15 April 1997 • Export-led Recovery Provides Little Relief for Current Account. Economic Outlook for 1997 and 1998 • Georg Busch

Merchandise exports should strengthen markedly in 1997 and give greater momentum to GDP growth. Domestic demand is set to remain subdued, even if restrictive demand effects from fiscal consolidation may prove weaker than initially expected. The current external account remains in considerable deficit indicating structural deficiencies in a number of sectors. On the domestic market in particular, the competitive position of Austrian suppliers appears fragile.

While demand and output in Austria have been heading upwards over the last 12 months, it is only since last fall that a business cycle recovery appears to be under way. Industrial and construction activity rebounded strongly in spring 1996, largely reflecting the catching-up of output losses from the long and severe winter period. Towards mid-year, the measures of fiscal consolidation envisaged by the federal government – such as an increase in the car registration tax – led to a wave of pre-emptive buying of consumer durables. Unlike widely expected, however, private consumption did not slump even after first tax increases and cuts in social transfers had taken effect: rather, households were ready to reduce their saving than to cut back on their consumption plans. Later in the year, as from October, exports picked up strongly as a consequence of both more favorable exchange rate developments and the beginning recovery in western Europe. For the whole of 1996, real GDP rose by 1 percent, somewhat more than projected.

If the situation on foreign exchange markets remains broadly stable – which is by no means certain in view of the political decisions to be taken in the context of EMU – goods exports should provide sufficient momentum as to gradually strengthen GDP growth, bringing it back to its trend rate by 1998. Austria's international competitive position is set to improve not only due to a softening effective exchange rate, but also due to labor cost developments. Lively demand for basic goods and semi-manufactures in a widespread build-up of inventories will benefit domestic suppliers and should allow them to gain export market shares.

More favorable exchange rates may also stem the decline of the domestic tourism industry. The trend fall in foreign demand over the last years should bottom out, although a turnaround towards a positive net contribution from tourism to GDP growth is not in sight.

Of crucial importance for further business cycle developments in Europe as a whole will be, to what extent and how quickly stimulus from exports is transmitted to private investment. Prospects in this regard appear relatively favorable for Austria, since the propensity to invest proved quite strong in the fragile climate of 1996 and the regular WIFO survey does not signal a significant change for the current year. A large number of enterprises find themselves exposed to heightened competitive and adjustment pressure, while profits are generally satisfactory and nominal interest rates low.

The so far robust consumer behavior will be tested to a still higher degree in 1997. A number of restrictive fiscal measures have only taken effect at the beginning of the year, real disposable income of households is being squeezed, and the labor market outlook is not becoming much brighter. A significant relapse in spending propensity cannot be ruled out, when households become fully aware of these adverse conditions – although evidence so far suggests otherwise. In any case, last years' advance purchases will have an "echo" effect, implying a year-on-year consumption decline in the first semester; on annual average, consumption is projected to edge up by 1/2 percent. With the cyclical recovery gaining momentum in 1998, consumer confidence should be boosted; the successful completion of the present stage of fiscal consolidation may constitute a further positive element in this respect.

Projections for the major components of demand imply a gradual acceleration of GDP growth to an average 1.4 percent in 1997 and 2.2 percent in 1998. While initially goods exports are set to be the driving force, domestic private demand, particularly for consumer durables, should rebound subsequently, eventually making a substantial contribution to overall growth. Still, from today's perspective, the recovery promises to be slow by past standards and lag behind the international trend. In order for Austria to restore its traditional growth advantage, consistent and sustained efforts at institutional and structural reforms are required to underpin the short-term revival of demand by ensuring lasting expansion of potential output.

The situation on the labor market has stopped deteriorating since last fall. Manufacturing industry and construction firms had reacted quickly to the slackening of activity by cutting their workforce. Moreover, the first "wave" of rationalization in service branches that have become exposed to greater competition has probably run its course. Thus, with somewhat brighter growth prospects for 1997, employment is unlikely to recede further but should rather head upwards. Unemployment is expected to remain at a ratio close to 4 percent of the labor force (Eurostat definition).

Consumer price inflation is likely to remain below 2 percent annual rate throughout the projection period. Sluggish final demand and strengthening competition keep a lid on price increases and profit margins, while unit labor costs are set to remain flat under the impact of excess labor supply bearing down on wages and of rationalization efforts.

In spite of a widening growth differential between exports and domestic demand, and despite favorable exchange rate movements the imbalance in the current account has hardly been reduced (the lower deficit in 1996 compared with 1995 originating mainly from smaller net transfers to the EU budget). Strong investment activity and lively demand for consumer durables and holiday travel have caused a marked upward shift in the marginal import propensity. Whether the ongoing investment and modernization boom, as is occasionally argued, will actually boost Austria's structural competitiveness and export capacity, eventually leading to a lower trade deficit and a higher surplus in non-tourism services, remains to be seen.