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Switzerland—2001 Article IV Consultation
1. Switzerland is enjoying its best economic performance for many years. Judicious macroeconomic policies and new policy making frameworks provide a sound basis for maintaining growth and low inflation. However, the structural reform momentum will need to pick up if Switzerland is to keep pace with its international competitors and improve its long-term growth performance.
2. Economic performance surpassed expectations in 2000. An estimated growth rate of about 3½ percent in 2000, the fastest in a decade, has brought output and employment back to levels consistent with productive capacity. Importantly, rapid growth has not been accompanied by an increase in inflation expectations thanks to timely policy actions by the SNB and successful efforts to eliminate the structural budget deficit.
3. Relatively robust growth should continue this year. The high level of consumer confidence, full order books, and healthy investment intentions all suggest that continuing expansion in Switzerland is, for now, well established. Nonetheless, with a less favorable external environment and the effects of earlier monetary tightening, growth is projected to slow to a more sustainable 2 to 2½ percent pace. The main risk would be if the slowdown that appears to be underway in the United States proves to be pronounced and spills over strongly onto European and Asian markets.
4. Although the earlier slack in the economy has been broadly eliminated, the current stance of policies should keep inflation in check. Core inflation remains around 1 percent and even steeply higher oil prices failed in 2000 to push headline inflation beyond the SNB's medium-term ceiling of 2 percent. Nevertheless, an increasing number of enterprises are reporting shortages of skilled labor and wage settlements point to higher wage growth than last year's low rate. The situation thus calls for vigilance by the monetary authorities. However, the tightening of monetary policy toward the end of 1999 and during the first half of 2000 appears at this stage to be sufficient insurance against the economy being pushed beyond sustainable limits and the mission projects that inflation will remain below 2 percent. Indeed, were the Swiss franc to appreciate sharply, particularly against the euro, or demand in foreign markets weaken markedly, scope for interest rate cuts could arise.
5. The new monetary policy framework has worked well in its first year, although some further evolution, mainly in presentation, is warranted. The explicit focus on medium-term price stability is appropriate—and provides a more transparent and easy to explain objective given the problems of stability in the monetary aggregates that had anchored the previous framework. The SNB has sound internal procedures for assessing the full range of information relevant for formulating policy under the new framework. However, as it recognizes itself, the SNB can do a better job in communicating its policy to the public. More details about the SNB's reading of inflation indicators, its forecasting assumptions, assessment of risks, and policy decisions would help to remove unnecessary uncertainties about policy intentions without compromising the SNB's flexibility to respond to new or unexpected developments. Moreover, the SNB would have a more articulated structure for explaining policy actions after-the-fact, which would work to preserve its high credibility and strengthen its accountability.
6. The appreciation of the Swiss franc against the euro in the past year provides a reminder that exchange rate variability is an integral part of an independent monetary policy. The appreciation was also consistent with the long-term upward trend in the real exchange rate and the large current account surplus. That is not to say, however, that the SNB should not continue to adjust its monetary policy in response to sharp movements in the exchange rate.
7. The elimination of the federal deficit ahead of schedule is a welcome development and the brake on public debt is finally on. Helped by the strong economy and, more significantly, by exceptional receipts of stamp duties and the withholding tax, the federal budget moved into surplus in 2000. Prudent policies at lower levels of government are also estimated to have given rise to surpluses for the cantons and communes.
8. Pressures to use the resources generated from overperformance in the federal budget in 2000 for anything other than debt repayment should be strongly resisted. The revenue bonus in 2000 was, in the main, most likely a temporary phenomenon. Accordingly, using it to finance new expenditures or tax cuts in the future could undermine constitutionally mandated balanced budgets. Supplementary spending in 2001 would also risk imparting unneeded fiscal stimulus to the economy. Likewise, receipts from sales of assets should be applied to debt reduction.
9. The plan (Schuldenbremse) to adapt the constitutional requirement of balanced budgets to permit some flexibility in fiscal policy over the business cycle makes good economic sense. Under the proposal, annual expenditure ceilings would be adjusted to allow deficits in recessions and surpluses in upswings, but on average the appropriate objective of freezing public debt—and hence reducing its ratio to GDP as the economy grows—would be retained. Despite some concerns that the proposed mechanism may not be sufficiently flexible to cope with prolonged downturns, and will not ensure that unexpected surpluses go toward debt reduction, overall it would be a welcome modification to the fiscal framework. The new framework should be complemented by measures to reinforce other elements of fiscal policy's automatic stabilizers. In this context, proposals to ensure that the unemployment insurance fund has adequate resources to absorb swings in unemployment without having to adjust contribution rates in a procyclical manner are a positive step. And keeping federal transfers to the unemployment insurance fund out of the expenditure ceiling will provide additional flexibility in exceptional circumstances.
10. The framework of balanced budgets places even more emphasis on medium-term planning for tax policy. The immediate agenda is focused on proposals to reform family taxation. The proposals are affordable within the authorities' fiscal framework for the next few years, assuming that the planned expenditure restraint takes place and receipts from the proposed VAT increases are not fully earmarked for the pension fund. The recent selected exemptions from the stamp duty can also be accommodated, but may ultimately not go far enough as new information technology squeezes margins in financial services and increases possibilities for evasion. Beyond the current agenda, it is not too early to begin thinking about some of the bigger questions concerning tax policy ahead of the expiry of the current federal tax system in 2006. In particular, thought needs to be given to the balance between direct and indirect taxation, taking into account the trade-offs between equity, efficiency, and the likely effects on competition from tax reform going on outside Switzerland.
11. The longer-run challenge for fiscal policy is to accommodate the pressures on expenditures from a rapidly ageing population. As the main strains on public pensions and health may not be felt until after 2010, long-term planning is essential in order to build consensus within the political system for change and to implement measures that take time to make a meaningful impact on costs. Much forward thinking is already in train and the raising of the retirement age for women and the proposed increases in VAT, which would be earmarked largely to the pension and invalidity funds, will alleviate most medium-term strains. In addition, a review of benefit formulae should not be ruled out as Switzerland will want to avoid longer-term pressures on contribution rates that could harm competitiveness and labor market performance. A strategy to address rising pressures on health care costs also needs to be developed.
12. A period of rapid growth is precisely the time when financial market supervisors have to be on their toes if problems are not to surface when the boom wanes. In addition, supervisors will need to stay abreast of the implications for the risk to financial institutions, both bank and non-bank, of the rapid changes that are occurring in the structure of financial markets and in the traditional financing sources for banks. Banks will need to strengthen their provisioning. That said, the modest rate of growth of credit and the absence of exuberance in the property market are comforting signs. The application of the new Money Laundering Law is also helping to assuage reputational threats to Swiss financial markets. Switzerland's participation in a Financial Sector Assessment Program (FSAP), most likely later on this year, will provide a timely opportunity to review supervision and regulatory issues and assess more broadly the state of financial markets.
13. Today's better economic environment should not provide an excuse to relax structural reform efforts. While the strength of the recovery has raised hopes that Switzerland's underlying productivity and growth performance have improved following the restructuring that took place in the 1990s, it is much too early to draw conclusions. Besides, the rest of the world will not relax its own reform efforts and Switzerland has a large unfinished structural agenda. The bilateral agreements with the EU are in this context both an opportunity and a challenge for Switzerland to benefit from more open markets and exploit its advantage of a flexible labor market.
14. The priority lies in opening up the sheltered sectors of the economy. Progress has been made with the introduction of new anti-cartel legislation, but the law lacks teeth and should be reinforced by allowing for tough penalties for offenders. Opening the door to more judicial support for the Internal Market Act by allowing the Competition Commission to appeal to the Federal Supreme Court would also help. In the telecommunications sector, liberalization has brought the visible benefit of falling prices. Liberalization of the "last mile" of telephone connections should not be delayed. Similar benefits of lower prices and more choice would follow from liberalization of the electricity sector. This should be speeded up. More generally, the thicket of regulations, especially at the cantonal level, should be scrutinized, and those that needlessly harm competition or raise the cost of doing business or starting up an enterprise, should be eliminated.
15. Agriculture remains one of Switzerland's most sheltered markets. While the difficulty of fighting strong vested interests is recognized, the reform efforts in train are little more than a welcome start: the fact that protection will remain above the very high levels in the EU even when the current reforms are completed speaks for itself. More aggressive reform would benefit consumers and help alleviate labor shortages in other sectors of the economy. Switzerland could lead by example and push for more rapid dismantling of protection in agriculture in global trade talks—something, which if achieved, would greatly benefit developing countries.
16. The mission welcomes Switzerland's intention to raise its official development assistance to 0.4 percent of GDP in the medium term—a target that should be well within range now that earlier budget consolidation efforts have run their course.
17. While Switzerland is participating in the IMF's Special Data Dissemination Standards, further efforts to improve the quality and comprehensiveness of statistics are strongly encouraged. A lack of timely data on wages, for example, hinders important economic analysis and the national accounts statistics need to be upgraded to more current methodology. Weaknesses also exist in balance of payments and fiscal data.
18. Switzerland's intention to continue publishing its IMF Article IV staff report is welcomed.
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