Public Information Notice No. 98/43

Press Information Notice: IMF Concludes Article IV Consultation with Austria

June 24, 1998

On June 17, 1998, the Executive Board concluded the Article IV consultation with Austria¹.

Background

First-round participation in European Economic and Monetary Union (EMU) has been the paramount objective of Austrian policymakers since Austria joined the European Union (EU) in 1995. Faced with a general government deficit in excess of 5 percent of GDP, the government adopted a two-year fiscal consolidation program aimed at ensuring EMU qualification by reducing the deficit to no more than 3 percent in 1997. At the same time, the social partners began to tackle long-delayed structural reforms to increase the flexibility of the labor and product markets.

The experience with the implementation of the fiscal consolidation program, which was launched in a low-growth environment, has been more favorable than expected: economic growth accelerated during 1996–97, and inflation declined to its lowest level in decades. While the economic expansion was still too weak to reverse the upward trend in the unemployment rate, the level of employment began to rise in 1997 after several years of decline. These results—brought about by strengthening foreign demand, improved competitiveness, expenditure-based fiscal consolidation, easier monetary conditions, and measures to make labor and product markets more flexible—have returned business (if not yet consumer) confidence to the level observed before the onset of the slowdown in early 1995 and brightened the outlook for 1998–99.

The recovery has so far been narrowly based on exports and business investment. Other components of domestic demand—notably private consumption, which was held back by wage moderation and continued fiscal consolidation—remained sluggish in 1997. Nonetheless, at 2½ percent, GDP growth is estimated to have slightly exceeded the growth of potential output, raising output to within ½–1 percent of its potential. The prospects are for growth to gain further momentum in 1998–99, and to become more broadly based as growing employment, higher real wages, and enhanced family benefits lead to a recovery of private consumption. With growth of 2¾–3 percent a year, the output gap is likely to be virtually closed by 1999. Inflation is, however, likely to remain subdued as employment gains will benefit primarily new entrants to the labor force, before beginning to reduce the unemployment rate, which is already the second lowest in the EU.

The fiscal consolidation program succeeded in reducing the general government deficit to 2.5 percent (2 percent on a cyclically adjusted basis) of GDP in 1997 and the debt ratio to 66 percent of GDP. As envisaged, most of the adjustment was brought about by expenditure restraint, but the expenditure ratio remains high at 50½ percent of GDP. With EMU participation assured and despite faster economic growth, the budgets for 1998 and 1999 foresee no further deficit reduction, and the debt ratio is likely to decline only very slowly, absent major debt reduction operations.

In close consultation with the social partners, a number of measures were taken to improve the functioning of labor, product, and financial markets. In particular, more flexible worktime arrangements and longer shop opening hours have lowered labor costs and created new, mostly part-time jobs and early retirement is becoming less attractive after a recent pension reform. Active labor market measures to expand the apprenticeship program and stimulate self-employment are under preparation. Deregulation of product markets included the reduction of regulated crafts and trades by about one half and the updating and relaxation of qualification requirements for the remainder. Simplified permit requirements and faster administrative approvals should soon facilitate investment. The restructuring of the financial, telecommunications, and electricity sectors has begun, and privatization is in progress in the former two. The partial opening of the electricity market is to be legislated soon.

Executive Board Assessment

Executive Directors expressed their satisfaction with Austria’s improved economic performance and its successful qualification for first-round participation in EMU. While noting that the acceleration of growth owed much to recovery abroad and favorable exchange rate movements, Directors underscored the major contributions of sound domestic policies to the positive trends in output, employment, and inflation. They commended the authorities for the successful implementation of their two-year fiscal consolidation program, noting that the skillful social balance of the package and its emphasis on expenditure reduction appeared to have buttressed confidence. The fiscal agenda for the future should draw upon the lessons of the past two years: notably, that household consumption had been maintained and business investment had rallied in the face of substantial fiscal retrenchment. Directors stressed, however, that further fiscal consolidation, wage restraint, and structural reform should be pursued resolutely in the period ahead in order to capitalize on EMU and a promising economicenvironment, and foster sustainable economic growth. The agenda should include plans to reduce the high levels of government debt, expenditure, and taxation; and it should seek to create room for countercyclical fiscal measures, if required, to maintain stability under EMU.

In the light of this agenda, Directors welcomed the authorities’ intention to achieve fiscal balance or a small surplus on a cyclically adjusted basis in the medium term. However, they regretted the lack of progress toward that objective in the budgets for 1998 and 1999. Directors considered that, in the presently favorable environment, maintaining the momentum of fiscal consolidation is warranted, as it could help prevent a widening of the underlying cyclically adjusted fiscal deficit and provide additional room for maneuver, particularly in the EMU context. Directors therefore urged the authorities to implement these budgets tightly and to use any revenue windfalls for deficit reduction. In addition, any proceeds from the sale of international reserves should be used for debt reduction. Efforts should also be stepped up to reduce government debt directly with the proceeds from privatization and financial asset sales. As in other cases of EMU participants, Directors noted the limited role of monetary policy under a monetary union, and the increased relevance of fiscal policy.

Directors encouraged the authorities to use the planned administrative and civil service reforms to curtail government expenditure. If sufficient durable cuts could be made in such areas as civil service compensation, social transfers, and subsidies, Directors suggested that the planned tax reform could lower the taxation of labor without either raising the taxation of capital or jeopardizing fiscal consolidation. Directors indicated that an early, comprehensive reform to meet the looming demographic pressures on the pension and health-care finances would be in Austria's best interest. Nevertheless, if the authorities preferred to pursue the envisaged incremental approach, they should carefully avoid the building up of fiscal pressures.

In view of evidence that past structural reforms had contributed to the improved economic performance, Directors encouraged the social partners to make further progress to enhance the functioning of labor, product, and financial markets. They emphasized the need to address unemployment problems through increased flexibility of job market arrangements and efforts in job creation. Directors encouraged the authorities to pursue their efforts in privatization, including in the financial sector. They also called for continued close supervisory attention as the restructuring of the financial sector proceeded.

Directors welcomed the increase in official development assistance disbursements despite budgetary stringency.