Public Information Notice No. 10/126

Public Information Notice: IMF Executive Board Concludes 2010 Article IV Consultation with Austria

September 8, 2010

On August 30, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with Austria.¹

Background

While severe, Austria’s recession had limited effects on unemployment. In light of its financial and economic openness, the contraction in world trade and the financial crisis impacted considerably on activity. Investment declined sharply but consumption helped cushion the recession, supported by tax cuts and various labor market measures together with large increases in real wages.

A gradual export-led recovery is underway, with gross domestic product (GDP) growth expected to reach 1½ percent in 2010 and 2011, after a 3.9 percent contraction in 2009. However, uncertainties are elevated and mainly center on developments in the international financial environment.

In the medium term, potential growth is unlikely to return to pre-crisis levels. It will be affected by population ageing and ongoing weakness in investment, due in part to lower growth prospects in some Central, Eastern and South Eastern European (CESEE) countries.

Austria’s fiscal position has weakened significantly in recent years, although to a lesser extent than the euro area average. As a result of the recession and as a consequence of stimulus measures of around 2 percent of GDP, mainly consisting of permanent tax cuts, general government deficit and debt levels are expected to reach respectively 4¾ percent and 70 percent of GDP in 2010.

Public support helped reduce market pressures on Austrian banks. The global financial crisis and the bursting of credit bubbles in some CESEE countries where Austrian banks are heavily exposed have weakened the sector. Public financial support, together with the EU/IMF-supported programs, was instrumental in improving market confidence, as evidenced by declining credit default swap spreads. Capitalization has continued to improve on the back of capital increases and deleveraging, but there is marked heterogeneity across banks and nonperforming loans have yet to peak. A particular risk stems from the extent of foreign currency loans made by subsidiaries in the CESEE region.

Executive Board Assessment

Executive Directors commended the authorities for their timely policy response, which has helped mitigate the impact of the global crisis. They noted that, as an open and competitive economy, Austria is well placed to benefit from the recovery in world trade, although considerable risks remain to the growth outlook. Directors also observed that, while Austria’s significant integration with other countries in central and south-eastern Europe has been beneficial, it has also exposed the economy to higher risks, notably in the financial sector. In this context, Directors encouraged the authorities to step up efforts to strengthen the fiscal position, improve the resilience of the financial system, and enhance medium-term growth prospects through structural reforms.

Directors welcomed the authorities’ plan to embark on a decisive fiscal consolidation path beginning in 2011. They saw the planned pace of consolidation as broadly appropriate and encouraged the authorities to set out concrete commitments and measures early on. Directors noted, in particular, that well-designed measures, which focus mostly on expenditure and involve participation of all levels of government, could minimize the effects on growth and enhance fiscal sustainability. Given the already high overall tax burden, revenue measures should be well targeted. Directors also recommended strengthening the current fiscal framework (“internal stability pact”) and introducing ceilings to local governments’ debt and guarantees issuance.

Directors observed the improvement of the overall financial position of banks, but noted that more efforts are needed to enhance the resilience of the financial sector. In this context, they noted that, while care should be taken to avoid distortions, the extension of the current financial support package is appropriate. Directors also welcomed recent reforms to the supervisory framework and recommended that regulatory changes and all other measures under consideration be designed carefully. To strengthen supervision and intervention powers, Directors encouraged the authorities to consider a system mandating early remedial action and a proper resolution framework for financial institutions. They also advised the authorities to monitor closely the situation of individual banks in light of the results of stress tests and stand ready to take action as appropriate.

Directors welcomed the authorities’ efforts to enforce tighter foreign-exchange lending standards in cooperation with other supervisors. They recognized, however, that reducing the share of foreign exchange loans, while providing continued financing to central and south-eastern Europe, will be challenging. Directors also welcomed the authorities’ action plan designed to address FATF recommendations.

With medium-term potential growth expected to be lower compared with pre-crisis levels, Directors welcomed efforts to raise labor participation in some segments of the population (older, low skilled, and foreign-born workers) and boost product market competition. In this regard, they saw scope to revisit special schemes and long transition periods in the implementation of the 2003 pension reform, which are undermining the necessary increase in the effective retirement age. They also encouraged measures to increase competition in the services sector, including through an effective transposition of the EU Services Directive.