Mission Concluding Statement 

Vienna, July 1, 2013

Austria is an area of relative strength, but the economic landscape in Europe remains challenging, and uncertainties persist in the broader international environment. Against this background, policies in Austria need to focus on safeguarding fiscal sustainability, improving the structure of public finances, and weakening fiscal-financial ties. To these ends, we encourage the authorities to:

i. Continue to strictly implement the medium-term fiscal adjustment plan, and strengthen it gradually to take bank restructuring costs into account.

ii. Accelerate downsizing and asset disposals in medium-sized banks under restructuring to minimize fiscal costs.

iii. Simplify the family benefits system and reallocate resources from cash transfers to child care facilities to increase labor supply by women and potential growth.

iv. Further strengthen financial supervision and introduce a new bank resolution framework and a unified, pre-funded deposit insurance system to limit the need for future bank support by the government.

Outlook

1. While Austria’s macroeconomic fundamentals are relatively healthy, growth has stalled and the forecast is for a slow recovery. After a swift post-crisis rebound, real GDP has been flat since mid-2012 with weakness in both domestic and foreign demand. Economic activity should recover in the second part of this year, reflecting an expected gradual strengthening in the international environment and a pick-up in disposable income in Austria owing to falling inflation. This would lead to growth of around ½ and 1½ percent in 2013 and 2014. Risks from the still difficult situation in the euro area and volatile global financial markets could delay the recovery.

Safeguarding Fiscal Sustainability

2. The authorities’ medium-term fiscal plan accommodates currently weak economic conditions. The 2013 budget envisages a slight structural expansion, which is appropriate given the current sub-par growth performance. Going forward, we encourage the authorities to focus on the further identification of still unspecified measures necessary to implement the already envisaged fiscal adjustment, particularly related to health care and subsidies. Efforts should be made to finance the recently-announced new stimulus measures within the existing budgetary envelope.

3. Further significant but manageable fiscal costs from medium-sized banks under restructuring are to be expected and should be compensated with additional gradual fiscal adjustment down the road. To contain these costs, faster disposal of troubled assets and downsizing of non-viable entities than in the past is necessary, and the authorities are moving in this direction. Correspondingly, structural fiscal adjustment should be strengthened gradually in the fiscal planning for 2014-18 to absorb bank restructuring costs in the medium term, with a view to bringing public debt down to its pre-crisis level around the end of the decade.

Restructuring Public Finances and Strengthening Work Incentives

4. While measures are being implemented to rein in early retirement, further reforms to make public spending more efficient would be desirable. As noted in earlier consultations, there is considerable scope for reducing spending in pensions, health care, and subsidies. An earlier equalization of male and female statutory retirement ages and automatic longevity adjustors would be welcome. A better targeting of subsidies towards more clearly defined long-term objectives is desirable. Further efficiency improvements in the health care area should be encouraged, even if the currently envisaged expenditure containment path is fully implemented. Better aligning spending powers and financing responsibilities in the federal system, including by introducing meaningful tax autonomy for states, would facilitate expenditure rationalization.

5. Expenditure savings could be used to finance a comprehensive reform of labor taxation and social and family benefits to foster labor supply and potential growth. Austria has a relatively high tax burden on labor which hampers work incentives in particular for the low-skilled and women. As pointed out in previous IMF staff reports, a comprehensive income tax reform and the selective lowering of social security contributions, taking interactions with social benefits into account, could help to remedy the situation. In addition, a simplification and redesign of the complex and costly family benefit system could strengthen work incentives for women. For example, a reallocation of funds from monetary transfers to the provision of high-quality and affordable childcare facilities would offer more women the choice to work longer hours.

Enhancing Financial Stability

6. According to the recent Financial Sector Assessment Program (FSAP), Austria’s banking system appears resilient to adverse scenarios but faces some challenges. Aggregate bank capitalization has improved but efforts are still needed to build stronger buffers to meet market expectations while repaying capital provided by the government. Against this background, we welcome the recent decision of one of the large banks to strengthen the quality of its capital by issuing new shares and fully repaying government and private participation capital. Bank funding conditions have eased, and foreign subsidiaries have reduced reliance on parent banks. In some CESEE countries, however, bank asset quality is still deteriorating, while depressed credit demand hampers profitability.

7. Austria’s financial supervision should be further strengthened to promote better risk management and governance practices in the small and medium-sized bank segment. The Financial Market Authority (FMA) and Austrian National Bank (OeNB) collaborate effectively in performing banking supervision, including on a cross-border basis. Nonetheless, some further improvements should be pursued. These include the increased availability and use of supervisory tools and powers for corrective action and the promotion of stronger risk management and governance standards, especially among small and medium-sized banks in a context of low domestic profitability.

8. A comprehensive framework for bank resolution would help reduce the need for state intervention in the future. While a common EU framework is the ultimate goal, in the interim the Austrian authorities should put in place a bank resolution regime consistent with international best practices and already-agreed elements of the forthcoming EU directive. This would complement the current legislative package, which covers early intervention tools and the preparation of recovery and resolution plans by banks.

9. As part of this new framework, the deposit insurance system should be unified and a bank resolution fund created. A unified and privately pre-funded scheme administered by the government would make it easier to close down failing banks without incurring excessive public liabilities. The forthcoming EU DGS Directive is an opportunity to move along this path. Future crisis management would also benefit from the creation of a bank resolution fund, which could eventually be integrated into a newly-created EU resolution fund. Proceeds from the existing bank financial stability contributions could be used for this fund.

10. Recent progress in strengthening the macroprudential framework is welcome and the OeNB should be given a leading role. The new macroprudential committee would comprise representatives from the Ministry of Finance, the Fiscal Council, the OeNB, and the FMA. The OeNB should be given a decisive role in the committee, in line with recommendations by the European Systemic Risk Board. Going forward the committee should consider a broad set of macroprudential tools, including for instance maximum loan-to-value and debt-service-to-income ratios, and the availability of related statistical information to diagnose emerging imbalances should be improved.

We wish to thank the authorities for their generous hospitality and willingness to engage in open discussions.