2003 Article IV Consultation—Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Switzerland

This 2003 Article IV Consultation highlights that following a solid expansion in 1997–2000, economic growth in Switzerland is currently stalled as exports have been hurt by the global slowdown and domestic investment has undergone a sharp downward correction from earlier high levels. The important financial sector has been hit particularly hard, in part because of the steep declines in equity prices both in Switzerland and abroad. Unemployment has doubled, although it remains low by international standards. Inflation is negligible, and the external current account is running a large surplus.


This 2003 Article IV Consultation highlights that following a solid expansion in 1997–2000, economic growth in Switzerland is currently stalled as exports have been hurt by the global slowdown and domestic investment has undergone a sharp downward correction from earlier high levels. The important financial sector has been hit particularly hard, in part because of the steep declines in equity prices both in Switzerland and abroad. Unemployment has doubled, although it remains low by international standards. Inflation is negligible, and the external current account is running a large surplus.

I. Introduction

1. Switzerland has a high per capita GDP (and, given large net external assets, even higher per capita GNP) and an impressive record of low unemployment and inflation (Figure 1). However, trend real GDP growth is slow and when there are cyclical downswings, as at present, the economy flirts with recession. Current weakness is compounded by the collapse of global asset prices and related pressures on the important financial sector. More generally, while high income levels partly explain slow trend growth, Switzerland’s underlying growth performance also reflects distortions in domestic markets and a sluggish pace of product market liberalization (Box 1).

Figure 1.
Figure 1.

Main Indicators

(In percent)

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source: IMF, World Economic Outlook.

2. Against this background, the consultation discussions focused on:

  • How monetary policy should be conducted in an environment where interest rates and inflation are both close to zero and the output gap is still widening.

  • How the credibility of the balanced federal budget rule (the “debt brake”), which came into effect this year, might be preserved in the face of an unexpectedly large structural deficit.

  • How the financial sector is coping in the global downswing and the status of measures to further upgrade supervision, including those recommended under last year’s Financial Sector Assessment Program (FSAP).1

  • How to invigorate product market reform.

IMF Policy Recommendations and Implementation

In concluding recent Article IV consultations, IMF Executive Directors have generally supported Switzerland’s conduct of, and framework for, macroeconomic policies but have called for greater efforts to free up product markets. Particular focuses of attention have been the slow pace of addressing cartels, dismantling barriers across the internal market, and liberalizing network industries—areas where Switzerland lags behind many OECD countries. The authorities support reform, but under the federalist system and the need for referenda, have found it difficult to mobilize wider popular support. General elections in October 2003 present a further test for garnering support for reform this year.

II. Economic Background

3. Following a solid expansion by Swiss standards in 1997-2000, economic activity has stagnated. A brief and shallow recession in 2001 has given way to tepid growth at best (Figure 2).2 In early 2003, conjunctural indicators pointed to an economy that remained broadly stagnant with little sign from expectations surveys that recovery was at hand (Figure 3). Unemployment has increased sharply and IMF staff estimate that, at end-2002, output was about 2 percent below potential.3

Figure 2.
Figure 2.

Real GDP

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source: IMF, World Economic Outlook.
Figure 3.
Figure 3.

Leading Indicators

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: KOF database and SECO.

4. Although weak external demand can explain the bulk of the slowdown in activity, a collapse of investment also points to domestic causes (Table 1 and Figure 4). Weak external demand has been exacerbated by an appreciating Swiss franc (Figure 5). As to domestic demand, the decline in investment has gone beyond that in other industrial countries, suggesting excess capacity was built up during the late 1990s (Table 2). By contrast, consumption growth has remained steady throughout the downswing, notwithstanding wealth losses from tumbling equity prices (Figure 6).4

Table 1.

Contributions to Growth Deceleration

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Sources: SECO; and IMF staff calculations.

Net of the import content of exports, stock building, investment in machinery and equipment, and private consumption. The import content is estimated, respectively, at 55, 60, 85, and 14 percent.

Figure 4.
Figure 4.

Exports and Partner Imports

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: SECO; and IMF staff estimates.
Figure 5.
Figure 5.

Exchange Rates

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: IMF, International Financial Statistics; and staff estimates.
Table 2.

Selected Countries: Decline of Machinery and Equipment Investment 1/

(In percent)

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Sources: IMF staff calculations; SECO; Deutsche Bundesbank; EUROSTAT; INSEE; ESRI; and BEA.

In real terms since peak in 2000 or 2001 to present.

Figure 6.
Figure 6.

Share Prices

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: KOF database; and IMF, International Financial Statistics.

5. The financial sector has been hit particularly hard in the slowdown. The crunch in international financial markets has led to a drying up of fee-generating activities such as investment banking and wealth management, inflicting heavy losses and triggering consolidation in banks and insurance companies. After having accounted for about half of real GDP growth in the past decade, the financial sector is estimated to have contracted in the past two years.

6. Throughout the current business cycle, inflation has remained low. Underlying consumer price inflation has generally been below 1 percent since mid-2001 benefiting from the appreciating Swiss franc and, to a lesser extent, greater competition in some domestic markets. Low inflation has been underpinned by wage moderation. Wages are estimated to have increased by under 2 percent in 2002 and weak labor market conditions point to a smaller increase in the current wage round (Figure 7).

Figure 7.
Figure 7.

Percent of Firms Reporting Labor Shortages

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source: KOF database.

7. With actual and projected medium-term inflation within its 0-2 percent price stability range, the SNB has cut interest rates aggressively but exchange rate appreciation has tempered the easing of monetary conditions. Since March 2001, the SNB has lowered its benchmark interest rate by 325 basis points, to just ¼ percent, driving short-term interest rates further below euro area rates and pushing real short-term interest rates into negative territory (Figures 8-9). However, the monetary conditions index has declined substantially less owing to the appreciation of the franc (Figure 10). While some safe-haven effects are likely to have been at work, especially after September 11, 2001 and ahead of the war in Iraq, much of the appreciation since mid-2002 has reflected the general weakening of the US dollar against major currencies. Meanwhile, real borrowing costs have been held up by receding inflation expectations, a steepening yield curve and widening corporate spreads (Table 3). Although broad money has been expanding rapidly, domestic credit has declined slightly.

Figure 8.
Figure 8.

Policy Interest Rate

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: KOF database; and Bloomberg.
Figure 9.
Figure 9.

Real Interest Rates 1/

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: KOF database; and IMF staff estimates.1/ Actual rates minus 12-month change in CPI index.
Figure 10.
Figure 10.

Monetary Conditions Index 1/

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source: IMF staff estimates.1/ The wights of the interest rate and the detrended exchange rate are proportional to 3 to 1, respectively.2/ At that date, the economy was estimated to have been at potential.
Table 3.

Selected Countries: Yield Developments, December 2000-December 2002

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Sources: IMF staff calculations; SNB, Deutsche Bundesbank; Bloomberg; WEO; and The Economist.

8. Fiscal policy is broadly neutral. The general government structural deficit is small and a projected increase in the actual deficit (excluding privatization receipts) to 2.1 percent in 2003, from 1.2 percent of GDP in 2002, largely reflects the operation of the automatic stabilizers. At the federal level, following an unexpected shortfall of revenue toward the end of 2002, the deficit as defined under the debt brake is set to exceed SwF 3 billion (0.8 percent of GDP) this year. The debt brake would require a sharp correction in 2004.5 Gross public debt is around 55 percent of GDP. Increases in the debt ratio in recent years have mainly reflected capitalization of pension funds for public sector employees. Such capitalization is well-advanced, but some further injections are scheduled in the years ahead to bring them into actuarial balance.

9. The external current account surplus remains very large. After a dip in 2001 due to lower net investment earnings, the surplus rebounded to 12 percent of GDP last year as imports contracted along with the decline in investment. As discussed in previous staff reports, the lion’s share of the current account surplus appears to be structural and partly reflects a high national savings rate (Figures 11-12).

Figure 11.
Figure 11.

National Savings

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source: IMF, World Economic Outlook.
Figure 12.
Figure 12.


Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source: IMF, World Economic Outlook.

III. Report of the Discussions

A. The Economic Outlook

10. The authorities, private forecasters and staff have a similar take on the outlook. Conditional on a gradual pick up in world demand and resolution of global uncertainties, growth is projected to gather steam in the second half of 2003 on the back of strengthening exports and recovering investment. However, given the slow start, average growth would only be about ½ percent. Growth would firm to 1¾ percent in 2004, somewhat above potential.

11. Nonetheless, the projected recovery is subject to considerable uncertainty with external risks predominating. There are as yet no concrete pointers to an upturn and recovery hopes hinge primarily on a pick up in growth in Europe, where forecasts have been repeatedly downgraded. In this regard, Switzerland is not immune from the adverse impact on confidence of current geopolitical uncertainties and related risks of a safe-haven exchange rate appreciation—although with oil imports amounting to only about 1 percent of GDP, direct vulnerability to oil price gyrations is modest. That said, the authorities did not believe there were major domestic imbalances that would hold up recovery. They accepted that some over-investment may have taken place in the late 1990s, particularly in ICT. But the subsequent sharp contraction in investment would have corrected any overhang. Staff agreed, noting that corporate gearing is less high than in other European countries and the United States (Figure 13). Even so, given the uncertain external climate, it cautioned against expecting a strong rebound in investment.

Figure 13.
Figure 13.

Debt-Equity Ratios of Non-Financial Corporations

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: IMF staff estimates.

12. The inflation outlook is benign and a period of falling prices cannot be ruled out. With sluggish recovery, inflation is expected to stay below 1 percent in 2003-04. Staff and the authorities agreed that inflation risks are not symmetric. Staff analysis (see accompanying Selected Issues paper) suggests that a combination of delayed recovery and exchange rate appreciation could easily push inflation into negative territory. On the other hand, a more forceful recovery would still leave inflation short of the SNB’s 2 percent ceiling.

B. Monetary Policy

13. With economic activity stumbling and inflation risks negligible, the SNB saw the need to maintain an expansionary monetary policy stance for the foreseeable future. Even at prevailing low interest rate rates, the SNB projected inflation would remain within their 0-2 percent price stability range over the next three years, although it would be close to the ceiling by 2005. Staff supported the SNB maintaining a bias toward easing, particularly if upward pressures on the Swiss franc persisted. Subsequent to the mission, the SNB reduced interest rates further, essentially using up the last remaining room for cuts.

14. SNB officials were mindful of the risks of deflation even though they, and private sector analysts, believed them to be low. They did not view the possibility of a short period of falling prices as problematic. But given the proximity of the zero interest rate floor, they were well aware of the potential costs of a liquidity trap if deflationary expectations were to take hold. They stressed that, if necessary, they would not shy away from using unconventional monetary policy instruments. Of the possible instruments, unsterilized foreign exchange market intervention would be the most effective. They had clearly communicated to the market their intention to intervene if unwanted appreciation pressures persisted.

15. Staff welcomed the SNB’s readiness to act to head off deflation, but noted that the decision to intervene in foreign exchange markets might not be clear-cut, raising the risk of a delayed policy response. Staff pointed out that the likelihood of a short period of falling prices was significant, although it agreed that the risks of this leading to a deflationary spiral were low (Box 2). The SNB should thus keep interest rates close to zero for some time and should intervene to counter upward pressures on the Swiss franc. Even absent such pressures, the SNB might need to intervene if the expected recovery were further delayed. SNB officials acknowledged that they would be more reluctant to weaken the exchange rate for business cycle reasons, noting that the recent appreciation had merely brought the exchange rate back to its long-run trend (Figure 14). They would nonetheless continue to monitor economic developments and inflation prospects closely. Given that output losses could be substantial if deflationary expectations took hold, staff urged the SNB, if in doubt, to err on the side of being too loose rather than too tight.

Figure 14.
Figure 14.

Real Effective Exchange Rate

(CPI based)

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source: IMF, International Financial Statistics; and staff estimates.

Deflation Risks

Recent staff cross-country analysis puts the risk of deflation in Switzerland as moderate.1 Switzerland has never before entered a downturn with such low inflation, the stock market has shed 140 percent of GDP in market capitalization during the last two years, and, although the steep fall in investment indicates that capacity is adjusting, a similar fall in Japan in 1992-94 failed to forestall deflation. But while there is a risk of falling prices leading to ingrained deflationary expectations, several factors suggest that the risks of a deflationary spiral reinforced by impaired corporate and financial sector balance sheets are low: inflation at the current rate of around 1 percent, with about one third of prices declining, has been the norm in recent years; real estate prices have held up well; the financial system is adjusting rapidly to recent strains (see below); and the corporate sector does not appear to be overly leveraged.

1Deflation: Determinants, Risks, and Policy Response (IMF, 2003).

16. Within the monetary policy framework, staff saw a case for keeping inflation, on average, somewhat farther from zero than it has been over the past decade. Staff and market analysts concurred that the framework had allowed the SNB to respond flexibly to business cycle and exchange rate developments over the past three years and to communicate its policy intentions effectively. The SNB’s decision to start releasing in 2003 its medium-term inflation forecast on a quarterly basis—rather than every six-months—would further enhance policy transparency. Nonetheless, staff argued that with trend inflation close to zero—it averaged only 0.9 percent a year in 1993-2002—the SNB might too often in downturns find itself faced with the need to make difficult judgment calls on the use of unconventional monetary policy instruments.6 Staff thus recommended that policy be designed to keep medium-term inflation close to the top of the 0-2 percent stability range. For their part, SNB officials considered that it would be difficult to fine tune the average level of inflation over the cycle and be confident of maintaining price stability given the lags and noise in the transmission mechanism. They doubted that pursuing a specific inflation target would have led to different decisions on interest rates in the past two years, noting that they had pursued an aggressive policy of easing.

C. Fiscal Policy

17. It was agreed that the overall public finances were generally in good shape, strains in the federal budget notwithstanding. Even without incorporating proposals to scale back spending plans, projected deficits in coming years have a large cyclical component and would be consistent with a broadly stable debt ratio (Table 4). In the long run, Switzerland is much better prepared to deal with the fiscal challenges of aging than most other European countries as it relies heavily on fully-funded pensions, including for public sector workers, with assets exceeding GDP. The authorities underscored that, since the rapid build-up of public debt during the prolonged economic slump of the first half of the 1990s, federal expenditure growth had been successfully reined in. Indeed, growth of federal expenditure was roughly in line with that of nominal GDP in 1996-2002, having outstripped it by 2 percentage points in 1988-1995. Nonetheless, staff estimates suggest that, while public debt sustainability concerns are low, the debt ratio could rise significantly in the next few years if the economy again entered a protracted slump and nominal expenditure growth were not scaled back.7

Table 4.

Staff Fiscal Projections 1/

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Sources: Federal Ministry of Finance; and IMF staff calculations.

Medium-term expenditure based on current financial plan, i.e., excludes savings measures under discussion.

Excluding privatization proceeds.

Smooths erratic revenue items (withholding tax and stamp duties).

Excluding privatization proceeds but including expenditure for large infrastructure projects.

Includes large one-time privatization revenue (0.9 percent of GDP) in 2002; excludes expenditure for large infrastructure projects.

Based on the HP filter.

18. Much of the discussion focused on how to bring the federal finances into compliance with the debt brake. The authorities had deemed the federal budget to be in structural balance when they decided in 2002 to implement the debt brake from 2003. But with hindsight, it had been in structural deficit as the revenue shortfalls of 2002 proved largely permanent not cyclical. In conjunction with already-approved income tax cuts for 2005 (0.3 percent of GDP), the deficit would inch up to over 1 percent of GDP in the medium term. If applied rigidly, the debt brake would force elimination of the entire structural deficit in the 2004 budget This would be neither feasible nor desirable. With the economy not in a severe recession, the authorities did not intend to invoke exceptional circumstances as a way round the debt brake strictures. Instead, they viewed as more transparent a process that, in recognizing the different starting position, modified the debt brake law and set out a clear path for bringing the federal finances into compliance with the debt brake. To this end, the government had proposed a three-step approach: (i) a savings package of 0.5 percent of GDP phased in over 2004 and 2005; (ii) postponement of the 2005 tax cuts; and (iii) tax increases if needed. Since the discussions, postponement of the tax cuts has failed in parliament and the government has asked the Ministry of Finance to propose compensating savings and tax measures. The government has also called for a related change in the debt brake legislation.

19. Staff agreed that the debt brake had to be implemented in a pragmatic way. Its own analysis confirmed that the recent revenue shortfalls had largely reversed an unsustainable increase in the revenue ratio in the boom years of the late 1990s and hence the unexpected deficit was largely structural (Figure 15). Full correction in 2004 would require measures of more than ½ percent of GDP. While the macroeconomic fall-out would register, especially if cuts in co-financed programs were amplified by cuts at the cantonal level, the main concern was the quality of federal spending. With primary federal expenditure accounting for less than 10 percent of GDP, the required cuts could be disruptive to public services. In these circumstances, and given available choices, staff acknowledged that seeking a transparent modification of the debt brake legislation was the preferable course of action. However, to avoid undermining credibility, it would be essential to establish a clear time line for eliminating the deficit, backed up by realistic and binding measures. In this context, staff emphasized that restraint in seeking supplementary budget allocations in 2003 and considerably scaling back the medium-term expenditure path would be important down payments. However, it was hard to see how tax hikes could be avoided: staff calculations, for example, suggest that the consolidation effort would otherwise require a three-year nominal spending freeze.

Figure 15.
Figure 15.

Main Federal Tax Revenues 1/

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Sources: Federal Ministry of Finance; and Fund staff calculations.1/Federal direct tax, VAT (formerly turnover tax), withholding tax, and stamp duties.

20. The debt brake mechanism could also benefit from technical refinements. Under the authorities’ current procedures, the responsiveness of deficit ceilings to the business cycle is overly muted, suggesting that a coordinated review of short-term revenue elasticities and the parameters used to detrend GDP is warranted. In addition, large fluctuations of erratic revenue items might require a rethink of whether the room for accommodating transitory deficit overruns is sufficient. Staff welcomed the government’s decision to exclude federal lending and repayment operations with the unemployment fund for debt brake purposes, thus eliminating one potential source of procylicality.

D. Financial System

21. The supervisors and market participants acknowledged that the past year had been a difficult one for the financial sector but noted that recent strains had triggered rapid adjustment and capital cushions remained intact. With the weakening of financial markets over the past two years, banks have suffered from a sharp drop in profits largely due to a fall in fee income. The two large international banks have been particularly affected—their combined profits declined from 4.8 percent of GDP in 2000 to -0.5 percent of GDP in 2002—owing to their relatively greater reliance on fee income, litigation costs in the United States and, in the case of one bank, spillovers from the poor performance of its insurance subsidiary. Private banks had also come under pressure from increasing competition in a shrinking market for asset management services. While some further worsening was expected, especially if the economic environment remained weak, supervisors noted that domestic banking had performed solidly, credit quality had not deteriorated significantly and overall capitalization remained comfortable (Table 5 and Figure 16). Moreover, banks had been quick to start consolidating, cutting costs, and strengthening management structures. Meanwhile, EU pressure to loosen Swiss bank secrecy to help prevent EU citizens from evading capital income taxes had receded. The issue appears to be moving toward a solution whereby Switzerland will impose and remit to the EU a withholding tax on EU residents’ interest earnings.

Table 5.

Indicators of External and Financial Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources; Swiss National Bank; Swiss Federal Banking Commission; IMF, International Financial Statistics; and IMF, World Economic Outlook.

Preliminary estimates.

Excluding foreign direct investment.

End-period data.

Figure 16.
Figure 16.

Selected Industrial Countries: Tier 1 Capital in 2001

Citation: IMF Staff Country Reports 2003, 148; 10.5089/9781451807202.002.A001

Source; OECD, Bank Profitability.

22. The insurance and pension sectors were under considerable strain from depressed equity prices, low returns on assets, and high claims (Box 3). Nonetheless, supervisors had not relaxed solvency requirements, insisting instead on recapitalization and consolidation. Asset sales had considerably reduced the equity allocation in pension fund and insurance company portfolios—which in the case of insurances, had been only 15 percent of their portfolio at end-2001 compared to 40 percent in the UK. To ease balance sheet pressures, the government had reduced the minimum interest rate on pensioners’ assets from 4 percent to 3¼ percent.

Underfunding of Pension Funds

In the 1990s, second pillar pension funds invested increasingly large sums in equities. They hoped to exploit a high equity risk premium and to compensate for the drop in bond yields below the (then) 4 percent statutory minimum return and for a fall in the actuarial value of the conversion rate below the minimum 7.2 percent. By the end of 2000, second pillar funds had an average equity allocation of 32 percent—although this was still considerably less than the allocation for US (60 percent) and UK (70 percent) funds.

With the equity price crash, funds have shifted back to bonds but in the process have realized large capital losses. According to one estimate, their average funding level declined from 123 percent in 1999 to 105 percent in June 2002. Other estimates show that already by end-2001, 6 percent of pension funds (including public sector funds) covering almost 20 percent of the insured, were underfunded, with a shortfall equivalent to 3 percent of GDP.1 The shortfall doubtless increased substantially in 2002. Shortfalls affect life insurance companies that manage such funds, the budget (in the case of public sector employees) and, to the extent that shortfalls are to be covered by employers, corporate earnings.

1Bericht des Eidgenössischen Departmentes des Innern über die finanzielle Situation der Vorsorgeeinrichtungen und der Lebensversicherer, Bern, November 2002. Half of the estimated shortfall carried public guarantees.

23. Staff cautioned that the period ahead would remain a testing one for the financial sector, underscoring the call in last year’s FSAP for heightened vigilance from supervisors. There was as yet no sign that strains in global financial markets were dissipating and competition in banking services was likely to intensify. In this environment, less tangible and predictable risks, such as reputational risks, needed to be guarded against. Staff agreed that the difficulties in the pension and insurance sectors did not appear to constitute a systemic vulnerability for the financial system as, with one main exception, the sectors’ links to the banking system were not strong.8 Even so, it was incumbent on supervisors to ensure that corrective actions take place in a timely, orderly and transparent fashion. In this context, more up-to-date information was essential—the time lag for comprehensive data being currently up to two years. Staff also strongly supported a further reduction in the minimum interest rate on pensioners’ assets given that it still exceeds the yield on government bonds.

24. Supervision is continuing to adapt to the changing environment. The Federal Banking Commission (EBK) has set up a unit for reviewing the performance of external auditors and introduced the practice of second examinations, to be performed periodically by independent third parties. Meanwhile, a draft law for creating an integrated financial sector supervisory authority is expected to be submitted to parliament by mid-2003. The law would provide for full budgetary and operational independence of the new entity, which initially would combine the operations of EBK and the Federal Office of Private Insurance. In this connection, a complete revision of the Insurance Supervision Law was also under way. Finally, a draft revised law on bank rehabilitation, liquidation and deposit insurance had been submitted to parliament. Staff welcomed these initiatives, which were in line with recommendations in last year’s FSAP report, although noted that the strengthening of pension fund supervision needed to be accelerated.

25. The authorities are further strengthening anti-money laundering (AML) and the regime for combating the financing of terrorism (CFT). Effective July 2003, a revised Money Laundering Ordinance covering the banking sector will extend the application of AML instruments to the prevention of the financing of terrorism and require the systematic recording and computerized monitoring of all high-risk transactions. Also in July, a new Due Diligence Agreement will strengthen the procedures of customer identification. A bill for the ratification of the UN conventions on the financing of terrorism, and related amendments to the Swiss Penal Code, are with parliament and could enter into force in 2003.

E. Structural Policies

26. With the financial sector likely to continue consolidating for some time, other sectors will have to contribute more to growth if the recovery is to be robust and sustained. Absent higher productivity growth, the authorities agreed that potential growth would likely stay in the 1-l½ percent range for the next few years. Raising productivity growth would require removing market inefficiencies.9 A poorly functioning internal market and the prevalence of sheltered sectors—agriculture, construction, and many services—not only hamper growth in the affected sectors but also keep prices and business costs high across the entire economy. This undermines the many attractive features that Switzerland offers to investors, not least a flexible labor market with well-educated workers. Meanwhile, external competitiveness does not seem to be a problem, notwithstanding adjustment strains inflicted by the recent appreciation of the Swiss franc. In the past twenty years, trend real appreciation has not held back a dynamic export sector and the current account surplus is projected to remain around 11 percent of GDP in the medium term. The solution for high domestic prices was product market reform, which has lagged that in other countries, not depreciation.

27. While all could agree on the diagnosis and need for product market reform, the harder question was how to move forward. The authorities considered that Switzerland’s rejection of participation in the European Economic Area (EEA) in 1992 had been a blow to liberalization efforts as the EEA would have simultaneously provided access to EU markets and forced open Switzerland’s internal market. Bilateral agreements with the EU—seven such agreements came into effect in 2002 and nine more were being negotiated—could eventually substitute for the former but the Internal Market Act had not addressed the latter satisfactorily. Joining the EU remained a long-term government objective, but currently commanded little public support. In the meantime, the authorities had been trying to advance reform on several fronts. However, the political economy environment was not propitious given the difficulties of mustering popular support in Switzerland’s decentralized system of direct democracy.

28. The authorities’ current reform priorities include strengthening competition and the fight against cartels. After some delay, a revised competition law was approved by parliament in March 2003 and is expected to enter into force in early 2004. The new law empowers the regulators to impose sizable fines and extends to first-time offenders and vertical agreements. Nonetheless, breaking up cartels would remain a challenge given the premise in Swiss competition law, unlike in other countries, that restrictions on competition are illegal only if they are not justified by legitimate business reasons. Preparations were also at a relatively advanced stage for revisions to the Internal Market Act and the Public Procurement Act. However, part of the ineffectiveness of the current Internal Market Act stems from the Federal Court’s tendency to support cantonal rights rather than free market access; this would be difficult to change. Finally, reviving deregulation in network services was seen as an uphill task. Notwithstanding the visible benefits of lower prices that had followed from liberalizing telecommunication, liberalization of the electricity sector had failed in a referendum last fall. Highly publicized corporate scandals at home and abroad had contributed to a lack of trust in market solutions.

29. Staff welcomed the efforts to improve competition and suggested that a more systematic sectoral approach might help build consensus for further change. Focusing on the reasons for high prices in particular sectors and the benefits to consumers from removing obstacles to competition might help tip the balance in favor of reform. At the same time, the loss of trust in markets associated with corporate scandals should be addressed by building on recent private initiatives that have established codes of conduct for disclosure requirements and guidelines for good corporate governance. Maximum efforts should also be made to leverage the bilateral agreements with the EU to bring product market practices and the pace of deregulation more into line with the rest of Europe. The authorities explained that it was their intention to adopt a more systematic sectoral approach. As a first step, the Ministry of Economy had prepared a comprehensive report on the reasons for slow growth in Switzerland.10 On corporate governance, a high-level group had been set up to look into current practices and the need for amendments and codification in the law. A review of the Federal Accounting and Auditing Act had also been initiated.

30. Labor market policies are aimed at further easing supply constraints. A shortening of the duration of unemployment benefits and lower contribution rates should help to sustain Switzerland’s low structural unemployment rate. The coming into force in June 2002 of the bilateral agreement with the EU on free labor mobility should help alleviate shortages of skilled labor, which in the last upswing had become a drag on growth. The launching of a pilot program for the expansion of daycare centers and a proposal for maternity benefits could help raise the already-high female participation rate. Finally, a budgetary priority was to raise allocations for education and research.

F. Other Issues

31. Switzerland has a relatively open trade regime, with the exception of agriculture.11 The average tariff on farm products is 34 percent (nearly four times the Swiss average), and some import duties are almost 700 percent. This is coupled with a system of producer support that is the highest among OECD countries, amounting to three fourths of gross farm receipts according to WTO estimates. Although price support is being dismantled and replaced by direct payments, staff noted that it would take years on current plans before protection of agriculture dropped to even the high level of the EU. The authorities support the Doha Trade Round and are committed to the progressive opening of services on a multilateral basis. Switzerland reduced custom duties on imports from the least developed countries by 30 percent in 2002. It plans to reduce them by another 30 percent in 2004 and to eliminate the remainder in 2006.

32. The authorities reaffirmed their intention to raise official development assistance from 0.35 to 0.4 percent of GNP by 2010. Swiss ODA policy has been favorably reviewed by the DAC for its effectiveness and its focus on poor countries. Staff expressed the hope that some trimming of ODA in the current budget would prove only a temporary setback.

33. Swiss legislation conforms to the OECD Convention on anti-bribery, except in respect of liability of legal entities for bribery. However, the requisite amendment to the Criminal Code was adopted by parliament in December 2002 and is expected to come into force in 2003.

34. Despite continuing improvement, deficiencies in the availability and quality of economic statistics remain (Appendix III). The authorities explained that the annual national accounts would be overhauled this year, but noted that budgetary constraints impeded more determined efforts to improve the quality and coverage of statistics.

IV. Staff Appraisal

35. Switzerland is well-equipped to deal with the current economic slowdown. The export sector has proved its resilience over the years despite an appreciating exchange rate. Labor markets are highly flexible. A stability-oriented policy framework has delivered low inflation. And the fiscal accounts are generally in good shape with a high reliance on fully-funded pensions lessening the longer-run strains from an aging population.

36. That said, insufficient competition in domestic sectors raises questions about the vigor of expected economic recovery. For the short term, recovery is to a large extent hostage to the external environment: a firming of growth in the second half of the year is projected, but global uncertainties are significant. But regardless of the timing of recovery, it is hard to see Switzerland moving to a higher underlying growth rate, especially if the key financial sector remains depressed. That is because barriers to the internal market and the prevalence of cartels and sheltered sectors dampen the vitality of the economy.

37. Structural reforms aimed at further liberalizing and creating competition in domestic product markets remain the priority if growth in the current decade is to improve on that of the 1990s. This is not a new issue: the challenge, as always, is to build popular support for reforms. In this regard, a more systematic, sectoral approach that identifies the reasons for, and costs of, high prices in Switzerland might prove more convincing.

38. The current macroeconomic policy stance is appropriately supportive. The absence of inflationary pressures has allowed the SNB to reduce interest rates to practically zero—and rates can safely remain low for the foreseeable future. From the fiscal side, the automatic stabilizers are providing appropriate support to demand.

39. However, near zero interest rates and inflation pose challenges for the SNB, which rightly wants to avoid inflation falling into negative territory. The SNB has responded promptly and boldly to evolving economic conditions. With conventional policy options now exhausted, further upward pressures on the Swiss franc that led to an unwanted tightening of monetary conditions should be countered by unsterilized intervention. But absent a clear signal from the foreign exchange market, the SNB could be faced with a more difficult choice of when to use unconventional monetary policy instruments if the economy continues to stall. Given the potentially high costs of deflation, the SNB should, in these circumstances, err on the side of being too loose rather than too tight. To avoid being confronted with difficult choices in the future, it would be better to allow average inflation to be closer to the top end of the current 0-2 percent stability range.

40. The unexpected federal deficit is the main problem for fiscal policymakers. The overall fiscal position appears sound but the federal deficit threatens the credibility of the new debt brake. Preserving credibility will require a degree of pragmatism. Given the small base of spending that the federal government controls directly, front-loading adjustment in 2004 seems neither feasible nor desirable. The authorities’ plan to modify the debt brake law to provide a transition period for eliminating the unexpected structural deficit appears to be a practical and transparent way forward—assuming that a clear time line is specified. However, it is equally important that sufficient, realistic and binding consolidation measures—including, probably, tax increases—are agreed upon. The debt brake rule might also benefit from technical modifications that would enhance its cyclical flexibility while preserving fiscal discipline over the medium term.

41. The current environment is likely to remain difficult for the financial sector, which could face a protracted period of consolidation. Banks are making considerable adjustments and supervision is continuing to adapt to the changing environment. In this context, fast enactment of a revised law on bank rehabilitation, liquidation, and deposit insurance, as well as plans to integrate banking and insurance supervision are encouraged, along with increased resources for the supervisory authorities who need to continue their ongoing efforts to strengthen oversight of external auditors. Prospective new anti-money laundering ordinances should provide an additional reputational safeguard for Switzerland’s financial sector.

42. Strains in the pension and insurance sectors raise important public policy questions. The reduction in the minimum interest rate on pensioners assets to 3¼ percent was an important step, but with government bond yields substantially lower than this, a further reduction seems necessary. From the supervisory perspective, closer oversight of pension schemes is needed to ensure that interventions remain timely and pensioners are protected.

43. The authorities are encouraged to bring forward their 2010 target for raising official development assistance to 0.4 percent of GNP. Development assistance will benefit from the authorities’ initiative to eliminate all trade barriers for imports from poor nations. Committing to a faster pace of dismantling high trade protection and subsidization of agriculture would also help poor countries as well as benefiting Swiss consumers.

44. Further efforts are needed to improve economic statistics. Although some progress has been made and statistics are adequate for surveillance purposes, weaknesses in national accounts, flow of funds, government finance, social insurance statistics and other areas continue to hamper the analysis carried out by both policymakers and the private sector.

45. It is recommended that the next Article IV consultation with Switzerland be held on the standard twelve-month cycle.

Appendix I: Switzerland: Basic Data

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Fund staff estimates and projections unless otherwise noted.

Change as percent of previous year’s GDP.

Nominal wage growth per employee

Including railway loans as expenditure.

Excluding privatization proceeds; smooths en atic revenue items.

Excludes transfers to the railway fund.

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Sources: IMF, World Economic Outlook database; Swiss National Bank; and Swiss Institute for Business Cycle Research.

Fund staff estimates and projections unless otherwise noted.

Based on relative consumer prices.

APPENDIX II: Switzerland: Fund Relations

(As of March31,2003)

I. Membership Status: Joined 5/29/92; Switzerland has accepted the obligations of Article VIII, Sections 2, 3 and 4.

II General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Projected Obligations to Fund: None

VII. Exchange Rate Arrangement:

The Swiss National Bank does not maintain margins in respect of exchange transactions. However, the Swiss National Bank has intervened when warranted by the circumstances. Switzerland’s exchange system is free of restrictions on the making of payments and transfers for current international transactions. However, Switzerland continues to apply exchange restrictions vis-à-vis Iraq (since August 1990).

VIII. Article IV Consultations:

Switzerland is on the standard 12-month Article IV consultation cycle.

IX. Technical Assistance: None

X. Resident Representatives: None

XI. Other FSAP, October 2001

APPENDIX III: Switzerland: Statistical Issues

Switzerland publishes timely economic statistics and posts most of the data and the underlying documentation on the internet. Switzerland is in full compliance with the Fund’s Special Data Dissemination Standard (SDDS) and its metadata are currently posted on the Dissemination Standards Bulletin Board. However, a number of statistical gaps and deficiencies remain to be addressed: wage statistics are available only on an annual basis; reliable general government finance statistics appear with considerable lags, mainly due to delays in compiling fiscal accounts at the level of cantons and communes; internationally comparable fiscal statistics on an accrual basis are not available; pension statistics are published with a long lag; the quarterly national accounts (compiled by the State Secretariat for Economic Affairs) lack-a production account; national accounts are still based on ESA79; GDP by industry appears with considerable lag; capital stock data and flow-of-funds statistics are not available. To a large extent, these deficiencies reflect a lack of resources and the limited authority of the Federal Statistical Office (BfS) to request information.

To address statistical deficiencies, the authorities have recently taken or intend to take the following steps:

The Swiss National Bank (SNB) has shortened from nine to six months the lag of publishing annual data on the international investment position and plans to publish, starting from 2003, quarterly foreign debt statistics. The SNB participated in the 2001 Coordinated Portfolio Investment Survey.

The BfS will switch in 2003 to the European System of Accounts 1995 (ESA95). In this connection, the BfS has reviewed the methodology of calculating value added in the financial services sector as well as the corresponding deflators and has been working (jointly with the SNB) on the methodology for compiling financial accounts and capital stock data (both for physical and financial capital). The BfS has also been negotiating a cooperation agreement with the European Union (EU) for the harmonization of Swiss statistics with EU standards.

The Federal Finance Administration has started preparations for the adoption of the Government Finance Statistics Manual 2001 classification and the revamping of the accounting framework, although implementation of the new framework is not expected before 2006. In the interim period, government finance statistics for publication in the GFS Yearbook will be reported on a cash basis but presented in the GFSM 2001 framework.

Switzerland: Core Statistical Indicators as of April 4, 2003

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BFS = Federal Statistical OfficeSNB = Swiss National BankKOF = Swiss Institute for Business Cycle ResearchMoF = Federal Ministry of FinanceBFK = Federal Office for Economic Policy

See Switzerland: Financial System Stability Assessment, IMF Country Report No. 02/108 (June 2002).


The quarterly GDP estimates are based on a limited set of indicators and are not fully integrated into the system of national accounts. Some indicators suggest that the pattern of growth was flatter during 2002.


The output gap estimate is subject to considerable uncertainty, not least because an elastic pool of foreign workers makes it difficult to gauge potential labor supply. Uncertainty has increased with the activation of free labor mobility with the EU as from June 2002.


At end 2002, households’ direct holdings of securities were estimated at SwF 450 billion (at par with GDP), having declined by one quarter in the previous two years. Modest house price rises and a pension system that shields households from stock market volatility would have attenuated wealth effects.


The debt brake requires the federal accounts to be in balance after adjustment for the economic cycle. Expenditure is set equal to projected revenue scaled up by the ratio of trend-to-actual GDP. Unanticipated deficits must be reversed in the following years. The debt brake rules can be over-ridden in exceptional circumstances if supported by a majority of members in both chambers of parliament. See Switzerland: Selected Issues, IMF Country Report No. 01/75 (May 2001) for more analysis.


The accompanying Selected Issues paper discusses the challenges for monetary policy in a low inflation, low interest rate environment.


For example, under relatively extreme assumptions of no growth in nominal GDP and unemployment rising to 6 percent in 2003-06, the debt ratio would increase from 55 percent of GDP in 2002 to 60 percent of GDP in 2006 if planned real expenditure growth were maintained. Large net foreign assets imply that external debt sustainability is not an issue.


At end-2001, banks’ exposure to domestic insurance companies and pension funds amounted to only 0.3 percent of bank’s total assets.


See Switzerland: Selected Issues, IMF Country Report No. 02/107 (June 2002).


Der Wachstumsbericht, SECO, 2002.


Switzerland’s rating on the IMF’s 1-10 scale of trade restrictiveness index is 4 (1 being the least restrictive), similar to that of most industrial countries.

Switzerland: 2003 Article IV Consultation—Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Switzerland
Author: International Monetary Fund