Switzerland: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Switzerland

The Swiss economy has performed relatively well since the global financial crisis.

Abstract

The Swiss economy has performed relatively well since the global financial crisis.

Context

1. The Swiss economy has performed relatively well during the decade since the global financial crisis, notwithstanding periodic safe-haven pressures. Cumulative economic growth compares favorably with other advanced economies. The high standard of living reflects high-quality human and physical capital, supported by sizable ongoing investment in innovation and education. Aggregate employment has grown robustly, and productivity is among the highest in the OECD. The fiscal and public debt positions are strong, and the external trade surplus remains large and stable despite several episodes of intense appreciation pressure. Strong fundamentals and sound macroeconomic management have contributed to the Swiss franc’s reputation as a safe haven.

uA01fig01

Cumulative real GDP growth 2006–2018

(2007=100)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: Haver;and IMF staff calculations.

Recent Developments

2, Output grew well-above trend in 2018, although momentum slowed during the second half of the year. Robust external demand early in the year buoyed net exports and investment. However, weaker global trade since mid-2018, combined with temporary factors—a drought that prevented transporting goods to market and bottlenecks in the European auto sector—caused growth to slow and temporarily turn negative in Q3:2018. In all, output grew by 2.5 percent last year, around one percentage point higher than in 2017, with proceeds from biennial international sporting events contributing about 0.3 percentage points.1 Year-on-year growth was 1.4 percent in Q1:2019.

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GDP Growth

(Percent, y/y)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: SECO; and IMF staff calculations.
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Inflation by Component

(Y/y percent change)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: Haver; and IMF staff calculations.

3. Despite a tightening labor market, inflation remains subdued. A surge in imported energy prices and depreciation of the franc temporarily pushed headline inflation above 1 percent in mid-2018. Subsequent reversals caused inflation to moderate to 0.7 percent in April 2019, below the mid-point of the SNB’s 0–2 percent price stability band. At around ½ percent, domestic-sourced inflation is lower and more stable than its headline counterpart. The unemployment rate has continued to decrease, reaching 4.6 percent at end-2018,2 and job openings point to shortages of engineers and IT specialists. Rising productivity and inflows of foreign workers have kept unit labor costs contained. While varying by sector, capacity utilization remains in line with—or somewhat above—long-term averages, consistent with a modest positive output gap.

4. The current account surplus increased strongly in 2018 owing to a rebound in investment income. At 10.2 percent of GDP in 2018, the current account (CA) surplus was around 3½ percentage points higher than the downwardly-revised value for 2017 on a swing in direct investment income. Nonetheless, the balance on trade in goods and services has remained stable at around 11 percent of GDP, notwithstanding fluctuations in the REER. The NIIP remained broadly constant at 128 percent of GDP.

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Current Account and Components

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources:SNB; Haver WEO; and IMF staff calculations.

5. Expectations of continued loose financial conditions are fueling investment in real estate. The franc depreciated sharply in nominal effective terms in early 2018, but has since partially reversed its previous weakness following a series of risk on-off cycles that created volatility for the safe-haven currency. However, from a longer-term perspective, the CPI-based REER has continued to appreciate. Interest rates remain near historical lows, with negative yields on government bonds with maturities up to 10 years. Private sector credit relative to GDP has risen strongly since the GFC, mainly for mortgages, and exceeds its long-term trend. The prospect of continued low interest rates has increased risk-taking in residential real estate, where prices are high or rising.

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Effective Exchange Rates

(Index, 2010=100)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: IMF INS database; and IMF staff calculations.
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Government Bond Yields

(Percent, eop)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: Haver; Thomson Reuters Datastream; and IMF staff calculations.
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Switzerland: Private Sector Credit

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: Haver, BIS, and IMF staff calculations.

Report on Discussions

A. Outlook and Risks

Staff’s Views

6. Following a near-term slowdown, GDP growth is expected to quickly return to a more-normal pace on a recovery in foreign demand. Annualized growth is expected to slow to around 1.1 percent in 2019 on more subdued global trade, carryover from weakness in the latter part of 2018 and the absence of biennial international sporting events. Nonetheless, momentum is forecast to recover quickly alongside the dissipation of the temporary restraining factors. As a result, output excluding the effects of international sporting events is projected to grow by around 1½ percent from 2020, close to its potential, keeping the output gap broadly closed over the medium term. In addition, the biennial cycle of sporting events will continue to add year-to-year volatility to headline GDP growth. The tightening labor market and limited spare economic capacity are projected to gradually return inflation close to the mid-point of the SNB’s inflation band by end-2020, while continued inflows of foreign workers will contain incipient wage pressures. The CA surplus is expected to remain broadly stable at around 10 percent of GDP, notwithstanding the hard-to-predict income balance.

7. External and domestic risks to the outlook are tilted down. A more sustained regional slowdown, intensification of international trade tensions, persistent weakness in global import demand, and a disruptive Brexit would adversely affect the very-open Swiss economy. High global indebtedness could create financial market volatility that transmits to the Swiss financial system and its globally-active banks. As a safe-haven currency, the franc remains vulnerable to appreciation pressure from renewed global or regional risk aversion. Search for yield in a prolonged low growth-low inflation setting could cause risks in the domestic real estate market to materialize. Uncertainties regarding an institutional agreement between Switzerland and the European Union and some remaining aspects of the domestic reform agenda—including for corporate taxation and old-age pensions—could increase volatility and reduce Switzerland’s appeal as an investment destination.

Authorities’ Views

8. Following a temporary slowdown, the authorities expect economic activity to recover and grow in line with potential. From mid-2017 to mid-2018, growth benefitted from an uplift from major trading partners’ import demand. A somewhat weaker effective exchange rate also provided support and enabled firms to rebuild profit margins. The direct effect of US tariffs on Swiss exports has been limited, but indirect effects are larger. As in other countries, Swiss growth momentum slowed in the second half of 2018. While growth should recover in 2019, carryover from the latter half of 2018 will weigh on growth this year, with GDP growth expected to reach 1.1 percent. Domestic and external demand are projected to raise growth to around 1.7 percent in 2020 and keep the output gap broadly closed. Conditioned on an unchanged policy interest rate, inflation is forecast to slightly decline in 2019 before rising gradually to 1.2 percent by 2021 (as of March 2019).

9. Risks to growth are seen as skewed to the downside. Greater recourse to protectionist policies, uncertainty over Brexit or concerns about fiscal sustainability in some euro-area countries could weaken global growth and trigger volatility in international financial markets that revives safe-haven pressures and impacts profits of the Swiss G-SIBs. On the domestic front, persistent imbalances in the mortgage and real estate markets, especially for residential investment property, create the risk of a price correction. In addition, further delays in finalizing an institutional agreement between Switzerland and the EU could prolong uncertainty for businesses and gradually erode access to some EU markets.

B. External Sector Assessment

Background

10. The size and composition of the external accounts are influenced by Switzerland’s role as a financial center and corporate hub. Large CA surpluses—averaging around 10 percent of GDP since the GFC—are increasingly driven by goods trade and profits from merchanting, with a declining contribution from services. Responsiveness of several components (profits from merchanting, trade in pharmaceuticals and luxury products) to changes in the REER appears limited. Direct investment income is subject to sizable year-to-year swings that introduce volatility into the CA, as well as to large ex post revisions that can make the CA difficult to predict3 From a saving-investment perspective, the CA surplus is attributed to households’ net lending, which is partly offset by corporates’ more-moderate net borrower position.4 The positive NIIP of 128 percent of GDP has been relatively stable over time, despite persistent accumulation of past CA surpluses, reflecting valuation losses on net foreign assets. Gross financial flows and stocks are large relative to GDP, reflecting pass-through investment by multinationals, private sector safe-haven flows and accumulation of official reserves. Gross positions declined in 2018 in reponse to the US Tax and Jobs Act5 Errors and omissions also tend to be volatile. The CPI-based REER is 16 percent higher than in 2008.

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Net Lending/Borrowing by Sector, 2017 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Source: OECD.1/ Data for BEL, CHE, GRC, IRL, POL, JPN, MEX are for 2016.
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NIIP by Currency

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: SNB, Haver; and IMF staff calculations.

Staff’s Views

11. While the REER has been volatile since the GFC, moderate trend appreciation is consistent with Switzerland’s highly-productive and profitable sectors. Despite at times very large FX purchases, several episodes of extreme safe-haven pressure resulted in sharp real appreciations, which have since been largely unwound by subsequent nominal depreciation and lower inflation in Switzerland than elsewhere. Nonetheless, from a longer-term perspective, the REER has generally strengthened in line with its trend, consistent with the presence of high value-added sectors that exert upward pressure on wages and prices across the economy. Thus, while the REER has returned to the level that prevailed during the floor against the euro, employment in more-traditional sectors exposed to international competition remains pressured.

uA01fig10

Switzerland: Real Effective Exchange Rate

(CPI-Based, end-2000 = 100)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: Haver; and IMF staff calculations.
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Pension Savings

(CHF billions)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: Swiss Federal Social Insurance Office, Federal Statistical Office; and IMF staff calculations.

12. High household saving is a major contributor to Switzerland’s current account surplus. Large saving under the mandatory pillar 2 pension scheme, supplemented with (partly tax incentivized) voluntary pension saving, reflects the sizable share of the population approaching retirement age and facing a long remaining life expectancy. A bequest motive among high net worth individuals also adds to saving. The high saving rate combined with limited domestic investment opportunities suggests a sustained external contibution to Switzerland’s GDP growth, and some rebalancing toward domestic absorption over the medium term would reduce this dependence. However, high savings could compress yields and encourage further saving in order to secure a target income in retirement. This effect is reinforced by a preference for domestic assets to avoid valuation losses on unhedged foreign-currency assets (or the cost of hedging) in the context of the higher post-crisis risk of appreciation given the franc’s safe-haven status. High household net lending, together with the increased preference for Swiss assets since the GFC, contributed to the rapid buildup of reserves by the SNB in previous years. At about 115 percent of GDP, reserves are large, but more moderate relative to short-term foreign liabilities.6 Reserves are the byproduct of monetary policy operations aimed at avoiding volatility in output and inflation especially when the policy interest rate is close to the effective lower bound. Resumption in mid-2017 of private financial outflows restored the pre-GFC balance of payments pattern.

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Balance of Payments

(Percent of GDP – negative=outflows)

Citation: IMF Staff Country Reports 2019, 180; 10.5089/9781498321488.002.A001

Sources: SNB; and IMF staff calculations.

13. Switzerland’s external position in 2018 was broadly consistent with medium-term fundamentals and desirable policies. Based on a cyclically-adjusted CA surplus of 10.4 percent of GDP and an external balance assessment (EBA) norm of 6.0 percent, policy gaps and the unexplained residual sum to 4.4 percent of GDP. However, some factors especially-relevant for Switzerland are not appropriately treated in the income account of the CA, and contribute 3.5 percentage points to the EBA unexplained residual (see Table 7).7 Excluding these factors results in a remaining CA gap centered on 0.9 percent of GDP with an uncertainty band of ±2 percentage points.8 Hence, the remaining CA gap is within— but close to the upper bound of—the “broadly consistent” range, with the corresponding REER gap estimated at [-6.5, +1.0] percent. Further real depreciation could therefore affect future assessments.

Table 1.

Switzerland: Selected Economic Indicators, 2016–24

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Sources: Haver Analytics; IMF’s Information Notice System; Swiss National Bank; and IMF Staff estimates.

Contribution to growth. Inventory accumulation also includes statistical discrepancies and net acquisitions of valuables.

Reflects new GFSM 2001 methodology, which values debt at market prices. Calculated as the sum of Federal, Cantonal, Municipal and Social security gross debts.

Based on relative consumer prices.

Table 2.

Switzerland: Balance of Payments, 2016–24

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Sources: Haver Analytics; Swiss National Bank; and IMF staff estimates.
Table 3.

Switzerland: SNB Balance Sheet, 2010–18

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Sources: Swiss National Bank; and IMF staff estimates.

Currency in circulation and sight deposits of domestic banks.

Table 4.

Switzerland: General Government Finances, 2016–24

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

Includes the balance of the Confederation and extrabudgetary funds (including Public Transport Fund, ETH, Infrastructure Fund).

Includes old age, disability, survivors protection scheme as well unemployment and income loss insurance.

Forcasted

Table 5.

Switzerland: General Government Operations, 2008–18

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Source: Federal Ministry of Finance.
Table 6.

Switzerland: Bank Soundness Indicators, 2010–18

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Source: Swiss National Bank.

Based on parent company consolidation. This consolidation basis equals the CBDI approach defined in FSI compilation guide plus foreign bank branches operating in Switzerland, and minus overseas deposit-taking subsidiaries.

Mining and extraction, production and distribution of electricity, natural gas and water, financial intermediation, social security, exterritorial bodies and organizations, other.

In 2015, the indicator was redefined in line with Basel III regulations, leading to a series break. The 2015 value under the new definition is not yet available.

Table 7.

Switzerland: External Sector Assessment

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