This Selected Background Issues paper on Switzerland reviews a few monetary and exchange rate issues, including questions related to the monetary policy framework and the assessment of recent monetary conditions and exchange rate developments. The paper examines the Swiss savings and investment levels from a welfare point of view, employing for this purpose some “golden rule” criteria of capital accumulation put forward in the academic literature. It finds that, with its unusually high levels of saving, Switzerland may be one of the few advanced industrialized countries that strictly fulfills the “golden rule” criteria.

Abstract

This Selected Background Issues paper on Switzerland reviews a few monetary and exchange rate issues, including questions related to the monetary policy framework and the assessment of recent monetary conditions and exchange rate developments. The paper examines the Swiss savings and investment levels from a welfare point of view, employing for this purpose some “golden rule” criteria of capital accumulation put forward in the academic literature. It finds that, with its unusually high levels of saving, Switzerland may be one of the few advanced industrialized countries that strictly fulfills the “golden rule” criteria.

III. Some Aspects of the International Investment Position and Investment Income in Switzerland: A Comparison with Other Countries 1/

1. Introduction

Large and persistent current account (CA) surpluses have enabled Switzerland over the years to build a positive international investment position (gross external assets minus gross external liabilities). By the end of 1994, the net position exceeded 106 percent of GDP, with gross assets at 287 percent and gross liabilities at 181 percent of GDP (Table III-1). Net investment income has also reached a very high level. On average over the last 10 years, it constituted 6.6 percent of GDP, exceeding the average size of the CA surpluses (5.4 percent of GDP).

Table III-1.

Switzerland: External Assets and Liabilities

(In percent of GDP)

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Source: Unless otherwise noted the source is International Monetary Fund, Balance of Payment Statistics. For the U.S., U.S. Dept. of Commerce and for Germany, Bundesbank.

The aim of this note is to investigate if there are any features of the Swiss capital account and the composition of external assets and liabilities that help explain the size and persistence of net investment income. To this end, Swiss external stocks and flows are compared with those of some other countries. 1/ The main findings are: (a) that the rate of return on both assets and liabilities has been lower in Switzerland than in the other countries, but (b) that, in contrast to the other countries in the sample, the return that Switzerland earns on foreign assets has been significantly larger than the return it pays on liabilities.

2. Composition of gross external assets and liabilities

As can be seen from Table III-1, Switzerland’s net external assets relative to GDP are far above the levels in comparable countries. Even in gross terms, assets and liabilities are in general larger than in the other countries, but the differences are less pronounced.

The decomposition of assets and liabilities in Chart III-1 is not very detailed due to lack of data. However, on the assets side it appears that the share of both gold and FDI is higher in Switzerland than in the other countries. On the liability side, Switzerland has—somewhat surprisingly—a higher share of FDI than the majority of the other countries. Among the other countries Japan stands out as having a very small share of FDI. The U.K. has a very large share of loans among both its assets and liabilities. 1/

CHART III-1
CHART III-1

Switzerland: Composition of Gross External Assets and Liabilities

(Percent of total, average 1985-94)

Citation: IMF Staff Country Reports 1996, 032; 10.5089/9781451807226.002.A003

Source: IMF, Balance of Payment Statistics; IMF, International Financial Statistics; US Department of Commerce; and Bundesbank.1/ Comprises portfolio investments, other investments excluding loans and monetary reserves excluding gold.

3. Rate of return on gross external assets and liabilities

The size of net external assets is not the only factor determining net investment income. In the U.S., for instance, net investment income is positive in spite of a negative net investment position. Consequently, it is necessary also to compare the relative earnings from the various components of gross assets and liabilities.

Simple ratios of investment income credits and debits, to gross external assets and liabilities, respectively, are presented in Table III-2. The stocks of assets and liabilities are averages of the amounts outstanding at the end of the current and the previous year, in order to avoid (to a large extent) the potential problem of exchange rate changes biasing the results. Also, since gold earns no return and the level of gold varies substantially between countries, reserve holdings of gold are excluded from total assets in this calculation. A comparison of gold reserves is presented in Annex 1.

Table III-2.

Switzerland: Total Investment Income Credit and Debit in Percent of Gross External Assets and Liabilities

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Source: IMF Staff calculations.

1986-1993 for Canada.

There are two striking features about the numbers in Table III-2:

  • —The rate of return on both assets and liabilities is significantly lower in Switzerland than in the other countries. 1/

  • —The return on assets is significantly higher than the return on liabilities while in the other countries,’ except the U.S., this net return is very small or even negative.

Differences in the currency distribution and in other risk factors in the various assets and liabilities are presumably the main factors behind the differences in the measured rates of return. In the following we investigate further the importance of differences in: currency composition, FDI, and international banking activity. We also discuss statistical problems.

a. Currency composition

Assets and liabilities consist of assets denominated in both domestic and foreign currencies. Intuitively one might think that external liabilities are more likely to be denominated in domestic currency while external assets are more likely to be denominated in foreign currencies. The major exception is loans. Domestic banks’ loans to foreigners—external assets—are likely to be denominated in domestic currencies while domestic residents’ loans from foreign banks—external liabilities—are most likely denominated in foreign currencies. As can be seen from Chart III-1, the share of loans in total assets and liabilities, respectively, varies considerably among these countries, with loans constituting a comparatively large share of liabilities and a small share of assets in Switzerland.

It is well documented that the real interest rate, real rate of return in the business sector, and nominal interest rates are lower in Switzerland than in other countries. According to last year’s report (Switzerland—Selected Background Issues, SM/95/2 Supplement 1), over the period 1979 to 1994 Swiss interest rates have been lower than would be implied by uncovered interest parity. An investment in Swiss francs, for instance, would have earned on average 1.06 percent less per year than an investment in deutsche mark over this period when measured in a common currency. This differential was even bigger when the Swiss franc was compared to other currencies. If assets denominated in Swiss franc are dominant on the liability side, the fact that the average rate of return on Swiss liabilities over the period 1986 to 1993 was 3 percentage points lower than the unweighted average of the return to liabilities in the other countries would be consistent with the observed lower interest rate level in Switzerland.

The numbers in the tabulation below confirm that this is the case. Estimates of the currency composition of external assets and liabilities by the Swiss National Bank show that 61.6 percent of liabilities and 28 percent of assets are denominated in Swiss francs.

Currency Composition of Swiss External Assets and Liabilities

(In percent, at end-1994)

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Source: Swiss National Bank.

As far as the external assets are concerned, there is little reason a priori to believe that local currency interest rates should have a stronger influence than other currencies’ interest rates. The return on gross external assets would be expected to be determined mainly by international interest rates. Well diversified portfolios both among countries and among assets would hence imply less variation in the return on gross assets than in the return on gross labilities. This seems to be confirmed by the numbers in Table III-2. Also, the difference between Switzerland and the other countries is less on the return on assets than on the return on liabilities.

b. Foreign direct investment (FDI)

Investment in equities is considered more risky than other investment alternatives and should thus on average yield a higher return. The fact that book values rather than market values are used in the statistics on stocks of FDI would only increase this tendency further. Book values are based on historical cost and may significantly underestimate the market value of the stock. Consequently, the return calculated based on these book values would overestimate the real return on FDI and large stocks of FDI, both inward and outward, would on that ground be expected to be associated with high rates of return on both assets and liabilities. 1/

However, on average, outward FDI as a share of total external assets is only slightly higher in Switzerland than in the other countries. For the U.S. the share is much higher. The same pattern holds true for inward FDI and its share of total liabilities. 2/

Even though the shares of inward and outward FDI in Switzerland are not very different from those in other countries, the return on FDI could be different among countries, thus helping to explain differences in the measured rate of return on overall assets and liabilities. In Tables III-3 and III-4 we have repeated the same exercise as in Table III-2 but this time total assets and liabilities are split between FDI and other investment. It is shown that the return on Swiss FDI assets is not significantly lower relative to other countries than the return on other external assets.

Table III-3.

Switzerland: Investment Income from Foreign Direct Investment, Credit and Debit in Percent of Foreign Direct Investment, Assets and Liabilities

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Source: IMF Staff calculations

1986-1993 for Canada and Switzerland.

Table III-4.

Switzerland: Investment Income from Other Investment than FDI, Credit and Debit in Percent of Stocks of Other Investments Assets and Liabilities

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Source: IMF Staff calculations.

1986-1993 for Canada and Switzerland.

c. International banking activity

By virtue of its role as an intermediator of international capital flows, one would expect Switzerland to experience large gross inflows and outflows of financial capital. As banks earn more on loans than they pay on deposits net investment income would be larger the larger the gross flows through the banking system. This intermediation “spread” could even be higher in Switzerland than in other countries as many investors might be willing to accept lower deposit rates than elsewhere due to the secrecy laws in Swiss banking. However, as shown in Chart III-1, loans—which mainly exist in the form of bank loans—are not a particularly large part of assets or liabilities in Switzerland. This is not necessarily inconsistent with the perception that Swiss banks play a major role in international financing as the BOP statistics register only those international banking transactions that relate to claims between residents and non-residents. A large part of the financial flows involving Swiss banks is in the form of so-called fiduciary funds or it takes place in branches located outside Switzerland. 1/

Fiduciary funds are funds managed by the banks on behalf of their clients and at the clients’ risk. The funds are off the banks’ balance sheets. Foreigners have large amounts invested in these funds but it is only to the extent that the funds invest in assets issued by Swiss residents that the Swiss capital account is influenced. 2/

d. Statistical problems

A potentially important, but not easily quantifiable, factor behind the differences in the calculated returns is statistical problems. Measuring stocks of foreign assets and liabilities is associated with many problems and many countries do not provide these numbers at all.

In Switzerland the statistics on external assets and liabilities are compiled through a comprehensive survey of financial institutions and non-financial enterprises and are considered to be very accurate. On the other hand, however, there are known shortcomings in the statistics on the corresponding investment flows as indicated by the under-reporting of the return on FDI liabilities. A large part of investment income in the category other assets and liabilities is not recorded.

Due to this bias in the quality of the underlying statistics the calculated returns most likely underestimate the true return on both assets and liabilities in Switzerland. There is no reason to believe that the same bias exists—to the same extent—in other countries.

4. Conclusions

Switzerland’s external assets and liabilities earn a lower rate of return than is the case in other countries, but Switzerland’s net rate of return is positive and larger than that of any other country. The latter fact can be attributed to the historically low level of interest rates in Switzerland and a much lower share of Swiss franc denominated assets on the asset side than on the liabilities side. The difference relative to other countries in the rate of return on liabilities can be attributed in part to a comparatively low rate of return on FDI in Switzerland. This in turn may reflect to some extent statistical problems, in particular an under-reporting of nonresidents’ earnings from FDI in Switzerland. At any rate, the low Swiss interest rates and FDI do not account for all of the observed cross-country differences in the rate of return on foreign assets and liabilities. The remaining differences are not due to different levels of gold reserves and probably not linked to Switzerland’s position as a banking center. They may, however, be explained in large part by a statistical bias whereby data on the stock of external assets and liabilities are more accurate than data on the corresponding investment income flows. This implies that the rate of return on both assets and liabilities in Switzerland may be underestimated.

ANNEX: Comparison of Gold Holdings

Table III-5 shows some measures of gold holdings in Switzerland compared to the other countries. In relation to GDP the Swiss gold reserves are substantially higher than in the other countries. This is less pronounced when seen in relation to total external assets. Neither of these countries value gold at market prices but the Swiss gold reserves on the national valuation are more undervalued relative to market prices than is the case in most of the other countries.

Table III-5.

Switzerland: Gold Reserves

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Source: International Monetary Fund, International Financial Statistics.

If gold were measured at market prices and converted into interest earning assets this would, in the case of Switzerland, have a substantial impact both on the size of the assets and on the investment income. It is fairly easy to see that if all the Swiss gold holdings had been converted into assets yielding 5 percent nominal interest rate (measured in swiss franc) in 1981, net investment income would have increased by 0.8 percent of GDP. However, as the stock of gold also would have been converted into a market value more than 6 times its national valuation, the effect on the measured rate of return would have been negative.

1/

This chapter was prepared by A. Lund.

1/

The countries in the sample are: the United States, the United Kingdom, Germany, Canada, and Japan. They are chosen mainly because of the availability of data, but they also have some important features in common with Switzerland such as large and open capital markets.

1/

The relatively high share of inward FDI in Switzerland—which would have been even higher if measured in percent of GDP—runs counter to the view that obstacles to imports and to the establishment of foreign firms impede direct investment in Switzerland. The lower share of loans in Switzerland than in the other European countries in the sample is also a bit surprising as Switzerland is considered to be an international banking center.

1/

Reflecting the high level of net assets, the low rate of return on both assets and liabilities in Switzerland tends—other things being equal—to reduce net investment income. Keeping in mind that the net investment position is about 100 percent of GDP, a 1 percentage point higher return on both assets and liabilities would have raised net investment income—and the CA surplus—by about 1 percent of GDP.

1/

In the U.S., which publish data on FDI both at current cost (book value) and market value, the latter exceeded the former by almost 40 percent in 1993.

2/

That the outward FDI of Swiss companies should be smaller than that of other countries contradicts the common impression of Switzerland as a country with large multinationals and corresponding large flows of foreign direct investments. But the observed shares are small only when measured as a share of gross flows and stocks of capital. In relation to GDP outward FDI is larger than in the other countries. However, to explain the return on Swiss external assets and liabilities it is the share of FDI in the stock of foreign assets and liabilities that is relevant, not its share in GDP.

1/

At the end of 1993 Swiss banks had foreign assets equal to Sw F 440 billion according to the banking statistics. (Fiduciary accounts are not included in this number.) At the same time, Swiss banks’ foreign assets amounted to 191 billion Swiss francs according to the Balance of Payments Statistics, implying that a significant part of lending took place through branches abroad.

2/

By the end of 1994 total balances in these funds equalled Sw F 270 billion or 74 percent of GDP. But only a very small portion of the total was in the form of liabilities of Swiss residents.

Switzerland: Selected Background Issues
Author: International Monetary Fund