Krugman Comment: Pröll versus Bankruptcy

Photos: Finance Minister Josef Pröll (standing) delivering the budgetary speech, Apr. 21, 2009. Photo Credit: Matthias Wurz

The plenary chamber of the Austrian parliament was packed by 9:00 on Apr. 21, just like the stands for the general public in anticipation of ÖVP Finance Minister Josef Pröll’s 63-minute presentation of the budget.

At 9:05, Pröll rose from his seat to deliver what was expected to be his most important speech of his career so far, presenting the budgets for 2009 and 2010, which was broadcast live by ORF Austrian Television.

Austria, along with much of the world, is in the worst economic crisis in recent memory and the financial outlook is gloomy. The country’s national debt will increase by 3.5% in 2009 and 4.7% in 2010, well above the permitted Maastricht level of 3%. Consequently, the total national debt will reach an alarming 78.5% of Austria’s GDP by 2013, up from 62.5% in 2008. The bank rescue package (Vienna Review reported, April 2009) weighs with EUR 9.3 billion heavily (2009).

Economic Minister Reinhold Mitterlehner added in Der Standard of Apr. 25 that in order to consolidate the budget in the years to come “we also need new sources of income.” In other words, raise more taxes as the estimated tax income for the state drops by EUR 4.5 billion in 2010.

But Pröll in his budget speech seemed eager to rise to the occasion, perhaps hoping to imitate U.S. President Barack Obama’s rhetorical skills.

“In presenting this budget today, the hour of truth is upon us,” Pröll intoned. “And this budget is a clear declaration of war against the [economic] crisis.”

But Pröll is by no means an eloquent speaker. His delivery was uninspiring, so much as that only the members of his party are enthused to applause, and as journalists followed along the printed version of the speech, they noted some of the more amusing interjections of the opposition.

Most members of the majority Social Democrats (SPÖ) – Pröll’s senior coalition partner – listened with apparent apathy. After all, this was essentially a conservative-crafted budget intended to combat a serious financial and economic crisis, and left little room to reward their own electorate.

Just a week earlier, Princeton University economics professor and 2008 Nobel Prize Laureate Paul Krugman, who writes a bi-weekly column for the New York Times, gave rise to speculation on whether Europe’s fourth-richest country – in Pröll’s own definition of income per capita – might in fact be on the brink of bankruptcy.

Speaking at the Foreign Press Club in New York on Apr. 13, Krugman revived the debate on the impact of the financial crisis on Austrian banks, because of their strong engagement in Central and Eastern Europe (CEE) – see also my commentary of mid-April.

In the question period, Krugman was asked about Austrian banks’ high exposure to Eastern Europe. Austrian banks have more than U.S. $200 billion of exposure to Eastern Europe, roughly 70% of the Austrian GDP – not including Bank Austria (UniCredit) and Hypo Alpe Adria (Hypo Group) that are foreign-owned. Was there a chance this might lead the country into bankruptcy? Krugman responded pointedly:

“Now it’s a tiny one, it’s Iceland but that just shows that it can happen, even to advanced countries. Ireland looks pretty bad because of large financial exposure. And Austria would probably be my third candidate in those leads.”

His provocative remarks sparked high-profile responses and anger in Austria.

“Absolutely absurd,” Pröll responded on Austrian Television on Apr. 15. There was no need for “unqualified statements based on inadequate information, which can put a country under massive pressure if they are uttered carelessly.”

Besides, Austria’s high lending exposures in the CEE area has to be set against savings, Pröll clarified, with deposits of some 85% of the EUR 200 billion owed.

The head of the Austrian Chamber of Commerce, Christoph Leitl, was right behind him. In Der Standard, the same day, Leitl stressed that Austria’s AAA rating was in no danger, which several rating agencies recently confirmed, but emphasized that “erroneous’ statements could lead to higher risk premiums on Austrian bonds. That really damages Austria.”

“It seems that I have reached the stage where I create a stir by saying the obvious,” Krugman responded in his blog two days later; and over 100 comments followed within a few hours.

Krugman’s statement has revived a debate of the past months when media reports, such as the Austrian news magazine profil, asked in mid-February: ‘Is Austria going bankrupt?’

But in Vienna, at least, the tangible evidence just doesn’t seem to be there.

“It is a palpable presence in people’s everyday lives [in Central and Eastern Europe], as it is in America,” said Robert Graffam of Darby Investments, a private equity firm in Vienna that specializes in CEE. “In Austria, somehow, you don’t feel that.”

Indeed, the severe financial troubles of Austria’s neighbors highlight the huge investment Austrian banks had made since the 1990s in the CEE countries. They are the most exposed in the area, led by Raiffeisen with 54% of its risk-weighted assets, and Erste Bank Group with 38%.

Evidently Finance Minister Josef Pröll set off for a ‘face-saving’ trip to Bulgaria, Romania, Croatia and the Ukraine in mid-February promoting the Austrian government’s proposal for a financial stability pact for the CEE countries.

However, Pröll’s goodwill tour sparked fresh concerns in the Austrian financial sector.  On Feb. 17, the Romanian business online magazine, the Wall-Street was headlined ‘Romania Could Drive Austria to a Meltdown.’

At the same time, a report by Der Standard back home estimated that even a 10% default of CEE loans could lead to a collapse of the Austrian financial sector. The figures of the European Bank for Reconstruction and Development (EBRD) confirmed estimates of at least 10% bail-out of bad loans.

Not surprisingly, the government’s rescue plan failed to convince the other EU member-states, as it seemed to be motivated only by Austrian self-interest.

Thus, while Krugman’s comment may be exaggerated, as bankruptcy seems unlikely in Austria at this stage, he still made a valuable point: Austria should not underestimate the effect a widespread financial collapse of financial institutions inevitably has when the CEE countries are not stabilized

If this aspect of the financial crisis is mishandled, predicted The Daily Telegraph columnist Ambrose Evans-Pritchard on Feb. 15, it could mean “a debacle [that is] big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.”

Austria would then certainly play the leading role.

This is an excerpt, the full article was published in May 2009 in The Vienna Review.