On behalf of our Swiss authorities, we would like to thank staff for the useful set of reports that provide a thorough and insightful analysis of the macroeconomic situation. In most respects, the authorities share staff’s assessment of the challenges going forward and they welcome the candid policy recommendations, which are a valuable contribution to the domestic policy debate in Switzerland.
The authorities broadly agree with staff on the outlook. Supported by the acceleration in global output growth since early 2017, economic activity in Switzerland has gained pace. In the first quarter of 2018, despite losing some momentum compared with the second half of 2017, growth remained broad-based across sectors and strong at 0.6 percent against the previous quarter. The authorities expect the dynamic recovery to continue, with above potential growth in 2018 and 2019. According to the latest forecasts of the Federal Government’s Expert Group, GDP is projected to grow by 2.4 percent in 2018 and 2.0 percent in 2019, respectively. That said, this outlook is subject to risks, especially those related to the international economic environment. In particular, as illustrated by recent developments, an increase in international political risk can renew demand for the Swiss franc as a safe-haven asset. Further, spiraling protectionist tendencies could affect global economic conditions and external demand. On the domestic side, imbalances on the mortgage and real estate markets persist, and an abrupt adjustment could have macroeconomic repercussions.
The “debt brake” fiscal rule at the federal level has served Switzerland well, contributing to a structurally balanced budget. General government debt stands at just over 40 percent of GDP, with sound public finances at all levels of government. This ensures the financing of, among other things, a high-quality education system and an extensive public infrastructure.
Recent measures to curtail within-year underspending, particularly the introduction of new global-budgeting procedures, are expected to curb future budget underruns. Aside from that, budget underruns in recent years have led the government to task a group of experts with reviewing the debt brake rule. Measures are under consideration, including a simplification of procedures for within-year supplementary budgets that should reduce incentives to maintain safety margins in spending execution. The Ministry of Finance will continue to monitor the development of budget underruns. In spring 2019 the Federal Council will consider possible amendments to the rule, based on a report of the Ministry of Finance. In addition, the domestic sectors of the economy are currently performing well, and fiscal policy is not a suitable tool to address the economic effects of exchange rate shocks. Therefore, the authorities continue to regard the fiscal stance as adequate. Prudent levels of public debt will continue to help ensure Switzerland’s fiscal sustainability and increase resilience to long-term trends and future shocks.
The authorities agree with staff that the current accommodative monetary policy remains appropriate. Despite the depreciation of the franc since mid-2017, the Swiss franc remains highly valued. Also, CPI inflation remains low and is expected to increase only gradually. Moreover, the recent appreciation of the Swiss franc against the euro has shown that the situation in the foreign exchange market remains fragile and that monetary conditions can change rapidly. The negative interest rate on sight deposits and the SNB’s willingness to intervene in the foreign exchange market as necessary therefore remain essential. This keeps the attractiveness of Swiss franc investments low and eases pressure on the currency.
Financial Sector Policies
As mentioned by staff, considerable progress has been achieved in strengthening the resilience of the banking sector. Capital and liquidity buffers have increased across all categories of banks. Regulation for systemic banks is more stringent than international minimum standards. The authorities concur with staff that this is appropriate, given the importance of these banks and the size of their balance sheets relative to the size of the Swiss economy. In addition, macroprudential measures introduced between 2012 and 2014 have helped to contain risks in the real estate and mortgage markets, particularly with respect to owner-occupied residential real estate, where the growth in lending volumes has come down.
Nevertheless, imbalances in the real estate and mortgage markets persist, and affordability risks in mortgage lending have increased. Notably, the search for yield induced by the current low interest rate environment has fueled the market for income-producing real estate (IPRE).
Meanwhile, the overall resilience of the banking system has not deteriorated. The authorities are cognizant of the risks from high exposures to real estate and from high household debt. FINMA exercises close oversight of activities and has already intensified its supervisory activities in the area of IPRE. Also, greater differentiation of risk weights between income-producing and owner-occupied mortgages, as well as among different loan-to-value buckets, is foreseen under the revised Basel III standardized approach. The authorities will continue to closely monitor developments in the real estate and mortgage markets. They agree that further measures should be considered, as necessary, to reinforce the prudential framework, with a focus on IPRE and affordability risks, to limit a future buildup of risk and strengthen the resilience of the banking sector.
The authorities concur that regulatory arbitrage by nonbank mortgage lenders should be prevented. In this context, we would like to highlight that mortgage lending by insurance companies constitutes only a small part of the mortgage market and is subject to requirements that are no less strict overall than those for mortgage lending by banks. This is evidenced by the resulting lower risk profile of the mortgage portfolios of Swiss insurers. Apart from that, we agree that it is crucial for financial supervision to remain vigilant and independent. Also, from a long-term perspective, the authorities agree with staff on the merits of eliminating the tax deductibility of mortgage interest payments for individuals along with removing taxation of imputed rental income. Conversely, they do not share staff’s concerns with respect to the timeliness of self-regulation. To the contrary, self-regulation has demonstrated its effectiveness and can typically be deployed more swiftly than changes in mandatory regulation, given that the latter necessitate legal amendments.
External Sector Assessment
The authorities welcome the careful analysis of the Swiss external sector. In particular, they appreciate the formal treatment of retained earnings on portfolio equity by multinationals and of inflation compensation on debt instruments as contributors to the current account. These factors have a significant impact on the current account not only of Switzerland, but also of other countries. The authorities agree with staff that further work is warranted to better understand how financial center characteristics influence external accounts. Moreover, as rightly noted by staff, demographic factors play an important role in the determination of the current account. Further work is needed to understand how the interaction between pension systems and demographics affects the current account.
The authorities concur that pension reform is essential to maintain a sustainable and effective social safety net against the backdrop of an aging population and the low interest environment. Following the rejection of the “reform 2020” package in a referendum, the strategy is now to focus on reforming the first pillar initially. Unification of the retirement age at 65, increasing earmarked revenue, and strengthening incentives for working longer are key elements of the planned reform.
Finally, corporate tax reform and, with it, the abolishment of non-compliant tax regimes is a key policy priority of the government. A swift adoption of the proposed corporate tax reform is crucial to dispel uncertainty while maintaining a competitive corporate tax system. Parliament is currently discussing the reform proposal.