Switzerland
2006 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Switzerland

Switzerland showed commendable economic growth with low inflation and increasing employment. Executive Directors commended the prudent macroeconomic management, sound monetary and fiscal policy frameworks, structural reforms, and flexible labor markets. They noted that the monetary policy framework continues to serve Switzerland well, underpinned by effective practices of the Swiss National Bank (SNB). They agreed that the Swiss financial system appears to be healthy and dynamic, and appreciated the regulatory and supervisory framework, and the vigilance in monitoring financial sector risks.

Abstract

Switzerland showed commendable economic growth with low inflation and increasing employment. Executive Directors commended the prudent macroeconomic management, sound monetary and fiscal policy frameworks, structural reforms, and flexible labor markets. They noted that the monetary policy framework continues to serve Switzerland well, underpinned by effective practices of the Swiss National Bank (SNB). They agreed that the Swiss financial system appears to be healthy and dynamic, and appreciated the regulatory and supervisory framework, and the vigilance in monitoring financial sector risks.

I. Introduction

1. Following a period of mixed performance, the Swiss economy is now picking up. An educated labor force and business friendly environment support high per-capita incomes, skillful monetary management delivers low inflation, and flexible labor markets keep unemployment subdued. However, a slow pace of structural reforms has kept productivity growth low among industrial countries, and some sheltered sectors contribute to a high domestic price level. As a result, Switzerland’s relative economic position declined in the past 15 years, with growth averaging only 0.9 percent a year and the public debt ratio rising steadily (Figure 1, (Table 1). Nevertheless, the economic cycle is now picking up with strong global growth, a disciplined policy framework, and the onset of some reforms.

Figure 1.
Figure 1.

Main Economic Indicators in International Perspective

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: IFS; OECD; and WEO.
Table 1.

Switzerland: Basic Data

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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.

Change as percent of previous year’s GDP.

Including railway loans as expenditure. In 2005 excludes revenue from gold sales equal to 4.6 percent of GDP.

Excluding privatization proceeds and gold sales; smooths erratic revenue items.

Based on relative consumer prices.

2. The main policy challenges are of a medium-term nature, reflecting moderating potential growth and fiscal pressures from aging. Driven by demographics, the authorities and the staff project potential output growth to drop below 1 percent a year in ten years. Without measures, the primary fiscal deficit could rise to 5 percent of GDP by 2030 (IMF Country Report/05/190), highlighting the interaction of subdued growth and higher entitlement costs.

uA01fig01

Output growth is projected to decline.

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: BFS and IMF staff projections.

II. Recent Developments

3. The slowdown that followed the burst of the equity bubble has come to an end. On the supply side, the financial sector was particularly affected and made a negative contribution to growth of 1.8 percentage points of GDP (cumulative) during 2001–04. However, reduced policy interest rates supported a revival in residential construction, the telecommunications sector benefited from liberalization, and spending on health care services continued its upward trend. From a demand perspective, the stagnation in 2001–04 was driven by the weakening of external demand and a protracted slowing of equipment spending. More recently, the economic rebound in 2005 was supported by exports and an accommodative monetary policy. Private consumption gained pace as unemployment stabilized, and concerns about the soundness of the second pillar pension system subsided.1 Housing investment benefited from low interest rates and a demand shift to owner-occupied apartments. In turn, exports were supported by strong external demand and some weakening of the Swiss franc. 2 GDP grew by 1.8 percent in 2005, narrowing the output gap to -½ percent (Figure 2).

Figure 2.
Figure 2.

Switzerland: The Recovery is Underway 1/

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Source: SECO; and IMF, World Economic Outlook.1/ Seasonally adjusted annualized growth rates in percent, unless otherwise indicated.2/ Year-on-year percent change of goods and non-factor services.3/ 4-quarter moving average of annualized growth rates in percent.
uA01fig02

Cyclical evolution of components of aggregate supply and demand.

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Switzerland: Aggregate Demand

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Sources: SECO and IMF staff calculations

Contribution to growth. Includes also statistical discrepancy.

4. The financial sector accounted for almost half the growth rebound in 2005. It benefited strongly from the recovery in global equities and expanded funds under management. The EU Savings Directive went into effect with a 15 percent withholding tax on interest income, but did not affect significantly savings intermediation (partly because investors moved to non-interest bearing instruments).

5. Job creation and unemployment responded with some delay. The labor market normally lags economic activity (generating productivity gains first), but the reaction was also somewhat tentative relative to earlier recoveries. With enterprises still cautious, part-time jobs expanded faster than full-time employment (Figure 3). Foreign employment from EU countries expanded, including with the entry of high-skilled workers from Germany. In early 2006, unemployment (s.a.) eased to 3.5 percent and vacancies increased.

Figure 3.
Figure 3.

Switzerland: The Labor Market

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: IMF, World Economic Outlook; and KOF Institute.1/ Percentage points.

6. Inflation is low. CPI inflation averaged 1.2 percent in 2005 and early 2006—within the SNB’s definition of price stability (0–2 percent)—and core inflation was 0.5 percent. Low inflation has benefited from declining nonoil import prices (including from China and India); increased competition in domestic goods and services markets (in telecommunications, and with lower retail prices following the entry of foreign retailers); higher productivity growth; and moderate wage developments (including with the relaxation of restrictions on employment of EU workers) (Figure 4). Nominal wages increased by 1.4 percent in 2005 and are projected to rise by 1.6 percent in 2006, at par with labor productivity growth.

Figure 4.
Figure 4.

Switzerland: Inflation is Low

(12-month percent change)

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Source: KOF database.

7. As growth picked up, the SNB resumed raising interest rates. The SNB increased the 3-month policy rate to 1 percent and 1.25 percent in December 2005 and March 2006, respectively. Still, interest rates remained below their historic averages and short-term rates are slightly negative in real terms (Figure 5). Long-term interest rates continued to decline, flattening the yield curve. The slight weakening of the franc also eased monetary conditions somewhat. Money and credit growth remained strong (Figure 6) while equity prices rose to approach their peak of end- 2000. Real estate prices rose moderately, with the exception of owner-occupied apartments whose prices rose sharply, driven by demographics and shifts toward smaller families (Figure 7).

Figure 5.
Figure 5.

Switzerland: Monetary Conditions Remain Supportive

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: KOF database; Bloomberg; International Financial Statistics; and IMF staff estimates.1/ Actual rates minus 12-month change in CPI index.
Figure 6.
Figure 6.

Switzerland: Money and Credit Aggregates Have been Growing Robustly

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Source: IMF, World Economic Outlook; and KOF Institute.
Figure 7.
Figure 7.

Switzerland: Asset Prices

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: KOF database; BIS; Bloomberg; and IMF, International Financial Statistics; and IMF staff estimates.
uA01fig04

Overall house price increases in Switzerland have been moderate.

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

8. The fiscal impulse was neutral in 2005. Disciplined budgetary operations, with successful implementation of the debt brake, and tax buoyancy lowered the federal government deficit below budget. Subnational governments also consolidated, benefiting from stronger than expected growth. A surge in investment income reduced the social security deficit, but its structural deficit still deteriorated. Overall, the general government deficit halved to 0.6 percent of GDP but the structural deficit remained unchanged (Tables 2 and 3). General government gross debt eased to 52 percent of GDP (when deducting the proceeds from the SNB gold sales, 4.6 percent of GDP, it dropped below 50 percent).

Table 2.

Switzerland: General Government Finances

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

Excludes VAT increase planned for 2008, since it has not yet been approved.

Excludes SNB gold sales transfers of SwF 21 billion, 4.6 percent of GDP, in 2005.

Includes the balance of the Confederation, Railway Infrastructure Financing Fund, and Swiss Federal Institute of Technology.

Excludes revenues from Swisscom share sale (2002: SwF 3,703 million, 2005: SwF 1350 million).

2004 total expenditures exclude policy reserves of the ETH, Swiss Post, Skyguide (SwF 1,071 million) and capital injection to Skyguide (SwF 50 million).

Includes old age pensions (AHV), disability insurance (IV), unemployment insurance (ALV), and loss of earnings insurance (EO). Excludes subsidies for health care premia (KV), which are included in the federal budget.

Structural balance excludes cyclical and one-off items.

Table 3.

Switzerland: Federal Government Finances 1/

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

Includes the balance of the Confederation, Railway Infrastructure Financing Fund, and Swiss Federal Institute of Technology.

Excludes VAT increase planned for 2008, since it has not yet been approved.

Excludes SNB gold sales transfers of SwF 21 billion, 4.6 percent of GDP, in 2005.

Exclude revenues from Swisscom share sale (2002: SwF 3,703 million, 2005: SwF 1350 million).

2004 total expenditures exclude policy reserves of the ETH, Swiss Post, Skyguide (SwF 1,071 million) and capital injection to Skyguide (SwF 50 million).

Excludes cyclical and one-off items.

Table 4.

Switzerland: Balance of Payments

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Sources: IMF, World Economic Outlook database; and Swiss National Bank.

Fund staff estimates and projections unless otherwise noted.

Fund Recommendations and Implementation

The authorities tend to pursue prudent monetary, fiscal, and financial sector policies that have been well aligned with Fund advice. They have found it more difficult to implement structural reforms. With the high standard of living and absence of pressing difficulties, the status-quo bias is strong. Moreover, political power is diffused across the highly autonomous levels of government and referenda on reforms are frequent.

The authorities value the Fund surveillance, but also suggested new means to get the message to the public, such as publishing the Concluding Statement in German and French and, perhaps, preparing an op-ed article for the main newspapers.

Monetary policy: Focuses on price stability. The Fund has praised the monetary framework for its design, transparency, and the SNB for it skillful implementation.

Fiscal policy: The Fund has supported the authorities’ efforts to phase out the federal deficit mainly through expenditure restraint. It has underscored the risks of unfunded future entitlement costs for long-term fiscal sustainability and has encouraged the publication of fiscal sustainability reports. Expenditure adjustment plans have been enacted and implemented; the authorities are now preparing a long-run fiscal sustainability report; and are developing innovative proposals to tackle aging costs.

Financial sector: In line with recommendations of the 2002 FSAP, the authorities have enhanced their surveillance of the financial system and strengthened the supervision and regulation of insurance. A focused FSAP update is planned for November 2006.

Structural and trade policies: A recurring theme in the consultations has been the need to strengthen domestic competition through opening up sheltered sectors, dismantling barriers across the internal market, and further liberalizing network industries and agricultural trade. The government’s 17-point growth agenda (2004) contains valuable steps, some of which have begun to be implemented, but the unfinished reform agenda remains large. Progress in liberalizing agricultural trade remains slow.

III. Report On The Discussions

9. With the economy rebounding and effective policy frameworks in place, the discussions focused on three main issues: ensuring fiscal sustainability in the face of population aging; fiscal federalism; and the effects of structural reform on prices and growth. The mission also discussed the pace and timing of the withdrawal of monetary stimulus, the determinants of the large current account surplus and the exchange rate, and the outlook for and supervision of the financial sector and the occupational pension schemes.

10. There was substantial agreement on the direction of policies. Staff encouraged faster structural reforms, especially opportune now that the cycle is clearly strengthening. The authorities agreed but underscored the need to build political support for reforms to be adopted.

A. Short-Term Outlook

11. The staff and forecasters expect growth to accelerate to over 2 percent in 2006, closing the negative output gap. The strength of leading indicators suggests that the growth momentum will carry into 2006 (Figure 8). Growth is benefiting from continued strong external demand, still-supportive monetary policy, and stronger business investment encouraged by high capacity utilization, low corporate bond spreads, and improved balance sheets. Low oil dependency is limiting the direct adverse effects from elevated oil prices, and some increased competition in domestic markets is helping to dampen inflation. The staff projects growth to taper off in 2007 toward potential.

Figure 8.
Figure 8.

Switzerland: Leading Indicators Suggest that the Recovery will Continue

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: KOF database; and Bloomberg.
uA01fig05

Oil Consumption 2004

(in percent of nominal GDP in USD)

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Source: IEA, Fund staff calculations.
uA01fig06

Oil Imports 2004

(In percent of nominal GDP in USD)

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Source: COMTRADE, Fund staff calculations.

12. Risks are mostly external. The downside risk with most serious repercussions, but also uncertain probability, would be a disorderly unwinding of global imbalances. If the U.S. dollar were to fall sharply, and U.S. interest rates were to spike, Swiss exports would suffer and global equity markets could drop sharply. With Switzerland being a premier global wealth manager, this would reverberate significantly into the Swiss financial sector. Additional risks were geopolitical instability, which could suddenly push up the franc as a safe-haven currency, and indirect oil price effects if these were to slow global growth. An avian flu pandemic could also disrupt growth and the authorities were examining personnel and IT systems contingencies to mitigate its possible effects. On the upside, the global environment may remain buoyant with imbalances yet unwinding slowly and smoothly. Success with implementing domestic reforms could lift potential output growth, and further assist the expansion in the near term.

B. Monetary Policy

13. The authorities intend to continue to tighten monetary policy at a measured pace. The authorities noted that mixed signals about the strength of the recovery in early 2005, and very low inflation, had justified the suspension of monetary tightening that had been started in mid-2004. By December 2005, however, the outlook had clearly brightened whereas real interest rates remained below neutral levels. To keep inflation expectations well anchored, the SNB resumed the gradual normalization of the monetary policy stance.

uA01fig07

Monetary conditions remain supportive.

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

1/ A weighted average of the 3-month interest rate (¾) and the detrended nominal effective exchange rate (¼).

14. The SNB intends to constantly assess the appropriate pace of interest rate increases against key economic indicators. Mindful of the substantial transmission lag from monetary policy to economic activity, the closing output gap, and the risks of keeping interest rates low for too long, the SNB had signaled to the market its tightening bias. At the same time, officials noted that gauging the equilibrium interest rate had become difficult as several factors (absence of wage pressures, stronger productivity growth, globalization, and the effects of domestic reforms) may have reduced the neutral rate—at least temporarily. Markets expect a gradual increase in the policy rate to 2 percent by January 2007.

uA01fig08

With the recovery gathering steam, markets expect monetary tightening.

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

15. The authorities are vigilant about a possible unwinding of global imbalances. They emphasized that monetary policy would be relaxed appropriately in the event of an abrupt appreciation of the franc, which could undermine activity and threaten deflation.

16. The SNB has a transparent and open communication strategy. Market participants appreciate the quality of information and guidance provided by the SNB through publications and speeches. There was consensus that good communication is key to avoiding surprises in financial markets.

17. The SNB and the mission discussed two specific features of the monetary policy framework. Staff noted that it would be preferable to decouple the legal link between housing rents and mortgage rates, which hinders the effectiveness of policy rates in controlling inflation and could cause interest rate overshooting. 3 The authorities concurred, but noted that because of the extended period of stable interest rates, this link had been somewhat less distortive recently. Moreover, the SNB and the mission agreed that a proposed popular initiative (KOSA) to earmark SNB profits above a certain floor to financing the social security system could compromise the independence of the SNB and its ability to focus on price stability. The KOSA initiative is scheduled for a vote in September 2006.

C. External Balance and Exchange Rate

18. The current account surplus is likely to remain high. The main contributor to the surplus is the 10 percent of GDP earnings on Switzerland’s large net foreign assets (140 percent of GDP) (Figure 9). From a saving-investment perspective, the current account surplus reflects high gross savings, which in recent years have exceeded 30 percent of GDP, with gross investment also strong at over 20 percent of GDP. The business sector accounts for more than half of gross national savings, reflecting favorable corporate income tax rates combined with a stable political and business environment that has attracted many multinationals. Given the complexity of multinational business transactions, it is possible that the statistical recognition of corporate savings in the Swiss accounts is overstated, but on the basis of preliminary data the authorities could not readily discern a significant bias.4 5 At 9 percent, the household savings rate is not exceptionally high by international standards and reflects the stage of the lifecycle of the population (high income levels just prior to a wave of retirements). In addition, the emphasis on funded pension schemes also tends to boost national savings. In terms of net lending to abroad, the household sector together with occupational pension funds account for the bulk of the current account surplus.

Figure 9.
Figure 9.

Switzerland: External Competitiveness

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: Direction of Trade database, IFS, OECD, SNB, WEO, and IMF staff calculations.
uA01fig09

Current Account in Percent of GDP

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

uA01fig10

Investment Income Balance in Percent of GDP

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

uA01fig11

Household saving rates, 2001-2005

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

19. The trend real appreciation of the franc has paused, but the SNB saw scope for it to continue without jeopardizing competitiveness. This is consistent with the staff’s assessment that the Swiss franc is 5–20 percent below its medium-term equilibrium rate, reflecting mostly undervaluation vis-à-vis the U.S. dollar. 6 The authorities do not intervene in the foreign exchange markets, and were not concerned that the gradual trend real effective appreciation (on average about 0.7 percent a year)7 would undermine economic activity given that manufacturing is oriented toward price-inelastic, high value-added markets and the financial sector (wealth management) tends to benefit from a strong franc (Figure 10).

Figure 10.
Figure 10.

Switzerland: Structural Reforms and Real Exchange Rate Appreciation

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Sources: OECD, WEO and IMF staff calculations.

20. The authorities discussed several reasons why the real exchange rate may have paused in its long-run trend appreciation:

  • Domestic reforms could temporarily put downward pressure on the real exchange rate (a reverse Balassa-Samuelson effect). With prices in sheltered sectors exceeding by 30 percent those in neighboring EU countries, liberalizing domestic reforms will spur productivity gains and lower mark-ups, especially in these sheltered and nontradable sectors.8 This puts relative downward pressure on nontradables prices and depreciates the equilibrium real exchange rate.

  • The very low growth since the housing market collapse in the early 1990s brought with it a long period of weak absorption, also alleviating the real exchange rate.

  • Monetary policy has been supportive of growth with very low interest rates for some time, generating negative interest rate differentials vis-à-vis the U.S. dollar.

21. Thus, while there is room for the franc to appreciate, the exchange rate is reflecting market factors. The strengthening of domestic growth should boost absorption. The tightening bias toward neutral policy interest rates also should support the franc. However, if domestic reforms continue, nontradables inflation could remain subdued for some time and lower the equilibrium real exchange rate.

D. Fiscal Policies

22. The authorities were confident that they would meet their objective to eliminate the structural federal deficit by 2007. Two short-run adjustment packages had been put in place in 2003 and 2004 to meet the objectives of the federal debt brake. These packages aim at restraining annual expenditure growth to 1.7 percent per year in 2006–09 (almost half the rate of nominal GDP growth). The debt brake mechanism was working well in focusing public attention on the need for adjustment and, with the key measures now in place, automatic stabilizers would be allowed to operate.

23. Adjustment in cantons and communes was more moderate. Moreover, after some consolidation, subnational governments were facing increasing pressures for spending in education and healthcare. At the time of the mission there was uncertainty to which extent cantons would use the proceeds from gold sales to retire debt. 9 Officials noted that 18 out of 26 cantons had announced tax cuts (especially for high income persons; also, some cantons have no debt). They underscored, however, that most cantons and communes had fiscal rules and tended to pursue prudent fiscal policies.

24. Regarding tax competition between the cantons in Switzerland’s highly devolved federalism, the authorities were not concerned that it would degenerate into a race to the bottom because: (i) the new financial equalization scheme discouraged “predatory” tax cuts by linking equalization transfers to a standardized tax base (thus local tax cuts might lead to smaller revenue transfers) (ii) the attempts at “competitive” tax cuts were limited to very small cantons with minimal spillovers to large ones and, (iii) should tax competition reach harmful levels, public pressure for harmonization would increase and thus undermine the cantons closely guarded independence. Indeed, rather than fearing tax competition, the authorities felt that in combination with direct democracy, where tax increases are often subject to referendum (mandatory for federal tax increases), some horizontal tax competition had helped to contain the size of government and limited the spending bias associated with the common pool problem (Box 2).

uA01fig12

Change of Tax Revenue as Percent of GDP, 1998-2004

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

uA01fig13

Tax Revenue as Percent of GDP, 2004

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

Source: OECD Revenue Statistics of OECD Member Countries, Vol 2005.

Fiscal Federalism in Switzerland

Switzerland has one of the most decentralized government systems in the world, alongside Canada and the US. 1/ As cantons can freely raise own revenues, horizontal competition is intense, fostering accountability. Together with direct democracy, these arrangements tie the size of government to citizen’s demand for public goods and services rather than to policy makers eagerness to spend, resulting in a relatively small government sector and low taxes.

Strongly devolved federalism raises policy coordination issues. First, gearing ex-ante fiscal policy towards macroeconomic objectives is challenging, with a greater risk of procyclical policies and difficulties to internalize intertemporal pressures. Second, horizontal tax competition may weaken the government’s ability to meet citizen’s demands. Third, extended devolution may limit economies of scale.

Empirical evidence confirms that the fiscal stance of the general government has been procyclical, reflecting mainly subfederal policies. The policy response to rising public debt in the 1990s has been slow, with the burden of adjustment falling mostly on the federation. However, tax competition is unlikely to reach harmful levels as net equalization transfers respond negatively to competitive tax cuts. Also, the mere threat of harmonization discourages cantons to overplay competitive tax reforms.

Fiscal federalism arrangements matter for the policy response to aging. The current system is more effective at preventing new spending programs than containing pressures from existing ones. In particular, frictions between the confederation and the cantons on sharing the cost of adjustment for aging may delay reforms. The federation, currently seen (although legally it is not) as the financier of last resort for social security, is exposed to the bulk of spending pressures at unchanged policies, which may encourage free riding by subnational governments.

With limited scope for ex-ante coordination, promoting greater transparency on intertemporal challenges is essential. The authorities are working on a Long-Term Fiscal Sustainability report, and are considering extending debt-brake type fiscal rules to entitlement programs. The strong transparency and discipline imposed by such far-reaching innovations could contain free riding problems.

1/

See accompanying Selected Issues paper on “Coordinating Fiscal Policy in Switzerland: Issues, International Experience and Prospects.”

25. For the long run, the authorities agreed that social security and health systems were not well-calibrated to absorb the pressures from aging. The debt brake was working well for the federal budget within a cyclical context, but given its exposure to deficits in the entitlement programs, it might not be robust to structural pressures from aging. The authorities felt that the federation was approaching its limits of budgetary flexibility with current discretionary expenditure having been reduced considerably, while tax increases would be subject to mandatory referendum. Thus, given the mounting pressures from social security and with a view to preserving the credibility of the debt brake, the authorities agreed that structural fiscal reforms would be needed—and, indeed, were being prepared. They had already launched a comprehensive review of federal tasks and subsidies (reports would be prepared by year end).

Social security has been a drag on federal finances.

(In percent of GDP)

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Sources: Federal Finance Administration, and IMF staff calcuations.

2005 are the budget numbers.

Direct transfers to old age pensions (AHV), disability insurance (IV), unemployment insurance (ALV) and compensation for loss of earnings (EO) funds, and VAT transfers to these funds.

Subsidies for health care premia (KV) included in the federal budget.

uA01fig14

Under current policies, aging would raise public debt to unsustainable levels.

Citation: IMF Staff Country Reports 2006, 202; 10.5089/9781451807295.002.A001

26. To place the social programs on a sounder long-run footing, the authorities were considering several measures, some of which would be far-reaching and require careful discussion with the public:

  • Disability insurance. More timely intervention for, and faster reintegration of disabled workers, and slightly higher payroll taxes. The authorities also envision a 0.8 percentage point increase in the VAT, earmarked for the disability fund.

  • Health care. In consultation with cantons, the excess supply of clinics would need to be reduced. Hospital efficiency would be improved through benchmarking and applying performance pay. And there would be increased freedom to contract health and insurance providers, thus leveraging competition. Raising copayments was also under consideration.

  • First pillar pensions. The authorities intend to raise the female retirement age from 64 to 65 (planned for 2009), seek to extend the working life of older workers, and would consider reducing indexation for pensions, subject to safeguards for the needy.

  • Civil service pensions. The authorities plan to split the civil service pension fund in two: one for retirees, with grandfathering of current provisions; and another for current employees who will be transferred to a defined contribution scheme, without grandfathering. 10

27. The authorities agreed that dealing successfully with aging would require that these proposals be placed in a long-run comprehensive policy framework and be coordinated across levels of government. Therefore, they were preparing the Long-Run Fiscal Sustainability Report, which could bring out policy options and their separate impact on the confederation, cantons, communes, and the social security funds. The mission recommended that the Report include a preliminary public sector balance sheet that incorporates an estimate of the net present value of projected future deficits under current policies (Box 3). This could help assess what public assets are vital for the functioning of the state, and provide indications of the need for fiscal structural reforms.

Preliminary Public Sector Balance Sheet 1/

A comprehensive public sector balance sheet provides useful information on the health of public finances. The balance sheet should include all assets and liabilities of the general government and the present value of the future stream of fiscal balances that is expected to be generated under current policies.

Preliminary calculations for Switzerland suggest an intertemporal imbalance. The Swiss public sector owns substantial assets that more than offset the 2004 accumulated net financial liabilities. However, the present value of unfunded liabilities over the next fifty years is estimated at 153 percent of GDP. 2/ Taken together, this suggests a negative intertemporal net worth of 103 percent of GDP.

Public Sector Balance Sheet

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Source: Swiss National Bank, Federal Finance Administration and IMF staff calculations.
1/

See accompanying Selected Issue paper “A Preliminary Public Sector Balance Sheet for Switzerland.”

2/

This number is indicative of the challenge faced by the debt brake and fiscal rules at the lower level governments. The authorities acknowledge that the debt brake by itself, without structural fiscal reforms, would not be robust to this pressure.

E. Financial Sector Developments

28. The authorities noted that the banking sector was robust, adequately capitalized, profitable, liquid and dynamic. They saw Switzerland as retaining a strongly competitive banking sector with high-quality and innovative institutions, good supervision and legal infrastructure, and excellent macroeconomic stability. At the same time, they noted that wealth management by Swiss institutions was expanding rapidly in Asia, where demand was most dynamic. Financial soundness indicators were at comfortable levels and banks’ equity prices were strong (Tables 58, Figure 11). Bank profits rose in 2005, benefiting from an expansion of asset management and trading activities, lower provisioning, and restructuring. At the same time, intensifying competition had put some pressure on interest rate margins. Low interest rates continued to stimulate mortgage lending but stress tests suggested limited vulnerability of households thanks to moderate levels of loan-to-value and debt-service ratios.

Table 5.

Switzerland: Major Financial Institutions, 2002-05

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Source: Company reports; and IMF staff calculations.
Table 6.

Switzerland: Financial Soundness Indicators

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Source: Swiss National Bank.

As percent of total credit to the private sector.

Mining and extraction, production and distribution of electricity, natural gas and water, financial intermediation,

Table 7.

Switzerland: Encouraged Set of Financial Soundness Indicators

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Sources: Swiss National Bank; and Social Security Administration.

Simple ratio of capital to total assets, without risk weighting.