Wide Angle Shot: Austria soon top-notch AAA-rated sovereign again?

In the course and aftermath of the euro sovereign debt crisis, Austria, like France and Finland, lost its top AAA rating by the three major rating agencies. In 2012, S&P lowered Austria's rating to AA+, followed by Fitch and Moody's in 2015 and 2016 respectively. Of the aforementioned countries, however, Austria was and still is the closest to regain the AAA status. Fitch already had a positive outlook outstanding from July 2018 to May 2020, which was downgraded again to ‘neutral’ due to the coronavirus pandemic. Between October 2022 and August 2023, the rating outlook was even temporarily set to ‘negative’ due to uncertainty surrounding Russian gas supplies. S&P already had a positive outlook outstanding between February 2022 and August 2022, which was then downgraded to ‘neutral’ again due to the same uncertainties. Beginning of August 2024, S&P changed the rating outlook for Austria back to ‘positive’ again.

In addition to the three leading agencies mentioned above, Scope and DBRS should also be mentioned, whose ratings are also taken into account by ECB. Austria has an outstanding AAA rating from DBRS. Scope withdrew Austria's top rating in its last review in April 2024 and lowered it one notch to AA+.

In principle, the rating agencies' assessments are very similar to each other, especially when it comes to the highest rating bucket(s). All EU countries with a AAA rating by at least one of the three leading rating agencies are also assigned a triple-A rating and stable outlook by all other major rating agencies. These are the euro members Germany, Netherlands and Luxembourg, as well as Denmark and Sweden inside EU and Norway plus Switzerland. Rating agencies also agree on the second-highest credit rating bucket inside the euro bloc. In addition to Austria, Finland can be found here. There is a tendency towards greater fluctuation among sovereign ratings as creditworthiness falls, also inside the euro area (see Chart 3).

The similarity in sovereign ratings is not surprising at all. Rating agencies have by and large similar approaches to their assessment and basically work with the same indicators. In a first step, a preliminary indicative rating is usually calculated based on quantitative and qualitative factors. Here, the quantitative indicators and relevant creditworthiness figures have a clear overweight. Above all, realized values over a longer period of time are also included, not just forecasts (i.e. past performance counts). In a second step, the indicative rating is adjusted based on factors that were not, or not sufficiently, taken into account in the first place. Overall, creditworthiness indicators/factors, which are taken into account by the rating agencies, are highly comparable. However, they differ in the details of the selected quantitative time series/ratios and in the weights they assign to individual factors. For example, S&P uses the net government debt ratio, among other things, to measure the debt burden, whereas Moody's uses the more conventional (gross) public debt-to-GDP ratio. There are also differences in the treatment of structural factors, such as membership in a monetary union.

S&P bases its indicative rating on five pillars. This comprises institutional, economic, external, fiscal and monetary factors (see Exhibit 1). A rating is assigned for each of these pillars (1-6). Specific predefined data and qualitative adjustments are included here. In a first step, the five factors are combined with different weightings to form two sub-factors (‘Institutional and economic’ and ‘Flexibility and performance’), which ultimately determine the indicative rating. In a final step, an additional adjustment (‘supplemental adjustment’) can then be made to the indicative rating. This is intended to take into account additional factors that were not adequately reflected in the previous five pillars. The reason cited for the current factual rating of the Republic of Austria, which is ultimately one notch lower than the indicative rating, is the remaining uncertainty regarding future gas supplies. In regard to the USA, for example, the role of the US dollar as world reserve currency has a positive risk-mitigating effect. In the case of top-notch sovereign credit ratings, however, an adjustment to the indicative rating like in the case of Austria is the exception rather than the rule (Table 2).

On 25 February 2022, S&P confirmed Austria's AA+ rating, which was also flagged by the indicative rating back then, and at the same time raised the outlook from ‘neutral’ to ‘positive’. The main reason given for this was the improving fiscal outlook. One day before the rating outlook was raised, Russian troops invaded Ukraine. At the occasion of Austria's next rating review in August 2022, the outlook was lowered again to ‘neutral’ due to uncertainties regarding gas supplies from Russia. Two years later in August 2024, as gas shortages have not materialized, S&P raised the outlook again to ‘positive’. In contrast to August 2022, however, the rating agency's indicative rating now points to the top-notch AAA-rating. Since 2023, the ‘external’ factor has been raised by one notch, which has led to the indicative rating being raised to aaa. Among other things, this takes into account the expectations of continued high current account surpluses and the comparatively low net external debt (overall economy) in relation to current account inflows. Compared to the AAA-rated peers, Austria stands out favorably in regard to this external liquidity measure. Only Germany and Switzerland can also capitalize on a top-notch score (1) here.

Austria receives a lower scoring compared to AAA-rated euro peers in the fiscal domain. Regarding this rating driver, Austria's assessment (3) is one notch lower than that of the Netherlands and Germany (2) and two notches lower than that of Denmark and Sweden (1). In particular, the high net debt (including consideration of liquid funds) in relation to GDP of 68% in 2023 has a negative impact. No other AAA-rated country exhibits such a high value. Austria's final AA+ rating is based on an additional adjustment (‘supplemental adjustment’) of one notch downwards. The rating agency cites the uncertainty regarding energy supplies. At the same time, S&P stresses that Austria can cope with possible short-term disruptions and limit the economic damage that could be caused by the end of the gas transit agreement between Ukraine and Russia at the end of this year. S&P cites two points for a possible rating upgrade in its latest review. Firstly, continued robust economic performance, even in the event of energy supply disruptions, and secondly, fiscal results that exceed current expectations. The next standard rating reviews by S&P in 2025 are expected to take place in February/March and August/September.

The rather subdued performance of Austria in peer comparison to other AAA credits in the fiscal domain is also evident when looking at budget balances. Since 2016, Austria posted higher deficits/lower surpluses than AAA-rated countries like Germany and the Netherlands in each and every year (Chart 4). The most "recent" outperformance vis-a-vis Germany when it comes to fiscal accounts dates back almost two decades (2005). On the one hand, this is due to higher interest expenditure (Charts 6 & 7), which had been higher in relation to economic strength as well as relative to government revenues since the 2010s. However, the difference has narrowed since the inflation crisis and the rise in interest rates. The longer duration of Austrian government debt and the generally faster rise in government revenue with higher inflation may have evidently had a positive effect. On the other hand, Austria has also generated relatively low primary surpluses (Chart 5). From 2016 to 2022, these were consistently lower than in Germany or the Netherlands. Only in the last two years has the primary balance been on a par with Germany, whereas the Netherlands continues to show better results. Although the longer-term track record on the budget and primary balance is worse in Austria compared to Germany and the Netherlands, there has recently been a convergence with Germany, although this appears to be due more to a deterioration in Germany than a structural improvement in case of Austria.

The (relative) level of government indebtedness in Austria is also higher than in Germany, the Netherlands and Finland. From the mid-2000s until the euro sovereign debt crisis, Austria posted a public debt-to-GDP ratio in the neighborhood of Germany (Chart 8). With the stronger decline in interest costs and a more bold fiscal consolidation in Germany, the public debt-to-GDP ratio fell more strongly/earlier. In the late 2010s, Austria's debt ratio was around 10 percentage points (pp) higher than in Germany. Since the coronavirus pandemic, the difference has increased slightly. In Austria, public debt as a percentage of GDP in 2023 was 7 PP higher than in 2019, in Germany 4 PP higher and in the Netherlands 2 PP lower (Chart 9). In Finland, the debt ratio rose by 11 PP.

The long-term subdued fiscal performance compared to AAA euro credits and the less constant generation of primary surpluses in economically ‘good growth times’ has meant that Austria has only been able to reduce its government debt-to-GDP ratio by around 10-12 percentage points (from the peak in the 2010s to 2019), while the Netherlands and Germany managed to lower their public debt-to-GDP ratio by around 20 percentage points (during the same time horizon). Compared to AAA-rated sovereigns inside the euro area, Austria has hardly managed any structural fiscal consolidation over the last decade. In our opinion, institutional reasons rather than direct economic factors can be held responsible for this. The more recognizable fiscal consolidation in the Netherlands should also be a reason for the significantly faster return to the status of an untarnished AAA debtor (following a loss of the AAA-status in the early 2010s). In principle, Austria is not yet at the same level as the AAA-rated euro peers Germany or the Netherlands in terms of deep sovereign credit fundamentals when it comes to structural government debt and refinancing metrics (e.g. interest payments in relation to economic output, government revenues or the government debt ratio).

Austria's current account balance has recovered from its lows in 2022, similar to Germany and the Netherlands (Chart 10). However, the level of surpluses is still significantly lower in Austria. In Austria, the surplus in 2023 was 2.7% of GDP, in Germany 6.3% and in the Netherlands 10.2%. The increase in Austria's current account balance is due in particular to a recovery in trade in goods (Chart 11). The surplus in the goods sector has even risen above that in the services sector, a situation that was not observed in the past. However, it should be noted that the increase in the current account surplus and the solid export performance up to now were ‘subsidized’ via lower profitability and profit margins. Instead of passing on the substantive (wage) cost increases on the Austrian home market to end customers abroad (the export price trend is in line with the European average), i.e. Austrian (industrial) companies have accepted lower profits. With regard to Austria's external position, S&P positively takes note of the low net external debt (total economy) compared to current account inflows. With regard to the current account (surplus) position, we currently see downside risks given increasing signs of an erosion of the international price competitiveness of the Austrian economy at the macroeconomic level.

According to the latest polls, the balance of political power in Austria is likely to change after the upcoming National Council elections on 29 September. According to the polls, the current governing parties would no longer have a majority, which means that a new coalition is to be expected. In the short term, we do not expect a (potential) change of government to have any tangible impact on the rating of the Republic of Austria, which means that we share the view of the rating agencies. S&P expects the economic policy of the new government to remain largely unchanged, while we certainly see an opportunity for an economic policy that is more strongly orientated towards supporting the competitiveness position and business location via supply-side oriented policies. However, a change towards a lower degree of fiscal responsibility in the sense of comprehensive spending or economic stimulus programmes would clearly have a negative impact. In this context, reference should once again be made to the more subdued fiscal performance compared to other AAA sovereigns and the lack of a ‘track record’ when it comes to structural fiscal consolidation. In this respect, the new government should actively take current fiscal and macroeconomic challenges into account.

We share the view that Austria should not expect any challenging gas supply shortages. Despite the currently still high import quota from Russia, Austria is still well "hedged" due to the filled gas storage. The increased diversification from abroad and the expansion of gas pipelines to Germany and Italy are prepared for a possible abrupt end of the gas transit via Ukraine (see scenario analysis by the Austrian Energy Agency, in German language). However, more clarity about the future energy purchasing strategy could reduce market and rating uncertainty. Here, more decisive action or clear communication from the future government might be required.

On a macroeconomic level we are currently observing alarming developments in the Austrian economy that warrant great caution when it comes to the near- to medium-term growth outlook (see Austrian focus: Endless recession instead of the end of the recession?). Shortly after the rating outlook was raised by S&Ps, the Q2 growth rate was substantially revised downwards (from 0.0% to -0.4% QoQ). Hence, we have adjusted our GDP call for the full year 2024 substantially downwards (from +0.2% to -0.5%). After a recession in 2023, we now expect another year of negative GDP growth in 2024. On a per capita basis, real economic output in Austria at the end of 2023 is 1.6% lower than at the end of 2019. Inside the euro area, only Estonia (-2.1%) posted a worse result. Furthermore, low investment activity has been observed since 2022. Gross fixed capital formation as a percentage of GDP has been lower in Austria since 2022 than inside the euro area and also lower than in the "sick man of Europe" Germany. If the trend of low investment activity continues, this could lead to additional medium-term risks when it comes to the international competitiveness position (lack of productivity gains, production relocations, further decline in international competitiveness), including a potential eroding of the current account surplus position. In addition, the significantly worsening economic outlook — also compared to other AAA-rated countries — makes fiscal consolidation an uphill battle. These risks clearly do not appear to be fully shared by S&P (yet). In this respect, the better-than-expected budgetary results demanded for a rating upgrade are possible, but have become less likely in light of the challenging near- to medium-term macroeconomic outlook. S&P expects fiscal deficits of 3.0%, 2.8% and 2.8% in 2024, 2025 and 2026. The European Commission (as of May) is forecasting budget deficits of 3.1% and 2.9% in 2024 and 2025. Our expectations (as of July) are slightly worse than those of S&P at 3.1% and 3.0% respectively (2024 and 2025), and currently face upside risks. Any potential improvement of the sovereign rating should thus also be backed up by a credible fiscal policy perspective — bearing in mind that there is no history of bold structural consolidation over the last decade.

In sum, the improved indicative rating of S&P in particular speaks for an upgrade to AAA. Like the rating agency, we do not expect to experience any economically damaging shortage in gas supplies. The argument for the additional adjustment ("supplemental adjustment") of the rating could accordingly be dropped in the medium term. However, we see risks on the economic front. The budget deficit could be higher than previously expected this year according to the latest data. If the competitiveness position of the domestic industry continues to deteriorate, the current account surplus position could also decline. In the short term, a possible change of government should not affect the sovereign rating and in case substantive economic policy slippages will be avoided. All in all, we think sovereign rating upgrades (S&P) for Austria to AAA in the coming years, possibly later in 2025, remain feasible. However, a stability-oriented course setting in the areas of fiscal policy and wage setting plus a greater focus on the international competitiveness position of the Austrian economy (with likely positive effects on the current account position) could be supportive for such a re-rating outlook.

Moreover, when and if financial markets will fully price the Republic of Austria as AAA credit and/or if such a top-notch rating will be is finally attained Austria could save approximately EUR 1 billion in debt (re-)financing costs in the coming years. Additionally, some reform measures necessary to achieve an untarnished AAA rating in the market should also sustainably improve the structural fiscal position of the Republic of Austria, promising further savings and/or cost reductions in the public sector. Private issuers on the capital market might also be able to achieve slightly more favorable refinancing costs, although we would expect the effects here to be rather minor compared to the Republic of Austria.

In the CDS market, Austria’s default risk is priced between that of AAA-rated countries like Germany and the Netherlands, and countries with AA+ to AA- ratings like Finland, Belgium, and France (Chart 12). Austrian bonds, on the other hand, price a comparable risk premium to Belgium and Finland (Chart 13). An AAA rating for Austria would be consistent with pricing in the CDS market but is not implied by it. On bond markets, Austria is currently not priced as AAA sovereign credit. Thus, an upgrade or market speculation in this direction would have a positive impact, including on the actual refinancing costs of the Republic of Austria.