Background.
The Austrian economy has been doing well in recent years. This was the combined result of solid economic policies, structural reforms, wage moderation, and an early focus on Central, Eastern and Southeastern Europe (CESE). Economic growth exceeded 3 percent in both 2006 and 2007— ignificantly higher than the euro area average and than growth in major trading partners—with strong employment growth and unemployment coming down to about 4 percent. The external position remained strong, but inflation has been under upward pressure, as elsewhere in the euro area. The structural fiscal position has not improved significantly during the economic upturn.
Key issues and recommendations
Short-term outlook. In response to global economic developments staff expects growth to come down to around 2 percent in 2008-09. Inflation is expected to reach close to 3 percent in 2008. To sustain growth and minimize the negative effects of a weaker external environment, keeping Austria competitive will be critical. This will require continued wage moderation.
Fiscal policies. The government has recently confirmed its objective of a structurally balanced budget by 2010. However, reaching that target will be challenging. The structural deficit in 2007 was about 1 percent of GDP, and the authorities have announced tax cuts for 2010 to the tune of another 1 percent of GDP. To achieve the required lasting expenditure savings, a fundamental reform of fiscal federal relations is needed.
Financial sector. The rapid expansion of Austrian financial institutions in CESE has been beneficial for both Austria and the host countries. However, it has also brought greater vulnerabilities and equires active credit risk management, in particular with regard to foreign currency lending. The authorities are aware of the need to continue strengthening financial sector policies and governance, and this prompted a reorganization of banking supervision, with a larger role for the Austrian National Bank (OeNB). The financial sector has so far not been affected significantly by the recent global financial turmoil, although funding costs have gone up.
Structural policies. Structural reforms need to be implemented as planned, with a special focus on further deregulation, increasing competition in domestic markets, and labor market reforms.