Austria: Island of Stability? - Part Three

Thanks to the lively demand for Austrian goods and services from outside Europe, the real effects of the ongoing debt crisis in the euro area have been contained – at least so far.

This year the Austrian economy will post a strong growth of around 3%.

Certainly, the reason for this is that Greece, Portugal, Ireland and Spain weigh relatively lightly in Austria’s foreign trade. These four countries together had a market share of just around 4% of total Austrian commodities exports in 2007. Due to the crisis, their share declined further to below 3% in 2010. In tourism, Austria’s main service export, the four countries make up less than 1% of all over-night stays in Austrian resorts.

Yet with the debt crisis still unfolding, the resilience of Austria’s economy could come under pressure. The Italian government has announced a substantial austerity package to calm its creditors, as ten-year yields on Italian bonds jumped dangerously beyond 7% in November. The new prime minister, Mario Monti, has set about balancing the fiscal budget within two years – from its current deficit of -4% of GDP. This will be an additional strain on the already stagnating Italian economy and could have a greater impact on Austria’s than it has been so far.

Italy is Austria’s second largest trading partner after Germany, with an export market share for commodities of around 8%. Moreover, 2.5% of all over-night stays are booked by Italian tourists, mostly in cities where spending tends to be higher than on the ski slope. The austerity programme, meanwhile, is sure to dampen Italians’ demand for Austrian products, as well as their taking chic weekend holidays in Vienna.

Another way that the negative effects of the debt crisis could be transmitted to Austria is the exposure of Austrian banks to financial distress abroad.

Whereas the amount of Greek, Portuguese and Irish sovereign bonds held by the Austrian banking system is relatively modest, Italian bonds make up a substantially larger part of their portfolio. If these have to be depreciated, this could endanger the capital structure of Austrian banks.

In fact, Italy’s troubles already seem to be crossing the border into Austria. In November, yields for Austrian sovereign bonds unexpectedly rose sharply from 2.6% to 3.8%. This happened despite the fact that Austria is one of the world’s richest nations, with a debt to GDP ratio that is lower than Germany’s, strong economic growth before and after the crisis, and the EU’s lowest unemployment rate.

The reason for the sudden spike in interest rates paid on Austrian debt, then, could be that markets are aware of the Italian economy’s importance for Austria. As Austrian firms lose business in Italy, lenders seem to fear that the Austrian state also may run into difficulty in servicing its debts, and are hence charging a risk premium.

A further reason could be that the reduced creditworthiness of Italian bonds held by Austrian banks increases the probability that they will have to be rescued by the government. Such a bailout would drive up Austria’s public debts, as well as their yields. While this is an extreme scenario, the shifting odds are enough to actually push up the yields on Austrian bonds.

Admittedly, if the crisis deepens in Italy, this will increase the impact on the Austrian economy. But, despite Italy’s relative importance, it is unlikely to be decisive; the Austrian business cycle – like Germany’s – is much more dependent on factors outside of Europe.

Over the past 10 years, growth in Austria was on average 1.25% higher than in Italy, but this year the difference will reach 2.5%, as the Austrian economy will grow by 3%, despite Italy’s meagre growth of 0.5%. For the next two years, the European Commission forecasts the growth gap to narrow again to 1%.

This means that, even with Italy in a mild recession, the Austrian economy should continue to grow.

Marcus Scheiblecker is an expert on Austrian development and European economic policy at the Austrian Institute of Economic Research (WIFO).

For more economists’ perspectives, see also: Austria: Island of Stability? - Part One, and Austria: Island of Stability? - Part Two