Due to high household indebtedness and the sharp economic downturn in Emerging Europe, financial markets have become increasingly worried about Austrian banks’ large loan exposure to this region. The strong financial and trade links with Eastern Europe, which have boosted Austrian growth over the past few years, have now become the Achilles’ heel of the Alpine Republic. Given the high importance of Germany and Eastern Europe for Austria’s export sector, the economy is highly vulnerable to the current growth weakness of these countries.

Due to high household indebtedness and the sharp economic downturn in Emerging Europe, financial markets have become increasingly worried about Austrian banks’ large loan exposure to this region.

Financial markets have sharply re-priced the risk for Austrian government debt over the past few weeks. At times, Austrian 10-year sovereign bond spreads climbed to fresh multi-year highs of more than 130 bp vs. German Bunds. 5-year sovereign CDS spreads soared to around 270 bp and are still on par with highly-indebted Greece and only topped by Ireland. However, one has to bear in mind that the CDS market may not be solely driven by default risks but also by other factors. Very recently, sovereign bond and CDS spreads have narrowed again to around 110 bp and 180 bp, respectively.

The strong financial and trade links with Eastern Europe, which have boosted Austrian growth over the past few years, have now become the Achilles’ heel of the Alpine Republic.

With foreign bank lending of USD 278 bn or 65% of Austria’s GDP, Austrian banks are by far the biggest foreign players in the transition economies, both in absolute terms and relative to GDP, according to the Bank for International Settlements’ consolidated banking statistics. Emerging Europe has become the most important foreign region for the Austrian financial sector and Austria the most important financier for this region. Accounting for almost 50% of total Austrian foreign bank assets, Eastern Europe clearly stands out. Around 45% of Austria’s lending to Eastern Europe goes to economies such as Romania (USD 43.7 bn), Hungary (USD 36.9 bn), Russia (USD 22.4 bn), Ukraine (USD 14.3 bn) and Bulgaria (USD 5.5 bn). Since all these economies are currently facing severe economic slowdown or are suffering from painful economic adjustments of past exuberance in private sector credit, Austrian banks are exposed to rising household and business loan defaults. In light of already high household sector indebtedness and a heavy debt service burden (for many households at 30% of disposable income in some economies), there is further pressure from the high prevalence of FX household loans, not least as a result of significant domestic currency depreciation over the past few months (see chart). Overall, as a result of the large banking sector exposure the government faces relatively high contingent liabilities. Recently, Standard & Poor’s estimated the banks’ gross problematic assets (applied to domestic credit) at around 12-24% of GDP. Hence, the sovereign faces potential recapitalisation costs of 2% and 5.3% of GDP in S&P’s base and worst case scenario, respectively.

As a result of the global financial and economic crisis the public debt ratio already rose to 62.6% of GDP in 2008 from 61.9% in 2007 (according to the OECD) and is expected to climb further to slightly below 70% of GDP by 2010. Austria’s fiscal deficit is forecast to soar to around 4-5% in 2009/10 from 1.2% of GDP in 2008 due to rising expenditures and falling tax revenues (similar to that of its neighbour Germany).

Austrian banks have increasingly relied on short-term debt securities over the past few years.

On a positive note, Austrian banks rank relatively well among other Western European economies in terms of bank capitalisation ratios, according to the ECB’s MFI balance sheet data. In December 2008, their capital & reserves ratio stood at a relatively high 7.1% of total assets. However, one should bear in mind that these figures are on a non-risk-adjusted basis. Although the share of deposit refinancing only fell moderately over the past ten years to 55.1% of total assets (December 2008) from 61.9% (January 1999), Austrian banks increased the share of debt securities refinancing over the same period to 24.6% of total assets from 17.5%. In light of relatively strong reliance on capital market funding – only topped by Denmark and Sweden – the share of short-term debt securities (i.e. debt with a maturity of less than two years) climbed to 11.6% at the end of 2008 from 1.5% of total securities issued in January 1999.

Given the high importance of Germany and Eastern Europe for Austria’s export sector, the economy is highly vulnerable to the current growth weakness of these countries.

Due to exceptionally strong trade links with Germany and Eastern Europe (which account for around 30% and 25% of total exports, respectively) Austrian exports are vulnerable to the deep recession in Germany and the pronounced downturn in Emerging Europe. Although Austria has outperformed Germany’s real GDP growth since 2002, Austria has always closely followed the German cycle. Given the deep German recession and significant economic adjustments in its Eastern European trading partners, the Austrian economy is likely to also follow Germany down this time and hence looks set for one of the deepest recessions of the past few decades.

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Sebastian Becker (+49) 69 910-30664

 

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