Austria Pinched by Eastern Europe Woes

Vienna has felt like a changed place since the unmentionable words first began slipping off the tip of people's mouths—terms like "crisis in Austria," and "impending government bankruptcy." The bad news seems to affect everything and everyone.

The once-proud national airline Austrian Airlines? It's up for sale, because, among other problems, its managers miscalculated when they speculated on kerosene prices. If the European Commission approves the deal, German national carrier Lufthansa will soon acquire the Austrian airline, with the government in Vienna even throwing in €500 million ($625 million) in state aid as part of the dowry.

Vienna's old-fashioned streetcars, popular among local residents and tourists alike? It is said that they are only still running due to the fact the the US investor the city leased its streetcars to, in a deal worth millions, still wants the trolleys to operate.

And what about ORF, Austria's main public television station, which must provide politicians as well as bankers from among its advertising customers with a soap box from which they can paint conditions in Austria in a gentler light? It announced a loss of €79.8 million ($100 million) for 2008. The loss, as the general director hastens to add, was not as bad as expected, given the previously grim predictions for the broadcaster.

What is going on here—in this, one of Europe's richest countries?

After 1989 Austria, which had developed its own economic miracle, transformed itself into a gateway between markets in the East and West. It became the commercial hub for the booming former communist countries and, within the European Union, positioned itself as the go-to specialist on Eastern Europe, a manager of sorts for its ancestral backyard (thanks to the blessed days of the Hapsburg Empire, which spread across much of the region).

Austrian bankers optimistically placed their bets on the East and issued loans to places like Hungary, Romania and Ukraine—and to possibly dubious borrowers. Now these countries—from Russia to Croatia—are spiraling downward, and the Austrian lending industry is being criticized for taking on "aggregate risk."

The mood is gloomy in financial center Vienna, even more so following the recent publication of a report by Moody's, a leading credit rating agency. The document cites a "deteriorating macroeconomic framework for East European banks" that could threaten the credit ratings of Western European banks active in these markets. According to the report, "the Austrian banking system is most exposed as Eastern Europe accounts for nearly half of Austria's global bank claims."

Growth in Eastern Europe was built on borrowed foreign capital, in a system that often benefited the subsidiaries of Western companies, whose profits—as long as they continued to be generated—flowed back to the home countries. But now many investors are pulling out and taking their money to regions with even lower wages, leaving investment ruins behind. The sharp decline in orders and the global recession have crippled the East to the point of standstill, making it more difficult for borrowers there to repay their loans.

These concerns led the news magazine Profil to ask: "Is the Republic of Austria on the verge of bankruptcy?" Austrian daily newspaper Die Presse asked: "When, exactly, will Austria go into bankruptcy?" The rumor mill is filled with catastrophic scenarios, most of them based on the projection that Austria has outstanding accounts in the East worth €293 billion ($371 billion), which is roughly equal to the country's annual gross domestic product. If worse comes to worst, the government will be liable for repayment of much of that debt.

As a precautionary measure, the Austrian National Bank, the country's central bank, has performed "stress tests" akin to laboratory tests in the international financial market. The tests are being used to assess the resilience of banks whose Eastern European subsidiaries could face major loan defaults. According to their results, if "only" Ukraine and Romania, both countries recently facing the prospect of national bankruptcy "come crashing down," those banks with large lending portfolios in the East—like Raiffeisen International, Erste Bank and Bank Austria—could just about survive the crisis. The chances that EU member state Romania will fall into the abyss in the immediate future, however, diminished this week, as negotiations began with the EU and the International Monetary Fund for billions of euros in emergency loans.

Austrian banks, including Bank Austria, which is owned by Italy's UniCredit Group, hold about one-quarter of the €1.2 trillion ($1.5 trillion) in outstanding loans to Central and Eastern European countries (including Turkey). Raiffeisen and Erste Bank reacted to the Moody's report by moving up their balance sheet conferences for 2008. Nevertheless, their stock prices tumbled precipitously after the beginning of the year, with Erste Bank's stock falling a full 54 percent.

The branches of Austrian banks dominate the banking market in Eastern Europe, from Ukraine to Romania, Slovakia to Serbia and Bosnia-Herzegovina. Austrian banks hold €51.6 billion in outstanding loans in Hungary and Russia alone. Up to 10 percent of the outstanding loans are considered unrecoverable. Die Presse speculates that anyone who believes "that the key corpses from the banks cellars have already been flushed to the surface could be in for an unpleasant surprise soon."

The Austrian banks' practice of issuing so many loans to Eastern European customers in euros, Swiss francs and dollars has proven to have been a mistake, now that the Ukrainian hryvnia and the Hungarian forint have lost so much of their value in recent months. As a result, consumers are seeing their installment payments on items such as refrigerators and cars rise dramatically.

In Hungary, for example, 60 percent of all mortgages, as well as one in two business loans, were issued in foreign currencies. The country is "standing in stinging nettles with its trousers down," says György Jaksity, chief executive of Concorde Investment and a former chairman of the Budapest Stock Exchange.

The government in Vienna has approved a €100 billion bailout program. It also requested aid from the EU for at least as much money, but was turned down. Critics in Vienna assume that the charitable "Save Eastern Europe" mission is little more than a camouflaged effort to rescue Austria.

How bad are things on the eastern front? Even experienced bankers are perplexed, and there is disagreement over the true scope of the expected losses. The Eastern Europe bank EBRD projects the risk of loss for Austria at no more than €20 billion. Other studies project losses of up to €31 billion. Financial experts in Vienna say that, based on the current situation, this would bankrupt neither the banks nor the government.

On the other hand, the news that the number of unemployed people in Austria has increased by 23.7 percent since February 2008 has attracted attention. "The sheer misery of the 1930s, when people knocked on doors to beg for pieces of bread," will not return, says Kurt Rothschild, Vienna's 94-year-old doyen of economics. He insists that Austria's real economy is too robust for that.

However, Rothschild adds, "the fear of unemployment is back. And of toxic securities. Predicting the scope of this crisis would be futurology."

In February, Chancellor Werner Faymann declared that it is possible, though unlikely, that major banks will have to be nationalized in Austria. And after a disastrous whirlwind tour of Eastern European countries the same month—with stops in Romania, Croatia, Bulgaria and Ukraine, where he sought to drum up support for an EU rescue package—Vice Chancellor and Finance Minister Josef Pröll became less eager to issue prognoses.

It was "the most expensive trip in a long time," because Pröll's act of desperation greatly damaged Austria's creditworthiness, says Hannes Androsch, deputy chancellor and finance minister under former Chancellor Bruno Kreisky in the 1970s. Androsch, now a wealthy industrialist who wears a pinstriped suit, a Hermès tie and dazzlingly polished shoes, is viewed by some observers as Austria's shadow finance minister.

In earlier days, Androsch liked to call Eastern Europe the "opportunity of the century." Nowadays, his message is one of blame—to those who are hesitating in a dangerous situation: the EU, which Androsch criticizes for not taking advantage of its opportunities, "instead proving itself to be a community of individualists," and, of course, the finance minister, a man deeply rooted in the circles of the Austrian Farmers Association and Raiffeisenbank, to whom he attributes, condescendingly, an "agrarian view" of the global distortions in markets.

The West cannot leave its Eastern neighbors out in the cold now, warns Androsch. Particularly Germany, which has been "quasi co-financed" by Austria in its role as the biggest exporter in the markets of the East, must now show responsibility, he insists. But German Finance Minister Peer Steinbrück in Berlin has shown little interest to date.

Many in Austria are now warning against the stubbornness of the country's larger EU partners. The criticism begins with the president of the Austrian Federal Economic Chamber, who accuses Steinbrück of being "blind in both eyes" when he characterizes the fear of the crisis in the East as an Austrian matter. But for Werner Kogler, the Austrian Green Party's spokesman on financial policy, this is nothing but a smoke screen. "They are shameless poker players, our bankers," he says, adding that they are now becoming nervous.

According to Kogler, it is difficult to tell who is in charge—the government or the banks. Kogler has asked parliament to look into rumors that Finance Minister Pröll embarked on his ill-fated PR tour of Eastern Europe on board the the jet of Raiffeisen CEO Christian Konrad. Merely the fact that the heads of the National Bank and the financial market regulatory agency were willing to discuss the condition of the government's finances in a closed-door session before a parliamentary committee last Wednesday highlights the scope of the crisis, says Kogler.

Austria is now considered a risky borrower. The republic, whose debt level of 60 percent of gross domestic product is not unusual for EU countries, must now pay a risk premium—1.3 percent more than Germany pays for a 10-year bond—for money it borrows in the capital markets. The premium is responsible for additional costs of about €300 million a year.

This almost places the Alpine nation, to its chagrin, on a level with Italy and Portugal, traditionally derided as soft-currency, "Club Med" economies. However, a patriotic front consisting of leading politicians, business leaders and publishers insists that Austria is being wronged and, as has happened so many times before, is being incorrectly appraised by foreigners.

On Feb. 19, the chancellor and the vice chancellor made an appearance at the Vienna Opera Ball, in defiance of the crisis, while the heads of many major corporations, for image reasons, stayed away from their expensive box seats at the society event of 2009. "I've lost so much weight that my tuxedo doesn't fit anymore," Raiffeisen CEO Konrad said, alluding jokingly to the barren years ahead.

His counterpart at Erste Bank, Andreas Treichl, did attend the ball, however. Austria's executive of the year in 2007, who earned €4.4 million in salary and bonuses, making him the country's highest paid banker at the time, did more than perform his informal obligations. His wife Desirée organized the annual event this year.

Treichl is convinced that there can be nothing more damaging at the moment than sticking one's head into the sand. In the charming jargon of a well-travelled Vienna banker, he says: "We are completely clean of toxic assets, that's our advantage. We do business with private customers. We were dramatically less oafish than our esteemed colleagues from Germany. And we don't want a comparison with the Asian crisis. We don't work with fly-by-night characters, local tycoons and South Chinese drug dealers."

Treichl believes that his bank can survive three to four lean years, because customers in Romania and elsewhere have been tried and tested, and are not easily rattled. And because a bank like Erste, which manages between 20 and 30 percent of all private deposits in Austria, the Czech Republic, Romania and Slovakia, simply cannot go under.

According to Treichl, there is plenty of commotion and little certainty at a time when "50,000 self-proclaimed economics professors are speaking their minds." Even the analysts in London, whose confidence he has just spent several days trying to gain, could not predict what else Austria could face says. But his conscience is clear, says Treichl. "We worked through all disaster scenarios."

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