Switzerland: Selected Issues
Author:
International Monetary Fund. European Dept.
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Publication Date:
20 Jun 2022
eISBN:
9798400212994
Language:
English
Keywords:
investment return rate; acquisition-accumulation gap; investment performance difference; cumulative finance account balance; revaluation gain; International investment position; Portfolio investment; Return on investment
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This paper identifies exchange rate revaluation losses and relatively low returns on foreign assets as key factors for the large gaps between Switzerland’s net foreign assets acquisitions and accumulations. It suggests a few directions that may help Switzerland reduce the gaps, including robust global diversification by Swiss investors that would also relieve appreciation pressures on the franc, improving the currency composition of foreign assets to reduce exchange rate risks, and raising foreign investment returns, e.g., through improved pension fund performance.,

Abstract

This paper identifies exchange rate revaluation losses and relatively low returns on foreign assets as key factors for the large gaps between Switzerland’s net foreign assets acquisitions and accumulations. It suggests a few directions that may help Switzerland reduce the gaps, including robust global diversification by Swiss investors that would also relieve appreciation pressures on the franc, improving the currency composition of foreign assets to reduce exchange rate risks, and raising foreign investment returns, e.g., through improved pension fund performance.,

Big Acquisition, Small Accumulation: Why?1—A Look at Switzerland’s BOP-IIP Dynamics

This paper identifies exchange rate revaluation losses and relatively low returns on foreign assets as key factors for the large gaps between Switzerland’s net foreign assets acquisitions and accumulations. It suggests a few directions that may help Switzerland reduce the gaps, including robust global diversification by Swiss investors that would also relieve appreciation pressures on the franc, improving the currency composition of foreign assets to reduce exchange rate risks, and raising foreign investment returns, e.g., through improved pension fund performance.,

A. The Puzzle of Big Acquisition and Small Accumulation

1. The balance of payments (BOP) and the international investment position (IIP) are two important macroeconomic accounts to assess an economy’s external activities. The BOP is a flow table that records external transactions during a certain period. It has two components, the current account (CA)—showing the sources of savings (a positive balance) or dissavings (a negative balance), and the financial accounts (FA)—showing how the savings in the CA are allocated for asset accumulation or how the dissavings in the CA are financed (Figure 1). The IIP, on the other hand, is a stock table reflecting the economy’s external assets and liabilities at a certain point of time. The changes in IIP stocks during a period can be accounted for by the FA of the BOP, often with small discrepancies due to other, non-transactional changes (e.g., valuation changes related to exchange rate movements). Such discrepancies, however, were quite large for Switzerland.

Figure 1.
Figure 1.

An Illustration of the BOP-IIP Dynamics

Citation: IMF Staff Country Reports 2022, 172; 10.5089/9798400212994.002.A001

Note: Some items, such as financial derivatives and the capital accounts, are not shown. For a more complete presentation, please see the Balance of Payments and International Investment Position Manual, Sixth Edition (BPM6).
Figure 2.
Figure 2.

Switzerland: The Puzzle of Big Acquisition and Small Accumulation

Citation: IMF Staff Country Reports 2022, 172; 10.5089/9798400212994.002.A001

Source: Have Analytics.

2. Switzerland has, on a net basis, acquired large amounts of foreign assets over time. The increase in its net IIP, however, has been much smaller. The BOP data show that Switzerland’s cumulative finance account balance (CFAB) amounted to CHF1.2 trillion during 2000–2020 (Figure 2). The increase in its net IIP, however, was only around CHF220 billion during the same period. Such a gap between the net acquisition of foreign assets and the increase in the net IIP (the “acquisition-accumulation gap”) was more striking in 2008–20, the period after the global financial crisis (GFC): while Switzerland’s net acquisition of foreign assets was over CHF600 billion, its net IIP increased by only CHF25 billion.

3. This paper aims to shed light on the acquisition-accumulation gaps from two different perspectives. The first angle draws on the new Swiss integrated IIP statement, which provides a detailed breakdown of changes in IIP stocks. The second angle takes a cross-country perspective, comparing Switzerland to a group of economies that also had large net foreign assets acquisitions, but with different IIP accumulation outcomes.

B. Analysis of Switzerland’s Integrated IIP Statement

Net Position of Total Investment

4. From an aggregate perspective, negative exchange rate revaluations were the main driver of the acquisition-accumulation gaps. The integrated IIP statement breaks changes in IIP stocks into transactions, exchange rate revaluations, price revaluations, and other changes (Table 1).2,3 For the period 2000–2020, negative revaluations due to exchange rate movements (CHF 704 billion) accounted for nearly 60 percent of the acquisition-accumulation gap (CHF 977 billion). These revaluation losses were particularly large relative to transactions in the post-GFC era (CHF 558 billion versus CHF 632 billion). This is not surprising given the sharp nominal appreciation of the franc since 2008 (Figure 3). “Other changes” was another important category underlying the acquisition-accumulation gap, which, to certain extent, reflects the challenge of accurately measuring the BOP and IIP for a small, open economy like Switzerland (see footnote 2). Price revaluations was also a contributing factor, but only played a minor role compared to exchange rate revaluations and other changes.

Table 1.

Switzerland: Net International Investment Position

article image
Source: Swiss National Bank Data Portal. Note: Excluding financial derivatives.
Figure 3.
Figure 3.

Switzerland: Franc NEER Index

Citation: IMF Staff Country Reports 2022, 172; 10.5089/9798400212994.002.A001

Source: Haver Analytics.

Analysis by IIP Component

5. An analysis of the gaps by IIP component has three focuses: exchange rate revaluations, investors’ willingness to invest, and investment returns. Changes in Swiss investors’ willingness to invest abroad (and willingness of non-residents to invest in Switzerland)— an important factor that interacts with exchange rate movements—are assessed by comparing transaction volumes before and after the GFC.4 The investment return rates of certain assets are estimated using the following equation:

Investment return rate=Investment income(from BOP CA)+price revaluationsAverage stock position

6. All major components of the IIP experienced significant exchange rate revaluation losses during 2008–2020, except other investment.5 Direct investment lost CHF 235 billion due to exchange rate revaluations during 2008–2020 (Table 2). While the exchange rate revaluation was also negative during 2000–2007, the magnitude was much smaller (CHF 37 billion). Developments for portfolio investment and reserve assets were similar.6 Other investment, in contrast, enjoyed a small exchange rate revaluation gain (CHF 17 billion) during 2008–2020. Since other investments are mostly cross-border banking activities, this is probably an indication of sound exchange rate risk management by banks.

7. The private sector in Switzerland appears to have become less willing to invest abroad after the GFC, while the SNB leaned against such a trend. During 2000–2007, the net acquisition of foreign assets by the Swiss private sector averaged CHF 73 billion a year.7 This turned into a net reduction of foreign assets during 2008–2020, averaging CHF 16 billion a year.8 This shift was driven by other investment and portfolio investment, while the average annual net FDI abroad remained largely unchanged before and after the GFC.9 By contrast, the SNB acquired, on average, CHF 65 billion reserve assets each year after the GFC, compared to a small net reduction of CHF 2 billion a year before.10 As a result, while the net IIP of non-SNB sectors declined by CHF846 billion during 2008–2020, the SNB’s net IIP increased by CHF869 billion. The additional acquisition of foreign assets by the SNB, however, only partially offset the decline in private investment abroad. This may be a reason why, despite the SNB’s large FXI operations during 2008–2020, the Swiss franc still faced persistent appreciation pressures in this period.

Table 2.

Switzerland: International Investment Position by Component

article image
Sources: Swiss National Bank Data Portal, IMF staff calculations.

Due to two-way holdings by financial holding companies and active balance sheet management by banks, a further breakdown of direct investment and other investment by assets and liabilities is not partuciularly informative and therefore not shown in the table. For these two categories, net transactions (rather than transactions of foreign assets) were used to assess Swiss investors’ willingness to invest abroad. For more discussions on this issue, please see “Swiss Franc – Safe Haven for Whom?” IMF Selected Issues Paper, Country Report 21/131.

The price revaluations for 2000–2007 and 2000–2020 included gains of around CHF25 billion from an extraordinary revaluation of SNB’s gold holdings in 2000.

8. The difference in returns on portfolio investment assets and liabilities was another important reason for the acquisition-accumulation gap. During 2008–2020, the average return rates on Switzerland’s portfolio investment assets and liabilities were 4.3 percent and 5.3 percent, respectively (Table 3). The average return rate on reserve assets, 3.9 percent, was lower.11 Had portfolio investment assets and reserve assets achieved the same return rate as portfolio investment liabilities, the acquisition-accumulation gap during 2008–2020 (CHF609 billion, see Table 1) would have been narrowed by around CHF260 billion.

Table 3.

Switzerland: Investment Returns of Foreign Assets and Liabilities

article image
Sources: Haver Analytics, Swiss National Bank Data Portal, IMF staff estimates.

For reserve assets, the year of 2000 was not included in the calculations, to exclude the gains from an extraordinary revalution of SNB’s gold holdings in 2000.

9. Investment performance differences can be, at least partly, explained by risk profiles associated with portfolio investment assets and liabilities. During 2008–2020, the average shares of debt securities and equities in Swiss portfolio investment assets abroad were 55 percent and 45 percent, respectively (Table 4). In contrast, over 90 percent of foreign portfolio investments in Switzerland were equities. The SNB maintained a different risk profile on its substantial and growing portfolio investment: during 2011–2020, the shares of equity investment among SNB foreign currency reserves averaged 17.5 percent.

Table 4.

Switzerland: Shares of Equity Investment

article image
Sources: Haver Analytics, Swiss National Bank annual reports, Swiss National Bank Data Portal, IMF staff calculations.

Average of 2011–2020 year-end shares.

10. If exchange rate revaluations are also considered, the returns on foreign assets in the post-GFC era look even less attractive relative to those on foreign liabilities. The 1-percentage-point return gap between portfolio investment assets and liabilities widens to 2.4 percentage points (Table 3). This seems to suggest that the decline of private Swiss investors’ interest in overseas portfolio investment in the post-GFC era was rational, and its interaction with the exchange rate (lower return and depreciation of non-CHF holdings) may have led to a self-reinforcing component in the persistent appreciation pressure on the franc during this period.12

C. A Cross-Country Comparison

11. The cross-country analysis focuses on the post-GFC period and compares Switzerland with ten other economies that also acquired significant amounts of foreign assets.13 We are particularly interested in the post-GFC era, because Switzerland’s acquisition-accumulation gap was especially large in this period (Figure 2). The 2008–2020 cumulative financial account balances (CFABs) of the economies in the group all exceed 30 percent of their respective 2020 GDPs.14 Limiting the sample to these economies ensures a certain degree of comparability, thereby making the analysis of a complex, multifaceted problem more trackable.

12. More specifically, the paper aims to provide a better understanding of Switzerland’s large acquisition-accumulation gap by exploring two specific, exchange rate-related questions. The questions concern exchange rates because the large appreciation of the franc, as discussed in the previous section, was a key driver of Switzerland’s acquisition-accumulation gap. The first question is why Israel managed to achieve a larger net IIP increase than its cumulative foreign assets acquisition, despite a 45-percent nominal appreciation of the shekel, second highest among the group and only next to the 55-percent appreciation of the Swiss franc (Figures 4 and 5). The second question is why some currencies (e.g., the Norwegian krone, the Singapore dollar, and the new Taiwan dollar) appreciated much less than the franc, even though the net acquisitions of foreign assets of these economies were much larger than Switzerland’s.

Figure 4.
Figure 4.

Cumulative Financial Account Balances versus Changes in NIIP, 2 008–20

Citation: IMF Staff Country Reports 2022, 172; 10.5089/9798400212994.002.A001

Sources: IMF World Economic Outlook database; IMF staff calculation.Note: Based on IMF WEO data denominated in USD.
Figure 5.
Figure 5.

Cumulative Financial Account Balances versus NEER Changes, 2008–20

Citation: IMF Staff Country Reports 2022, 172; 10.5089/9798400212994.002.A001

Sources: BIS, IMF World Economic Outlook database, IMF staff calculation.Note: The financial account balances were calculated using IMF WEO data denominated in USD.

Question 1. How to explain the difference between the acquisition-accumulation gaps for Switzerland and Israel, despite similarly large appreciations of their currencies?

13. Exchange rate revaluations explained a large part of the difference between the acquisition-accumulation gaps of Israel and Switzerland. For Switzerland, negative exchange rate revaluations (CHF558 billion) offset nearly 90 percent of its net foreign assets acquisitions during 2008–2020 (Table 5, Column 2). In contrast, Israel experienced only a small exchange rate revaluation loss (ILS4 billion) compared to its net foreign assets acquisition (ILS130 billion).

Table 5.

Switzerland versus Israel: Cumulative International Investment Position Changes, 2008–2020

article image
Sources: Haver Analytics, Swiss National Bank, IMF World Economic Outlook database, IMF staff estimates.

Estimated based on the Swiss IIP in CHF. For period T, the beginning IIP was converted using the exchange rate of period T-1, and the ending IIP, transactions, price revaluations and other changes were converted using the exchange rate of period T. The exchange rate revaluations in USD was calculated as (ending IIP_USD – beginning IIP_USD – transactions_USD – price revaluations_USD – other changes_USD).

Table 6.

Switzerland versus Israel: International Investment Returns (%), 2008–2020 1/

article image
Sources: Haver Analytics, Swiss National Bank, IMF World Economic Outlook database, IMF staff estimates.

Investment return rate = (Price revaluation+investment income)/average stock.

14. In addition to the slight difference in strength of the franc and shekel, other factors also contributed to the difference in exchange rate revaluations. These include the currency used for IIP denomination, the currency compositions of foreign assets and liabilities, and the size of net IIP. Denominated in USD, the negative exchange rate revaluations for Switzerland would become smaller relative to total transactions (Table 5, Column 3). On the other hand, the still-sizable exchange rate revaluation losses (USD381 billion) suggest that a currency mismatch between Switzerland’s foreign assets and liabilities played an important role as well.15 During 2008–2020, Israel’s net IIP averaged around 30 percent of GDP, while the ratio was almost 100 percent for Switzerland, exposing it to more exchange rate revaluation risks.

15. Investment returns appear to be an important factor underlying the differences for Israel and Switzerland as well. While the overall return on Israel’s foreign assets (5.0 percent) was higher than that on its foreign liabilities (4.6 percent), it was the opposite for Switzerland (Table 6). If the returns on Switzerland’s foreign assets and liabilities were the same as Israel’s, it would have had around CHF300 billion additional price revaluation gains during 2008–2020. This investment performance difference is most notable for portfolio investment: while the average return on Israel’s foreign assets was 3.2 percentage points higher than that on its foreign liabilities, the differential was -1.0 percentage point for Switzerland.16 This seemed mostly driven by their different asset returns (Israel 8.2 percent versus Switzerland 4.3 percent) rather than liabilities. Higher risk appetite might help explain Israel’s better investment returns, although more work is needed to understand what other factors, and to what extent they have, played a role.17

Question 2. Why did some currencies (e.g., NOK, SGD and TWD) appreciate much less than the franc, even though these economies had larger CFABs than Switzerland?

16. Inflation differentials seem able to bridge the disconnect between nominal exchange rate changes and CFABs for most economies in the sample. Without considering Switzerland, Israel or Norway (the lone major commodity exporter among the group), a simple regression of changes in real effective exchange rates (REER) against CFABs produced a very good fit, with an R2 of almost 0.9 (Figure 6). This shows that, for these economies, higher CFABs (the flip side of current account balances) were indeed associated with larger exchange rate appreciations or smaller depreciations—after adjustments for inflations. Given the importance oil products in Norway’s overall exports, the REER of krone was closely linked to oil prices (Figure 7). The excess depreciation of the krone was likely, at least to some extent, driven by the collapse of oil prices during 2014 and 2015—the krone REER depreciated by 16 percent in this period, accounting for ¾ of the total depreciation during 2008–2020.

Figure 6.
Figure 6.

Cumulative Financial Account Balances versus Changes in REER, 2008–20

Citation: IMF Staff Country Reports 2022, 172; 10.5089/9798400212994.002.A001

Source: BIS, IMF World Economic Outlook database, IMF staff calculation.
Figure 7.
Figure 7.

Norwegian Krone REER and Oil Prices

Citation: IMF Staff Country Reports 2022, 172; 10.5089/9798400212994.002.A001

Source: Haver Analytics.

17. The fact that the SNB and the Bank of Israel had to lean against safe haven flows and the resident and non-resident private sectors through FXIs seems to help explain the particularly large appreciations of their currencies. Among the economies in the sample, only in Switzerland and Israel, did the non-central-bank sectors record net capital inflows between 2008 and 2020 (Table 7). In some other economies, such as Singapore and Taiwan Province of China, central banks also had to step in to mitigate appreciation pressures, although it was the non-central-bank sectors that did the most heavy-lifting (by investing abroad). While the fit of regressing REER changes against CFABs for the full sample was poor (R2 of 0.01),18 adding the non-central-bank sectors’ shares in total capital outflows (the last column of Table 7) as an additional regressor increased the R2 to 0.74. This suggests that the low willingness of non-central-bank sectors to invest abroad may indeed have played an important role for the larger appreciations of the franc and the shekel compared to others.

Table 7.

Decomposition of 2008–2020 Cumulative Financial Account Balances

article image
Sources: Haver Analytics, IMF WEO Database, IMF staff calculations.

A negative value indicates net capital inflows.

D. Summary

18. The paper identifies exchange rate revaluation losses and relatively low returns on foreign assets as two important factors for Switzerland’s large acquisition-accumulation gaps. The strength of the franc was a main reason for the exchange rate revaluation losses, but the currency composition mismatch between foreign assets and liabilities and the large size of the net IIP (and therefore exposure) also played roles. In the post-GFC era, the Swiss private sector became more reluctant to invest abroad. The cross-country comparison suggests that this might help explain why the franc appreciated more than other currencies, even though all of the economies in the sample had sizable CA balances. The difference in investment returns can be attributed in part to portfolio risk profiles, as measured by the allocation between debt securities and equities.

19. Since there were complex trade-offs associated with these outcomes, the paper’s findings should be interpreted more from a positive rather than a normative perspective. For instance, while Switzerland’s large official FX reserves may be less-than-optimal from a perspective of aggregate investment returns—because the SNB has a different risk profile than private sector investors, FXI operations by the SNB have helped to reduce volatility on the FX market and mitigate appreciation pressures on the franc and therefore downward pressure on domestic inflation in Switzerland and, to some extent, the self-reenforcing loop between Swiss investors’ home bias and the appreciation trend of the franc. Another example of such a trade-off is that while appreciation of the franc has led to significant IIP revaluation losses, it has also brought a substantial increase of foreign purchasing power to the overall wealth of Swiss residents.

20. That said, this study points to some directions that may help Switzerland reduce its acquisition-accumulation gap. One is to relieve appreciation pressures on the franc in a fundamental and sustainable way, including through more robust global diversification by Swiss investors.19 Swiss investors should also be more active in assessing and improving the currency composition of their foreign assets to limit exchange rate revaluation losses. Finally, there appears to be room for private Swiss investors to improve the returns on their foreign investments. For instance, pension funds are an important part of the asset management industry. The large number and relatively small size of pension funds in the current system indicate room for efficiency gains through consolidations.20

References

1

Prepared by Li Zeng (EUR). The author would also like to thank Mark Horton and seminar participants at the Swiss National Bank for their helpful comments.

2

Price revaluations reflect unrealized nominal holding gains/losses due to price changes, while realized holding gains (if reinvested) or losses are recorded as part of transactions. Other changes are changes in IIP stocks which are caused neither by transactions nor revaluations. They arise from, for instance, expansions in the reporting population or reclassifications.

3

In the IMF’s external sector assessment (ESA) exercise, the gaps between the current account balances and IIP stock changes were partially accounted for through adjustors for measurement issues under the sixth edition of the IMF Balance of Payments and International Investment Position Manual. For more discussions on these adjustors, see “The Measurement of External Accounts,“ IMF Working Paper 19/132. In the integrated IIP statement, which gives a more complete breakdown of those gaps, the impacts of the measurement issues are reflected in different components. For instance, the adjustor for nominal interest on fixed income securities is captured as a part of the exchange rate revaluations, and the adjustor for retained earnings of portfolio equity investment is a driving factor for the price revaluations.

4

Changes in transaction volumes may also reflect other factors, such as regulation changes.

5

Other investment mainly covers cross-border banking activities, such as foreign deposits and cross-border loans.

6

For portfolio investment, foreign liabilities brought some exchange rate revaluation gains. But they were smaller compared to the losses on assets, because most of such foreign liabilities were denominated in Swiss franc.

7

Direct investment +CHF27 billion, portfolio investment +CH51 billion, and other investment -CHF5 billion.

8

Direct investment +CHF29 billion, portfolio investment +CH14 billion, and other investment -CHF59 billion.

9

For direct investment and other investment, net transactions (rather than transactions of foreign assets) were used to assess Swiss investors’ willingness to invest abroad. This was due to the large amounts of offsetting transactions, e.g., caused by financial holding companies or banks’ active management of both their assets and liabilities. For more discussion, please see “Swiss Franc – Safe Haven for Whom?” in IMF Country Report 21/131. The reduction of net other investment holdings was probably a contributing factor to banks’ good exchange rate risk management in the post-GFC era. On direct investment, one caveat is that much of the outward FDIs occurred after the U.S. tax reforms in 2017—net FDI outflows averaged nearly CHF100 billion during 2018–2020. This was likely driven by financial holding companies’ withdrawals.

10

Foreign exchange purchases by the SNB through FXIs were mostly concentrated in a few episodes with particularly large safe-haven capital inflows, for example, in early 2010 after the outbreak of the Greece debt crisis, in 2012 with the spread of the European debt crisis, in late 2014 and early 2015 with the anticipation of QE operations by the ECB, and in early 2020 after the outbreak of the Covid-19 pandemic.

11

During 2008–2020, investment on foreign currency securities accounted for, on average, 80 percent of total reserve assets. This ratio was around 55 percent during 2000–2007.

12

See also “Swiss Franc – Safe Haven for Whom?” IMF Selected Issues Paper, Country Report 21/131, IMF.

13

These include Germany, Israel, Japan, Korea, Macao SAR, Netherlands, Norway, Singapore, Sweden, and Taiwan Province of China.

14

A few economies were excluded due to their distinctive features, including Hong Kong SAR (with a currency board exchange rate system linked to the U.S. dollar) and Macao SAR (highly dependent on tourism, with a 54-percent contraction of real GDP in 2020), Belgium (with a particularly large financial sector balance sheet relative to the overall economy), and oil-exporters Saudi Arabia and Russia.

15

The sizable exchange rate revaluation losses when the IIP is denominated in USD suggest that Switzerland must have more foreign assets than liabilities that were denominated in currencies that were weaker than the USD (e.g., euro), and/or more foreign liabilities than assets that were denominated in currencies that were stronger than the USD (e.g., the franc). A detailed breakdown of the Swiss IIP by currency can be found at the SNB Data Portal.

16

Since the calculations of the investment return rates did not include exchange rate revaluations, whether the Swiss IIP was denominated in CHF or USD did not make a big difference.

17

The average share of equities in Israel’s portfolio investment assets during 2008–2020 was about 55 percent, compared to Switzerland’s 45 percent. This may have reflected, for example, the two countries’ different demographics, which may have led to different risk appetites of their pension funds.

18

The same regression as the one underlying the fitted line in Figure 6, but without excluding Switzerland, Israel and Norway.

19

See also “Swiss Franc – Safe Haven for Whom?” IMF Selected Issues Paper, Country Report 21/131, IMF.

20

See “Switzerland: 2021 Article IV Consultation Staff Report,“ Country Report No. 21/130, IMF.

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Cover IMF Staff Country Reports
Switzerland: Selected Issues
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2022: Issue 172
Publisher:
International Monetary Fund
ISBN:
9798400212994
ISSN:
1934-7685
Pages:
44
DOI:
https://doi.org/10.5089/9798400212994.002
Figure 1.

An Illustration of the BOP-IIP Dynamics
Figure 2.

Switzerland: The Puzzle of Big Acquisition and Small Accumulation
Figure 3.

Switzerland: Franc NEER Index
Figure 4.

Cumulative Financial Account Balances versus Changes in NIIP, 2 008–20
Figure 5.

Cumulative Financial Account Balances versus NEER Changes, 2008–20
Figure 6.

Cumulative Financial Account Balances versus Changes in REER, 2008–20
Figure 7.

Norwegian Krone REER and Oil Prices