Austria 2008 Article IV Consultation, Preliminary Conclusions of the Mission
March 17, 2008
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Slowdown expected after strong performance in recent years
1. A mix of solid economic policies, wage moderation, and an early focus on Eastern Europe explain Austria's strong economic performance in the past period. Economic policies have contributed to this performance by focusing on macroeconomic stability and structural reforms. Wage moderation, resulting from a strong social partnership, has preserved competitiveness and supported export led growth, which has significantly exceeded the euro area average in the past period. The private sector, including the financial industry, has reaped significant benefits from an early entry into fast growing Central, Eastern and Southeastern Europe (CESE).
2. In line with developments in major trading partners, a slowdown is expected for 2008-09. The economy grew very strongly in 2006-07: real GDP increased by more than 3 percent in both years, driven by robust exports and investment. Employment growth accelerated and has reached historical highs, and unemployment, at 4.2 percent in February, remains significantly lower than in the euro area. Looking ahead, leading indicators appear off their peaks and the growth momentum is expected to soften in the course of the year as activity in trading partners dampens. Growth is expected to slow in 2008-09 to around 2 percent, which is close to potential. Risks to this outlook include the possible further impact of international financial turmoil on Austria through its main trading partners, and developments in the euro exchange rate and oil prices.
3. Inflation has increased and continued wage moderation will be essential to maintain Austria's competitiveness and relatively low unemployment. As elsewhere in Europe, headline inflation in Austria went up due to sharp increases in energy and food prices, while core inflation has risen also, albeit at a less pronounced pace. Fortunately, there is little indication of a wage-price spiral: wages have been increasing moderately, despite higher labor demand, and unit labor costs have been contained. Recent wage agreements between social partners for 2008 show a continuation of this trend. The mission welcomes this development as significant wage increases would worsen Austria's healthy external position, with negative repercussions for growth, exports, and employment.
Need for improvement in the fiscal position
4. We strongly support the government's objective of targeting a balanced budget over the cycle. This consolidation is required to (i) prepare for pressures arising from aging in the medium and long term, in particular on health, care and pension expenditures; (ii) keep public debt on a downward path from its current level of just below 60 percent of GDP, which also reduces interest costs; and (iii) meet Stability and Growth Pact commitments.
5. Current policies, however, are unlikely to deliver a balanced budget by 2010. Unfortunately, there has been too little consolidation in recent good economic times. While the deficit for 2007, at 0.7 percent of GDP, turned out to be smaller than projected, this primarily reflected the effect of the cycle. On a structural basis there was limited consolidation, and this pattern is likely to be repeated in 2008. Although the government' projections imply strong consolidation in 2009 and 2010, measures to deliver this outcome have not yet been identified. Another concern is that plans to implement major infrastructure projects through public companies raise the prospect of a substantial increase in the contingent liabilities of the government.
6. Consolidation measures should be implemented sooner rather than later. Since the target date for achieving a balanced budget was already pushed back from 2008 to 2010 at an earlier stage, further delays would raise serious doubts about the commitment to consolidation. The government should stick to the 2008 budget and implement measures to reach a structurally balanced budget by 2010. The current economic outlook, with growth around potential and low unemployment, does not indicate a need for a discretionary fiscal stimulus, but the automatic stabilizers should be allowed to operate.
Reform of fiscal federal relations overdue
7. Substantial reform of fiscal federal relations is needed to achieve major and lasting expenditure savings and efficiency gains. Rather than raising taxes, the needed consolidation will have to be achieved through expenditure savings. These have to be large enough to move the fiscal position to structural balance while also creating space for addressing aging pressures and reducing the tax burden. Such major expenditure savings will require a reform of fiscal federal relations. Most public sector efficiency gains achieved in recent years have been accomplished at the federal level, with the provincial governments lagging in key areas such as pension and administrative reform.
8. We urge the government to intensify its efforts in this area. The grand coalition government has the power to undertake fundamental fiscal reform in Austria. This reform should focus on strengthening accountability and incentive structures at the sub-national level. Reform measures should include (i) clarifying the expenditure responsibilities of the different levels of government; (ii) substantially enhancing the tax autonomy of provincial and municipality governments; (iii) creating stronger incentives for mergers of small municipalities; and (iv) strengthening disclosure and accounting standards. In this regard, the recently agreed revenue sharing agreement (Finanzausgleich) was disappointing in terms of not creating strong incentives to increase the efficiency of subnational government spending, while the constitutional reform process has stalled.
Tax cuts not to be implemented before expenditure measures are in place
9. The authorities should resist pressures for the adoption of unfunded tax cuts. The Stability Program announces tax cuts in 2010 and there are currently proposals to bring these forward. Tax cuts, however, should be implemented only when corresponding expenditure savings are in place, to avoid worsening the structural fiscal balance and moving away from the objective of a structurally balanced budget by 2010. Once the necessary space has been created, tax cuts should focus on labor taxes in order to boost employment and competitiveness.
10. We welcome the adoption of a medium-term fiscal budgetary framework, and urge the authorities to implement it firmly. For the new framework to be most useful, long term considerations, such as the implications of aging, should be integrated into the framework. Forceful implementation paired with transparency is key to establish credibility. Sub-national governments should be incorporated into the framework as soon as possible.
Financial sector overall resilient but risks to be managed carefully
11. The Austrian financial system is generally robust. Soundness indicators for banks and other financial institutions are at satisfactory levels, and 2007 seems to have been a good year for the industry. Improved cost efficiency has helped restore the profitability of domestic operations, and Austria has not seen a rapid increase in real estate prices or household indebtedness.
12. The financial system's rapid expansion into CESE and some Commonwealth of Independent States (CIS) countries has brought higher profits and diversification, but also increased exposures. Some economies of the region exhibit macroeconomic imbalances and possibly overheating. Furthermore, certain individual institutions have large exposures to individual markets. The significant volume of foreign-currency-denominated lending both in Austria and abroad represents a risk factor that deserves special attention by supervisors and banks' risk managers. Stress tests conducted as part of the Financial Sector Assessment Program (FSAP) Update indicate considerable resilience, while confirming these pressure points.
13. The recent global financial market turmoil has not had a major short-term impact on Austrian banks, but has increased funding costs. Banks' direct exposures to affected asset classes and off-balance sheet risks seem to be modest. Nonetheless, as concern about a global slowdown intensified, stock prices of listed Austrian banks have come under pressure. Funding costs and in particular risk premia are likely to remain elevated, which will make it more expensive to expand credit in CESE and CIS countries. This shift may contribute to a desirable "soft landing" for the region, but there are down-side risks. Over the longer term, profit margins will narrow as the financial sectors in these countries mature.
Prudential regulation and supervision need to keep up with an evolving financial sector
14. The increased uncertainty in global markets reinforces the importance of the authorities' efforts to improve financial sector regulation and supervision. Regulations have been amended to keep up with international standards, and supervisory practice has become more risk-based. Indeed, both the supervisors and the financial institutions may benefit from a period of consolidation during which they can become fully familiar with the many complex provisions that have been introduced in the past few years.
15. The recent amendment of the bank supervisory framework will require close cooperation between the OeNB and FMA. The amendments have clarified that the FMA, besides its responsibilities in the nonbank area, will retain overall responsibility for banking supervision-and in particular responsibility for licensing, regulation and enforcement-while banking inspection and analysis will now be assigned wholly to the OeNB. For the new financial supervisory structure to be effective, the OeNB and FMA will need to be fully committed to seamless cooperation; worthwhile initiatives to enshrine this cooperation in operational procedures are already under way.
16. The authorities are taking actions to keep financial sector supervision up to date with a rapidly evolving financial sector. Some themes are worth stressing:
· Financial sector oversight has become more demanding and more reliance must be placed on direct, on-going supervision by the authorities. Financial institutions and their operations have become more complex, and more intertwined with fast-moving financial markets. Hence, the supervisory authorities will need to have adequate resources to conduct effective and timely on- and off-site supervision.
· Further strengthening of international supervisory cooperation as an integral part of supervision is key. Not only do Austrian financial institutions have a large presence in CESE and the CIS, but Austria also hosts important institutions with foreign parents. Therefore, Austria should continue its efforts to develop cross-border supervisory arrangements, especially those in the EU context.
· The effectiveness of supervision-and financial sector efficiency-would be enhanced by providing better legal protection for supervisory action. The current very broad definition of institutional liability ("Amtshaftung"), which is not in line with international practice, is costly to the taxpayer and may give rise to moral hazard.
Maintaining the pace of structural reforms
17. The mission welcomes recent structural reforms, and encourages the authorities to focus on further measures that support competition. Recent reforms include the relaxation of regulations on working and shopping hours, and on inflows of certain categories of skilled workers from new member states. But more is needed. Pension reforms should be implemented firmly to contribute to long-run fiscal sustainability and encourage labor market participation and flexibility. There is still scope for increasing competition in the free professions, and full implementation of the EU directive on services would further deregulate the services sector and foster entry and competition. The resources and investigative powers of the Federal Competition Authority could be strengthened. Stronger competition would support economic growth and could also reduce price pressures in some sectors. The mission supports initiatives to enhance public and private sector R&D in the context of the Lisbon agenda, provided the cost-effectiveness of these measures is ensured.