Morningstar DBRS Confirms Republic of Austria at AAA, Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Austria’s (Austria) Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, Morningstar DBRS confirmed Austria’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of the Stable trend reflects the view that despite persistent fiscal deficits, Austria’s public sector debt ratio will remain broadly stable in the coming years. The recession and the temporary fiscal support will not alter significantly the long-standing prudent fiscal approach, although economic policy measures and tax reforms present a near-term challenge. Austria’s economy has been in recession since the second half of 2022, but the Oesterreichische Nationalbank forecasts a recovery from -0.7% real GDP growth in 2023 to 0.6% in 2024 and 1.7% in 2025. The country remains exposed to risks including those related to the still high reliance on Russian gas imports and to a more severe economic downturn in Austria’s main trading partner, Germany. Fiscal deficits are projected to level off near the current level of 2.7% of GDP and the public debt-to-GDP ratio is projected to stabilize at around 76% of GDP.

The credit ratings are underpinned by Austria’s prosperous, diversified, and stable economy. The country benefits from a real GDP per capita in purchasing power terms that is estimated at about 24% higher than the European Union (EU) average, solid and credible institutions, and a sound external position. Moreover, an overall conservative fiscal approach is expected to offset fiscal pressures from a variety of costs associated with an ageing population, defense and climate measures.

CREDIT RATING DRIVERS
One or a combination of the following factors could lead to a downgrade: (1) Austria’s government commitment to improve its public finances weakens significantly over the medium term; or (2) there is a material worsening in macroeconomic prospects, leading to a persistent and significant increase in the public debt ratio.

CREDIT RATING RATIONALE

Austria is Slowly Adjusting to Alternative Energy Supplies and an Economic Recovery is Forecast for this Year

Austria’s credit ratings benefit from its high GDP per capita level, relatively low output volatility, and high diversification. Despite its moderate size, the country enjoys a high level of integration in the EU bloc, which generally supports Austria’s external competitiveness. The recent economic downturn is linked to relatively high inflation. Consumer prices have been growing at a higher pace than in the euro zone average since mid-2022, which has weighed on consumption. Weaker external demand and high interest rates are constraining investment, particularly in the construction sector. After posting strong growth of 4.8% in 2022, the economy is estimated to have contracted by 0.7% in 2023. However, a gradual recovery is likely going forward, with output forecast to grow by 0.6% this year, 1.7% in 2025, and 1.3% in 2026. As inflation declines amid strong wage gains, real wage growth will support the recovery, albeit presenting some challenges to external price competitiveness. Although gas storage levels are high, Austria remains dependent on Russian gas, which makes the economy relatively more vulnerable than other European countries to geopolitical risk from the conflict in Ukraine.

Medium-term economic prospects are partly constrained by restrictive regulations in the services markets, a high part-time employment rate among women, and a high tax wedge. However, with the tax reforms and other measures included in Austria’s Recovery and Resiliency Plan (ARRP), the government aims to ease these constraints and lift GDP potential.

Fiscal Trajectory to Remain Broadly Stable

The economic rebound, along with a gradual withdrawal of fiscal support measures, should facilitate the stabilization of public sector accounts after the sizeable deterioration in the budget balance in 2020. The deficit peaked at a record level of 8.0% of GDP in 2020 and then declined substantially to 3.5% in 2022 and 2.7% in 2023, despite the costly energy- and cost-of-living packages. The government aims to wind down support in 2025, and the fall in energy prices is likely to result in a lower take-up of energy subsidies. However, the government projects the fiscal deficit to remain at 2.7% of GDP this year and then rise to 2.8% in both 2025 and 2026, before falling again to 2.7% in 2027. Moderate nominal GDP growth should continue to support a positive trend of revenues, despite the impact of the eco-social tax reform and the elimination of bracket creep. Coming years are also likely to see higher military spending and social benefits that will challenge the fiscal accounts. To account for these fiscal risks, we have added a negative qualitative adjustment to the “Fiscal Management and Policy“ building block assessment.

In Morningstar DBRS’ view, Austria’s additional fiscal vulnerabilities relate more to the long term because of the expected rise in age-related expenditures. In particular, according to the government, health and long-term care expenditures will increase to 8.5% and 3.1% of GDP in 2060, respectively, from 7.1% and 1.3% of GDP in 2019. At the same time, the cost of gross public pensions at 13.4% of GDP in 2019 was one of the highest in the EU and is expected to continue to rise, peaking in 2035 at 15.5%, reflecting a declining working age population and relatively low participation rates among older workers. However, some measures envisaged in the ARRP should contribute to improving the fiscal sustainability of the pension system.

Elevated Debt Profile But Structural Benefits

Moderate nominal GDP growth along with the unwinding of temporary fiscal measures support Morningstar DBRS’ expectation of a stabilization in the public debt-to-GDP ratio over the medium term. After the peak of 83.0% in 2020, the debt ratio is estimated to have declined to 76.4% last year. Government borrowing yields have increased substantially, reflecting the tightening in monetary policy but debt affordability remains sound thanks to a favourable debt profile. As debt is expected to be refinanced at a higher rate, total interest payments on the federal debt are projected to rise from 0.7% of GDP in 2023 to 1.4% in 2026, a level that if reached would still remain below that of 2017. The long maturity profile and the fact that almost all federal government debt is at fixed rates reduces the risk of a rapid increase in the interest bill. The stock of contingent liabilities, estimated by the government to decline from 15.2% of GDP in 2022 to 13.3% this year, is not negligible but is not expected to weigh significantly on public finances. All of these factors contribute to lowering debt sustainability risks and lend support to Morningstar DBRS’ positive qualitative adjustment in the “Debt and Liquidity” building block assessment.

Current Account Position is Improving

Austria’s external position is sound and benefits from service exports as well as a diversified manufacturing base that is well integrated into EU value chains. Despite the pandemic-related restrictions from 2020 to early 2022, and the deterioration in terms of trade associated with the energy shock, Austria’s external performance has remained resilient. The rapid recovery in tourism flows mitigated the impact of the rise in energy bills. The current account is estimated to have shifted from a deficit of 0.3% of GDP in 2022 to a surplus of 2.4% last year, an amount slightly higher than the average in the 2009–19 period (2.0%). On the other hand, if the trend in strong wage growth is sustained, increasing unit labour costs could negatively affect external competitiveness. Morningstar DBRS views this risk as contained at the moment, as wage growth should moderate reflecting a decline in inflation, and the inflation differential with Austria’s main trading partners should narrow.

Austria’s credit ratings benefit also from a healthy positive net international investment position (NIIP). At 17.6% of GDP in Q2 2023, the NIIP is lower but not far off from the record level of 21.1% of GDP registered in Q3 2022. Since March 2013, NIIP has shifted to a net asset position, reflecting a growing stock of foreign direct investment abroad as well as a decline in inward portfolio investment.

Sound Banking System, Moderate Household Debt, and Macroprudential Measures Mitigate Risks to Financial Stability

Risks to financial stability remain contained in Austria thanks to the elevated level of capitalisation in the banking system and the introduction of stricter lending standards in the real estate lending process. Austrian banks’ sound capital position and profitability should help withstand the expected deterioration in credit quality as a result of high inflation, the tightening in financial conditions, and the phase-out of the pandemic and cost-of-living support measures. Austrian banks’ exposure to Central, Eastern and South-eastern Europe (CESEE) countries remains elevated, although it provides a certain degree of diversification. The banking sector’s exposure to Russia remains a point of attention in light of the conflict in Ukraine and possible sanctions and counter-sanctions.

The real estate market is stabilising after years of increasing overvaluation. This, together with binding lending standards, bode well for financial stability. Furthermore, the worsening in household debt affordability due to rising rates is mitigated by the moderate amount of debt. According to the Oesterreichische Nationalbank (OeNB), after seven quarters of annual growth of more than 10%, residential real estate prices have decelerated since the end of 2022 and declined by 2.9% in the third quarter of 2023, reflecting the impact of tighter monetary policy. According to OeNB, this contributed to a decline in property price overvaluation, which stood at 21.7% in Austria and at 31.8% in Vienna in April 2023, compared with 36% and 42%, respectively, in April 2022. However, according to OeNB, household debt affordability is deteriorating as a result of the monetary tightening and the large share of mortgages at variable rates. Nevertheless, households tend to display high incomes and wealth by international standards. Their balance sheets are strong, reflecting moderate debt in aggregate as a share of gross disposable income. Moreover, a relatively high net financial worth, estimated at approximately 129% of GDP as of Q3 2023, provides a buffer for households to absorb potential shocks. Macroprudential binding measures adopted since August 2022 further mitigate risks stemming from risky borrowers. Nonetheless, in view of the financial risks, including the high share of mortgages at variable rates, Morningstar DBRS applies a negative qualitative adjustment to the “Monetary Policy and Financial Stability” building block assessment.

The Institutional Framework Remains Sound Despite the Frequent Changes in Leadership Over the Past Few Years

In spite of an unusual period of political uncertainty over the past years leading to changes in government leadership, the institutional framework in Austria is sound. This is reflected in very high scores in the Worldwide Governance Indicators. In Morningstar DBRS’ view, the coalition government comprising the Österreichische Volkspartei (ÖVP) party and the junior partner (Greens) will likely continue until the end of the legislative term in 2024. Elections later this year may bring to power a right wing coalition, as the Freedom Party is leading in opinion polls. This would bring more attention to immigration and security issues.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social and Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (04 July 2023) https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/426398.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (06 October 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition Morningstar DBRS uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Statistik Austria, OeNB (Financial Stability report – November 2023, Austria’s Economic Outlook - December 2023 ), Österreichische Bundesfinanzierungsagentur (OeBFA, Investor Presentation – December 2023), Austrian Ministry of Finance (BMF, Budget 2024 and Medium Term Expenditure Framework 2024-2027 at a Glance), FISCALRAT - Public Finance Report December 2023, EC (Autumn forecast 2023 – November 2023, the Digital Economy and Society Index – September 2022, Commission Opinion on Draft Budget - November 2023), Social Progress Imperative, Entsog, Transparency International, European Central Bank, WIFO, Eurostat, International Monetary Fund (IMF WEO October 2023, IFS), Organisation for Economic Co-operation and Development (OECD), Weltrisikobericht, World Bank, Bank for International Settlements, Haver Analytics, Politico Poll of Polls. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

Morningstar DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS’s outlooks and ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/426401/.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Nichola James, Managing Director, Credit Ratings, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: June 21, 2011
Last Rating Date: July 14, 2023

For more information on this credit or on this industry, visit dbrs.morningstar.com.