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.
Austria—2009 Article IV Consultation, Preliminary Conclusions of the MissionVienna, June 30, 2009
The Austrian economy, which did well until recently, is now feeling the full impact of the global crisis. The economy’s openness and outward orientation—major contributors to past growth—mean that it cannot insulate itself from foreign shocks. The transmission runs through two main channels: trade—in particular the negative impact on exports of the worsened outlook for the European region—and financial flows—including the impact of the slowdown in Eastern Europe on the returns on foreign investments of the Austrian banks and corporates. These shocks have a major adverse impact on the economy.
The key policy challenges for the authorities looking forward are to support the economy through responsible fiscal policy, while ensuring financial stability. These two objectives are connected. The financial sector has been expanding rapidly, mostly outside Austria. This has brought great benefits, but also increased risks and vulnerabilities. Maintaining financial stability under stress will be essential for ensuring macroeconomic stability, fiscal sustainability, and a return to growth. It will also have important spillovers to regional economic and financial stability, from which Austria stands to benefit. At the same time, medium-term fiscal sustainability—in particular after the large fiscal stimulus package—needs to be ensured to maintain financial stability.
A sharp decline after years of strong growth
1. The Austrian economy entered the crisis from a relatively good starting position. The economy has been doing well in recent years. This can be attributed to a focus on structural reforms, a tradition of wage moderation, and a strong outward orientation, including through the establishment of trade and financial relations with Eastern Europe. Austria has seen significantly better economic outcomes than the euro area in terms of both growth and unemployment, while it also benefited from a stable housing market.
2. Nevertheless, the current downturn is expected to be the deepest in decades. Unemployment began rising and the economy started shrinking around the fall of 2008, as the global financial crisis intensified and world trade fell sharply. This process accelerated in the first quarter of 2009 with exports of goods declining by roughly a quarter compared with 2008. Consumption has held up well so far—due to substantial wage increases agreed to last year when inflation was high, and tax cuts—but as unemployment rises, as is expected through 2010, household spending will lose momentum. The mission expects GDP to decline by around 4 percent in 2009 and to recover in the course of 2010—depending on global developments. Inflation is expected to remain low and the external position sound.
3. The uncertainties surrounding this outlook are considerable. The extent of economic decline hinges critically on developments in trading partner countries. Should the current downturn in the euro area, and in particular in Germany, be deeper or longer, the contraction in Austria would be larger, while positive developments in Europe would quickly improve the outlook for Austria. An additional uncertainty is the impact of the crisis on Austria’s financial sector. Due to its large exposure to Eastern Europe, it would be hit hard by a further economic decline in the region, which could translate into deteriorating credit quality, declining profitability, and the possibility of a credit crunch.
Sizeable fiscal stimulus will support the economy, but requires an exit strategy
4. The fiscal stimulus measures are welcome, although they could have been better targeted. The government has approved a fiscal stimulus package of 1.5 percent of GDP in 2009 and an additional stimulus of 0.3 percent of GDP in 2010. This is higher than the European average in 2009 and will continue to stimulate demand in 2010. However, this stimulus consisted largely of bringing forward planned permanent tax cuts for middle-income earners and, hence, is not optimally effective in raising demand. An additional stimulus will come through the advancement of public investment by state-owned companies.
5. The stimulus, in combination with large automatic stabilizers and financial sector support, will weaken public finances significantly. The deficit is projected to remain at 5-6 percent of GDP over the next few years. As a result of these deficits and capital support for the banks, the stock of public sector debt is expected to rise to above 80 percent of GDP by 2012, from slightly above 60 percent only four years earlier. In the light of this fiscal deterioration, and in particular the sharp rise in debt, further stimulus is not recommended at this stage.
6. The authorities should therefore prepare a credible fiscal consolidation plan to be implemented once the economy stabilizes. This will be crucial to strengthen the market’s confidence in fiscal sustainability, thereby contributing to a lowering of borrowing costs. In particular, debt should be brought back to a downward path to accommodate the costs of aging and avoid crowding out the private sector. Plans for fiscal consolidation—which in Austria take time—could be agreed upon in the course of this year, so that implementation can start when the economy recovers, which is expected in the course of 2010.
7. Expenditure measures should be taken in preference to tax hikes to ensure medium-term fiscal sustainability. Since taxation in the major categories remains relatively high in Austria, expenditure measures should have priority. Key areas for consolidation, as identified in various studies by national and international organizations, include administration at lower levels of government, pensions, and education and health, where efficiency gains are possible without reductions in service levels. Concrete measures should be identified with a view to enhancing expenditure efficiency based on cross-country benchmarks. In this context, it is important that the Working Group on Fiscal Consolidation makes early progress in developing specific recommendations. Accompanying measures on the revenue side could include increases in non-distortionary taxes such as the fuel tax or the real estate tax, although the potential increase in these revenues is likely to be limited.
8. Recent fiscal reforms, such as the long-awaited adoption of a medium-term budget framework, are welcome. The authorities are encouraged to build on these reforms to ensure long-term sustainability. The federal equalization law for 2008-13 needs to be complemented by better-enforced limits on subnational deficits and by greater cooperation between municipalities to reap efficiency gains. The medium-term budget, implemented this year for the first time, establishes binding ceilings to 2013 for broad categories of federal government expenditures. The ceilings in the current budget, however, are unambitious. Fiscal discipline could be enhanced still further by including in the medium-term budget framework an explicit requirement to take into account long-term demographic projections.
The financial system is facing significant challenges, in Eastern Europe and in Austria
9. While the financial sector had been relatively unaffected by the US subprime crisis, the events of late 2008 had a significant impact. The deteriorating outlook for Eastern Europe was already raising concerns about the banking, insurance, and corporate sectors because of their significant exposures to the region. Sudden losses resulting from exposures to Lehman and the Icelandic banks, together with the liquidity crunch in interbank markets, then weakened the financial position of the banks. The insurance sector, as well as mutual and pension funds, were affected by falling asset markets. More recently, the banking system has been confronted with a rapidly declining domestic economy, with the perspective of adverse consequences for loan quality and profitability of the domestic business.
10. The authorities’ response to the crisis was swift and effective. The Austrian National Bank (OeNB) and the Financial Markets Authority (FMA) cooperated to address the issues raised by financial institutions facing liquidity shortages. One small bank was subject to intervention and sold to creditors, while another had to be nationalized. Parliament enacted a large banking support package, which included fresh capital and guarantees for new debt issues, and measures were taken to reduce liquidity pressures in the interbank markets. A blanket deposit guarantee was introduced in response to similar measures by other EU members. The package was also extended to major insurance companies, but support has not been needed. Supervision has been stepped up, as has cooperation with foreign regulators. The measures have ensured that banks remain adequately capitalized with access to funding. While CDS spreads remain elevated, they are well below early 2009 highs.
11. We welcome the OeNB’s use of stress tests to identify banks’ vulnerabilities. The stress testing methodology applied by the OeNB is in line with international best practice. Current indications from the tests are that the capital ratios of all systemic banks would remain above minimum regulatory requirements under a range of adverse shocks. Because of uncertainty over the impact of the recession on future levels of banks’ non-performing loans, ratios well above the regulatory minimum may still be needed to support private investors’ confidence in banks. The authorities are therefore advised to discuss with the banks the potential need to further increase capital buffers in the period ahead. The large size of the government support package suggests that there are sufficient resources to respond to demand, if any, for further public sector participation.
12. The banks are now strengthening their financial position, while reiterating their commitment to Eastern European markets. Many banks are reducing risk by tightening lending policies, curtailing foreign currency lending and, where possible, shortening the term of lending portfolios. They are also seeking to broaden their deposit base. At the same time, the major banks have stated the intention to support their subsidiaries in Eastern Europe. In this context, the active role of the Austrian banks and authorities in the European Bank Coordination Initiative (the “Vienna Initiative”) is important and welcome.
Financial sector vulnerabilities require intense monitoring by supervisory authorities
13. The authorities should continue the use of stress tests and review procedures to address possible future strains in the financial sector. There is a particular need to monitor the development of banks’ non-performing loans. The authorities should undertake further stress tests as necessary and maintain their close cooperation with foreign supervisors. Contingency planning at this stage would help the authorities to implement intervention measures quickly and effectively, if needed in the future. This will require addressing constraints on rapid implementation of interventions highlighted by a relatively slow pace of disbursements under the public support program to date. Care will be needed to ensure that measures to exit from existing government interventions, in particular the blanket deposit guarantee, are made in coordination with other countries, especially in the EU.
14. The insurance and pensions sectors also require attention. The FMA should continue to monitor major insurers, particularly their vulnerability to asset falls that may accompany economic downturn in Austria and Eastern Europe. Further development of stress tests will be useful in this context. Close supervision should be maintained where unrealized losses have developed (insurers are not required to recognize all investment losses immediately). Government initiatives to consider possible reforms to the private pension system in light of the crisis, including changes to the design of the key Zukunftsvorsorge product (state-supported retirement provision), are also welcome.
15. The authorities should continue to strengthen the regulatory framework in response to crisis lessons. Supervisory resources at the OeNB and FMA have already been increased and regulatory powers extended. A further strengthening of regulatory capacity may be needed as EU and wider international initiatives, for example on bank capital and liquidity and the perimeter of regulation, are implemented. Gaps in the FMA’s powers, for example its ability to levy significant fines, should be filled. The authorities should build on existing close cooperation between the OeNB and FMA, and with foreign regulators, to continue strengthening their capacity to identify and respond to the build-up of risks in the financial system in the future.