OREANDA-NEWS. 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 long-term foreign - and local-currency bonds have also been affirmed at 'AA+'. The Country Ceiling has been affirmed at 'AAA' and the Short-Term Foreign Currency and Local Currency IDRs at 'F1+'. The issue rating on Austria's Short-Term Local Currency debt has been affirmed at 'F1+'.

KEY RATING DRIVERS

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

Austrian economic activity rebounded in 1Q16 to 1.7% (y-o-y) boosted by recovering domestic demand. We expect real GDP growth to remain on a steady upward trend and average 1.6% in 2016-2017 after four years of sluggish activity. We believe the 2016 economic momentum will mostly rely on one-off effects, including an increase in private consumption supported by the income relief provided by the 2015/2016 tax reform and increase in public spending related to refugees. However, we expect underlying growth to pick up in 2017 as investment continues its steady recovery and net exports make a positive contribution to growth.

We believe risks to the forecast are tilted to the downside as potentially lower than expected economic growth in Austria's main trading partners could hamper the investment recovery and pick-up in exports. In addition, forecast inflation above the eurozone-average and rising unit labour cost could also erode Austria's price competitiveness, while high taxation on labour, rising unemployment and restrictive market regulation could dampen a recovery of medium-term growth.

The fiscal deficit was better than expected in 2015 at 1.1% of GDP compared with a 1.9% target. The over-performance was notably due on the revenue side to higher capital return tax, and on the spending side to lower than expected pension costs and low interest expenditure. This offset the additional costs related to HETA and refugee-related expenditure.

Fitch expects Austria's fiscal policy to remain prudent, producing small primary general government surpluses during 2016-2018. We forecast the budget deficit to widen in 2016 to 1.9% of GDP before slightly narrowing to 1.7% in 2017. The wider projected fiscal deficit mostly stems from a rise in social transfers due to higher unemployment, increased refugee-related costs and subdued revenues following the implementation of the tax reform. Fitch's fiscal forecasts for 2016-2017 assume an under-performance of compensatory measures announced by the government to finance the tax reform, and therefore remain higher than official projections of a 1.6% and 1.5% budget deficit in 2016 and 2017, respectively.

Fitch expects Austria's gross general government debt (GGGD) to decrease to 84.8% of GDP in 2016 after peaking at 85.5% in 2015. The agency believes the downside risks from the resolution of the nationalised "bad banks" are now remote. These include the liabilities of HAA (HETA), KA Finanz and immigon. Our debt forecasts do not include the potential windfall, estimated at -1.8% of GDP in aggregate over 2016-2020 by the Ministry of Finance, resulting from the asset disposals of KA Finanz and immigon as the timing and valuation of these operations remain uncertain. Liquidation of the assets therefore would likely improve the debt trajectory. Excluding the "bad banks'" liabilities, GGGD decreased to 77.5% of GDP at end-2015.

The resolution of the wind-down unit of HAA (HETA) is ongoing and a partial write-down of HETA's debt could be completed later this year. A memorandum of understanding was signed in May between the Federal Government and HETA's creditors for a buy-back by the fund of HETA's liabilities subject to the guarantee provided by Carinthia. This would lead to a decrease in recorded GGGD and remove the risk of creditors claiming compensation from the province for the amount of the haircut decided by the Financial Market Authority on 10 April.

We note that Austrian banks improved their capitalisation throughout 2015 and reduced the gap with international peers, but net interest margins are still low and legacy issues remain. The high, albeit decreasing share of foreign currency loans and variable rate loans to households still represented 16% and 67.3% of total loans in 1Q16, while the FX exposure of Austrian banks in Central, Eastern and South-eastern Europe (CESEE) was 38.2% at-end 2015. Vulnerabilities also arise from substantial exposures to CESEE, where the stock of NPLs remains large at 11.5% of the total loan portfolio and where Austrian subsidiaries may face legal interventions in Poland and Croatia.

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 among the lowest in the EU at around 6% but it has been increasing over the past few years. Fitch considers the government's financing risk to be low, reflecting an average debt maturity of about eight years, low borrowing costs and strong financing flexibility.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Austria a score equivalent to a rating of AA on the Long-Term FC IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

-Macroeconomic: +1 notch, to reflect the absence of large domestic imbalances in Austria and consequent macroeconomic stability.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

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.

- Material costs from the financial sector that worsens 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 fiscal 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

We assume the outcome of the presidential election in October following the Austrian constitutional court's decision to overturn the May election result is unlikely to change the political stance due to the relatively ceremonial role of the president. The next legislative elections are to be held by October 2018 and we do not expect grand coalition parties to trigger an earlier election.