## cr18272 - 3.1 percent (y/y) in 2018: Q1. This provides an opportunity to implement reforms to

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### Recent developments
- GDP expanded by 3 percent in 2017, and by 3.1 percent (y/y) in 2018: Q1.
- Growth drivers in 2017–18 included income tax cuts in 2016, higher public spending on refugees, a recovery in private investment, and a favorable external environment supporting strong net exports.
- Employment growth accelerated; unemployment declined to 7.7 percent in May (national measure, based on registered unemployment). The EU harmonized rate was 4.9 percent in April, ¾ percentage point lower than a year before.
- Inflation was 2.1 percent y/y in May, having decelerated slightly from its peak in 2017: H2.
- Fiscal outturn 2017: structural deficit stood at 0.6 percent of GDP; headline deficit was 0.7 percent of GDP. Public debt fell by 5 percentage points, to 78.5 percent of GDP.
- Financial sector: large banks’ capital levels have been increased; profitability rose largely due to reduced risk provisions; cost-cutting efforts continue. Legal basis created for real-estate specific macroprudential measures.
- Refugee inflows slowed sharply since 2015; integration challenges persist (language barriers, low skills). New government tightening of acceptance criteria and possible curtailing of access to social benefits noted.

### Outlook and risks
- Near-term projection:
  - GDP growth is projected to be 3 percent in 2018.
- Medium-term projection:
  - Growth projected to slow gradually and settle at its potential rate of about 1¾ percent beyond the projection horizon.
- Inflation and output gap:
  - Inflation expected to run slightly above 2 percent in the medium term with a mildly positive output gap.
- External position and REER:
  - 2017 cyclically-adjusted current account balance: 2 percent of GDP versus an estimated norm of 1.8 percent of GDP.
  - Model-based REER overvaluation estimated at about 7½–10¼ percent; staff analysis suggests an indicative REER gap of -1.2 percent.
- Key downside risks:
  - Retreat from cross-border integration, reducing openness and affecting exports, FDI, and confidence.
  - Structurally weak growth in advanced economies and emerging markets; CESEE deceleration (CESEE accounts for 21 percent of Austria’s exports) could affect financial stability and the broader economy.
  - Insufficient integration of immigrants could reduce their economic contribution, slow growth, and increase welfare spending.
  - Indirect spillovers from developments in Italy: Austrian banks’ direct exposure to Italy is about 1.3 percent of total foreign claims; confidence effects could still be important.
- Staff assessment:
  - Risks largely external and would likely have limited impact if they materialize (Annex II).

### Preserving long-term fiscal sustainability
- Recent fiscal trajectory:
  - Public debt has been declining since 2016; gradual fiscal consolidation has resumed, keeping public debt on a downward path.
  - Medium- to longer-run fiscal pressures from population aging will increasingly strain public finances.
- Policy priorities:
  - Use current window of opportunity to implement efficiency-boosting expenditure reforms, in particular in the health sector and in subsidies.
  - Broader structural reforms to raise growth potential.
- Authorities’ Stability Program plans:
  - Aim to achieve overall balance by 2019 and structural surplus over the medium term.
  - Revenue projected to decline by 1¼ percentage points over the next five years; expenditure projected to decline by 2.4 percentage points of GDP.
  - Specific measures: reduction of unemployment insurance contributions for low-income earners; reduction of VAT on overnight stays; increase in income tax relief for families with children; comprehensive tax reform planned for 2020.
  - Structural balance would reach MTO of -0.5 percent of GDP in 2019, and nominal and structural balances would reach a surplus of 0.4 percent of GDP by 2022 under authorities’ plan.
  - Authorities project public debt to decline by more than 15 percentage points of GDP over five years, approaching 60 percent of GDP.
- IMF staff view:
  - Staff projections are more conservative; most planned savings (administrative efficiency, personnel cost reductions) are difficult to quantify and may be slow to materialize.
  - Under staff scenario, structural balance would decline to -½ percent of GDP by 2020 and nominal balance zero, before widening again as demography-related spending rises. Public debt projected to continue declining to 61 percent of GDP by 2023.

### Fiscal sustainability and reform priorities (policy emphasis)
- Austria’s MTO of a structural balance of -0.5 percent of GDP remains appropriate.
- Savings potential from structural fiscal reforms could be in the range of 2½–3   percent of GDP.
- Key objectives:
  - Rebuild fiscal buffers and further lower public debt to ensure long-term fiscal sustainability.
  - Ensure government spending is on a sustainable footing as the population ages.
- Likely required measures:
  - Additional reforms in fiscal federal relations, including stronger incentives for cost savings in the health system.
  - Further reforms to the pension system to ease future fiscal pressures.
- Timing:
  - Current window of opportunity—economy performing strongly and before ageing costs rise significantly—should be used to implement reforms.
- Implementation note:
  - A more specific fiscal program would provide greater confidence that the MTO can be achieved.
- Equity considerations:
  - Austria’s income inequality and poverty rates are relatively low; preserving this outcome is a policy objective.
  - Trade-offs between equity and incentives need to be carefully weighed.
  - Reduction in social security contributions for low-income earners is positive; further steps to lower the tax wedge on low incomes should follow, potentially financed by higher taxation of environmental pollution and wealth.
  - The increase in the family bonus set for 2019 does not support families with incomes below the threshold at which income taxes are due.

### Reducing unemployment — findings and policy measures
- Recent labor trends and projections:
  - Labor force increased by 6.2 percent between 2011 and 2017.
  - Share of non-Austrian citizens in the labor force rose from 11.5 to 16.2 percent.
  - Employment increased by 5.1 percent (2011–2017).
  - Unemployment rose slightly from 4.9 percent in 2012 to 5.3 percent in 2018: Q1 (EU harmonized rate).
  - Labor force growth projected to slow gradually; refugee labor market entry is gradual and new immigration has slowed.
  - Labor force participation of Austrian women and elderly workers expected to edge up further.
  - Above-potential growth in the next few years should generate employment growth outpacing labor force growth, lowering unemployment.
- Policy measures recommended to durably reduce unemployment:
  - Improve education: address high unemployment among those with only compulsory schooling; maintain training guarantee for people under 25; leverage Austria’s dual-education apprenticeship system.
  - Integrate foreigners: address recognition of qualifications and language skills; target integration of accepted refugees.
  - Active labor market policies: target specific segments, notably elderly workers who face increasing unemployment and difficulties finding jobs once unemployed.
  - Boost labor demand: strengthen innovation and competition, lower barriers to entrepreneurship, shift the tax mix away from labor, and increase public investment; improve support for start-ups, more financing for R&D, and increase flexibility in working hours.
- Authorities’ perspectives:
  - Authorities agree improving the education system is critical.
  - On unemployment among foreign nationals: partly attributed to seasonal employment patterns and skill gaps.
  - On support for elderly workers: authorities prefer supporting continuous training and education over subsidized employment.

### Consolidating financial stability — banking sector and macroprudential
- Banking sector metrics (end-2017 unless noted):
  - Sector-wide capital adequacy ratio: 18.2 percent.
  - CET-1 ratio: 14.6 percent.
  - Thirteen largest banks set to meet the systemic risk capital buffer of up to 2 percent, to be fully phased in during 2019.
  - Weighted average liquidity coverage ratio (LCR) at the unconsolidated level: 145 percent.
  - NPL ratio: 3.4 percent at end-2017; domestically 2.4 percent.
  - Consolidated coverage ratio: 63.8 percent.
- Credit and funding trends (February 2018 y/y):
  - Nominal credit to the private sector: +3.7 percent.
  - Credit to nonfinancial corporations: +5.7 percent.
  - Credit to households: +3.5 percent.
  - Growth in residential real estate loans: +4.8 percent.
  - Indebtedness remains below peers’ levels.
- CESEE exposure and funding:
  - Banks’ dependence on wholesale funding is low.
  - Bank Austria’s CESEE operations shifted to Unicredit in Italy, significantly reducing direct exposure of Austrian banking system to CESEE.
  - Austrian banks’ subsidiaries in CESEE: loan-to-deposit ratio declined to 79 percent, from over 100 percent in 2011.
- Regulatory and supervisory measures:
  - Supervisory guidance updated in 2017; focus on strengthening business models: rationalization, cost cutting, IT investments, and further capital strengthening.
  - Legal basis established for targeted real-estate macroprudential tools (LTV caps, DSTI limits, term restrictions, DTI ceilings, minimum amortization requirements); comprehensive monitoring expected from 2019.
  - Current guidance: no formal activation of new macroprudential tools necessary now; authorities should remain vigilant and prepared to act preemptively and consider clearer quantified supervisory guidance.
  - Single Resolution Board and the FMA issuing binding targets for MREL for most banks; process to be completed in 2019. For small deposit-taking banks the expectation is liquidation rather than resolution in case of difficulties, with no recourse to state aid.
- AML/CFT:
  - Continue strengthening AML/CFT framework per action plan adopted in response to 2016 FATF Mutual Evaluation Report.
  - Implement the 5th EU AML Directive to address anonymity of virtual currencies, lack of transparency of beneficial ownership and high-risk countries.
- Staff recommendations for banks and supervisors:
  - Banks: buttress profitability, safeguard internal capital generation, continue adjustment plans, raise further capital, limit dividend payouts, reduce structural costs, invest in efficiency-enhancing infrastructure, refocus on core activities, withdraw from non-profitable/high-risk activities.
  - Smaller banks: reduce costs, accelerate digital banking, increase fee-based activities.
  - Supervisors: ensure banks raise capitalization, reduce vulnerabilities, and implement cost-cutting plans.

### Staff appraisal and macro outlook
- Economic assessment:
  - Economy robust with strong foundations: growth driven by investment, rising labor supply, and net exports.
  - Public debt-to-GDP ratio has continued to fall; unemployment has declined; financial sector strengthened.
  - External position broadly in line with fundamentals and desirable policies.
- Projections:
  - 2018 GDP growth projected at 3 percent.
  - Growth path: strong in 2018 as investment growth and public consumption taper off but private consumption and net exports accelerate; output gap turns positive and growth gradually slows to potential rate of about 1¾ percent.
  - Inflation should run slightly above 2 percent in the medium term.
  - Employment grows faster than labor force; unemployment would gradually decline.

### External Sector Assessment — key points
- International investment position (IIP): moved from -21 percent of GDP in 2001 to 6 percent in 2017.
- Banks’ external position:
  - Gross external assets declined from over 100 percent of GDP in 2008 to about 62 percent of GDP in 2017.
  - Transfer of Bank Austria’s CESEE operations to Unicredit reduced the banking system’s asset and liability position by about 30 percent of GDP.
- Current account and REER:
  - Current account balance in 2017: 2 percent of GDP (cyclically adjusted).
  - Estimated norm for the current account: 1.8 percent of GDP.
  - Model-based REER overvaluation: around 7½–10¼ percent; unexplained residual large. Using a semi-elasticity of 0.07 yields an indicative REER gap of -1.2 percent.
- Policy implications:
  - External position sustainable and broadly in line with fundamentals.
  - Ageing population implies build-up of external assets warranted as buffer.
  - Structural priorities: raise efficiency of health expenditures and reform pensions to unlock significant savings potential.

### Risk Assessment Matrix — selected entries
- Retreat from cross-border integration:
  - Relative Likelihood: Medium; Time Horizon: ST, MT; Impact/Policy Response: Medium. Exports comprise over 50 percent of GDP (of which about 70 percent to the EU).
- Policy uncertainty (Brexit, U.S. tax bill, NAFTA, elections):
  - Relative Likelihood: Medium; Time Horizon: ST, MT; Impact/Policy Response: Low.
- Fragmentation/security dislocation (Middle East, Africa, Asia, Europe):
  - Relative Likelihood: High; Time Horizon: ST, MT; Impact/Policy Response: Low. Could increase migrant flows; response: invest in integration.
- Further pressure on traditional bank business models (non-banks, fintech):
  - Relative Likelihood: Medium; Time Horizon: MT; Impact/Policy Response: Low. Response: strengthen capital cushions and efficiency drive.
- Structurally weak growth in key advanced economies:
  - Relative Likelihood: High; Time Horizon: MT; Impact/Policy Response: Medium. Response: accelerate structural and fiscal reforms.
- Cyber-attacks:
  - Relative Likelihood: Medium; Time Horizon: ST, MT; Impact/Policy Response: Low. Response: strengthen defenses and cooperation.
- Integration of immigrants:
  - Relative Likelihood: Medium; Time Horizon: ST, MT; Impact/Policy Response: Medium. Response: maintain/increase integration efforts.

### Debt Sustainability Analysis — main findings and baseline
- Main findings:
  - Austria’s debt outlook has improved further; public debt is sustainable within the medium-term projection horizon, though ageing cost pressures loom in the longer term.
  - Under the baseline, debt will fall from around 84 percent of GDP at end-2016 to 61 percent of GDP by end-2023.
  - Standardized stress tests indicate that lower growth and a combined macro-fiscal shock could shift the debt-to-GDP ratio upwards, but debt would remain on a downward trajectory.
  - In the longer term (starting in the mid-2020s), ageing cost pressures and higher interest rates would reverse the debt path without additional policy measures.
- Baseline technical projections (selected rows):
  - Nominal gross public debt: 78.7 (2016), 83.6 (2017), 78.5 (2018), 74.2 (2019), 70.9 (2020), 67.8 (2021), 65.0 (2022), 62.8 (2023), 60.9 (end-2023 as repeated elsewhere)
  - Public gross financing needs: 11.2 (2016), 9.4 (2017), 8.1 (2018), 8.7 (2019), 9.5 (2020), 8.7 (2021), 8.0 (2022), 7.6 (2023), 8.2 (2023 cumulative entry)
  - Real GDP growth (in percent): 1.0 (2016), 1.5 (2017), 3.0 (2018), 3.0 (2019), 2.1 (2020), 1.5 (2021), 1.5 (2022), 1.4 (2023), 1.5 (2023)
  - Inflation (GDP deflator, in percent): 1.9 (2016), 1.1 (2017), 1.6 (2018), 1.8 (2019), 1.8 (2020), 2.1 (2021), 2.2 (2022), 2.1 (2023), 2.1 (2023 cumulative)
  - Nominal GDP growth (in percent): 2.9 (2016), 2.6 (2017), 4.6 (2018), 4.8 (2019), 4.0 (2020), 3.7 (2021), 3.7 (2022), 3.6 (2023), 3.6 (2023)
  - Effective interest rate (in percent): 3.8 (2016), 2.6 (2017), 2.3 (2018), 1.9 (2019), 1.7 (2020), 1.7 (2021), 1.6 (2022), 1.6 (2023), 1.7 (cumulative)
- Cumulative flows 2016–23:
  - Change in gross public sector debt: -17.6 (percent of GDP).
  - Identified debt-creating flows: -17.1 (percent of GDP).
  - Primary deficit: -5.8 (percent of GDP).
  - Automatic debt dynamics: -8.9 (percent of GDP).
  - Interest rate/growth differential: -8.9 (percent of GDP).
  - Other identified debt-creating flows: -2.3 (percent of GDP).
  - Stock-flow adjustment (incl. asset recovery): -2.3 (percent of GDP).
  - Residual, including asset changes: -0.6 (percent of GDP).
- Stress tests:
  - Low-growth scenario: growth slower by one standard deviation in 2019–20 (reduction by close to 2½ percentage points) leads debt-to-GDP to increase only marginally and then decline to 68 percent of GDP by 2023.
  - Contingent liability shock of 10 percentage points of GDP would raise public debt to 88 percent of GDP, slowly declining to 81 percent of GDP by 2023.
  - Other standardized shocks (primary balance, REER, real interest rate) do not lead to significant deviations from the baseline.
  - Combined shock: similar path to low-growth scenario.
- Vulnerabilities:
  - Main vulnerabilities: contingent liabilities and high share of public debt held by non-residents, and longer-term ageing-related spending and higher interest rates starting mid-2020s.

### Skills mismatch and labor-market functioning
- Skills mismatch:
  - Demand for highly skilled workers is rising much faster than for those with lower skills.
  - Mismatch for highly skilled workers (university or post-secondary college degree) has remained broadly unchanged since 2007/08, but at a higher level than for other workers.
  - At the low end, both demand and supply of low-skilled workers have declined significantly; unemployment has risen for workers with only compulsory schooling.
  - The mismatch has recently fallen back to pre-GFC levels, but there appear to still be too many workers with only compulsory school education.
- Nationality-related mismatch:
  - Removal of mobility restrictions on citizens of the EU’s New Member States (NMS) in 2011 led to a significant increase in their number.
  - Foreign nationals are much more likely to be unemployed than Austrians; independent of education level, foreign nationals—particularly from outside the EU—face higher unemployment risk.
  - Contributing factors: language barriers, possible skills gaps despite similar formal education, fewer informal connections.
  - Second-generation foreign nationals have the highest unemployment rate in some segments, suggesting entrenched poverty and unemployment.
- Vienna-specific observations:
  - Education- and nationality-related mismatches help explain Vienna’s higher unemployment, which is higher across all educational levels and nationalities.

*International Monetary Fund — Austria: 2018 Article IV consultation (August 23, 2018).*

### 3.1 percent (y/y) in 2018: Q1. This provides an opportunity to implement reforms to

### cr18272 - 3.1 percent (y/y) in 2018: Q1. This provides an opportunity to implement reforms to

### Recent developments
- GDP expanded by 3 percent in 2017, and by 3.1 percent (y/y) in 2018: Q1.
- Growth drivers in 2017–18 included income tax cuts in 2016, higher public spending on refugees, a recovery in private investment, and a favorable external environment supporting strong net exports.
- Employment growth accelerated; unemployment declined to 7.7 percent in May (national measure, based on registered unemployment). The EU harmonized rate was 4.9 percent in April, ¾ percentage point lower than a year before.
- Inflation was 2.1 percent y/y in May, having decelerated slightly from its peak in 2017: H2.
- Fiscal outturn 2017: structural deficit stood at 0.6 percent of GDP; headline deficit was 0.7 percent of GDP. Public debt fell by 5 percentage points, to 78.5 percent of GDP.
- Financial sector: large banks’ capital levels have been increased; profitability rose largely due to reduced risk provisions; cost-cutting efforts continue. Legal basis created for real-estate specific macroprudential measures.
- Refugee inflows slowed sharply since 2015; integration challenges persist (language barriers, low skills). New government tightening of acceptance criteria and possible curtailing of access to social benefits noted.

### Outlook and risks
- Near-term: Growth momentum remains strong. GDP growth is projected to be 3 percent in 2018.
- Medium-term projection: Growth is projected to slow gradually and settle at its potential rate of about 1¾ percent beyond the projection horizon.
- Inflation: Expected to run slightly above 2 percent in the medium term with a mildly positive output gap.
- External position: 2017 cyclically-adjusted current account balance was 2 percent of GDP versus an estimated norm of 1.8 percent of GDP. Model-based REER overvaluation estimated at about 7½–10¼ percent; staff analysis suggests an indicative REER gap of -1.2 percent.
- Key downside risks:
  - Retreat from cross-border integration, reducing openness and affecting exports, FDI, and confidence.
  - Structurally weak growth in advanced economies and emerging markets; CESEE deceleration (CESEE accounts for 21 percent of Austria’s exports) could affect financial stability and the broader economy.
  - Insufficient integration of immigrants could reduce their economic contribution, slow growth, and increase welfare spending.
  - Indirect spillovers from developments in Italy: Austrian banks’ direct exposure to Italy is about 1.3 percent of total foreign claims; confidence effects could still be important.
- Staff assessment: Risks largely external and would likely have limited impact if they materialize (Annex II).

### Preserving long-term fiscal sustainability
- Public debt has been declining since 2016; gradual fiscal consolidation has resumed, keeping public debt on a downward path.
- Medium- to longer-run fiscal pressures from population aging will increasingly strain public finances.
- Policy priorities to preserve and expand fiscal space:
  - Use current window of opportunity to implement efficiency-boosting expenditure reforms, in particular in the health sector and in subsidies.
  - Broader structural reforms to raise growth potential.
- Authorities’ plans (Stability Program):
  - Aim to achieve overall balance by 2019 and structural surplus over the medium term.
  - Revenue projected to decline by 1¼ percentage points over the next five years; expenditure projected to decline by 2.4 percentage points of GDP.
  - Specific measures: reduction of unemployment insurance contributions for low-income earners; reduction of VAT on overnight stays; increase in income tax relief for families with children; comprehensive tax reform planned for 2020.
  - Structural balance would reach MTO of -0.5 percent of GDP in 2019, and nominal and structural balances would reach a surplus of 0.4 percent of GDP by 2022 under authorities’ plan.
  - Authorities project public debt to decline by more than 15 percentage points of GDP over five years, approaching 60 percent of GDP.
- IMF staff view:
  - Staff projections are more conservative; most planned savings (administrative efficiency, personnel cost reductions) are difficult to quantify and may be slow to materialize.
  - Under staff scenario, structural balance would decline to -½ percent of GDP by 2020 and nominal balance zero, before widening again as demography-related spending rises. Public debt projected to continue declining to 61 percent of GDP by 2023.

### Reducing unemployment
- Sustained reduction of unemployment to pre-GFC levels requires additional measures:
  - Strengthen the education system.
  - Special efforts to integrate foreign nationals into the labor market.
  - Structural and fiscal policy measures to raise labor demand.
- These measures would also boost potential growth.

### Consolidating financial stability
- Financial system is stable; large banks’ capital levels have risen, reducing gaps with peers and reaching levels targeted in the bank sustainability package.
- Further capital increases are warranted, but policy focus should shift toward boosting cost efficiency where progress has been slow.
- Risks in the real estate market are currently limited but warrant continued monitoring.
- Bank-sector resilience: stronger capital buffers, adequate and stable liquidity, and limited reliance on wholesale funding provide a buffer against shocks.

*International Monetary Fund — Austria: 2018 Article IV consultation (August 23, 2018).*

### 16.      Time is ripe for implementing efficiency-raising reforms. Rebuilding fiscal buffers and

### 16.      Time is ripe for implementing efficiency-raising reforms. Rebuilding fiscal buffers and

### Fiscal sustainability and reform priorities
- Austria’s MTO of a structural balance of -0.5 percent of GDP remains appropriate.
- Savings potential from structural fiscal reforms could be in the range of 2½–3   percent of GDP.
- Key objectives:
  - Rebuild fiscal buffers and further lower public debt to ensure long-term fiscal sustainability.
  - Ensure government spending is on a sustainable footing as the population ages.
- Likely required measures:
  - Additional reforms in fiscal federal relations, including stronger incentives for cost savings in the health system.
  - Further reforms to the pension system to ease future fiscal pressures.
- Timing:
  - Current window of opportunity—economy performing strongly and before ageing costs rise significantly—should be used to implement reforms.
- Implementation note:
  - A more specific fiscal program would provide greater confidence that the MTO can be achieved.

### Equity considerations in designing reforms and tax reform
- Austria’s income inequality and poverty rates are relatively low; preserving this outcome is a policy objective.
- Trade-offs between equity and incentives need to be carefully weighed.
- Measures noted:
  - Reduction in social security contributions for low-income earners is a positive step to help employment prospects.
  - Further steps to lower the tax wedge on low incomes should follow.
    - Potential financing for these steps: higher taxation of environmental pollution and wealth.
- Family policy observation:
  - The increase in the family bonus set for 2019 does not support families with incomes below the threshold at which income taxes are due.

### Authorities’ views on fiscal stance
- Authorities acknowledged the challenge of reducing revenue and the deficit simultaneously but were confident feasibility.
- Emphasis placed on accelerating debt reduction toward the Maastricht target of 60 percent of GDP to rebuild fiscal buffers.
- Observations:
  - Strong growth in 2017 and 2018 had tax and social security contributions approaching the 40 percent target.
  - High output growth is expected to automatically reduce the expenditure-to-GDP ratio.
  - Combined with already-announced measures, this would reduce spending sufficiently to limit the need for additional cuts.

### Reducing unemployment — recent trends and projections
- Labor force changes 2011–2017:
  - Labor force increased by 6.2 percent between 2011 and 2017.
  - Share of non-Austrian citizens in the labor force rose from 11.5 to 16.2 percent.
- Employment and unemployment:
  - Employment increased by 5.1 percent (2011–2017).
  - Unemployment rose slightly from 4.9 percent in 2012 to 5.3 percent in 2018: Q1 (EU harmonized rate).
- Labor force growth projection:
  - Projected to slow gradually; refugee labor market entry is gradual and new immigration has slowed.
  - Labor force participation of Austrian women and elderly workers expected to edge up further.
- Outlook:
  - Above-potential growth in the next few years should generate employment growth outpacing labor force growth, lowering unemployment.

### Policy measures to sustainably reduce unemployment
- Improve education:
  - Unemployment highest among those with only compulsory schooling.
  - Recent increase up to age 18 of compulsory schooling or training and the training guarantee for people under 25 are positive.
  - Austria’s dual-education apprenticeship system is an asset to boost skills.
- Integrate foreigners (including accepted refugees):
  - Foreign-born residents often have lower education and training; even at same education level, face higher unemployment.
  - Need to address hurdles: recognition of qualifications and language skills.
- Active labor market policies:
  - Target specific segments, notably elderly workers who face increasing unemployment rates and difficulties finding jobs once unemployed.
  - Note: Government decision to discontinue targeted support through secondary labor market for over 50-year-old long-term unemployed will likely have adverse effects on this age group; costs and benefits need careful weighing.
- Boost labor demand:
  - Policies recommended earlier include strengthening innovation and competition by lowering barriers to entrepreneurship, a shift in the tax mix away from labor, and higher public investment.
  - Planned steps seen as promising: better support for start-ups, more financing for R&D, strengthening education system and better integration with the economy, increasing flexibility in working hours.

### Authorities’ views on unemployment policy
- Authorities agreed tackling unemployment remains a challenge and concurred that improving the education system is critical.
- On unemployment among foreign nationals:
  - Partly attributed to employment in seasonal activities (tourism, construction); lack of skills acknowledged as a factor.
- On support for elderly workers:
  - Authorities consider subsidized employment (including in the public sector) inefficient and likely to crowd out regular labor market.
  - Prefer supporting continuous training and education for workers as more effective.

### Consolidating financial stability — banking sector strength and vulnerabilities
- Capitalization and liquidity:
  - Sector-wide capital adequacy ratio stood at 18.2 percent at end-2017.
  - CET-1 ratio was 14.6 percent.
  - Thirteen largest banks set to meet the systemic risk capital buffer of up to 2 percent, to be fully phased in during 2019.
  - Weighted average liquidity coverage ratio (LCR) at the unconsolidated level: 145 percent.
- Profitability and provisioning:
  - Profits rose further in 2017 largely due to reduced risk provisioning as NPLs declined.
  - NPL ratio stood at 3.4 percent at end-2017; domestically 2.4 percent.
  - Consolidated coverage ratio of 63.8 percent.
- Funding and CESEE exposure:
  - Banks’ dependence on wholesale funding is low.
  - Bank Austria’s CESEE operations shifted to Unicredit in Italy, significantly reducing direct exposure of Austrian banking system to CESEE.
  - Austrian banks’ subsidiaries in CESEE: loan-to-deposit ratio declined to 79 percent, from over 100 percent in 2011.
- Credit trends:
  - Nominal credit to the private sector grew 3.7 percent (y/y) in February 2018.
  - Credit to nonfinancial corporations: +5.7 percent.
  - Credit to households: +3.5 percent.
  - Growth in residential real estate loans: +4.8 percent.
  - Indebtedness remains below peers’ levels.

### Regulatory, supervisory, and macroprudential measures
- Supervisory updates and focus:
  - Supervisory guidance updated in 2017.
  - Focus shift to strengthening business models of major internationally active banks: rationalization, cost cutting, IT investments, and further strengthening capital.
- Legal basis for targeted real-estate macroprudential tools established:
  - Tools include loan-to-value caps, debt-service-to-income limits, term restrictions, debt-to-income ceilings and minimum amortization requirements.
  - Authorities collecting additional data to improve analysis; comprehensive monitoring expected from 2019.
- Policy guidance:
  - Currently no need to formally activate new macroprudential tools; reporting requirements for full evaluation expected effective only in 2019.
  - Authorities should remain vigilant and prepared to take preemptive action if needed.
  - Consideration should be given to providing clearer guidance to banks on sustainable lending standards, including quantifying specific loan-to-value, debt-to-income and debt-service-to-income limits.
- MREL and resolution expectations:
  - Single Resolution Board and the FMA issuing binding targets for MREL for most banks; process to be completed in 2019.
  - For small deposit-taking banks (local and regional banks) the case for MREL in excess of minimum capital requirements is weaker; expectation should be liquidation rather than resolution in case of difficulties, with no recourse to state aid.

### Anti-Money Laundering / Combating the Financing of Terrorism (AML/CFT)
- Need to continue strengthening AML/CFT framework in line with action plan adopted in response to the 2016 FATF Mutual Evaluation Report.
- Progress and next steps:
  - Several Action Plan items addressed by legislative measures over the last two years; improvements acknowledged by FATF in the first follow-up report in December 2017.
  - Austria should further improve investigation and prosecution of money laundering and the use of financial intelligence.
  - Next step: implement the 5th EU AML Directive to address anonymity of virtual currencies, lack of transparency of beneficial ownership and high-risk countries.

### Staff recommendations for banks and supervisors
- Banks should use the benign macroeconomic environment to:
  - Buttress profitability and safeguard internal capital-generating capacity.
  - Continue implementing adjustment plans and raise further capital to bolster cushions above regulatory limits, including by limiting dividend payouts.
  - Reduce structural costs, invest in efficiency-enhancing infrastructure, refocus on core activities, and withdraw from non-profitable and high-risk activities and locations.
- For smaller banks:
  - Reduce costs, accelerate development of digital banking, and increase fee-based activities to offset shrinking interest rate margins.
- Supervisory and regulatory authorities need to:
  - Ensure banks raise capitalization levels, continue to reduce vulnerabilities, and implement cost-cutting plans.

### Authorities’ views on financial stability and AML/CFT
- Banks:
  - Authorities agreed that banks needed to sustainably raise profitability and improve capitalization; acknowledged potential short-term cost increases from necessary investments (IT, staff reductions).
  - Viewed further strengthening of capital buffers in large banks as desirable, particularly in the current high-growth environment.
- Real estate risks:
  - National supervisory authorities assessed real estate-related risks as limited at this time despite some loosening in lending standards.
  - Noted the ESRB’s 2016 warning did not sufficiently consider initial conditions and country-specific features such as low home ownership.
  - Targeted dialogue conducted with banks whose mortgage lending practices were deemed riskier.
  - Comprehensive mortgage-related monitoring to be possible from 2019.
- AML/CFT:
  - Government emphasized strong commitment to strengthening the AML/CFT framework.
  - Noted improvements in 2017 FATF follow-up report, increased supervisory resources, and establishment of a register of beneficial ownership.
  - Preparing to implement the EU 5th AML directive, including improving coordination and information sharing among agencies.

### Staff appraisal and macro outlook
- Economic assessment:
  - Economy is robust with strong foundations: growth driven by investment, rising labor supply, and net exports.
  - Public debt-to-GDP ratio has continued to fall; unemployment has declined; financial sector strengthened.
  - External position broadly in line with fundamentals and desirable policies.
- Outlook and projections:
  - 2018 GDP growth projected at 3 percent.
  - Growth path: strong in 2018 as investment growth and public consumption taper off but private consumption and net exports accelerate; with the output gap turning positive, growth gradually slows to potential rate of about 1¾ percent.
  - Inflation should run slightly above 2 percent in the medium term.
  - Employment grows faster than labor force; unemployment would gradually decline.

*Source: IMF Country Report (excerpt).*

### 36.      Risks arise largely from external factors, but their impact is likely limited overall. A

### 36.      Risks arise largely from external factors, but their impact is likely limited overall. A

### External risks and domestic vulnerability
- Risks arise largely from external factors: a retreat from cross-border integration, or slow growth in other advanced economies and emerging markets.
- Main transmission channels: confidence, trade, and financial channels.
- Offsetting factors:
  - The European Single Market provides a stable framework.
  - Declining bank exposure to CESEE is containing vulnerabilities.
- Domestic risk: unsuccessful integration of immigrants could reduce their contribution to the economy.

### Short-term fiscal outlook and long-term sustainability
- Short-term: The fiscal outlook is favorable; debt is set to decline further throughout the medium term.
- Authorities’ planned fiscal consolidation is described as ambitious and welcome, but the measures needed to achieve it are not fully identified.
- Policy priorities recommended:
  - Give priority to structural fiscal reforms that enhance the efficiency of public expenditure and the sustainability of the pension system to create fiscal space for aging-related spending needs.
  - Use the current window of opportunity to put in place efficiency-boosting expenditure reforms, in particular in the health sector and in subsidies.
  - Many reforms require adjustments in fiscal relations between the federal and subnational governments.
  - Further reforms to the pension system could ease future fiscal pressures.
  - Combine potential savings with growth-raising reforms to ensure long-term fiscal sustainability.

### Equity considerations in reform design
- Austria’s strong welfare state achieves relatively low levels of income inequality and poverty rates.
- In designing reforms, including a tax reform, equity considerations need to be taken into account.
- Trade-offs between equity and incentives should be carefully weighed.
- Any rebalancing of the tax burden and expenditure cuts must be designed to preserve Austria’s social achievements.

### Reducing unemployment durably — recommended policies
- Decline in unemployment so far owes to the strong economy; durable reduction to pre-GFC levels requires additional measures.
- Recommended measures include:
  - (i) improving education outcomes;
  - (ii) special efforts to supporting the integration of foreigners into the labor market;
  - (iii) targeted active labor market policies where needed;
  - (iv) structural measures to raise labor demand (and potential growth), shifting the tax mix away from labor, and raising public investment.
- Several authorities’ initiatives are noted as steps in the right direction, including lengthening the duration of compulsory schooling and training guarantees.

### Financial stability and banking sector actions
- Banks should continue to implement adjustment plans to cut costs and raise further capital.
- Although large banks’ capitalization has improved, creating further buffers for a less benign environment is important.
- To ensure sustainable profitability and capital-generating capacity, banks need to strengthen business models via:
  - rationalization;
  - cost cutting;
  - IT investments.
- Dividend payouts should be consistent with adequate earnings retention.
- Regulatory and supervisory authorities need to ensure banks implement these measures.
- Real estate market risks remain limited but warrant continued close monitoring.
  - Formal macroprudential instruments do not appear necessary at this time.
  - Authorities should not shy away from targeted proactive steps, which could include quantified supervisory guidance, to maintain sustainable lending standards.
- To preserve Austria’s position as a financial center, authorities need to continue bolstering the AML/CFT framework, notably by improving the investigation and prosecution of money laundering and the use of financial intelligence and implement the recently-issued 5 th EU AML Directive.

### Institutional recommendation
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

*Source: IMF staff report text (content unit 36–41).*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### External position
- Austria’s international investment position (IIP) moved from -21 percent of GDP in 2001 to 6 percent in 2017.
- The current account moved into surplus in 2002 as goods exports rose faster than imports following deeper integration into European value chains after EU entry in 1995.
- Trade in goods moved closer to balance while trade in services (largely tourism) became more important in overall trade.
- Austrian banks sharply reduced reliance on foreign wholesale financing and exposure to CESEEs:
  - Banks’ gross external assets declined from a peak of over 100 percent of GDP in 2008 to about 62 percent of GDP in 2017.
  - The transfer of Bank Austria’s CESEE operations to Unicredit contributed to a reduction in the banking system’s asset and liability position in the order of 30 percent of GDP.

### Current account balance and real exchange rate (REER)
- The current account gap is near zero; the external balance is assessed as broadly consistent with medium-term fundamentals and desirable policies.
- Current account balance in 2017: 2 percent of GDP (cyclically adjusted).
- Estimated norm for the current account: 1.8 percent of GDP.
- Model-based estimates suggest the REER was modestly overvalued (around 7½–10¼ percent); however, the unexplained residual is large and accounts for close to two-thirds of the estimated overvaluation.
- Using the current account gap as reference and an estimated semi-elasticity of 0.07 yields an indicative REER gap of -1.2 percent, assessed as broadly consistent with fundamentals.
- Policy gap drivers noted include:
  - Low budget deficit relative to trading partners (policy gap contributing to external position).
  - High health expenditure relative to trading partners (partly counterbalancing).
  - Relatively weak credit as a percentage of GDP.

### Capital and financial account
- Net direct investment outflows to both CESEE countries and the EU-15 have recovered quickly after the GFC, driven by real-sector investment, keeping the FDI position generally in surplus.
- Net portfolio investment outflows have been strong and are expected to remain so despite retrenching of Austrian banks’ foreign holdings; the negative net portfolio investment position is expected to narrow gradually.
- A decline in the net “other investments” position is expected to mirror these trends.
- Footnote: In 2016, the transfer of CESEE operations of Bank Austria (a subsidiary of Unicredit) to Unicredit in Italy led to a temporary decline in net FDI outflows.

### Overall assessment and policy implications
- Austria’s external position is sustainable and broadly in line with fundamentals.
- The ageing population implies that a build-up of external assets in the next few years is warranted as a buffer for future withdrawals.
- Policies are broadly appropriate; recommended structural priorities include:
  - Raising the efficiency of health expenditures.
  - Reforming pensions to unlock significant savings potential and help ensure long-run fiscal sustainability.

### Risk Assessment Matrix — selected risks, likelihoods, horizons, and policy responses
- Retreat from cross-border integration
  - Relative Likelihood: Medium
  - Time Horizon: ST, MT
  - Impact/Policy Response: Medium. Austria is a very open economy, with exports comprising over 50 percent of GDP (of which about 70 percent to the EU). A retreat could reduce exports and potential growth and jeopardize fiscal consolidation. Policy response: maintain free movement of goods, services, capital, and labor with key partners as at present.
- Policy uncertainty (Brexit, U.S. tax bill, NAFTA, elections)
  - Relative Likelihood: Medium
  - Time Horizon: ST, MT
  - Impact/Policy Response: Low. Effects largely indirect via Germany and other EU partners; slump in confidence could reduce investment. Policy response: implement reforms to boost productivity and potential growth.
- Fragmentation/security dislocation in parts of Middle East, Africa, Asia, and Europe
  - Relative Likelihood: High
  - Time Horizon: ST, MT
  - Impact/Policy Response: Low. Could increase migrant flows and political tensions, straining public finances short term. Policy response: invest in integration of admitted asylum seekers.
- Further pressure on traditional bank business models (competition from non-banks, fintech)
  - Relative Likelihood: Medium
  - Time Horizon: MT
  - Impact/Policy Response: Low. Could affect confidence and financing conditions if profitability does not improve. Policy response: further strengthen banks’ capital cushions, reinforce efficiency drive.
- Structurally weak growth in key advanced economies
  - Relative Likelihood: High
  - Time Horizon: MT
  - Impact/Policy Response: Medium. Austria would be directly affected if growth in Germany, the rest of the EU, or CESEE were to slow. Policy response: accelerate structural and fiscal reforms; continue close monitoring of banks' profitability and capital levels and implement adjustment plans.
- Cyber-attacks on interconnected financial systems and institutions
  - Relative Likelihood: Medium
  - Time Horizon: ST, MT
  - Impact/Policy Response: Low. Policy response: strengthen domestic defenses including back-up systems and financial cushions and promote international cooperation.
- Integration of immigrants
  - Relative Likelihood: Medium
  - Time Horizon: ST, MT
  - Impact/Policy Response: Medium. Reduced integration efforts could lower productivity and increase welfare dependency, slowing growth and increasing welfare spending. Policy response: maintain or increase integration efforts.

*Source: Annex I. External Sector Assessment (cr18272).*

### Annex III. Debt Sustainability Analysis

### Annex III. Debt Sustainability Analysis

### Main findings
- Austria’s debt outlook has improved further.
- Public debt is sustainable within the medium-term projection horizon, though ageing cost pressures are looming in the longer term.
- Under the baseline, debt will fall from around 84 percent of GDP at end-2016 to 61 percent of GDP by end-2023.
- Standardized stress tests indicate that lower growth and a combined macro-fiscal shock could shift the debt-to-GDP ratio upwards, but debt would remain on a downward trajectory.
- In the longer term (starting in the mid-2020s), ageing cost pressures and higher interest rates would reverse the debt path without additional policy measures.

### Baseline projections and assumptions
- Fiscal policy is set to return the structural deficit to ½ percent of GDP (Austria’s MTO) by 2020.
- Positive effects from the deal with the creditors of HETA, the wind-down unit of the former Hypo Alpe Adria bank, contribute to the outlook.
- Gross public debt projected to reach 61 percent of GDP by 2023, almost 18 percentage points down from its 2017 level.
- Gross financing needs are moderate in the period 2018–23.
- Key baseline technical projections (Figure 3, selected rows):
  - Nominal gross public debt: 78.7 (2016), 83.6 (2017), 78.5 (2018), 74.2 (2019), 70.9 (2020), 67.8 (2021), 65.0 (2022), 62.8 (2023), 60.9 (end-2023 as repeated elsewhere)
  - Public gross financing needs: 11.2 (2016), 9.4 (2017), 8.1 (2018), 8.7 (2019), 9.5 (2020), 8.7 (2021), 8.0 (2022), 7.6 (2023), 8.2 (2023 cumulative entry)
  - Real GDP growth (in percent): 1.0 (2016), 1.5 (2017), 3.0 (2018), 3.0 (2019), 2.1 (2020), 1.5 (2021), 1.5 (2022), 1.4 (2023), 1.5 (2023)
  - Inflation (GDP deflator, in percent): 1.9 (2016), 1.1 (2017), 1.6 (2018), 1.8 (2019), 1.8 (2020), 2.1 (2021), 2.2 (2022), 2.1 (2023), 2.1 (2023 cumulative)
  - Nominal GDP growth (in percent): 2.9 (2016), 2.6 (2017), 4.6 (2018), 4.8 (2019), 4.0 (2020), 3.7 (2021), 3.7 (2022), 3.6 (2023), 3.6 (2023)
  - Effective interest rate (in percent): 3.8 (2016), 2.6 (2017), 2.3 (2018), 1.9 (2019), 1.7 (2020), 1.7 (2021), 1.6 (2022), 1.6 (2023), 1.7 (cumulative)
- Change in gross public sector debt cumulative 2016–23: -17.6 (percent of GDP).
- Identified debt-creating flows cumulative 2016–23: -17.1 (percent of GDP).
- Primary deficit cumulative 2016–23: -5.8 (percent of GDP).
- Primary (noninterest) revenue and grants cumulative: 286.0 (percent of GDP over period as reported).
- Primary (noninterest) expenditure cumulative: 280.1 (percent of GDP over period as reported).
- Automatic debt dynamics cumulative: -8.9 (percent of GDP).
- Interest rate/growth differential cumulative: -8.9 (percent of GDP).
- Other identified debt-creating flows cumulative: -2.3 (percent of GDP).
- Stock-flow adjustment (incl. asset recovery) cumulative: -2.3 (percent of GDP).
- Residual, including asset changes cumulative: -0.6 (percent of GDP).

### Stress tests and scenarios
- Low-growth scenario:
  - Assumes growth is slower by one standard deviation of the historical outturn, implying a reduction by close to 2½ percentage points in 2019–20.
  - Debt-to-GDP ratio would increase only marginally and then decline to 68 percent of GDP by 2023.
- Contingent liability shock:
  - A contingent liability shock of 10 percentage points of GDP would raise public debt to 88 percent of GDP, which would only slowly decline to 81 percent of GDP by 2023.
- Other standardized macro shocks (primary balance shock, real exchange rate shock, real interest rate shock):
  - Will not lead to significant deviations from the baseline debt path.
- Combined shock:
  - Driven by assumed lower growth and leads to a similar debt path as in the low-growth scenario.
- Heat map assessment:
  - Vulnerabilities remain limited.
  - Declining debt level implies potential shocks would not push Austria’s debt up—except for a contingent liability shock—over the relevant thresholds.
  - High share of public debt held by non-residents and attendant external financing requirements are a potential vulnerability.
  - This vulnerability is limited by the perception of Austria as a safe haven but could lead to higher volatility in spreads, especially once the European Central Bank’s (ECB) asset purchases end, depending on interest rate dynamics outside Austria and residual risks from commercial banks’ CESEE exposure.

### Alternative scenarios and composition
- Alternative scenarios shown include: Baseline, Historical scenario, and Constant Primary Balance scenario.
- Composition of public debt:
  - By original maturity: medium and long-term vs short-term (historical and projection panels shown).
  - By currency: local currency-denominated vs foreign currency-denominated (historical and projection panels shown).
- Selected alternative scenario assumptions (Figure 4):
  - Historical scenario effective interest rate projections higher in later years (e.g., 1.9, 1.7, 1.9, 2.1, 2.3, 2.5).
  - Constant Primary Balance scenario holds Primary Balance at 1.0 across projection years.

### Predictive densities and realism checks
- Evolution of predictive densities of gross nominal public debt shows percentile bands (10th-25th, 25th-75th, 75th-90th) around the baseline projection for 2016–2023.
- Realism of baseline assumptions (Figure 2):
  - Forecast track record versus all countries for Real GDP Growth, Primary Balance, and Inflation (Deflator) with Austria’s median forecast errors:
    - Real GDP growth: Austria forecast error -0.78 (percent), has a percentile rank of 32%.
    - Primary Balance: Austria forecast error 0.22 (percent of GDP), has a percentile rank of 79%.
    - Inflation (Deflator): Austria forecast error -0.10 (percent), has a percentile rank of 66%.
  - Assessing projected fiscal adjustment:
    - Austria 3-Year Adjustment in Cyclically-Adjusted Primary Balance (CAPB): percentile rank of 57% (3-year adjustment distribution).
    - Austria 3-Year Average Level of CAPB: percentile rank of 59% (3-year average level distribution).

### Implications and vulnerabilities highlighted
- Medium-term sustainability is supported by projected fiscal consolidation to a structural balance of ½ percent of GDP by 2020 and nonrecurring factors (e.g., HETA deal).
- Main vulnerabilities:
  - Contingent liabilities (a shock of 10 percentage points of GDP materially raises debt).
  - High share of public debt held by non-residents, implying external financing needs and potential spread volatility.
  - Longer-term risks from ageing-related spending pressures and higher interest rates beginning in the mid-2020s, which could reverse the debt path without additional policy measures.

*Source: IMF staff (Annex III. Debt Sustainability Analysis).*

### 3.      Mismatches have increased nonetheless, although the labor market appears to operate

### 3.      Mismatches have increased nonetheless, although the labor market appears to operate well overall

### Skills mismatch
- Demand for highly skilled workers is rising much faster than for those with lower skills.
- The mismatch for highly skilled workers (with a university or post-secondary college degree) has remained broadly unchanged since 2007/08, but at a higher level than for other workers.
- Interpretation: the education system is keeping up with the needs of the labor market, but the increasing share of highly-skilled workers in both the workforce and in vacancies implies the economy-wide skills mismatch has increased relative to where it would have been without the shift to demand and supply for higher skills.
- At the low end of the education spectrum:
  - Both demand and supply of low-skilled workers have declined significantly.
  - Unemployment has risen for workers with only compulsory school education.
  - The mismatch has recently fallen back to pre-GFC levels, but there appear to still be too many workers with only compulsory school education.

### Nationality-related mismatch
- Removal of mobility restrictions on citizens of the EU’s New Member States (NMS) in 2011 led to a significant increase in their number.
- Geographic proximity (especially for Vienna) facilitates daily or weekly commuters residing in neighboring countries but working in Austria.
- Foreign nationals are much more likely to be unemployed than Austrians.
- Independent of the level of education, foreign nationals—particularly those from outside the EU—face a higher risk of unemployment than Austrian nationals.
- Contributing factors include language barriers, possible skills gaps despite similar formal education levels, and fewer informal connections.
- Over time, the unemployment difference does not decline significantly; second-generation foreign nationals have the highest unemployment rate, suggesting that in some population segments poverty and unemployment may have become entrenched.

### Vienna-specific observations
- Education- and nationality-related mismatches explain some of Vienna’s higher unemployment, which is significantly higher than elsewhere in Austria—an unusual pattern compared to other European countries.
- Unemployment rates in Vienna are higher across all educational levels and nationalities.

*Source: cr18272 - 3.      Mismatches have increased nonetheless, although the labor market appears to operate well overall.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18272.pdf_