Public Information Notice No. 03/66

Public Information Notice: IMF Concludes 2003 Article IV Consultation with Switzerland

June 2, 2003

On May 23, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Switzerland.¹

Background

Following a solid expansion in the period 1997-2000, growth is currently stalled as exports have been hurt by the global slowdown and domestic investment has undergone a sharp downward correction from earlier high levels. The important financial sector has been hit particularly hard, in part because of the steep declines in equity prices both in Switzerland and abroad. Unemployment has doubled, although it remains low by international standards. Inflation is negligible and the external current account is running a large surplus.

In response to low inflation and the weak cyclical position of the economy, interest rates have been reduced rapidly and, at short maturities, are close to zero. However, the loosening of monetary conditions has been dampened somewhat by the appreciation of the Swiss franc. Fiscal policy is broadly neutral, with a projected rise in the general government deficit this year to just over 2 percent of GDP largely reflecting the operation of the automatic stabilizers and a drop-off in privatization receipts. The federal deficit is expected to fall outside the permissible range under the new balanced-budget rule, the debt-brake, which was introduced in January. Assuming a pick-up in external demand, IMF staff project a modest-paced recovery beginning in the second half of this year. Growth is projected at just under 2 percent next year. Inflation is expected to remain low.

Executive Board Assessment

Executive Directors commended the authorities' sound macroeconomic management and Switzerland's flexible labor markets, which have secured a continued low level of inflation and unemployment, and a high standard of living. The country's external position remains strong, with large external assets attributable in part to a high savings rate. Based on the sound reliance on fully-funded pensions, Switzerland is well prepared to handle the consequences of the aging of the population.

Directors observed, however, that average economic growth in the past decade has been low, owing in part most recently to uncertainties in international financial and equity markets and the evolution of external demand, but more generally because of highly protected domestic product markets. Against this background, Directors considered that the authorities should focus on setting the Swiss economy on a path of faster growth, through a carefully accommodative monetary policy and further product market liberalization, and avoiding a procyclical fiscal impact from the implementation of the fiscal rules set by the "debt brake."

Directors noted that growth is projected to revive in the second half of 2003, but stressed that insufficient competition in domestic sectors raises questions about the vitality of growth. In particular, barriers to the internal market, cartels, and sheltered sectors reflect a sluggish pace of product market liberalization. Directors thus welcomed recent efforts to strengthen the powers of the Competition Authority, and pressed for an acceleration of reforms aimed at further liberalizing domestic markets. They suggested that the authorities pursue a systematic, sectoral analysis to pinpoint the key reforms and build public support for them.

Directors observed that the monetary policy framework, with its focus on medium-term price stability, has allowed the Swiss National Bank (SNB) to respond flexibly to economic developments. With inflation risks remaining low, output below potential, and signs of recovery uncertain, the current low level of interest rates could be maintained for the foreseeable future.

Directors cautioned that, with interest rates near zero, the authorities would likely have to rely on quantitative measures, including unsterilized foreign exchange market intervention, to achieve further easing if the recovery should continue to stall. In the view of some Directors, those measures could be applied proactively. Noting that the potential costs of deflation could be high, Directors welcomed the authorities' determination to avoid deflation, and they emphasized the importance of responding swiftly to prevent the entrenchment of deflationary expectations. Most Directors were of the view that the SNB should err on the side of being too loose rather than too tight in the current circumstances. At the same time, to avoid having to resort to unconventional monetary policy instruments in future downturns, some Directors considered that the SNB should allow average inflation over the cycle to be closer to the top end of the current 0-2 percent range.

Directors considered the overall fiscal position to be sound. At this juncture, the automatic fiscal stabilizers are providing appropriate support to demand. Nonetheless, the unanticipated federal deficit threatens the credibility of the new debt brake rule. Bearing in mind the cyclical position, Directors urged that the debt brake be implemented pragmatically. At the same time, specifying binding consolidation measures and a transparent timeline to eliminate the structural deficit will therefore be important. Directors also considered that the debt brake rule could benefit from technical modifications that would enhance its cyclical flexibility while preserving fiscal discipline over the medium term.

Directors were encouraged by the significant adjustment currently being undertaken by financial institutions, and by the authorities' continued efforts to further strengthen financial sector supervision. They welcomed the progress made in the enactment of a revised law on bank rehabilitation, liquidation, and deposit insurance; plans to integrate banking and insurance supervision, along with increased resources for the supervisory authorities; and the ongoing efforts to strengthen oversight of external auditors. They commended the authorities for the revised Money Laundering Ordinance and the new Due Diligence Agreement covering the banking sector, which will further strengthen anti-money laundering legislation and the regime for combating the financing of terrorism.

Directors emphasized that strains in the pension and insurance sectors arising from the decline in value of their equity portfolios need the continued, careful attention of supervisors. They considered the reduction in the minimum interest rate on pensioners' assets as a necessary step, but with government bond yields being still substantially lower, they recommended that a further reduction be considered.

Directors commended the authorities' initiative to eliminate all trade barriers to imports from poor nations. They encouraged them to accelerate the dismantling of the high level of trade protection and subsidization of agriculture. They commended the authorities for the effectiveness of Swiss official development assistance (ODA), and welcomed the intention to raise ODA to 0.4 percent of GNP by 2010.

Directors welcomed the accommodation of collective action clauses (CACs) in the Swiss legal framework, and the authorities' intention to introduce CACs in Switzerland's own sovereign bond issues.

Directors noted that Switzerland's economic statistics are generally adequate for surveillance purposes, but saw scope for strengthening data in key areas, including national accounts, public finance, wages, and on the activities of sub-national governments.