Abstract
KEY ISSUES Switzerland has once again had to contend with capital flow volatility. Following the exit from the exchange rate floor in mid-January 2015 and the subsequent appreciation of the franc, the Swiss economy faces exchange rate overvaluation, slower near-term growth, and deflation. Both growth and inflation are expected to recover gradually over the medium term—to around 2 percent and 1 percent, respectively—as the economy adjusts to the shock. However, this relatively benign scenario is subject to important risks, most notably that operating in a low inflation environment may prove more difficult than assumed in the central scenario. Monetary and fiscal policies can support faster adjustment and reduce risks. Further monetary easing via purchases of (mainly foreign) assets would help limit the near-term growth slowdown, reduce risks related to low inflation, and lessen franc overvaluation. Central bank communication should also be geared toward building an understanding of policy objectives and ensuring that inflation expectations do not become entrenched at low levels. Scope for fiscal policy to support aggregate demand is limited by Switzerland’s fiscal rule and the small, open nature of Switzerland’s economy. That said, fiscal policy can still support recovery by allowing automatic stabilizers to operate freely, as allowed under the rule. The rule’s escape clause should be triggered in the event of a severe downturn to allow discretionary fiscal stimulus, as monetary policy would likely be overburdened in such a scenario. The financial sector reform agenda should also be completed. The Swiss authorities have made important progress in this regard, and further steps are planned. Specific priorities, as laid out in last year’s Financial Sector Assessment Program (FSAP) update, include raising the leverage ratios of the two large international banks, increasing public disclosure of information on risk weights, reforming FINMA’s use of external auditors, overhauling deposit insurance, and containing housing- and mortgage-related risks. Over the medium term, Switzerland faces a number of structural challenges; the authorities’ ongoing efforts to address them are welcome and should continue. Priorities include adopting proposed pension reforms to ensure the sustainability of the system for future generations; completing ongoing reforms of corporate taxation and financial controls in ways that ensure full compliance with international initiatives aimed at limiting money laundering and cross-border tax evasion and avoidance; and reducing uncertainties related to future immigration policies and relations with the European Union.
General
On behalf of the Swiss authorities, we would like to thank staff for presenting a helpful report and for their candid policy recommendations. The report includes a thorough and insightful analysis of the macroeconomic situation. Moreover, it adds considerable value to the domestic policy discussions in Switzerland. In most aspects, we share staff’s opinion on the challenges going forward.
Outlook
Staffs outlook for the Swiss economy is well in line with our authorities’ latest forecast, which was done in March 2015. We are slightly more optimistic than the Fund regarding growth prospects for 2016, as our forecast relies on a firming recovery in export sectors. We fully share staffs risk assessment.
Monetary and exchange rate policy
The Swiss National Bank (SNB) shares staffs view that monetary conditions are too tight, given the overvaluation of the Swiss Franc. The SNB will therefore remain active in the foreign exchange market, as necessary, in order to influence monetary conditions. Regarding a preannounced program of foreign purchases, this might be one of the policy options. However, the effectiveness of such a policy should not be overestimated. As the recent experience suggests, the quantity of foreign assets to be purchased would presumably need to be fairly high to have a meaningful effect on the exchange rate. Moreover, this would expand the balance sheet at a pace that might limit the flexibility of monetary policy in the future. As it regards moving inflation back near the upper end of the target range (i.e., closer to 2 percent) over the medium term, the SNB’s view is that it is not possible, in a small open economy like Switzerland, to fine-tune inflation to such an extent. Announcing a narrow target would suggest that the SNB has better control of inflation than it actually does.
Fiscal policy
We agree with staff that both the debt brake rule at the federal level as well as the different fiscal rules at the cantonal level have largely contributed to the success of fiscal policy in recent years. According to our latest estimates, the general government should record a small deficit amounting to 0.1 percent of GDP in 2014. This nearly balanced result, which was reached in an increasingly difficult environment, underscores the decisive efforts at all government levels to keep fiscal policy on a sustainable path. In moving forward, we remain committed to the fiscal strategy of (i) complying with the requirements of the debt brake rule in the short and medium-term and (ii) maintaining expenditure growth at a sustainable level. At the same time, we are aware that economic indicators for Switzerland have recently worsened, pointing to a slowdown in growth. We share staff’s opinion that in this situation allowing automatic stabilizers to operate freely is the best way forward. Discretionary stabilization measures should remain an option only in case of a severe recession.
External assessment
We welcome the very helpful analysis of the factors underlying Switzerland’s large current account surplus. As rightly noted by staff, several special factors, such as (i) the treatment of retained earnings of multinational corporations, (ii) merchanting activities, and (iii) financial services, are important to understand the level and movement of the Swiss current account. It should be also noted that merchanting activities are not the only key driver of the goods balance surplus. In fact, the pharmaceutical and chemical export industry, which is not mentioned in the report, makes an even larger contribution, by accounting for more than 40 percent of total exports in goods.
Pension reform
We welcome staff’s recommendation to go forward with the comprehensive pension reform package prepared by the government. We also take note of the recommendation to reduce the minimum guaranteed interest rate on invested assets for second pillar pension funds. In this regard, we would like to note that our authorities review this minimum interest rate every year and acts, on the recommendation of a commission of external experts, to ensure an adequate level of objectivity, reliability, and transparency. The criteria considered include, among others, movements in equities, bonds, and real estate. Thus, the average yield of 10-year Swiss government bonds is not the key reference for setting the aforementioned minimum interest rate, as the staffs report might suggest. The last review of the rate in October 2014 did not give grounds for a rate reduction. In fact, while the yield on Swiss government bonds remained low, other asset classes including real estate posted good performances. The next review will take place in autumn 2015.
Financial sector policies
We generally agree with staffs assessment and recommendations on Swiss financial sector policies. We would like to provide comments in these three key areas.
Large banks
We welcome staffs support for the recommendations in the “Brunetti Report,” especially regarding the need to raise leverage ratio requirements for large banks to levels that are internationally leading. We agree that while these banks are well capitalized relative to peers in terms of risk weighted capital ratios, their leverage ratios are below the average of other major banks. We also share staffs view that improvements in risk weighted assets (RWA) transparency are needed. To address these and other issues, a working group led by the Federal Department of Finance is reviewing the Too-Big-To-Fail framework and will make concrete proposals by end-2015, taking into account the finalization of an international standard on Total Loss-Absorbing Capacity (TLAC) for global systemic banks. This group has a mandate, in particular, to recalibrate risk weighted and leverage ratio requirements so that they are internationally leading and to review the method of calculating RWA and propose adjustments, if necessary. Finally, we share staffs view that, while the large banks have announced important steps to adapt their legal structure, continued action, including at international level, is needed to further improve their resolvability.
Housing and mortgage sector
We share staffs assessment that, despite a partial slowing of dynamics in the housing and mortgage sectors, risks remain high. Various prudential measures have been undertaken between 2012 and 2014 to address these risks. While the measures appear to have had some positive effect, large imbalances remain. As noted in the report, measures implemented recently require more time to take full effect. Our authorities will continue to (i) closely monitor developments in the housing and mortgage markets and (ii) reassess on a regular basis the need for an adjustment to the countercyclical capital buffer. Moreover, they agree that further policy action may be warranted, in particular, to target affordability and the income-producing real estate sector.
FINMA’s supervisory approach
Regarding staff’s recommendation to improve the system of external audit firms used for regulatory audits, we understand that directly mandating audit firms and paying them through a FINMA-managed and bank-financed fund may reduce conflicts of interests. Switching to such a system would, however, require legislative changes. Furthermore, effective measures are already in place to ensure FINMA’s control over the work conducted by audit firms and to prevent banks from influencing their auditors. Our authorities are also of the opinion that periodic rotation of audit firms, as recommended by staff, would not be an effective measure to enhance the Swiss supervisory approach, owing to the oligopolistic structure of the audit market. Finally, after a recent significant expansion in staffing, FINMA considers its current resource to be adequate.