Austria: Island of Stability? - Part One

With Europe in crisis, Austria can count itself lucky. The country has outperformed the rest of the European Union in these economic hard times. The recession of 2009 was not as deep – Austria’s economy shrank by 3.9% of the Gross Domestic Product (GDP), compared to the EU average of -4.2%. And Austria’s return to growth was faster and stronger than in the rest of the EU, marking 2% of GDP in 2010 against the EU average of 1.8%.

How has this been so? Austria’s strong showing can be traced to three things: low budget deficits before the crisis, in turn enabling countercyclical fiscal policies, as well as successful management of the credit crisis in the Central European and South Eastern European (CESEE) region.

A low annual budget deficit and modest state debt before the crisis allowed the Austrian government to counter the dawning recession with a bold fiscal stimulus. Infrastructure building put firms and people to work. Income tax cuts freed up consumer spending, as did cash-handouts to people willing to scrap their old cars and buy new ones.

Not least, a €100 billion loan package to Austrian banks helped increase their capital and enabled them to resume lending.

Yet despite these costly interventions, the state’s annual budget deficit remained lower than the EU average. Its high watermark was 4.6% of GDP in 2010, while the EU’s hit 6.4% that year. Therefore, Austria’s total public debt of 73.8% of GDP in 2011 remains significantly lower than the 86.5% average for the euro area, the EU average of 82.3%, and far lower than the U.S.’s 101% or Japan’s staggering 212%.

Finally, Austria’s activism at the European level helped stem the burgeoning financial crisis in CESEE that was threatening Austrian banks which have large exposures to the region.

To recap, immediately after Icelandic banks collapsed in October 2008, financial contagion spread to Hungary. By early 2009, the entire CESEE region was confronted with rapid capital outflows, depreciating the countries’ currencies and thereby making it more costly for states and households to service their foreign debts. This put Austrian banks, with massive outstanding loans in the region, at risk.

At this point, Austria stepped up its international effort. Intense lobbying and a strong Austrian-French coalition overcame German resistance in the European Council, paving the way to the decision in March 2009 to increase the EU balance of payments facility to €50 billion, and provide the IMF with €75 billion.

Together with the later decision by the G20 group of rich and emerging economies to increase IMF funds to $750 billion, this stabilised the currency and bond markets. Investors were confident that the EU and the IMF now had enough funds to rescue the entire region, if necessary. In the end, only a fraction of those funds had to be spent.

Crucially, Austria initiated private sector involvement that helped turn the crisis around. In the so-called Vienna Initiative, a group of Western and Eastern European banking supervisors, joined by the IMF and the European Bank for Reconstruction and Development, successfully lobbied the private sector to maintain its exposure in CESEE countries, preventing the panic-selling of bonds and currencies that would have driven up interest rates and made a default more likely.

In the euro area as a whole, international cooperation has, up until now, been less successful. Following the crises that started in Greece in 2010, contagion has spread to Spain and Italy.

We should learn from the successful response to the CESEE crisis in 2009. Now, as then, the EU, euro area and IMF must provide sufficient funds to cover all of Spain’s and Italy’s possible financing needs, including recapitalisation of  their banks. This would get credit flowing back into their starved economies. At the same time, a recast "Vienna Initiative" should convince private lenders to hold on to their Spanish and Italian bonds to keep interest rates down.

Franz Nauschnigg is the head of the European Affairs and International Financial Organizations Division at the Austrian National Bank (ÖNB)

See also Island of Stability? - Part Two, and Island of Stability? - Part Three from the Dec. 2011 / Jan. 2012 issue.