Austria: Political rebalancing, for how long and in the face of headwinds?

Since last weekend, coalition negotiations in Austria have officially failed to reach a broader three-party coalition or a “grand coalition”, with hardly any parliamentary majority, bypassing the election winner FPÖ (Three-party coalition: Conservatives/ÖVP, Leftist/SPÖ, Economic Liberals/Neos; Grand Coalition ÖVP, SPÖ).

A three-party coalition stretched very wide across the ideological party spectrum was viewed rather skeptically in certain parts of the political elites and above all in larger parts of business circles. This was against the backdrop of (economic) policy experiences in Germany and, above all, widely divergent economic policy positions. This is of particular importance given current economic reform and restructuring requirements in the Austrian economy. In this context, an explicitly (populist) left-wing positioning in parts of the Social Democrats also played a role. In economic policy matters, the Greens in Austria were not considered a constructive coalition partner either by the ÖVP or by business circles.

Ultimately, previous coalition negotiations have largely failed due to economic and budget policy issues. Despite the now challenging new political situation, we consider it positive that the economy and economic policy are now a central part of the political and public debate — this has not been the case for too long in this country.

The upcoming coalition negotiations between the right-wing populist FPÖ and the conservatives (ÖVP) could lead to swift results in some areas. This applies in particular to economic and fiscal policies or parts of migration and immigration policy agendas. In this respect, there is certainly the option that a new and effective government could be in place in three to four weeks. However, apart from economic policy, there are a number of policy areas (e.g. stance towards EU, foreign policy) where negotiations are likely to be tough. In parts of the ÖVP and its affiliated (business) organizations, there is also still a noticeable skepticism towards FPÖ and certain leading personalities. Furthermore, it remains to be seen how aggressively negotiations will be conducted on behalf of the FPÖ and to what extent more critical positions within the conservatives itself will gain relevance. At the moment, the right-wing populist FPÖ voices a genuine loyalty to the state and constitution, but hard populist positions towards the previous “mainstream parties” and the ÖVP are recognizable as well. At the same time, new elections would be a less disastrous scenario for the FPÖ than for other political players and previous governing parties.

A certain degree of domestic political polarization against a potential FPÖ-led government is currently discernible around here. This includes social and ecclesiastical circles or some NGOs. However, in terms of foreign policy and from EU institutions, we do not expect any particular headwinds. The (co-)government of right-wing populist forces has become a factual reality in Europe in recent years. We also believe that an emerging FPÖ-ÖVP government will be able to send a credible fiscal policy perspective to the EU rather quickly. Even if a complete budget will not be in place by January 20/21, it should be possible to present a consolidation plan and prevent an EU deficit procedure — if this is what the FPÖ/ÖVP constellation aims for. However, it is not yet clear whether a potential FPÖ/ÖVP government will seek to clash with the EU over these issues or not.

At present, it is not possible to predict whether an FPÖ-ÖVP government constellation can and will last for five years. Whether this is possible will hinge on the quality of cooperation, the inner stability of both coalition parties and the emergence of any potential radical actions and/or domestic political scandals (in combination with the voter sentiment according to the polls). In principle, however, we do not currently see any strong motivation on the part of the FPÖ to position itself as an extremely radical political actor in direct comparison with other right-wing and EU-skeptical parties within EU. This is especially true since the FPÖ's electorate now extends well into the political centrist spectrum.

Even in the event of an early FPÖ-ÖVP coalition agreement, a clear course towards long-lasting domestic political stability cannot immediately be assumed. However, a successful overall economic policy reforming could also ensure the stability of the coalition, while pragmatic cooperation already exists at the federal/provincial level. A successful economic reforming could also lay the foundation for continued high approval ratings for the FPÖ beyond the current term of office.

Italy, France, Belgium, Slovakia, Malta, Poland, Romania and Hungary are currently in an EU Excessive Deficit Procedure. Will Austria become the ninth EU country this year?

A look at the current budget deficit forecasts for the Austrian economy do not bode well for the fiscal credibility. The EU Commission is forecasting deficits of 3.6% and 3.7% for 2024 and 2025 (November forecasts), while the (Austrian) Fiscal Council is even more pessimistic at 3.9% and 4.1%. A decision on the opening of an excessive deficit procedure against Austria could be made as early as January 21 (meeting of EU finance ministers). The EU Commission, which issues a recommendation to the finance ministers in advance, had already ordered Austria to submit a budget plan in advance, which would need to show necessary fiscal savings. As it seems unlikely that a government will be formed in the next two weeks including a detailed budget plan, the Commission will probably have to be satisfied with a “budget planning light” at most. In our opinion, the absence of a budget plan or the lack of any progress in the coalition negotiations would trigger an excessive deficit procedure. Furthermore, it cannot be ruled out that the new government will deliberately accept a procedure. According to the Fiscal Council, savings of EUR 7.4 bn (EUR 6.3 bn, based on forecasts by the EU Commission) are necessary to comply with the deficit limit in 2025. In contrast to Austria, Finland, which will also have a deficit of over 3% in 2024, is not facing any proceedings. Forecasts and a draft budget plan indicate that the deficit criterion will be met in 2025. Accordingly, a convincing budget plan on the part of Austria could still avert an excessive deficit procedure. There is also the possibility that EU will grant Austria a further delay due to the formation of a government. However, in view of the approaching deadline in combination with the ongoing coalition negotiations, we cannot rule out the initiation of an excessive deficit procedure. This would not be the first time that an excessive deficit procedure has been opened against Austria. Between 2009 and 2014, Austria had been already under increased fiscal surveillance by the Commission.

A look at Austrian government bonds shows that financial markets have so far been relaxed when it comes to a potential FPÖ-led government or a possible EU deficit procedure. In principle, right-wing governments are nothing new in the EU. Italy, Czechia, Hungary and the Netherlands, among others, are (co-)governed by right-wing parties (parties that belong to the Patriots for Europe or the European Conservatives and Reformists in the European Parliament). Furthermore, from an investor perspective a coalition of only two parties, that are rather close to one another in economic policy terms, appears more stable than the three-party coalition that has now been rejected. If the excessive deficit procedure were to be opened, Austria would basically be in "good company". Two rating/financial market peers, Belgium and France, are already subject to an excessive deficit procedure. Both currently exhibit significantly higher risk premium than Austria on government bond markets. However, this is mainly due to the domestic political uncertainties and the “ungovernability” in France, which also applies to some extent to Belgium. Before EU elections, risk premiums for France and Austria were still on a par. Furthermore, Austria not only posts significantly lower fiscal deficits, but also a significantly lower public-debt-to-GDP ratio and lower interest payments to be made than France or Belgium. Therefore, even if an excessive deficit procedure is initiated, we do not expect, all other things being equal, a significant market reaction or a convergence of the risk premium of domestic government bonds with France or Belgium.

Today, Fitch Ratings is scheduled to conduct the first regular review of Austria's sovereign rating in the course of 2025. Since the last Fitch review in July, when the current rating of AA+ including the neutral outlook was confirmed, the Republic's fiscal situation and outlook has deteriorated. The deficit of 2.9% for 2024 forecasted by the rating agency in the middle of last year will certainly be exceeded (negatively). The agency's rating model basically points to a two notch lower rating for Austria (AA-). The qualitative adjustment to ultimately AA+ is justified by the overall high degree of macroeconomic resilience (+1 notch) and the expectation of a falling debt ratio and the high average debt maturity (1+ notch). Due to the elections, the rating agency did not expect a budget plan to be submitted until March 2025 in its last review. We therefore do not expect Fitch to adjust the rating or outlook for the time being. However, if the budget plans negotiated by the new government deviate from medium-term consolidation, we see risks of a deterioration in the outlook in H2 2025. Fitch raised the rating outlook from negative to neutral in August 2023 after negative expectations regarding the gas supply failed to materialize. The Republic of Austria has had an AA+ rating from Fitch for almost 10 years. The next regular rating reviews by S&P (AA+, positive outlook) and Moody's (Aa1, stable outlook) will follow on February 14 and 21 respectively. A negative rating trend cannot be ruled out here if no clear multi-year fiscal consolidation path is apparent up until then.

In principle, we believe that risk premiums on long-dated benchmark bonds for the Republic of Austria (currently at 40-50bp) are at a fair level compared to rating peers. A clear AAA outlook has not really been priced on financial markets in recent years. Furthermore, in view of a further reduction in ECB bond purchases (reinvestment of government bonds) and generally increased fiscal deficits and sovereign issuance volumes in Europe as well as elevated interest rate market volatility, increased government bond spreads are also to be expected in the medium term compared to times of low interest rates, low market volatility and extensive ECB (government) bond purchases. In this respect, even a fiscal consolidation strategy should not cause the Austrian risk premiums to fall significantly in the short and medium term.