and CESEE (since Spring 2010). The implications of the appreciation on the credit quality of the stock of outstanding Swiss franc-denominated loan portfolios, however, deserve close monitoring by banks, customers and supervisors as well as a general readiness to implement risk-mitigating measures, if needed. The authorities are currently repeating a review of Swiss franc loans and loans with repayment vehicles last undertaken in 2009.