2008 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Switzerland

Switzerland showed impressive growth performance owing to its strong macroeconomic policies and structural reform efforts. Executive Directors emphasized the need to maintain financial stability. They welcomed the well-timed injections of liquidity into the banking system. Directors also welcomed the stress testing framework to improve liquidity risk management, banks’ contingency plans, and liquidity management policies. They commended the monetary policy stance and the strong fiscal performance. They welcomed the Long-Term Sustainability Report and also the extension of the debt-brake rule to incorporate expenditures.


Switzerland showed impressive growth performance owing to its strong macroeconomic policies and structural reform efforts. Executive Directors emphasized the need to maintain financial stability. They welcomed the well-timed injections of liquidity into the banking system. Directors also welcomed the stress testing framework to improve liquidity risk management, banks’ contingency plans, and liquidity management policies. They commended the monetary policy stance and the strong fiscal performance. They welcomed the Long-Term Sustainability Report and also the extension of the debt-brake rule to incorporate expenditures.

I. The Context

1. The Swiss economy performed impressively during the recent global upswing. Although its international preeminence has eroded in some respects, Switzerland rode the global expansion with much success, with growth exceeding the euro area average in the past four years. High-value added manufacturing gained in strength, Switzerland’s position as a major global financial center was reinforced, and a broader emphasis on services delivery has opened up new growth possibilities. Building on long-standing strengths—advanced infrastructure, a skilled and flexible workforce, openness to the flow across its borders of trade, capital, and people, low tax rates, and a small government—these developments augur well for the future.

2. But the risks to its financial service industry threaten to dent the gains achieved. The two major international banks—UBS and Credit Suisse—are closely intertwined in and have felt the full force of the international financial turbulence. The authorities have responded appropriately to limit the knock-on effects of the financial tensions, injecting liquidity and coordinating with major central banks. However, the still-unfolding developments will have a significant bearing on Swiss growth and impose important policy challenges, with implications not just for Switzerland but also for financial and economic developments in the rest of the world.

3. In light of Swiss susceptibility to externally-generated volatility, the discussions focused on the near-term outlook and policies to mitigate the risks of instability. The very strengths of the Swiss economy—its openness and its dynamic financial sector—also expose it to adverse developments overseas. As such, the economy experiences sharper swings than most advanced economies (Box 1). In turn, the risk-management strategies of Swiss banks can amplify international shocks, while also generating negative spillovers for the global financial system and the world economy. The policy task is to pay particular attention to decisions made by domestic financial players. This is best achieved by focusing directly on financial sector regulation and supervision. Monetary and fiscal policies are likely to play supportive roles within their well-defined frameworks.

The Influence of International Shocks on the Swiss Economy

Developments in the global economy have a significant bearing on Swiss growth. A factor structural vector autoregression (FSVAR) method was used to decompose deviations of real GDP from trend, as in Stock and Watson (2005).1 The methodology identifies: (i) country-specific or “own” shocks; (ii) common “international” shocks that affect all countries within the same period; and (iii) idiosyncratic shocks that “spillover” into the domestic economy after a one quarter lag. The following conclusions emerge:

  • In all countries, deviations from trend growth—a measure of volatility—have declined over time (left panel below).

  • However, they remain relatively large for Switzerland (only in Japan are they larger).

  • For Switzerland, just under half of these deviations are due to international shocks; another 15 percent arise from spillovers from other countries in this sample (right panel).

The implication is that, in periods of high international volatility, Swiss growth will be particularly subject to large fluctuations.


Trend Volatility of Real GDP Growth 1/

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

1/ Variance of band-pass-filtered GDP; multiplied by 10,000.

Switzerland: Contributions to Volatility of Various Shocks

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


J. Stock and M. Watson, “Understanding Changes in International Business Cycle Dynamics,” Journal of the European Economic Association, September 2005.

II. The Near-Term Growth Outlook

A. Background

4. In 2007, the economy was buoyed by external demand, with some pickup in consumption. GDP growth accelerated to 3.1 percent, capping the resurgence that began in early 2004 (Table 1). External demand, particularly from Germany, remained strong. Private consumption rose with improving consumer confidence and falling unemployment. Machinery and equipment investment was underpinned by strong corporate profitability and by capacity utilization—at 88 percent—well above its long-term average. Construction investment, however, fell as transportation projects were delayed. And inventories were drawn down.

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.

Excludes cyclical items only.

Excludes cyclical and one-off items: expenditures of SwF 4,500 million (about 1 percent of GDP) in 2008.

Based on relative consumer prices.


The economy has expanded rapidly since 2003.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


Capacity utilization is at a record high.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

5. The rebound extended an ongoing structural shift—productivity growth in services was supported by robust increase in skilled employment. Labor productivity growth rose smartly in the cyclical upturn. While Switzerland’s manufacturing transformation—from chocolates and watches to genetics and informatics—has continued, productivity growth in the trade and financial services sectors reinforced trends initiated in the mid-1990s. Employment continued to increase through 2007 despite financial sector woes, which slowed gains in the second half of the year. The unemployment rate was down to 2.7 percent in December, and vacancy rates continued to rise. Businesses were reporting particular shortages in technical and IT areas. Strong immigration and cross-border commuter flows—with rising skill content—have supported labor supply (Figure 1).

Figure 1.
Figure 1.

Switzerland: Labor Market Developments

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

Sources: Country authorities; and Fund staff calculations.1/ Tertiary education starts above high school, or apprenticeship level.

Switzerland: Annual Growth Rates of Sectoral Hourly Labor Productivity

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Source: SNB; based on SFSO national accounts and working hour statistics. The traded sector contains the SFSO codes Industry, excluding construction. Values for 2006 are estimated from OECD data.

6. The structural change accompanying the rebound has raised the potential growth rate, but the extent of the increase is unclear. The authorities’ estimates of potential growth have a large range. The methodologies that generate higher estimates of potential growth (and lower output gaps) are those that allow for time varying trends. These higher estimates reflect a shift from manufacturing, where capacity constraints apply in the short-run, to services-based growth, where capital is not a constraint and labor supply has recently met the skills demanded. Such a benign interpretation of developments is not unreasonable and could even imply no current output gap. However, for fiscal planning, staff and the authorities use a more conservative potential growth rate of 1.8 percent, which implies a positive output gap averaging some 1 percent in 2007-08.

7. Notwithstanding these favorable developments, the financial turbulence, felt with force in Switzerland, has raised systemic concerns—though no immediate credit contraction.

  • As elsewhere, the tensions were first manifested in the interbank markets for short-term liquidity, and these have continued to recur.

  • The asset portfolio of UBS—and to a lesser extent of Credit Suisse—has had to be significantly written down, and UBS has required two rounds of capital injection.

  • While asset deleveraging is ongoing and the big banks are increasing their liquidity, domestic lending has remained surprisingly steady. In contrast, the torrid pace of foreign lending is sharply down.

Subprime Related Losses and Capital Injections 1/

(as of April 24, 2008; in billions of US dollars)

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Sources: Bloomberg and staff estimates.

Writedowns and charges related to subprime assets.

8. Liquidity in interbank markets, particularly for term money, has periodically threatened to dry up—and spreads in these markets remain elevated, especially at longer maturities. Following the onset of the financial turbulence in July 2007, interest rate spreads (over the tomorrow/next index swap) widened—though less so than in other major financial markets. Spreads then seemed to fall and stabilize in much of the final quarter of 2007. They have, however, been subject to new waves of anxiety. In the most recent wave, longer-term interbank borrowing has been subject to substantially larger premiums than short-term borrowing. Clearly, banks are reluctant to lend for extended maturities and, especially the two large banks, have been building their liquidity reserves.


Interbank tensions emerged in mid-2007 and have returned in waves.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


Longer-maturity interbank spreads remain elevated in Switzerland.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

9. Pressures at the two large banks have also raised broader systemic issues. Concerns about their creditworthiness have remained elevated, evident in wide spreads on credit default swaps, a sharp fall in equity prices, and a declining estimated “distance to default.” Despite its allegedly riskier asset portfolio, reflected in higher credit default spreads before 2007, Credit Suisse earned estimated profits of $7.8 billion in 2007. However, in the first quarter of this year, concerns grew with the mark down of $5.3 billion on structured credit positions, resulting in a loss of $2.1 billion. UBS has been hit hard, reflecting its particularly high exposure to the US subprime assets. With writedowns now about $38 billion, UBS ended 2007 with a loss of $4 billion and reported a further loss of $12 billion in the first quarter of 2008. Since last summer, the long-term rating of UBS has been lowered from AA+ to AA- by Fitch and by S&P, and from Aaa to Aa1 by Moody’s. However, markets have responded favorably to a rights issue, which follows the capital injections earlier in the year from a sovereign wealth fund, a large private investor, and payment of dividend in stock rather than in cash. According to Fitch’s measure of the intrinsic strength of the banking system, the Swiss banking system has slipped from A (very high) to B (high).


CDS spreads have risen…

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


…and bank’s distance to default have declined.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

10. Despite these pressures, domestic credit growth has remained steady, while foreign lending has decreased sharply. The decline in overall credit growth is principally the consequence of a sharp contraction in the growth rate of foreign loans, from the elevated 70 percent annualized rate in mid-summer. Domestic private sector credit, which grew at a healthy rate of 5½ percent year-on-year through the summer of 2007, actually accelerated to 7 percent thereafter, despite global tensions. In this regard also, the Swiss experience has matched the experience in the eurozone, where domestic credit growth has remained relatively stable.


Total loan growth has slowed sharply, but domestic lending has remained stable…

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


….domestic lending growth by big banks has actually

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

1/ Bank coverage expanded in September 2006.

B. Growth Prospects

11. As the authorities emphasized, real sector forward-looking indicators have remained surprisingly positive. The momentum from buoyant growth in much of Europe during 2007 is still evident. Industrial capacity utilization and order books suggest continued strength, and sentiment indicators are moderating only gradually. Manufactured goods’ demand from Europe and Asia has remained relatively steady. The KoF composite leading indicator has trended down but only slowly. Nervousness in the financial sector notwithstanding, lending surveys do not yet foreshadow a credit squeeze. Indeed, some analysts regard corporate liquidity and profitability as constraining demand for credit. Consensus forecasts for growth in 2008 have come down since October 2007, but the average is still high—at around 2.0 percent—though with a large variance.


The KoF indicator has trended down, though only slowly.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


The consensus forecast has come down, but remains relatively high.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

12. Staff forecasts, however, assume that the global developments will take their toll on the Swiss economy. In the discussions, staff acknowledged that the current global environment is characterized by a high degree of uncertainty and, hence, projections are subject to more than the usual imprecision. Yet, consistent with the Fund’s projections for the U.S. and Europe, a sharp Swiss deceleration is anticipated. Because of presumed lag effects, the impact of the pronounced U.S. slowdown is expected to persist even after the U.S. bottoms out. For this reason, staff projects Swiss GDP growth to slow to 1.4 percent in 2008, and then to 1.3 percent in 2009.1 Largely because the authorities anticipate a less severe U.S. downturn, implying also a more modest European slowdown, the SNB projects GDP growth of between 1.5 and 2 percent in 2008, and the State Secretariat for Economic Affairs has a point estimate of 1.9 percent; both expect deceleration in 2009.


The slowdown is expected to persist through early 2009.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

13. The slowdown stems from several sources, which will likely emerge sequentially.

  • Exports of goods and services will slow at first, as U.S. and European imports decelerate. Given Switzerland’s strong export orientation, this influence will likely manifest early with reduced growth of goods’ exports and a sharp curtailment of financial service income. The authorities’ historical analysis shows that a sharp fall in stock prices, as has recently occurred, is accompanied by a sharp decline in financial service exports. While the stronger Swiss Franc has not reached levels that would significantly hurt exports of goods, continued appreciation could have a material effect. In the short-run, GDP growth will likely be held up by consumption growth, given the recent strength in employment.


Export dependence has been high and rising.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


Growth contributions of the financial sector have been significant.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

  • The drop in banks’ earnings will also have a direct and early impact on GDP growth, given the financial sector’s relatively large contribution to growth swings in recent years.

  • Finally, slowing exports, the inflationary effects of the oil price increase and, in particular, the global financial tensions can all be expected to dent consumer confidence, leading to weaker consumption expenditures in the late 2008 and especially 2009 (Box 2). This expected weakness in consumption contributes, especially in 2009, to staff’s difference in GDP growth projections relative to those of the authorities. While corporate profitability and existing orders should underpin machinery and equipment investment for a while, the uncertainty will likely engender caution.

III. Maintaining Financial Sector Stability

14. The Swiss authorities have responded vigorously to limit the knock-on effects of the current financial tensions. They have injected liquidity into the banking system, often in coordination with other major central banks, maintained an enhanced oversight of the major banks and insurance companies, and worked actively with other regulators to share information, coordinate supervisory activities, and draw lessons for the future.

Global Financial Conditions Weigh on Swiss Growth

Past relationships suggest that the global financial downturn points to continued risks. Staff analysis shows a remarkable correlation between profits at the two big banks and growth one year ahead. Based on recorded 2007 profits, this statistical relationship projects a sharply slowing growth rate in 2008. Further investigation suggests that profits at the two banks are a reflection of global financial conditions and are, in particular, correlated with the so-called term spread (the difference between the 10-year and 3-month interest rates). Just as the dropping profits in 2001 and 2002 predicted the slowdown of 2003, so did the shrinking term spread (or the flattening yield curve).


Growth is correlated with large banks’ RoE.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


Yield spreads have declined.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

The yield curve’s well-established record of predicting growth rates applies to Switzerland. Temporary rapid growth tends to push up short-term rates either because monetary authorities seek to cool the economy or market rates rise independently. Because future growth expectations do not rise, long-term rates stay stable or even decline, and the spread narrows. The spread between the 10-year Swiss confederation bond yield and the 3-month CHF Libor has dramatically declined in recent quarters. For the Swiss economy, the real GDP growth rate is well forecasted by this yield spread. The coefficient on the yield spread is statistically significant at one percent level and the model shows a high predictive power (0.8 R-squared) for future GDP growth. The yield spread is particularly successful in predicting the consumption component of GDP, implying that it is an early indicator of consumer sentiments and confidence. These forecasts predict weakness 4-6 quarters ahead.


Yield spreads help to predict GDP growth…

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


…and predict lower consumption growth.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

A. Interbank Liquidity

15. In line with central banks in other major financial centers, the Swiss National Bank (SNB) has provided the necessary liquidity to ease interbank tensions. Heavier than normal doses of liquidity provision have occurred on days of heightened concerns or at the start of maintenance periods. However, despite an active policy to enhance availability of liquidity, the monthly average level of commercial bank sight deposits at the central bank (a measure of SNB provided liquidity) has not grown more rapidly than in the past since liquidity injections and withdrawals have been carefully-timed. An expanded list of collateral eligible for SNB repos was approved in June 2007, prior to the onset of the crisis, and has proved adequate so far. The SNB also coordinated with the Federal Reserve and the European Central Bank in providing dollar liquidity.


Bank deposits at the SNB, and the monetary base, have remained relatively stable.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


As liquidity injections at the maintenance period’s start have been periodically clawed back.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

B. Capital Adequacy

16. Banks’ business models have evolved to economize on capital, thereby however raising systemic risk. The search for new, often low-margin, businesses in the increasingly competitive international financial markets has led to banks acquiring of apparently low-risk assets, often certified as such by rating agencies. The low assigned risk weights allowed some banks to comfortably meet their regulatory capital requirement (Tier-1 plus Tier-2 capital as a proportion of risk-weighted assets) while maintaining very high leverage (low ratios of capital-to-total assets). The UBS trends, in this regard, are striking. Other European banks, including Credit Suisse, have also taken this approach. In good times, this earned high returns for banks’ equity holders, as in 2006. However, ex post, their greater riskiness than earlier recognized and their illiquidity have reinforced each other. Actions of individual banks may have created spillover risks because of the perception of common vulnerability across European banks.


UBS has sharply adjusted their leverage.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


Swiss Banks: High Leverage for High Returns on Equity

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

Source: Thomson Financial.

17. Undercapitalization of UBS has been an important concern. Measured by international standards, UBS remains adequately capitalized but maintaining these standards has required it to rebuild capital to levels consistent with its positioning as a global banking group with major asset management as well as banking operations. In conjunction with reporting its first round of write-offs in December, UBS announced efforts to add SwF 19.4 billion (about $17.8 billion) to the bank’s Tier-1 capital. Despite initial reservations, shareholders approved capital injection by Singapore’s GIC and an unnamed private investor, though the cost was reportedly high for a then Moody’s Aaa-rated issuer and relative to other recent capital injections.2 A second round of new capital ($15 billion), to be raised in a rights issue following the second round of write-offs, has been underwritten by major U.S. and European investment banks. This will restore capital ratios close to levels prevailing before the credit market turmoil.

C. Banking Regulation

18. The lessons from recent events have identified the need for focus in four areas:

  • Better risk assessment and risk management;

  • Increased capital buffers;

  • More liquidity; and

  • Greater disclosure.

19. More realistic risk assessment is crucial. The call for more prudent risk management has followed two, complementary, tracks: better governance and enhanced regulation. Existing management structures clearly proved an insufficient restraint on risk taking. However, the effectiveness of proposed corporate governance measures remains unclear, especially with regard to compensation schemes and the role of non-executive directors, and implementation will need new industry norms. In contrast, it is widely accepted that the buildup of structured finance positions would have been lower had the Basel II regulatory framework been fully implemented.3 Compared with Basel I, the new framework captures off-balance-sheet assets better and takes a more sophisticated approach to measuring risks. The Swiss authorities have now largely implemented Basel II, including the Pillar 2 (supervisory review) process.4 But they are also revisiting their risk-based capital framework, drawing on the recently revealed outcomes and correlations across asset classes. These reassessments will, in turn, lead to typically higher capital requirements.

20. However, given the limits of any risk-based framework, consideration of additional capital is merited to cushion against unanticipated risks. The authorities are considering the use of a leverage ratio for large banks to supplement existing capital requirements. Such an approach could add a transparent capital buffer. As staff noted and the authorities recognize, the approach has its limitations, not least the possibility that banks will have an increased incentive to “hide” their assets by moving them off-balance-sheet. However, staff agreed that implemented with Basel II and appropriate safeguards, a leverage ratio approach could serve as a useful complement to the existing regime, while helping to strengthen the supervisory response to future increased risk-taking by the banks.

21. While additional capital will also mitigate liquidity risks, further development of liquidity risk management in response to recent events is a priority. In line with the recommendations in the Financial Sector Assessment Program (FSAP) update in May 2007, the authorities are developing a stress testing framework to improve global liquidity risk management by the major banks and are actively reviewing banks’ contingency plans and liquidity management policies. They are also collaborating with other regulators internationally to enhance global practices.

22. The Swiss Federal Banking Commission also recognizes that a lack of adequate disclosure amplified market anxieties and is working with regulators internationally on improvements. The Commission’s immediate focus is on close monitoring of the two big banks and reported it had the relevant information necessary for supervisory purposes. However, the authorities have also called for increased transparency of commercial banks’ risk positions in order to improve market discipline. They suggested that greater public disclosure requirements need careful consideration and standardization, particularly regarding complex financial instruments, to be useful to the public. The Commission is, therefore, pursuing options for enhanced disclosure mainly within the context of international discussions and developments.

D. Insurance Developments

23. Despite their risk-reduction efforts, Swiss insurance companies would suffer from a major global downturn. The insurers operate in a mature domestic market, derive a large share of premium income from overseas business, and have a major presence in global reinsurance. Since the problems experienced in the weak equity markets of 2001-03, the insurance sector has performed impressively, risk exposures have been reduced, and recent events in global credit markets have had a much smaller impact than on the banks. The authorities are closely monitoring credit exposures and noted that all companies currently meet minimum solvency standards, on a statutory basis. However, greater earnings volatility is now expected.

24. Although not a binding solvency requirement until 2011, the Swiss Solvency Test (SST) is spurring improvements in risk management and in the quality of supervisory dialogue. Regulators are using the SST to improve both their insights into insurers’ risks (for example the continuing exposure to worsening global economic and financial conditions) and their monitoring of solvency levels. The SST has been applied to major insurance companies since the start of 2006, and is now being extended to reinsurance companies (and smaller primary insurance companies). The regulator is also embedding the SST within a wider risk-based supervisory framework encompassing requirements on corporate governance, risk management and internal controls. These are welcome developments, broadly in line with the recommendations of the 2007 FSAP.

25. The insurance regulation agenda needs continued prioritization and attention to overall resources. As well as building on the success of the SST, there is a need to develop a system of onsite supervision linked to risk assessment, to increase supervisory resources for reinsurance and to strengthen international supervisory cooperation, particularly with regulators outside Europe. While the regulator has plans in these areas, staff observed that limited resources in relation to the scale of the tasks would require careful prioritization. The authorities noted there would be risks in deferring key parts of what is an integrated reform program and placed the emphasis on maintaining adequate resources overall.

E. Regulatory Capabilities

26. Regulatory enhancements will be of limited value without effective supervision and enforcement. The launch, on January 1, 2009, of FINMA—the new regulator, integrating banking, insurance, and anti-money-laundering—is an opportunity to further strengthen supervision. Although the authorities see limited scope for harmonizing regulatory requirements across sectors, they stressed that their vision for FINMA is for an even more effective regulator of the domestic financial sector and a more influential voice in international regulatory fora. As well as the continuing implementation of Basel II and the new insurance solvency requirements, FINMA will face early challenges in implementing regulatory change resulting from current credit market events.

27. A key to delivering the vision for FINMA will be to secure adequate skills and resources. The authorities noted that under the proposed staff regulations, if approved by the Federal Council, FINMA will have adequate flexibility to offer remuneration that will retain and attract the skilled staff. This flexibility will extend to FINMA’s wider budgeting and strategic planning. In this context, staff expressed concern that the full complement of board members as well as the chief executive or other members of the general management had not yet been appointed. The authorities recognized this as a priority.

28. FINMA’s special challenge lies in supervising the major banking and insurance groups. The authorities expect that FINMA will carry forward the existing approach that relies on close supervision, with extensive involvement of auditors. Staff recommended continued expansion of onsite activities by the Swiss Banking Commission to bring a better balance with the work of the auditors. Staff also supported a targeted rules-based framework, with transparent benchmark performance measures and linked supervisory responses for capital requirements. The authorities indicated their openness to such an approach. Also, particularly for the banking groups, close coordination of supervisory activities with key overseas regulators has worked well. However, the authorities recognized that maintaining the stability of global operations of their large, complex financial institutions will require stronger commitments from host supervisors, especially in adverse circumstances when conflicts of interest may appear.

IV. Monetary Policy

29. The current conjuncture poses special challenges for monetary policy. CPI inflation averaged a modest 0.7 percent in 2007, while core inflation was 0.6 percent. Foreign labor flows kept wage inflation contained (nominal wages rose by 2 percent—a 1.3 percent real increase, below productivity gains). However, fueled by oil and food prices, inflation reached 2.6 percent in March. For 2008, the average inflation rate is projected at 2.0 percent, falling to 1.4 percent in 2009, as also assessed by the SNB in the context of its March policy decision. Despite the projected decline in the inflation rate to below 2 percent, the risk is that the current high externally-generated inflation may feed into wages and core inflation. The greater inflation risk has unfortunately coincided with worsening growth prospects. At successive policy decision points since September, this polarization has increased, heightening the trade-offs involved. Moreover, the consideration of safeguarding against a particularly adverse outcome has added to the complexity of decision making.


Inflation has remained subdued despite spikes in foreign goods inflation.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

30. In this complex and uncertain environment, the SNB signaled its concerns regarding inflation in its September decision. Under a floating exchange rate, the SNB’s monetary policy seeks price stability, defined as a positive headline annual inflation rate but one below 2 percent. Policy decisions are guided by inflation forecasts over a three-year horizon. Within this objective, the SNB takes due account of business cycle conditions. The SNB seeks to influence the 3-month Libor, allowing that rate to move in a 1 percentage point band. The September decision to raise the target band by ¼ percentage point, led to a cumulative increase of over 200 basis points from mid-2005 to the 2.25-3.25 percent range. In doing so, the SNB maintained relatively stable monetary conditions as the decline in the exchange rate mirrored the increase in policy rates.


Policy interest rates have tended to move together.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


The Swiss franc has depreciated until recently.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

31. Recognizing that monetary conditions are tight, the SNB has eased by steering down the 3-month Libor when the risk premium has tended to rise. In September, the ongoing market turmoil had pushed the Libor rate to above the mid-point of the existing range, where it is typically maintained. In response to this market-driven tightening of monetary conditions, the SNB lowered the 1-week repo rate to bring the 3-month Libor down to 2.75 percent, the mid-point of the range. The SNB’s focus on the 3-month Libor recognizes this rate’s significance as a benchmark for a variety of longer-term rates, which directly influence lending and borrowing decisions. Thus, resisting an increase in this rate helped contain borrowing costs. In its March 2008 report, noting the strengthening of the Swiss franc, the SNB stated “on the whole, monetary conditions are tighter than they were in December” and was “of the opinion that an adjustment in the interest rate (the 3-month Libor) was not called for under the current circumstances.” While it has kept the target range of the 3-month Libor unchanged, slower expected growth and the insurance motive have continued to influence policy implementation (Box 3). Maintaining the 3-month Libor at or close to 2.75 percent—and in practice, preventing it from rising—has been achieved through lowering shorter-term repo rates. Because the SNB states its policy stance in terms of the 3-month Libor, it requires a comparison of the shorter-term policy rates of other central banks with the SNB’s 1-week repo to recognize that the SNB has eased in line with the Bank of England (text figure).


The SNB has steered the 3m Libor by adjusting the 1-week repo rate.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


The effective and announced policy changes have varied across central banks.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

1/ Fed funds (U.S.); Bank rate (U.K.); MRO rate (E.A.) and 1-week repo rate (Switzerland).

32. Staff supported the effective easing of monetary policy. The authorities themselves preferred to use the term “accommodative” to describe their effective easing. Inflation expectations remain well anchored, core inflation is below 1 percent, and the SNB’s medium-term headline inflation forecasts are well within the central bank’s definition of price stability. The monetary policy response has been appropriate, especially because fiscal policy, which was not especially effective in the previous downturn, could not have responded at the necessary speed and, as the authorities also emphasized, is subject to external leakages. Indeed, with its lower growth and contained inflation scenario, staff conveyed support of further modest monetary easing.

33. In contrast to the broad agreement on the monetary policy stance, the discussions on the operational framework were inconclusive. At the time of the September decision the target range for the 3-month Libor and the operational 1-week repo rate were moved in opposite directions. Thus, while the stance was signaling a tightening, accommodation was being engineered. Since September, the SNB has maintained its target range—and, hence, policy stance—steady, but provided monetary accommodation when necessary by adjusting the 1-week repo rate. The authorities rightly maintained that this has imparted some flexibility to the conduct of monetary policy in this stressful period. However, the implication is that the monetary policy stance of the SNB cannot always be inferred from its announced target range in the same way as that for other central banks. Thus, if SNB’s changes in the policy stance (inferred from the movements in the 3-month Libor) are compared to those of policy changes at other central banks, the SNB appears to have slightly tightened (text figure) while the others (U.S. and U.K.) have held steady or eased. However, when comparing like-for-like, the SNB has eased about the same as the Bank of England, with the ECB and the U.S. at the two extremes. Staff sees this as going beyond a communication issue, and its operational and substantive implications deserve further analysis.

Monetary Policy Under Uncertainty

Under tail-end shocks, monetary policy may be guided by an insurance motive. Switzerland has become increasingly integrated with international markets. Growth and inflation are closely tied to developments in the euro zone. Capital markets are tightly integrated with Europe—and even labor markets are quickly moving in that direction. Since integration gradually reduces the possibility of fine tuning inflation, the SNB’s decisions are typically related, though with some leads and lags, to the broader movement of official rates. However, significant independent response is sometimes called for, as in the severe downturn of 2001-2002.


Swiss and Euro area inflation move together…

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


…GDP growth rates are also highly correlated.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

Such an insurance motive may be operative now. Gauged by a Taylor’s rule, the decision to hike the rate by 25 basis points in September was consistent with the view that inflation was a concern. However, the decision was a surprise in view of the ongoing financial turmoil, and while inflation considerations may have suggested continued tightening into December, the SNB, citing uncertainty, then paused. A similar pause was evident in the previous downturn. Currently many financial markets appear to be in the midst of tail-end shocks. Theory and practice (including in Switzerland in the previous downturn) support such caution.


The SNB also paused in the previous downturn.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

V. Public Finances

34. Though strengthened by recent efforts, the long-run sustainability of public finances is not yet assured. The federation’s debt-brake fiscal framework, calling for a cyclically-adjusted balance over the cycle, helped achieve a fiscal surplus in 2006, a year ahead of schedule, and the surplus increased further in 2007. However, the debt brake can only deal with cyclical pressures at the federal level. It does not apply to the social security system; and the confederation cannot impose a fiscal rule on subnational governments. The highly devolved Swiss federalism requires time to coordinate a response to aging. The authorities are formulating comprehensive long-term policy initiatives, which the staff continues to support.

A. Fiscal Developments

35. The 2007 fiscal result was better than budgeted as tax revenues expanded with the continued economic strength. With tight expenditure control and buoyant revenues, the general government achieved a surplus of 2.2 percent of GDP in 2007, implying an improvement in the structural surplus to 1.7 percent of GDP. Surpluses at the federal level were supplemented by a balanced budget in social security accounts and surpluses at the cantonal and communal levels. Taken together, these efforts reduced the gross debt to 44 percent of GDP.

Fiscal Developments

(Percent of GDP)

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2008 includes extraordinary expenditures of SwF 5,247 million, about 1 percent of GDP.

Excludes cyclical items, but includes extraordinary expenditures.

Excludes cyclical and one-off items (extraordinary expenditures).

B. Fiscal Projections and Policy

36. The federal fiscal balance is projected to weaken and provide a small stimulus in 2008. An overall surplus of 0.8 percent of GDP is projected for 2008 (Tables 2 and 3), representing a big swing from a surplus of 2.2 percent in 2007. The authorities explained that the stimulus will, however, be small. About 1 percent of GDP constitutes extraordinary expenditures, with the bulk of it a transfer to the Infrastructure Fund. However, only about a quarter of this will be spent in this fiscal year. Another ¼ percent of GDP reflects accounting changes that reports expenditures already incurred in 2007 in the 2008 budget. The authorities stated that the modest positive impulse was not intended since their experience has been that a stimulus cannot be well timed and the additional expenditures largely increase imports. Thus, the stimulus applied in the downturn of 2001-2003 had little effect. Staff agreed with the policy stance. By 2009, some inevitable slowdown of revenue generation will occur. However, the authorities believe that projected surpluses in the cantons will likely be revised upwards.

Table 2.

Switzerland: General Government Finances 2005-10 1/

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

Excludes VAT increase planned for 2010, 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 1,350 million, 2006: SwF 2,100 million).

2008 total expenditures include extraordinary spending (SwF 5,247 mln). 2008-11 total expenditures exclude transfers out of the Special Infrastructure Fund created in 2008, due to lack of data.

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

Excludes cyclical items, but includes the one-off extraordinary expenditure of SwF 5,247 million (1 percent of GDP) in 2008.

Excludes cyclical and one-off items: expenditures of SwF 5,247 million (1 percent of GDP) in 2008.

Includes debt of Confederation (and special funds), cantons, and communes. Social security cannot issue debt.

Table 3.

Switzerland: Federal Government Finances 2005-10 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 2010, since it has not yet been approved.

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

Excludes revenues from Swisscom share sale (2002: SwF 3,703 million, 2005: SwF 1,350 million, 2006: SwF 2,100 million).

2008 total expenditures include extraordinary spending (SwF 5,247 million). 2008-11 total expenditure exclude transfer out of the special Infrastructure Fund created in 2008, due to lack of data.

Excludes cyclical items, but includes one-off extraordinary expenditures.

Excludes cyclical and one-off items: expenditures of SwF 4,500 million (about 1 percent of GDP) in 2008.

37. Although the public debt-to-GDP ratio is currently on the decline, long-run fiscal sustainability has not yet been achieved. Staff projections of an inter-temporal balance sheet suggest that the government’s net worth (including implicit liabilities from future aging costs and pension underfunding) is improving but a long-run shortfall still exits. As such, under current policies, debt will begin to increase in about 15 years (Table 4) in response to the projected rise of health care expenditures and other long-term pressures. The Long-Term Sustainability Report due to be published in May marks an important step in recognizing the tasks ahead and raising awareness of needed actions. However, as staff emphasized and the authorities recognize, this needs to be followed by concrete measures to contain expenditures. The authorities reported that while specific new actions had not yet been determined, the focus is likely to be on: (i) an increase in the VAT rate to finance disability insurance; (ii) an orderly reform of social benefits; and (iii) containment of health care expenditures. In this regard, staff suggested that the savings to be achieved through the Task Evaluation Program could prevent aging-related expenditures from crowding out other social expenditures. Staff also recommended the use of an inter-temporal government balance sheet as a tool for planning and communication.

Table 4.

Preliminary Public Sector Balance Sheet, 2002-07

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Sources: Swiss National Bank; Federal Finance Administration; and IMF staff calculations.

Reflecting mainly future deficits in social security. 2006 and 2007 improvements come from significant structural adjustment. Costs to the budget due to expenditures on old age, health and long term care assumed to increase 5.0% of GDP by 2050, same as the authorities projections in the Long Term Sustainability Report.


Under current policies, deficits increase…

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001


…and the debt increases.

Citation: IMF Staff Country Reports 2008, 170; 10.5089/9781451807400.002.A001

38. The debt brake rule is to be augmented to cover extraordinary expenditures. A concern with the debt brake rule has been that it exempts “extraordinary expenditures.” Since this exemption can be abused and since legitimate extraordinary expenditures for funding large projects will nevertheless occur, the proposal requires the authorization of these expenditures be contingent on additional measures over the medium term. Any extraordinary revenues will reduce the necessary compensation amount accordingly. The proposal has been submitted for public consultation in April and is expected to be approved by the parliament during the course of 2009. It is expected to enter in application with the 2011 budget.

39. The confederation is committed to improving the attractiveness of Switzerland as a business location. In this respect, the corporate income tax reform just approved, and to be implemented from 2009, will eliminate the double taxation of dividends for qualifying individual shareholders and, therefore, improve incentives to increase investment and remove biases favoring particular forms of project financing. A unified VAT framework, which will eliminate exemptions, improve efficiency, reduce administrative costs, and allow for a lower rate of 6 percent (currently 7.6 percent), could become effective as of 2011 at the earliest. Finally, the elimination of the marriage penalty tax has, for most married couples, reduced the high taxation of second earners and should increase labor force participation of skilled women. Similarly, cantons, with their low debt and traditionally-conservative fiscal stance, are likely to continue to lower their corporate tax rates. The authorities reiterated that these measures were consistent with their international obligations and that they served to create incentives for other countries to improve their public finances to create space for reduced taxation.

VI. Assessment of External Stability

40. Switzerland’s sizeable and growing current account surplus appears disconnected from developments in the real exchange rate. The current account surplus has steadily increased from 8 percent of GDP early in the decade to 17 percent of GDP in 2007 (Table 5). During that same period, the nominal and real exchange rates depreciated by about 7 and 10 percentage points respectively. This may suggest that a depreciating exchange rate has contributed to the growing surplus. However, the link appears tenuous:

Table 5.

Switzerland: Balance of Payments, 2005-13 1/

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

Fund staff estimates and projections unless otherwise noted.

Includes errors and omissions.

Official gold sales in 2005.

Table 6.

Switzerland’s International Investment Position, 2002-07

(in millions of Swiss francs, unless otherwise indicated; total at year’s end))

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As of September 2007.

Expansion of reporting population in 2004.

In 2005, distribution to Confederation and cantons of proceeds from gold sales.

In percent of GDP.