OREANDA-NEWS. February 08, 2016. Fitch Ratings has affirmed Austria's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'AA+' with Stable Outlooks. The issue ratings on Austria's senior unsecured foreign and local currency bonds have also been affirmed at 'AA+'. The Short-term foreign IDR has been affirmed at 'F1+' and the Country Ceiling at 'AAA'.

KEY RATING DRIVERS
Austria's IDRs and Stable Outlook reflect the following main factors:

After four years of subdued GDP growth, we expect Austrian economic performance to improve modestly in 2016-17, with real GDP projected to rise at an average of 1.7% over the next two years. This is mostly on the back of a pick-up in investment and improving outlook for external demand. The 2015/2016 tax reform, effective in January 2016, is also likely to boost private consumption as household disposable incomes will benefit from tax cuts. High migration inflows, resulting from the arrival and passage of asylum seekers through the country, are expected to have only a marginal positive impact on growth, mainly through increased government spending and consumption.

Austria's external position remains robust, with current account surplus expected to average 2.8% of GDP in 2016-17. Stable economic growth in the eurozone and sustained tourism inflows will support net exports throughout 2016-17. However, inflation remains persistently higher than the European average at 1.6% and could further dampen price competitiveness.

Austrian banks have strengthened their financial positions in the reinforced regulatory environment, but the sector is weaker than in most high-grade sovereigns. Reduced leverage, lower operational costs, and increased reliance on local funding for subsidiaries have helped clean-up balance sheets. Nevertheless, the sector remains quite large and concentrated, profitability appears comparatively weak and capitalisation is below that of other European countries, with a core equity Tier-1 ratio (CET1) at 11.5% in 1Q15. Vulnerabilities also arise from substantial exposures to Central, Eastern and South-eastern Europe, where the stock of NPLs remains large.

Despite noticeable progress made in relation to the resolution of the state-owned banks, several issues remain pending. The restructuring of the Volksbanken sector is well advanced and the sale of the South Eastern Europe network of Hypo Alpe-Adria-Bank International (HAA) was completed successfully in July 2015. However, the resolution of the wind-down unit of the HAA (HETA) brings its share of uncertainties. In March 2015, the resolution authority imposed a moratorium on all HAA liabilities, valid until May 2016. Further haircuts might then be imposed on HETA's outstanding liabilities and legal actions related to the cancellation of Carinthia's guarantee on HETA's subordinated debt that are not yet settled. On 20 January, Carinthia offered to buy back a portion og the debt instruments guaranteed by the province from HETA's creditors. This would help resolve the pending legal disputes over HETA liabilities and limit the impact on public finances as the transaction mostly rests on the disposal of HETA's assets. Creditors have until 11 March to accept the offer, but a blocking minority publicly rejected the province's proposal.

Fitch expects the budget deficit to widen slightly to 1.9% of GDP in 2016 as the tax reform kicks in and the government incurs exceptional costs to accommodate asylum seekers. The structural deficit, as assessed by the European Commission, is projected at 1% of GDP when excluding one-off revenues related to bank support measures (estimated at EUR0.7bn for this year) and additional costs for refugee assistance (estimated at EUR1bn). Fitch fiscal forecasts for 2016-2017 remain higher than official projections, which assume an effective implementation of the measures announced by the government to finance the tax reform.

Fitch expects Austria's general government debt (GGGD) to decrease slightly in 2016 to 86.2% after peaking at 86.4% in 2015, when the unsold portfolio of Kommunalkredit Austria was transferred to the state-owned "bad bank" KA Finanz (KF). The disposal of KF assets should help gradually reduce GGGD but further costs could arise from the ongoing resolution of failed state-owned banks. The government is strongly committed to support KF, as proven by the federal guarantee granted on debt issues. However, failure to reach an agreement with HETA's creditors on Carinthia guarantee would not lead to an upward revision of public debt, since HETA's liabilities were already classified into the general government sector in 2014.

Austria has a rich, diversified, high value-added economy with strong political and social institutions. It benefits from low private-sector indebtedness and a high household savings rate. The unemployment rate is around 6%, which is among the lowest in the EU. Fitch judges the government's financing risk to be low, reflecting an average debt maturity of about eight years, low borrowing costs and strong financing flexibility.

RATING SENSITIVITIES
Future developments that could individually or collectively, result in negative rating action include:
-Weaker nominal GDP growth or failure to place public debt on a downward trajectory over the medium term, for example because of significant slippage from fiscal consolidation targets.
-Further material costs from the financial sector outside the range of current expectations that worsen the government debt profile.

Future developments that could individually or collectively, result in positive rating action include:
-A declining trend in the public debt to GDP ratio from its peak to a level that provides the sovereign with greater flexibility.
-A stronger recovery of the Austrian economy and greater confidence in medium-term growth prospects, particularly if supported by the effective implementation of structural reforms

KEY ASSUMPTIONS
The ratings and Outlooks are sensitive to a number of assumptions:

We assume that the resolution of the state-owned "bad" banks will not increase public debt to GDP but could have an impact on the deficit.

Fitch's debt dynamics do not include any government bank asset disposals as the timing and values of such operations remain uncertain.