Concluding Remarks of 1999 Article IV Consultation -- Switzerland
November 15, 1999
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Switzerland—1999 Article IV Consultation
Bern, November 15, 1999
1. Switzerland's economy is on a positive track. Activity is strengthening, unemployment has declined rapidly, and inflation is low. In this favorable setting, the macroeconomic policy task is to provide conditions for a continued upswing with low inflation. For structural policies, the challenge is to assure Switzerland's long-term economic prospects in a competitive and rapidly changing global environment.
2. A year ago, the outlook for the Swiss economy was marked by considerable external uncertainties and downside risks. There were questions as to whether the emerging market crisis would be contained without lasting damage to the global economy, and closer to home whether the introduction of the euro would trigger exchange market pressures that would adversely affect Swiss competitiveness.
3. In the event, these risks did not materialize. Overall conditions in the emerging markets have turned around, and the export-induced slowdown that affected Switzerland and, more generally, the European economy from mid-1998 has been replaced in recent months by a steady strengthening in economic activity and prospects. Meanwhile, the introduction of the euro went smoothly. The SNB's accommodative monetary policy stance cushioned Swiss activity and its announced willingness to counter exchange rate pressures contributed, along with the similar cyclical positions of the Swiss and euro area economies, to a very stable relationship between the Swiss franc and the euro.
4. Looking forward, improving external conditions and positive domestic fundamentals should underpin a pickup in Swiss GDP growth in the near term from 1¼ percent in 1999 to about 2 percent in 2000. As always there are risks in the outlook, but these are much more balanced than a year ago: on the upside, the dynamics of the upswing in Switzerland and its neighbors could prove stronger than expected; on the downside, a "hard landing" of the U.S. economy from its seemingly endless expansion would undercut external demand and could also induce unfavorable exchange market pressures.
5. The prospect of above-trend growth for the Swiss economy--coming in the wake of sharp recent declines in unemployment and reports of shortages of some groups of skilled workers--raises the question of the degree of slack in the economy and the possible emergence of inflationary pressures. Some overall slack remains, as indicated by the numbers of jobseekers, indicators of capacity utilization, and estimates of the output gap; and "core" CPI inflation (excluding the effects of indirect taxes and energy prices) seems likely to stay close to 1 percent in 2000.
6. The current stance of macroeconomic policies, taking account both of ongoing fiscal consolidation toward the goal of budget balance and the SNB's action in allowing short-term interest rates to rise in recent weeks, provides a degree of insurance against upside inflation risks. At the same time, the lags between policy action and inflation call for vigilance to assure medium-term price stability. Particular attention will need to be paid in the period ahead to indications of possible inflationary pressure--such as accelerating earnings growth and above-average capacity utilization. All in all, while some further firming of monetary conditions is likely to be warranted in due course as the upswing matures, further policy action does not appear urgent at this juncture.
7. The present formal policy framework focused on monetary aggregates expires at the end of this year and a new framework will therefore need to be articulated. In our view, monetary policy should focus on the goal of medium-term price stability and be guided by a range of relevant indicators (including the cyclical position, the exchange rate, monetary aggregates, and the fiscal stance). It is desirable to communicate changes in the policy stance clearly to the public in a timely fashion. As in the past, the SNB will need to retain the option to react to exchange rate disturbances; at the same time, while retaining monetary autonomy could allow Switzerland to continue enjoying relatively low interest rates, it may (as also recognized by the SNB) imply accepting greater market fluctuation of the Swiss franc against the euro than so far observed. Also, the large external current account surplus points to the possibility of trend upward movements in Switzerland's real effective exchange rate over the medium term. If price stability is to be maintained under these circumstances, such movements would need to come about through changes in the nominal effective exchange rate rather than through higher prices.
8. Recent fiscal developments have been encouraging, with the general government deficit (now projected for 1999 at about 1½ percent of GDP) falling below initial expectations despite additional Kosovo-related spending. On current projections, policies are on track to observe the constitutional limit on the budget deficit of the Confederation next year, and the objective of balance in 2001 can be met with some additional expenditure savings (just over 0.1 percent of GDP) in the 2001 budget. Continued commitment to this objective is important for confidence and the broad economic climate, and it is essential therefore to resist pressures to relax fiscal policies.
9. While safeguarding the near-term fiscal position, it is important also to begin addressing fiscal issues of a more structural nature--the design of fiscal policy after 2001, demographic pressures on social spending, the division of responsibilities between the Confederation and the cantons, and the complexities of the Swiss tax system. In this context, the recent articulation of comprehensive guiding principles for fiscal policy (the Finanzleitbild) is a welcome initiative in transparency that should help foster informed discussion.
10. For the fiscal policy framework after 2001, the proposed goal of balancing the Confederation budget over the cycle would appropriately set the debt/GDP ratio on a declining trend. A key consideration in designing the framework will be ensuring that the automatic stabilizers--which will have the potential to be much more effective once tax collections in most cantons shift to a current-year basis, as envisaged by 2001--are allowed to operate. One possible approach that has had some success elsewhere in Europe is to establish medium-term expenditure ceilings linked to the expected trend rate of economic growth, and to allow tax revenues and the deficit to fluctuate with the cycle. The framework could also usefully include provision for discretionary fiscal stabilization under exceptional economic conditions. As regards the fiscal relations between the Confederation and the cantons, the Neuer Finanzausgleich represents a major undertaking in which a key element is the aim of establishing incentives more conducive to cost-effectiveness.
11. Switzerland's approach to social insurance, with the burden of old age provision shared among several pillars with a significant funded component, has important advantages over single-pillar PAYG schemes prevalent in some other European countries. Nevertheless, the state pillar of the Swiss system will face significant demographic pressures in the coming decades--notably after 2010, the current policy planning horizon. Through early action to address these long-term pressures, the scope for choice among the various options would be maximized. In this context, it would also be advisable to keep in mind the negative labor market results in other European countries from continually raising labor taxes and insurance contributions, and so not to rule out changes to benefit formulae. A strategy to address related demographic pressures on health spending will also need to be developed.
12. The tax policy agenda is considerable, given the complications and efficiency costs of the current system. The emphasis on achieving formal tax harmonization and on developing new legal mechanisms for facilitating the harmonization process is welcome. While mandatory material harmonization of tax rates across cantons is not needed and would reduce beneficial tax competition, it would be worthwhile to encourage cantons to consider shifting their corporate income tax systems to a system of proportional taxation of profits (as with the 1997 modernization of this tax at the Confederation level). As regards the securities transfer tax, the rising share of transactions in Swiss shares being transacted on non-Swiss exchanges suggests that further initiatives will likely be needed on this issue.
13. Concerning structural policies more generally, the challenge for Switzerland will be to adapt and thereby maintain a competitive economy in a rapidly changing world. The launch of the euro is already a major shift in the external environment, with implications for the Swiss franc, the competitive environment for Swiss exporters and the financial system; but in a broader sense it is a totem for the ongoing dynamic process of European integration that will continue to affect Switzerland regardless of future decisions on possible accession. In this context, the conclusion of the bilateral agreements with the EU is a major positive step; once in effect, these agreements should yield important long-term growth benefits through increased trade and investment. To maintain these benefits and Switzerland's competitive position, it will probably be necessary to go beyond just keeping pace with the momentum of further reform in the EU, and to begin closing the gap.
14. Against this background, there is scope for building on recent progress and deepening the process of structural reform, notably in the so-called "sheltered sectors." The recent changes in agricultural support policies are a start, but overall support levels remain considerably above those in the EU (which in turn are high by world standards). The more proactive approach to competition policy, and proposals to reinforce further the powers of the Competition Commission, are welcome; monopolistic and oligopolistic practices in importing and domestic activity, which appear to be a factor in the relatively high level of Swiss consumer prices, should be tackled with vigor. As regards utilities, recent reforms of telecommunications, rail and postal services are steps in the right direction; follow-up actions, notably to increase competition in telecommunications, are desirable. In the electricity sector where reforms are yet to begin and are scheduled to take several years, we would encourage efforts to accelerate the timetable for their completion.
15. The Swiss financial sector has weathered the period of turbulence, affecting in particular the big banks, associated with the 1998 emerging market crisis. While this sector appears likely to remain a major contributor to the Swiss economy, external and internal competitive forces and technological advances (including the growth of electronic banking) are all likely to maintain pressures for change. For the cantonal banks, the roles of guarantees, public ownership, and noneconomic mandates may come increasingly into question as possibly inhibiting new entry and as posing risks for cantonal taxpayers. In this regard, the new Banking Act, with its greater flexibility on the role of guarantees and in putting cantonal banks on an equal footing to others with regard to supervision, opens the way for more uniform treatment of banking institutions. Supervisors will need to be assured that internal risk management systems are adequate and remain vigilant for signs of undue risk-taking, whether by the big banks or others. The ongoing review of the structure of financial supervision (including the treatment of nonregulated financial service providers) is timely, and the recent legal and institutional changes designed to combat money laundering are welcome.
16. The recent improvement in labor market performance again underscores Switzerland's strengths in this area in comparison with many other industrial countries. These have their roots in Swiss labor market institutions and policies, to which the determination to learn from experience--exemplified by the ongoing reviews of the effectiveness of the 1997 policy changes--has made an important contribution.
17. While Switzerland's humanitarian contributions in connection with the Kosovo conflict are recognized, an increase in official development assistance to the national target of 0.4 percent of GDP is encouraged.
18. Regarding economic statistics, the forthcoming revision of the consumer price index is welcome, as is the ongoing progress toward improving national accounts statistics. To strengthen the basis for sound economic management, improvements in labor market and government finance statistics envisaged in the current multiannual program need to be implemented on an urgent basis.
19. Finally, we welcome Switzerland's participation in the pilot project for publication of IMF Article IV staff reports.