Concluding Remarks of 1998 Article IV Consultation--Switzerland

November 16, 1998

At the conclusion of annual Article IV bilateral discussions with the authorities, and prior to the preparation of the staff's report to the Executive Board, the IMF mission often provides the authorities with a statement of its preliminary findings.
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Switzerland—1998 Article IV Consultation

Concluding Statement
Bern, November 16, 1998

1.  Following six years of stagnation, a shift to expansionary macroeconomic policies initiated a recovery that is now well into its second year. Although the expansion appears resilient, the outlook is clouded by downside risks, particularly from the external demand side. In this setting, continued skillful macroeconomic policy implementation will be needed to ensure sustained recovery. Moreover, improving the economy's long-term productivity performance will require further progress in tackling entrenched structural rigidities.

2.  Since the first quarter of 1997, real GDP has expanded at a robust rate of 2½ percent per annum. Exports surged in 1997 in response to the unwinding of the Swiss franc's previous sharp real appreciation and faster growth in continental Europe. Domestic demand also picked up, particularly during the first half of 1998, underpinned by a sustained revival of consumer sentiment and increased spending on public infrastructure; private construction, however, remained subdued owing to continued high vacancy rates. Reflecting more buoyant activity, labor market conditions have improved markedly, as highlighted by the sharp and welcome decline of unemployment from the record level of early 1997.

3.  Looking ahead, we expect real GDP growth to slow from just over 2 percent in 1998 to 1½ percent in 1999, before picking up again in 2000. The temporary slowdown in output growth reflects the drag on exports from the Asian crisis and the recent turmoil in international financial markets. By contrast, growth of domestic demand is envisaged to hold up well, mainly supported by private consumption. There are, however, downside risks, particularly as regards foreign demand. Most importantly, Swiss export growth could slow more markedly, weighed down by a sharper-than-expected weakening of trading partners' activity or by surges in capital inflows that put upward pressures on the Swiss franc. As regards inflation, the short-term outlook is benign with the increase in the CPI picking up to 1 percent next year, mainly reflecting the scheduled increase in VAT.

4.  Monetary policy provided much of the initial stimulus that jumpstarted the recovery, and the Swiss National Bank (SNB) has maintained an accommodative posture. In particular, the monetary base has exceeded its medium–term target path by a substantial margin (about 6 percent in September 1998), although a series of unexpected velocity shifts has impaired the information value of this indicator of the monetary stance. The SNB's preferred supplementary monetary indicator, M3, has been less prone to large velocity shifts. Growth of this aggregate averaged about 6 percent during 1996-97, somewhat exceeding the SNB's estimate of M3 growth compatible with medium-term price stability, but slowed considerably in 1998. A tightening of monetary conditions will eventually become necessary as the current expansion regains momentum; however, clear signs of continued economic slack, low prospective inflationary pressures, and the expected near-term slowdown in real GDP growth are all factors suggesting that present monetary conditions, particularly the level of short-term interest rates, are in tune with the requirements of medium-term price stability. Indeed, if the above-mentioned downside risks to output growth materialize, there may be scope for a further relaxation of monetary conditions. In the light of past experiences, particularly with combating upward exchange rate pressures, the SNB will in that event need to be especially vigilant about medium-term inflation risks. In the area of policy transparency, the SNB's quarterly updates of its interpretation of monetary developments and its broad policy intentions represent a valuable enhancement.

5.  As regards fiscal policy, the adoption of the constitutional commitment to balance the Confederation budget by 2001 is an important step toward sustainable public finances. Within this framework, the general government deficit is set to decline from an estimated 2½ percent of GDP in 1998 (excluding Swisscom privatization receipts) to 1½ percent of GDP in 1999. The resulting shift to contraction in the fiscal stance is warranted from a medium-term perspective. At the same time, if economic activity slows unexpectedly sharply in 1999, allowing full operation of the automatic fiscal stabilizers would be appropriate. Turning to long-term issues, upward pressures on social spending, inter alia reflecting population aging, will result in a difficult uphill battle to contain fiscal deficits. In this context, we note that the proposed package of measures to balance the Confederation budget (Stabilisierungsprogramm 1998) would hardly dent these pressures, a tendency reinforced by the recent amendments in Parliament. Concerning the framework for the conduct of fiscal policy beyond 2001, it will be important to allow for the operation of the automatic fiscal stabilizers over the cycle and—in the case of particularly large shocks to the economy—provide room for discretionary fiscal maneuver.

6.  Further reforms of the Swiss tax system are desirable. There appears to be widespread agreement that there are high economic costs associated with the proverbial "Swiss tax jungle." The latter results from a lack of harmonization of tax rules across cantons and the Confederation in several areas: income tax base definitions, corporate tax rate schedules, and the timing of tax collections. In this context, recent progress on harmonizing the timing of personal income tax collections on a current-year basis by 2001 is most welcome, as it will strengthen automatic fiscal stabilizers and enhance real revenue collections. At the same time, new initiatives to promote the convergence of income tax base definitions would be worthwhile. Regarding international tax competition, globalization and increasing integration in Europe are likely to call for changes to long-standing features of the Swiss tax system, as illustrated by the ongoing discussions on the stamp duty on securities transfers (Börsenstempel). Finally, the dominance of direct taxes (including social contributions) over indirect taxes in overall tax revenue raises the overall efficiency cost of the tax system. Opportunities to address this issue will arise in the context of decisions on the long-term financing of social insurance and on ecological tax reform.

7.  Switzerland's disappointing productivity growth performance since the mid-1970s and a domestic price level that exceeds the EU average by some 40 percent point to significant structural rigidities. Further reform of the sheltered sectors—agriculture, construction, and many services—should therefore remain an urgent priority. Besides its direct benefits to consumers, further opening up of the sheltered sectors would also lower input costs in the export-oriented sectors of the economy. Furthermore, faster overall GDP growth and improved domestic investment opportunities would help to reduce Switzerland's mushrooming current account surplus. The main structural reform initiatives—such as the envisaged lowering of price subsidies to agriculture, the deregulation of the transport, telecommunications, and energy sectors, the liberalization of working time rules, and an improved framework for higher education—are steps in the right direction and should be firmly implemented. However, the speed and scope of at least some of these structural reforms could be accelerated and broadened, in particular in the agricultural area, where overall protection would remain exceptionally high. In this context, a successful conclusion of the protracted bilateral negotiations with the EU, and the successor negotiations that may follow, could provide a catalyst for further advancing Switzerland's structural reform agenda.

8.  Following spectacular losses by the two big banks related to derivative trading, hedge fund investments, and emerging market loan exposures, banking supervision has recently moved into the policy limelight. Excessive risk taking by or inadequate risk management within banks pose difficult and complex challenges to banking supervision. We therefore welcome the establishment of a new department within the Federal Banking Commission to undertake more intensive supervision of the domestic and global operations of the big Swiss banks.

9.  We would encourage Switzerland to raise overseas development assistance (ODA) to its own target of 0.4 percent of GDP.

10.  Further efforts are needed to improve the coverage and reliability of Swiss economic statistics. Although some welcome progress has been made, the present statistics in the areas of national income accounts, the labor market, and government finances leave room for considerable improvement. Additional resources for economic statistics would be helpful in this regard.