Fitch Ratings has downgraded Austria’s Long-term foreign and local currency Issuer Default Ratings (IDR) to ‘AA+’ from ‘AAA’. The Outlooks are Stable. The issue ratings on Austria’s unsecured foreign and local currency bonds have been downgraded to ‘AA+’ from ‘AAA’. Fitch has affirmed the Short-term foreign currency IDR at ‘F1+’ and Country Ceiling at ‘AAA’.
KEY RATING DRIVERS
The downgrade of Austria’s foreign and local currency IDRs reflects the following key rating drivers and their relative weights:
General government debt in Austria will reach a higher peak than previously thought and remain elevated for longer. This will significantly reduce the shock-absorbing capacity of the sovereign. The general government debt ratio (GGGD) is expected to peak around 89% of GDP in 2015, higher than all sovereigns in the ‘AAA’ category besides the US and in line with the UK (AA+/Stable). Fitch previously stated 80%-90% to be the upper limit of GGGD compatible with retaining a ‘AAA’ rating, provided the ratio is then placed on a firm downward path and other fundamentals are of the highest credit quality. Within a short space of time the debt dynamics of Austria have deteriorated significantly. Only 18 months ago, Fitch expected Austria’s debt ratio to peak around 75% of GDP in 2013/2014 and then decline to around 70% by 2017. At the time the Austrian government expected debt to peak at 74% before falling back to 67%. Recent upward revisions to the debt ratio mostly reflect the impact of bank restructuring on public finances. Since the 2008-09 crisis, the progress with the restructuring of medium-sized banks that fell into serious distress has been slow.
Under Fitch’s current baseline, GGGD is expected to ease just below 86% of GDP in 2017, compared with 80% previously (after accounting for estimates of ESA2010). The worsening debt dynamics reflects a combination of a higher than projected impact from the accounting changes, further debt crystallising on the sovereign balance sheet from bank restructuring, wider fiscal deficits and weaker nominal GDP growth.
Fitch expects official financial sector support to have added over 11% of GDP to public debt by end-2015. The continued restructuring of medium-sized banks is likely to add modestly to public debt in the near term, beyond the buffers in the government’s 2015 budget, but the exact timing and size remains unclear. Under our baseline, we assume that Kommunalkredit Austria AG will add a further 2% of GDP to the public debt this year. Investors have also filed a lawsuit against the Austrian government for the bail in of subordinated debt of EUR890 million (0.3% of GDP) and a similar amount relating to deposits in the resolution of Hypo Group Alpe Adria Bank (HAA). The resolution of HAA is largely responsible for a stock flow adjustment to public debt of around 4.4% of GDP in 2014. On ESA2010 accounting changes KA-Finanze added a further 2.2% of GDP to public debt.
The slow and weak recovery has increased uncertainty about medium-term growth prospects. Annual GDP growth has remained below 1% since 2012 and Fitch has significantly revised down its growth forecast for 2015 to 0.8% from 1.6% previously. Despite the government’s aim to reduce the tax burden on low income workers to boost labour supply (although details are yet to be finalised) reforms do not seem to be sufficient to fully reverse the trend decline in potential growth. Eastern Europe, which is a major trading partner, is also likely to be less receptive to Austrian exports than in the past as growth in the region will continue to catch up but be less dynamic than before. The Austrian Institute of Economic Research (WIFO), recently revised down its potential growth estimates to between 1% and 1.3%, which Fitch believes is a realistic range given recent trends. Previously, the agency believed long-term growth around 1.5% was possible. The Austrian government uses the WIFO economic forecasts to underpin its budget projections.
Recent developments outside of Austria have increased pressures on the broader financial sector, although they remain manageable. Banks’ exposure to Eastern Europe leaves them vulnerable to an escalation in the conflict between Russia and Ukraine. At 20%, Austrian banks account for the largest share of the total EU-15 banks’ exposure to CESEE (only including banks under majority domestic ownership, so excluding Bank Austria). Their claims on the region totalled EUR194bn (59% of GDP) in Q3 2014, with Russia and Ukraine accounting for EUR18bn (5.5% of GDP). The rise in loan impairment charges from the sudden appreciation of the Swiss franc will put additional strains on already weak profitability.
Despite the downgrade, Austria’s very high credit quality is reflected in its ‘AA+’ rating with a Stable Outlook, which reflects the following main factors:
The Austrian government has a relatively favourable underlying budgetary position. The headline fiscal deficit is estimated to have widened to 2.8% of GDP in 2014 from 1.5% last year. However, the underlying deficit (ie. excluding the one-off impact of HAA support) of 1.6% would remain relatively unchanged from 2013, below the EU 3% threshold .The planned fiscal adjustment should be sufficient to arrest the rise in the GGGD ratio under our baseline projections, assuming that further material financial sector support can be avoided.
Fitch judges financing risk to be low, reflecting an average debt maturity of nearly nine years, low borrowing costs and strong financing flexibility.
Austria has a rich, diversified, high value-added economy with strong political and social institutions. It also benefits from low private-sector indebtedness and a high household savings rate. The unemployment rate is around 5%, which along with Germany is the lowest in the EU. The unemployment rate remained stable during the large swings in the economic cycle over the past five years.
Austria remains internationally competitive. The current account has been in surplus since 2002 and the net international investment position is close to balance from a peak deficit of USD73.7bn in 2007.
Future developments that could individually or collectively, result in a downgrade include:
– Further material costs from the financial sector outside the range of current expectations that worsens the government debt profile.
– Failure to place public debt on a firm downward trajectory, for example because of significant slippage from fiscal consolidation targets or weaker nominal GDP growth.
Future developments that could individually or collectively, result in an upgrade include:
– A sustained track record of a decline in the public debt to GDP ratio from its peak to a level that provides the sovereign with greater fiscal flexibility.
– A stronger recovery of the Austrian economy and greater confidence in medium-term growth prospects, particularly if supported by the implementation of effective structural reforms.
The ratings and Outlooks are sensitive to a number of assumptions:
In its debt sensitivity analysis, Fitch assumes a primary surplus averaging 1.5% of GDP over the next 10 years, trend real GDP growth averaging 1.3%, an average effective interest rate of 2.8% and GDP deflator of 1.7%. On the basis of these assumptions, the debt-to-GDP ratio would peak at 89% in 2014 and 2015, before declining to 73% by 2023.
Despite growing risks of political paralysis over the funding of planned tax cuts on labour, Fitch believes the centre-left Social Democratic Party and the centre-right Austrian People’s Party will maintain their coalition government until 2018.
Fitch debt dynamics does not include any government bank asset disposals as the timing and values of such operations remain uncertain.
The ECB’s asset purchase programme will help underpin inflation expectations and supports our base case that in the context of a very modest eurozone recovery, the region will avoid prolonged deflation.
Fitch also assumes gradual progress in deepening financial integration at the eurozone level and that eurozone governments will tighten fiscal policy over the medium term.