Macroeconomic outlook

Staff rightly notes the strong fundamentals of the Austrian economy and resilience to shocks, which resulted in solid growth of 2.7% of GDP in 2011 despite the worsening of the external environment in the second half of the year. Output growth was supported by buoyant employment and investment activity, while consumption growth remained subdued due to relatively high inflation. Uncertainties over debt sustainability in the euro area periphery might have affected consumer confidence.

According to the latest available estimates, the first half of 2012 saw a moderate expansion of GDP, with growth rates of 0.5% in Q1 and 0.2% in Q2 (qoq). Employment growth continued well into 2012, even outperforming GDP growth in Q2 2012. However, a slowdown has set in and unemployment started to increase from past year’s post-crisis low of 4.2%. The outlook for the remainder of the year has deteriorated over the past few weeks, as weaker-than-expected external conditions will weigh on export and investment activity. However, on the back of solid consumption growth, supported by lower inflation and high wage increases, the economy is expected to escape recession and the authorities’ current estimate of a growth rate of 0.6% for 2012 as a whole should be feasible.

The authorities concur with staff that the main risks to the outlook are external and stem from a further intensification of the debt crisis in the euro area and possible spillovers to important trade and financial partners in CESEE. However, upward risks, in particular the possibility that uncertainty abates more quickly than currently expected, should also be taken into account. It is also noteworthy that Austrian sovereign bonds have been regarded as a safe haven, with spreads over German Bunds declining since the start of the year and long-term interest rates at historically low levels.

The staff report points out that Austria’s long-term growth potential would benefit from reforms to strengthen work incentives. The authorities have undertaken important efforts in this direction as part of the consolidation package enacted in early 2012. Access to early retirement and invalidity pension has been tightened and the opportunity cost of withdrawing from the labor market before reaching the statutory retirement age has been raised. Funds for full-day child care and education have been increased with a view to encourage labor market participation of women and low-skilled workers. The authorities continue to monitor labor market developments very closely and give priority to structural issues in the formulation of medium-term economic and fiscal policies.

Fiscal policy

The government has put in place a “debt brake” similar to the German model, restricting the general government structural deficit to 0.45% of GDP from 2017. Its implementation was accompanied by a comprehensive consolidation package, aimed at reducing the structural deficit to 0.4% of GDP by 2016 and putting the debt ratio on a strictly downward path from 2013 onwards. The package was applied in addition to the measures already implemented in early 2011.

The baseline scenario in the staff report is very close to the authorities’ projections in the Stability Program, thus underlining the overall credibility of the consolidation strategy. The report points out that the yield of some revenue measures in 2012 and 2013 is uncertain. However, Austria has a good track record of providing conservative and reliable revenue estimates and executing the budget strictly, so that risks to the consolidation targets are limited. Moreover, there are safety margins in the budget plans (e.g., interest expenditure in 2012 is likely to turn out lower than budgeted) and thus possible revenue shortfalls could be compensated. In the past, budgetary outcomes in Austria used to surprise on the upside rather than on the downside. As regards savings from 2014 onwards, the authorities remain fully committed to implement the necessary reforms in the areas of health care and subsidies as planned in cooperation with regional governments.

Budget execution at sub-national levels has benefited from the strengthening of the sanctioning mechanism in the Domestic Stability Pact in 2011, and will be reinforced this year by a complete overhaul, which extends the “debt brake” and the main elements of the reformed EU fiscal surveillance (debt and expenditure rules) to the state and local levels. It is noteworthy that the strengthening of the sanctioning mechanism seems to have had an immediate effect, with states overachieving deficit targets in the past year. Thus the risk of overspending at sub-national levels has been reduced significantly.

The staff report commends the consolidation package for striking a good balance between fiscal prudence and growth considerations, with structural reforms aimed at sustainable expenditure reduction at the center of the strategy. The authorities have put emphasis on a fair distribution of the burden without increasing mass taxes and with a view to future-oriented investment. Where taxes have been raised, emphasis has been put on broadening the tax base and on high-income groups, so as to avoid an increase in labor taxes that would counteract the efforts to increase work incentives.

Financial Sector

The Austrian banking sector is operating in a challenging international environment but managed to weather the renewed sovereign and banking sector stress in selected euro area countries relatively well so far. Over the past year, the liquidity management of Austrian banks has become increasingly conservative and the sector as a whole continues to exhibit below-average reliance on central bank funding compared to other euro area banks. Wholesale funding dependence is low in European comparison, and funding conditions for large Austrian banks with significant CESEE operations continue to be favorable. Nevertheless, as part of the euro area financial system, funding risks of Austrian financial institutions also remain contingent upon the broader international environment and in particular on current efforts to contain the crisis.

Recent foreign exposure developments by Austrian banks point at two diverging trends. On the one hand, banks gradually scaled back their comparatively low exposures to euro area countries with high risk premiums, partly related to the Greek PSI. On the other hand, the large and diversified foreign exposure to the CESEE region remained broadly stable in recent months and increased in many countries on an FX- and provisions-adjusted basis, as reflected in the staff report. The widespread deleveraging concerns that were raised in late 2011 have not materialized so far, and large Austrian banks continue to show a strong commitment to the region.

Despite the only modest deleveraging pressures, it is also important to recognize that the CESEE region has become, over the past three years, an increasingly heterogeneous market for banks to do business, both in terms of risks and potential returns. Signs of growing heterogeneity may not only be found in banking sector indicators such as credit risk or profitability, but also in policy choices, as illustrated by the unorthodox policy measures set by the Hungarian government in 2011, and macroeconomic conditions, as shown by the significant cross-country variation in current economic forecasts. From a prudential perspective, it is therefore obvious for CESEE banks to adapt to the increasingly heterogeneous operating environment and gradually rebalance their exposure to those segments that offer more favorable (and predictable) conditions than others. To the extent that exposure rebalancing is not associated with competitive pressures for other banks, it should be regarded as standard procedure in a market economy, and as something that prudential supervisors should expect from financial institutions managing their risks.

The Austrian authorities are closely monitoring the exposure development of Austrian banks to the CESEE region and are ready to set appropriate measures to prevent not only disruptive deleveraging but also the opposite situation, i.e. the build-up of additional risks that exceed their current risk-bearing capacity. Even though the large Austrian banks that participated in the EBA recapitalization exercise were able to meet the Core Tier 1 capital requirements as of end-June 2012, their capital position remains below average compared to international peers. Given the difficult market environment, a further strengthening of their risk-bearing capacity must be a priority before engaging in further growth. In addition, the authorities agree with the staff’s view that further expansion in the CESEE region should be funded to a larger extent by local stable funding sources than in previous years, both from a credit risk and a funding risk perspective.

The set of macro-prudential guidelines known as the “Sustainability Package” and published by the Financial Market Authority (FMA) and the Oesterreichische Nationalbank (OeNB) in March 2012, was an important move in the direction of encouraging large Austrian banks to take further steps to permanently strengthen their capital base, further improve their liquidity situation and enhance the sustainability of their business model. In order to safeguard as far as possible the free movement of capital within the European Union, the Austrian authorities made clear that specific measures based on the guidelines will only be set after consulting with host authorities in the context of supervisory college cooperation. Given the large presence of Austrian banks in the region, improvements along the objectives of the “Sustainability Package” will not only benefit the affected banking groups, but ultimately financial stability in host countries as well.

Given the sluggish economic environment, credit risks continue to exert a significant drag on banks’ overall profitability. NPL ratios in many parts of the CESEE region continued to increase during the second half of 2011, in particular in the foreign-currency loan segment. In Austria, the large stock of foreign currency loans and repayment vehicles loans poses a more medium-term challenge, assuming that the EUR-CHF exchange rate continues to stay at or above the floor set by the Swiss National Bank for the time being. The authorities concur with the staff’s view that banks should be conservative in allocating capital to the associated risks. The existing guiding principles on foreign-currency lending in the domestic market are already in the process of being harmonized with the respective ESRB recommendations. From 2013 onwards, Pillar 2 measures may be applied to cover the risks arising from existing funding gaps in repayment vehicle loans.