Eurozone:
- Snap elections in Austria: Alleged ‘political risk’ or non-event for financial markets?
Austria unexpectedly heads for early elections now slated for 15th October after the People’s Party (ÖVP) effectively abandoned the government coalition last week. As the Eurozone business cycle has been gathering speed and macro issues are gaining less attraction, financial investors have been closely following “political risks” from several electoral votes taking place this year. Austria just added another electoral vote, though likely nothing considered a significant “political risk” for the international investor community.
The biggest fear of investors is probably that a Euro-sceptic party could become part of the government prolonging reform backlog in the EU and speculation about countries leaving the Euro Area and/or EU reminiscent of the Euro crisis in 2011/12 (Grexit, Brexit, Frexit, Öxit, etc..). A very narrow election race and the non-negligible likelihood that the populist Freedom Party (FPÖ) could join the next government could spark increased volatility on government bond spreads; the differential between the Austrian government bond yield and the yield on German government bonds with equivalent maturity and a measure of perceived sovereign credit risk.
However, to put this into perspective: For example, during the Dutch general election campaign in February and March, the Dutch spread rose by 21 basis points from an average spread of 15 basis points during the 12 months until January to a high at 36 basis points in mid-February before returning to around 20 basis points recently. This is almost nothing. Investor’s feared that the populist, Euro-sceptic Partij voor de Vrijheid (PVV), led by Geert Wilders, could come into government.
At the height of the Euro crisis (Figure 1), when Eurozone break-up and sovereign default was a scenario with non-zero probability of occurrence in 2012, Italy’s spread peaked at 550 basis points. At this time, the spread on 10-year Austrian government bonds had risen to almost 200 basis points mostly due to market concerns about the Austrian banking sector. Obviously, the Dutch example makes a more realistic reference point.
The business cycle has been gathering pace and Austria made up ground vis-à-vis the entire Euro Area economy (Figure 2). Annual real GDP expanded by 1.9 % (Eurostat) in Q1 2017 with balanced growth in consumption and investment and a positive contribution from net exports. GDP growth around 2 % is also expected for the total of 2017. Supported by the improving business cycle, the labor market shows tentative signs of relief after the (partly) migration-induced labor supply shock since 2015. Manufacturing job growth strengthened moderately (1.7 % y/y in April). In recent months, the unemployment rate (Eurostat, seasonally-adjusted) started to decline slowly (5.7 % in February) after it had peaked in 2016 (6.2 %).
From a structural, long-term point of view, the Austrian economy faces challenges similar to other developed economies, though likely less deep. Living standards are high and inequality comparably low. We had summarized previously in this publication, that, for example, France is confronted with three main economic policy issues: stressed public finances, a high structural unemployment and a weak structure of the economy.
Within a stylized growth accounting framework, we had calculated that potential (long-term) growth is comparably low. Although the strong migrant inflow has changed the demographic forecast slightly, Austria faces a demographic shock that is going to evolve in the peak period between 2025 and 2030. The rise in the population of age 65 or older will be 50,000 persons per year, while at the same time working-age population (~20-64 years) is going to shrink by 25,000 persons per anno. Hence, the working age population will shrink by 0.4 % annually between 2025 and 2030 and by 0.3 % in the five years afterwards. Assuming that productivity growth (0.5 %) and the growth in the stock of physical capital (1.8 % p. a.) will equal the average growth rate since 2000, it is possible to isolate the negative drag of labor supply on potential output during the next 20 years (Figure 3).
The calculation implies a number of first-priority conclusions: First, the positive effect of a rise in labor force participation becomes eminently clear. Second, lowering unemployment is a main policy issue. Third, labor market integration of migrants becomes a major policy priority not only to tackle social problems but to enhance potential GDP growth.
The International Monetary Fund (IMF) estimates potential growth just above 1 percent. Nevertheless, in the Article IV review that was concluded in February, the IMF noted that overall vulnerability of the Austrian economy is limited and social cohesion is high. According to the IMF, a comprehensive reform package should focus on four key areas: 1) structural reforms to strengthen competition and further reduce firms’ administrative burden, 2) raising public investment to support private sector productivity and investment, 3) shifting the tax mix away from labor toward property, pollution and consumption and 4) provide incentives for higher labor force participation among elderly workers, as well as for full-time employment of women.
Projections indicate a reduction in the fiscal deficit and debt in the medium term. The deficit is estimated at 1.2 % and below 1 % in 2017 and 2018. In April, the European Commission updated its economic outlook to project public debt to fall to 81.2 % of GDP until 2018 from its peak at 85.5 % last year. (Compared to that, France’ public debt is estimated to peak around 97 % in 2018.) Among the suggested public sector policies are expenditure reforms in health, education as well as further pension reform measures and the adjustment in fiscal relations between the federal and state governments.
CEE
- Buoyant Q1 growth in the CE-4
- Ukraine GDP disappoints mostly amid freight transport interruption in Eastern Ukraine
In Central Europe (PL, CZ, SK, HU), economic growth accelerated strongly in Q1 2017 (Figure 4). On average, annual GDP growth stepped up to 3.5 % from 2.2 % previously. Basically, the acceleration was anticipated but eventually beat the already positive expectations. There are no GDP details available yet, but the identifying assumption is that EU funds absorption kicked in during the first months of the year. There was a period of transformation from the previous EU budget to absorption within the new budgetary framework thereby boosting fixed investment. Analysts had been waiting for the effect. In addition, household consumption has continued to expand solidly. Business cycle momentum is expected to continue, although likely at a gradually slower pace than in Q1.
In Poland, real GDP grew by 1.0 % (q/q) and by 4.0 % compared to the corresponding quarter in the previous year. Construction surged by 17.2 % (y/y) in March and home sales increased by 17.6 %. Growth in the Czech Republic surged to 2.9 % annually from 1.9 % in Q4 (1.3 % q/q). The Slovak economy expanded by 3.1 % (y/y). In Hungary, GDP got a strong 1.3 % boost compared to the previous quarter making the economy grow by 4.1 % annually (after 1.6 % previously). The Q1 GDP increase was larger than commonly expected particularly in Hungary and the Czech Republic.
Romania maintains one of the highest GDP growth rates in Europe expanding by 1.7 % (q/q) and 5.7 % (y/y). Bulgaria’s economy makes up ground with quarterly GDP growth of 0.8 % and 3.4 % (y/y). Bulgaria started to recovery in 2015 and has also reached solid cyclical momentum. Romania (15.1 % y/y in March) and Bulgaria (8.0 % in December) have high wage growth and low inflation supporting incomes and consumption.
The Ukraine economy disappointed against expectations in Q1 after a recovery had started last year (Figure 5). Quarterly GDP fell by 0.3 % and annual growth slowed from 4.8 % to 2.4 %. Industrial production slowed markedly in February and March (-2.7 % y/y) due to freight transport interruption in Eastern Ukraine. Firms make up supply of producer goods from Donezk and Luhansk by switching to import. Retail sales expanded by 2.2 % (y/y) on average in Q1; also gradually weaker than in H2 2016. The Q1 GDP outcome poses downside risks to the 2017 growth expectation of 2.5 %.