Country Report Switzerland
The strong appreciation of the franc after Switzerland abandoned its peg to the euro is likely to lead to lower growth. Macro-prudential policies have been tightened and the government has also announced some fiscal tightening. Meanwhile, the government still has to find a way to deal with the outcome of the February 2014 anti-immigration referendum.
Strengths (+) and weaknesses (-)
(+) Competitive and wealthy economy
Switzerland is one of the richest countries in the world. The economy is diversified and competitive, illustrated by the first place of Switzerland on the WEF Global Competitiveness Ranking.
(+) Public debt is low and on a downward trajectory
Public debt was 35% of GDP in 2014, which is low by industrialised country standards. The fiscal framework introduced in 2003, the debt brake, will avoid a fast accumulation of public debt in the future.
(+) Large, positive, net international investment position (NIIP)
Since 1981, Switzerland has had a persistently large current account surplus, which was 9.3% of GDP on average over 2005-2014, resulting in a positive NIIP of 122% of GDP in 2013.
(-) Large banking sector poses a contingent liability to the government
The Swiss banking system had assets equal to 486% of GDP as of late 2013. The two largest banks account for about half of total assets. The domestic loan book mainly consists of residential mortgages, which makes the banks vulnerable to a downturn in the real estate market. The resilience of the sector has been increased in recent years, as capitalisation levels have been boosted as part of a fast and strict implementation of the Basel III framework.
1. End of peg hits Swiss producers
On 15 January, the Swiss National Bank (SNB) abandoned the peg of the Swiss franc (CHF) to the euro that had been in place since 2011. As a result, the franc appreciated rapidly, from CHF 1.20 to CHF 1.01 per euro, before falling somewhat to about CHF 1.07 per euro in mid-March. In the four preceding years, the foreign exchange reserves of the SNB had more than doubled to about 75% of GDP. Keeping the peg in place would have required further large scale interventions, as is demonstrated by the fact that the government bond buying program of the ECB (QE) has already resulted in a strong depreciation of the euro against other currencies.
To discourage capital inflows and further appreciation, the SNB simultaneously also lowered interest rates further into negative territory. The SNB implements its monetary policy by fixing a target range for the reference interest rate, the 3 month Libor interbank rate. This range was lowered on 15 January to between -1.25% and -0.25%, from -0.75% and 0.25% previously. On 16 March, the Libor rate was -0.8%. It remains to be seen whether the SNB could lower interest rates even further, as this could result in a move into physical cash and could lead to problems for pension funds and insurance companies.
Meanwhile, the strong appreciation will hurt the competiveness of Swiss producers (see figure 1). Especially the tourism, machinery, metal, watches and chemicals sectors are likely to take a hit. The impact in several other sectors will be mitigated by the fact that quite a lot of exports consist of high-value goods and services and that Swiss producers have strong market positions in these markets. Furthermore, a sizeable part of production by Swiss companies is already taking place outside the country. Nevertheless, the stronger exchange rate will lower economic growth in 2015 and 2016. Furthermore, it has also resulted in more deflationary pressures, as deflation increased from 0.5% y-o-y in January to 0.8% y-o-y in February. Structurally, though, the Swiss economy remains very strong. The country has a very high current account surplus (see figure 2), while unemployment remains very low and the government a sound fiscal position.
2. Macro-prudential policy mix tightened
The government tightened its macro-prudential policies somewhat to deal with risks of rising mortgage debt. Per June 2014, the counter-cyclical capital buffer for domestic residential mortgage exposures (which was introduced in 2012) was doubled to 2% of risk weighted assets. In 2013, mortgage risk weights regulations for banks using the Internal Rating Based Approach had already been tightened. At more than 100% of GDP in mid-2014, mortgage debt is relatively high in Switzerland and has continued to rise in recent years. At the same time, Swiss households have high levels of (liquid) financial assets, while the household saving rate is also relatively high.
3. First fiscal deficit since 2005
In February, the government announced that it had run a small deficit of CHF 124 million, the first fiscal deficit since 2005. This was partially related to the fact that the Swiss National Bank did not pay dividends in 2014, after it had run a loss of CHF 9bn due to a strong fall of the value of its gold holdings. The government has announced CHF 1.3bn in corrective measures, which mainly consist of spending cuts to be implemented between 2016 and 2018. As public debt remains low, while the fiscal framework is prudent, sovereign risk remains very low.
4. General elections in October 2015
In October 2015, general elections will be held. The composition of the government is unlikely to change. Since the October 2011 elections, the country has been governed by a coalition of 5 parties. Annually, a president is elected from the seven-member cabinet, and in 2015 Simonetta Sommaruga is the president. One of the most important challenges for the government remains dealing with the outcome of a February 2014 referendum launched by the SVP political party. Voters then supported measures to limit immigration. However, these measures might violate bilateral treaties, such as the one on the free movement of labour between Switzerland and the EU. On 11 February, the Federal Council presented a formal bill on quotas on immigration from EU countries. This bill has a high chance of being rejected by the EU. As quotas have to be implemented per February 2017, this topic is likely to remain on the agenda for some time.
Switzerland has a relatively open, well-diversified and competitive economy. It is both a major financial centre and a big producer of chemicals, pharmaceuticals and luxury goods. As a result, the country is one of the wealthiest countries in the world. Moreover, the current account has been in surplus since 1981, which results in a large positive net international investment position.
The country has strong public institutions that are well-known for their prudent policies. The government has had a budget surplus since 2006 and public debt is rather moderate. Every year a ceiling is calculated for total government spending. Whenever this maximum has been exceeded, the government is forced to save more in the following years. The Swiss political system consists of a representative democracy with instruments of direct democracy (referendums). This sometimes limits the scope for far-reaching reforms and makes the system somewhat more prone to populism. The central bank, the Swiss National Bank (SNB), has proved successful in reaching its inflation mandate in the past. However, Switzerland’s safe haven status and its high current account surpluses have exerted strong upward pressure on the exchange rate. Despite the fact that the Swiss franc was still pegged to the euro, Switzerland experienced mild deflation in 2012 and 2013. In January 2015 the SNB abandoned the peg, which resulted in a strong real appreciation of the franc.
Switzerland’s very large banking sector (assets equal to 486% of GDP in late 2013) poses a contingent liability to the government finances, as shown by the necessary recapitalisation of UBS in 2008. After the global financial crisis, the regulation of the financial sector has become more stringent. All banks (both the big international banks and the domestic, mostly cantonal, banks have raised their capital levels significantly in recent years.