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Scope Ratings GmbH has today affirmed the Republic of Austria’s long-term issuer and senior unsecured local- and foreign-currency ratings at AAA, along with the short-term issuer rating of S-1+ in both local and foreign currency. All Outlooks are Stable.

Rating drivers

Scope’s affirmation of its AAA rating on the Republic of Austria reflects the country’s euro area membership, its wealthy, diversified and internationally competitive economy, robust economic growth rates, ongoing fiscal consolidation, favourable public debt profile, low private sector debt levels and improvements in the banking sector, including exposures to Central and Eastern European countries. Austria’s ageing society poses medium-to-long-term public expenditure and growth challenges. Limited reforms to the overly complex federal fiscal structure, which results in weak incentives to contain costs at the subnational level, as well as Austria’s labour-unfriendly taxation system pose further challenges. The Stable Outlook reflects Scope’s view that the risks Austria faces remain manageable given the economy’s inherent credit strengths, despite the cyclical slowdown.

Following strong expansion, the Austrian economy has reached a mature phase in the cycle. Real GDP growth is projected to have reached 2.7% in 2018, driven by: i) private consumption given favourable labour market developments evidenced by strong and sustained employment growth since 2010, an unemployment rate below 5% since February 2018, and increasing wages; ii) solid investment linked to high capacity utilisation in the business sector, and iii) a strong export performance, supported by the country’s internationally competitive position with the real effective exchange rate broadly unchanged over the past ten years. Going forward, Scope expects private consumption to remain stable, supported by increases in disposable income, while the contribution to growth from investment, which has been strong over the past few years, and net exports will decrease gradually. As a result, Scope expects GDP growth to moderate to around 1.5% for the 2019-21 period in line with the weaker global economy, and the growth rates of Finland and Germany.

Austria’s AAA rating is also underpinned by its sound public finances, sustained debt reduction and favourable debt profile. The headline deficit has been on a declining trend since 2009 from a budget deficit above 5% of GDP in 2009 to a balance in 2018. Scope notes that this improvement has been largely driven by very good cyclical conditions and a further decrease in debt servicing costs, which more than offset the slight loosening of fiscal policy in 2018, which is expected to continue in 2019. Scope expects the budget balance to improve slightly in 2019 and remain positive in 2020 and 2021. As a result of budget surpluses and the continued reduction of the debt of bad banks, the debt-to-GDP ratio is expected to drop to around 65.5% by 2021, still above the level of peers but markedly below the peak of 84.8% in 2015. In addition, Scope views Austria’s safe-haven status positively. In the context of the favourable financing environment, the Austrian debt agency’s funding strategy is prudent, with a funding profile of around 95% at a fixed rate, less than 15% of short-term debt and no foreign currency risk. The average life of debt outstanding was extended between 2010 and 2018 from around 7 years to 10 years, above the average debt maturities of Germany (6 years), the Netherlands (7 years) and Finland (6 years).

Austria’s AAA rating is also supported by its overall macroeconomic stability. Private sector indebtedness is low and has remained unchanged over the past 15 years, currently standing at around 140% of GDP, in line with the euro area average. In addition, gross external liabilities have fallen significantly, driven by the banking sector’s deleveraging of around 60 pp of GDP between Q1 2010 and Q3 2018, which has reduced Austria’s total external debt to around 151% of GDP as of Q3 2018, in line with that of Germany (145%), and below that of Finland (190%) and the Netherlands (534.2%). This development, together with sustained current account surpluses since 2002, turned Austria into a net external creditor in 2013. As of Q3 2018, the net international investment position stood at around 5.4% of GDP (approx. EUR 21bn), slightly above that of Finland (-1.6%) but still well below that of Germany (59.5%) and the Netherlands (65.4%).

Financial stability has strengthened in recent years, underpinned by an improved economic environment and supervisory measures. Capitalisation levels for Austrian banks have risen, with the consolidated common equity tier-1 ratio at 14.8% in Q3 2018, in line with the European average. In addition, Austrian banks’ credit quality has strengthened, with the non-performing loan ratio dropping to 3.1% in 2018 from above 6% in 2014. In this context, the asset quality of loans in the Central Eastern and South-Eastern European (CESEE) region continues to improve as Austrian banking subsidiaries have become more concentrated in EU countries. Over three quarters of total CESEE assets are now in the Czech Republic (AA/Stable), Slovakia (A+/Stable), Romania (BBB-/Negative), Hungary (BBB/Positive) and Croatia (BB+/Stable). Finally, the continued rise in residential property prices, particularly in Vienna, remains largely driven by fundamentals as opposed to a surge in credit growth (4% YoY).

Despite these inherent credit strengths, Scope sees three medium-to-long-term challenges. First, while the short-to-medium-term growth outlook is robust, with potential growth estimates at around 1.8% (IMF) and 2.0% (European Commission, (EC)) in line with peers and the euro area average, raising Austria’s growth potential will hinge on further increasing the participation rate and multifactor productivity. Austria’s labour participation rate remains comparatively low, particularly for women, the low-skilled and the elderly. Although it has increased since the early 2000s from below 70% to around 74% today, it remains below that of Germany (83%), the Netherlands (82%) and Finland (77%). In addition, multifactor productivity has remained flat over the past years, in part due to relative shortcomings in information and communications technology adoption, the flexibility of wage determination, labour mobility and the labour tax rate in addition to regulatory barriers in the business services sector.

Second, similarly to other advanced economies, Austria’s population is ageing with a steady increase in the population of those aged 65 or above. As highlighted by the IMF, age-related expenditure and a lower potential growth rate will reduce the Austrian government’s fiscal space in the coming years. Current pension expenditure is comparatively high and is expected to rise further as life expectancy increases while the statutory retirement age remains fixed. According to the latest EC ageing report, Austria’s pension spending is set to increase from around 13.8% of GDP to around 14.9% in 2040, above that of Finland (13.9%), Germany (12.0%) and the Netherlands (8.5%). The main driver of Austria’s high healthcare expenditure is its oversized hospital sector, which is the result of a fragmented financial and organisational structure. Efficiency gains can be made both at the system level, by shifting services to the less costly outpatient sector, and within the hospital sector itself by improving the use of public procurement. However, in the absence of reforms, the European Commission estimates that healthcare spending will increase from around 7% to 7.8% in the coming two decades, which is below the level for Germany (8.0%) but again above that of the Netherlands (7.0%) and Finland (6.8%). Based on these projections, Austria’s total healthcare and pension-related expenditure will be 22.7% of GDP in 2040, above the euro area average (21.0%), Finland (20.7%), Germany (20.0%) and the Netherlands (15.5%).

Finally, Scope notes that Austria’s federal fiscal framework still suffers from a pronounced misalignment between spending powers and revenue-raising responsibilities across the different levels of government. The fiscal framework is complex and gives subnational governments weak incentives to contain costs as their spending powers are disproportionately higher than their revenues from autonomous taxes. According to the OECD, in 2016 (the year with the latest figures available), subnational governments raised revenues amounting to 2% of GDP from their own taxes, while their overall expenditure amounted to 17.7% of GDP. The federal government has presented a legislative package including spending reviews, more task-oriented financing, benchmark systems, a reform of subnational competencies and discussions on increasing tax autonomy at the subnational level as well as reducing the rights of mutual approval. However, the Austrian Fiscal Council highlights that many work packages and reforms are behind schedule or have not been continued in the form originally agreed.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative ‘aa’ (‘aa’) rating range for the Republic of Austria. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.

For Austria, the following relative credit strengths are identified: i) macro-economic stability and sustainability; ii) debt sustainability; iii) market access and funding sources; iv) current account vulnerability/resilience; v) external debt sustainability; vi) resilience to short-term external shocks; and vii) financial imbalances and financial fragility. No relative credit weaknesses are signalled for.

The combined relative credit strengths and weaknesses generate a two-notch upward adjustment and indicate a sovereign rating of AAA for Austria.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope considers sustainability issues during the rating process as reflected in its sovereign methodology. Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, in which Austria has strong scores on a composite index of six World Bank Worldwide Governance Indicators.

Social factors are reflected in Austria’s comparatively high GDP per capita, very low rates of unemployment, and moderate old-age dependency ratios, compared with aa-indicative peers. In addition, Scope observes that while Austrian living standards are high and income inequality and poverty relatively low, reflecting a considerable redistribution of income, wealth inequality is high and stable. Finally, environmental factors are considered during the rating process, but did not play a direct role in this rating action.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that the risks Austria faces remain manageable given the economy’s inherent credit strengths, despite the cyclical slowdown.

The ratings/outlooks could be downgraded if: i) Austria reversed its fiscal consolidation process, resulting in a clear upward trajectory on debt ratios; ii) the government’s commitment to and implementation of structural reforms, including those related to the federal fiscal framework and the drivers of Austria’s growth potential faded; and/or; iii) risks in the banking sector re-emerged, increasing financial stability concerns and possibly raising the need for government intervention.

Rating committee
The main points discussed by the rating committee were: i) Austria’s growth potential; ii) macroeconomic stability; iii) current account vulnerabilities/resilience and competitiveness; iv) vulnerability to shocks; v) fiscal performance; vi) public debt sustainability; vii) fiscal framework; viii) external debt sustainability; ix) banking sector developments; x) recent events and policy decisions; and xi) peers.

Methodology
The methodology used for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.
The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance of Austria, the Central Bank of Austria (OeNB), the BIS, the European Commission, the European Central Bank (ECB), the Statistical Office of the European Communities (Eurostat), the IMF, the OECD, and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst: Alvise Lennkh, Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director, Public Finance
The ratings/outlook were first assigned by Scope in January 2003. The ratings/outlooks were last updated on 30.06.2017.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5, D-10785 Berlin.

Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Directors: Torsten Hinrichs and Guillaume Jolivet.