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Public Information Notice (PIN) No. 03/139
November 26, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with Austria

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with Austria is also available.

On November 24, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Austria.1

Background

In a major shift from the policies of the 1990s, the government in power since 2000 has adopted an ambitious program of consolidation and supply-side reforms, with the goal to balance the budget over the cycle, reduce the tax burden, contain fiscal pressures from population aging, and raise Austria's potential growth rate. It made significant steps in this direction with the first (albeit small) fiscal surplus in over 30 years in 2001, a wave of deregulation and privatizations during the last three years, a major pension package this year, and tax reforms planned for 2004-05.

Although Austria has entered its third year of sluggish growth, it has weathered the global slowdown better than its major EU partners. Real GDP growth was 1.4 percent in 2002 and is projected to slow to 0.9 percent this year. The cyclical weakness reflected mainly a sharp fall in investment through the end of last year, but this fall was partly offset by buoyant exports. Data for the first half of 2003 suggest that, even though investment may have started recovering from its two-year slump, the continuing weakness in partner countries has started to affect Austrian exports. During 2002-03, the unemployment rate has edged up only slightly to 4.5 percent and inflation decelerated to 1.3 percent by September, and both remain among the lowest in the EU.

The short-term outlook is for growth of real GDP to recover slowly to 1.6 percent in 2004 and accelerate further to 2.6 percent in 2005. This outlook is subject to considerable uncertainty, but small improvements in the external outlook could accelerate significantly the incipient recovery in investment and lead to higher growth. Indeed, the international environment appears to be improving and there are indications that activity in Austria has bottomed out.

Fiscal policy remains anchored on the target to balance the budget over the cycle. The general government recorded a deficit of 0.4 percent of GDP in 2002 (on ESA95 basis), reflecting in large part the operation of the automatic stabilizers. The budget for 2003-04 is aimed at maintaining the broad structural balance reached in 2002, but mainly because of cyclical factors, the general government deficit is expected to be 1.5 percent of GDP in 2003 and 1 percent of GDP in 2004. Budget plans for 2004 include the first round of tax reform, but its revenue impact in that year is to be almost entirely offset by hikes in environmental taxes. More ambitious tax reform measures are planned for 2005, consistent with the government's goal to bring down the tax burden by about 4.5 percentage points of GDP by 2010. To make room for the tax cuts, the authorities plan to cut spending in a number of areas. But because the spending cuts in 2004-05 would not fully compensate for the revenue losses from tax reform (though the aim is to cover the ground in 2006-07), there would be a temporary increase in the deficit in 2005, which, given current projections, would be procyclical.

A major pension reform was adopted in 2003, which is expected to eliminate over one third (about 1.5 percentage points of GDP) of the projected increase in the pension system deficit in the long run. Moreover, the reform will help raise labor force participation of the elderly, thus lowering the fiscal burden of the pension system even further, though its impact in this area is more uncertain. Benefit losses from the reform were capped at 10 percent. On other structural areas, the government sold in September its stake in one of the remaining six enterprises in which it owns a large share; cut red tape and reduced the administrative burden on establishing new business; and expanded the scope for competition with measures targeting the product markets. Recent changes to the severance pay system will increase labor market flexibility.

The financial system has fared reasonably well during the slowdown, and supervision has strengthened with the establishment of the Financial Market Authority in 2002 and steps to improve cross-border supervision. However, foreign currency loans to households have continued to rise, and the supervisors have intensified the monitoring of highly exposed banks and started a public information campaign.

Executive Board Assessment

Directors commended the authorities' sound macroeconomic management and structural policies, which have helped Austria weather the global slowdown better than its major EU partners and secure a low level of unemployment and inflation. Directors endorsed the authorities' broad economic policy strategy to reduce the burden of the state, balance the budget over the cycle, liberalize markets, and promote private entrepreneurship. They commended the authorities for passing a major pension reform this year, despite significant opposition, which is expected to contribute appreciably toward long-term fiscal sustainability. Directors encouraged the authorities to stay firm on this strategy, while ensuring that the pursuit of a lower tax burden does not compromise macroeconomic stability.

Directors were encouraged by the signs that activity is picking up pace. They anticipated a gradual recovery in 2004 and a further strengthening of activity in 2005, as supportive monetary conditions and a strong competitive position should allow Austria to benefit from the expected improvement in the international environment. In this context, Directors supported the broadly neutral fiscal stance implied by the 2003-04 budget plans, and underscored the importance of maintaining a balanced budget over the cycle in the coming years.

Directors agreed that tax reform over the medium term will help improve Austria's growth potential. Directors broadly supported the tax plans for 2004-05 and stressed that the aim of tax reform should be not just to cut rates but to simplify and modernize the tax system and minimize distortions.

Directors emphasized that expenditure reform was a condition for successful tax reform. They urged the authorities to supplement their Stability Program with a comprehensive and detailed medium-term expenditure framework. Such a framework would improve the planning, monitoring, and transparency of spending decisions; would enable the government to move beyond ongoing efforts to reduce administrative outlays to a more fundamental reform of entitlements, where there was considerable scope for savings; and would bolster the credibility of the government's medium-term objectives.

In this connection, Directors generally observed that the tax cuts envisaged for 2005 are not matched by commensurate expenditure measures and would thus lead to a widening of the deficit at a time when the economy is expected to be growing rapidly. Directors acknowledged that this temporary increase in the deficit is unlikely to undermine fiscal sustainability, and noted that the government's Stability Program envisages additional adjustment in later years. Nevertheless, they urged the authorities to identify and quantify more precisely future spending cuts. It was noted that the widening of the deficit in a pre-election year might tend to undermine the credibility of the authorities' medium-term commitments, which underscored the need for a comprehensive medium-term expenditure framework. Because designing and implementing such a framework might take time, some Directors suggested that the government consider phasing in the 2005 tax reform more gradually in the meantime.

Directors stressed that the reform of inter-governmental fiscal relations was key for achieving the authorities' medium-term fiscal objectives. They expressed the hope that the negotiation of a new financial arrangement between the various levels of government in 2004 would align revenue-raising power with spending authority and ensure a more equitable sharing of the burden of fiscal adjustment.

Directors commended the Austrian authorities on the recent pension package, which they considered a major step toward ensuring the long-term sustainability of the public pension system. They welcomed the considerable savings to be generated by the effective reduction in benefits to more realistic levels and the gradual elimination of early retirement schemes. Many Directors considered that the 10 percent cap on benefit losses weakens the link between contributions and benefits and reduces savings in the long run. However, a number of Directors considered the cap to be a necessary political compromise; some expressed confidence that the authorities will address the issue in due course, while others were reassured by the authorities' claim that the effects of the cap will be dampened over time. While they supported the goal of protecting pensioners from the impact of the reform, Directors stressed that such protection should focus on low-income pensioners.

Directors noted that the pension reform agenda remains substantial and encouraged the government to press ahead with its plans to harmonize the various pension schemes, with the objective to reduce inequities and distortions. Directors also agreed that the ongoing rationalization of the disability pension should aim at preventing its abuse and ensuring its availability to those truly unable to work.

Directors observed that the financial system has fared reasonably well during the slowdown. They noted that the creation of the Financial Market Authority had strengthened financial supervision, but argued for continued vigilance. Directors felt that the growing foreign currency loans to households, though unlikely to jeopardize the stability of the financial sector, should come under closer scrutiny. They welcomed the recent steps by the supervisory authorities to educate bank customers on the risks involved and strengthen banks' risk management. Directors commended Austria's actions to ensure full compliance with the Financial Action Task Force's Recommendations on money laundering and terrorism financing, and they looked forward to the findings of the forthcoming Financial Sector Assessment Program.

Directors broadly endorsed the government's structural reform agenda. They noted that the drive to further divest government ownership in enterprises, deregulate the economy, and promote private entrepreneurship would boost competitiveness and growth in the long run. Directors praised the authorities for the significant progress made since 2000, and encouraged them to complete their reform agenda. They emphasized measures to raise the labor force participation of the elderly—where Austria lags behind the rest of Europe—increase productivity, and promote competition in product markets.

Directors welcomed the authorities' progress toward raising official development assistance to 0.33 percent of GNP by 2004—two years ahead of the EU schedule—and encouraged them to raise it further toward the UN target of 0.7 percent of GNP.


Austria: Selected Economic Indicators


 

1999

2000

2001

2002

2003 1/


           

Real economy

Change in percent, unless otherwise noted

           

GDP

2.7

3.4

0.8

1.4

0.9

Domestic demand

2.9

2.6

-0.1

0.0

0.7

CPI (year average) 2/

0.5

2.0

2.3

1.7

1.3

Unemployment rate (in percent) 2/

3.9

3.6

3.6

4.1

4.5

Gross national saving (percent of GDP)

22.7

22.7

22.2

24.3

22.4

Gross domestic investment (percent of GDP)

25.9

25.3

24.4

23.6

22.3

           

Public finance

In percent of GDP

           

Central government balance 3/

-2.6

-1.8

-0.7

-1.0

-1.9

General government balance 3/

-2.4

-1.6

0.1

-0.4

-1.5

General government balance (EDP basis)

-2.3

-1.5

0.3

-0.2

-1.3

General government debt

67.5

67.0

67.1

67.1

67.3

           

Money and credit

End of year, percent change

           

M3 4/

4.5

2.2

11.4

1.2

5.7

Domestic credit 4/

5.3

6.8

3.5

1.1

1.2

           

Interest rates

In percent

           

Money market rate 5/

3.0

4.4

4.3

3.3

2.1

Government bond yield 5/

4.7

5.6

5.1

5.0

4.4

           

Balance of payments

In percent of GDP

           

Trade balance

-1.7

-1.4

-0.7

1.6

1.5

Current account

-3.2

-2.6

-2.2

0.7

0.2

           

Fund position (as of August 31, 2003)

         
           

Holdings of currency (in percent of quota)

57.6

Holdings of SDRs (in percent of allocation)

74.0

Quota (in millions of SDRs)

1,872.3

           

Exchange rate

         
           

Exchange rate regime

Member of euro area

Euro per US dollar 5/

0.94

1.08

1.12

1.06

0.86

Nominal effective rate (1990=100) 2/

102.1

99.9

100.2

100.8

102.6

Real effective rate (1990=100) 2/ 6/

80.3

78.8

78.5

79.0

80.7

           

Sources: IMF, International Financial Statistics; Austrian National Bank; Austrian Statistical Office; and IMF staff projections.

1/ IMF staff projections, unless otherwise indicated.

2/ The figure for 2003 refers to September.

3/ On ESA95 basis. The Maastricht Excessive Deficit Procedure (EDP) definition-used by the Austrian authorities and in EU multilateral surveillance-differs from this due to the inclusion of revenues from swaps.

4/ The figure for 2003 refers to August.

5/ The figure for 2003 refers to October 16, 2003.

6/ Based on relative normalized unit labor costs in manufacturing.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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