Mission Concluding Statements
Switzerland and the IMF
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Switzerland-2002 Article IV Consultation
Bern, March 4, 2002
1. The past year has been a mixed one for the Swiss economy. The strong growth recorded in 2000 turned out to be rather fleeting and the slowdown in real GDP growth during 2001 was greater than expected. To a large extent, this can be attributed to the severity of the slowdown in the global economy and to the technology investment cycle. By contrast, consumer demand and sentiment have proved fairly resilient. The hope is that the overall economy is also more resilient than it was in the 1990s and hence better placed to take advantage of the expected upswing in global activity. Policy makers can facilitate this by continuing to adhere to stability-oriented macroeconomic policies and by accelerating the structural reform agenda, particularly as regards product markets.
2. The signs are pointing toward growth strengthening during the course of this year. Prospects for recovery in major export markets-and notably the United States and Europe-have firmed in recent months, with much of the heightened uncertainty following the September 11 terrorist attacks dissipating. The first signs that the Swiss economy may be close to a turning point are also becoming evident. Nonetheless, forecasts-including our own-emphasize that the pace of recovery is likely to be moderate. While the growth rate of real GDP should pick up during the course of the year, the annual average growth rate is projected to be just under 1 percent in 2002. The gap between the economy's actual and potential output would not be closed by the end of the year and unemployment would remain on average above last year's level.
3. Monetary policy can afford to remain supportive of recovery at this stage. Toward the end of last year, the Swiss National Bank (SNB) reacted swiftly to the significant weakening of inflation pressures associated with softer-than-expected economic activity and the sharp appreciation of the Swiss franc after September 11. As a result of the interest rate cuts, monetary conditions are currently expansionary. Nonetheless, inflation risks still appear very low: core inflation is less than 1 percent, wage pressures are modest, and output is below potential. Thus, in our view, the bias of monetary policy can, for now, lean safely toward further easing, at least until the recovery is more firmly established. Interest rate cuts would be justified if the tentative signs of recovery are not validated or if the Swiss franc were to appreciate. On the other hand, should the recovery turn out to be more robust than expected, it will be necessary to begin raising interest rates later this year.
4. The monetary policy framework is working well. The focus on medium-term inflation has allowed the SNB to respond flexibly to business cycle conditions and exchange rate developments. So far, the framework has provided an effective vehicle for communicating policy intentions and appears to be well understood by financial markets. The mission encourages the SNB to continue expanding the information it provides about its inflation forecast and the rationale for policy decisions.
5. Fiscal policy is also supporting recovery, although its role should be constrained. The Confederation's budget (including the railway fund) appears to be heading toward a deficit of SwF2-2½ billion this year. Taking into account expected developments in other levels of government, the overall fiscal stimulus would be about ½ percent of GDP. Such a stimulus is not by itself worrisome given the cyclical position of the economy. However, at the federal level, there is clear drift from balanced budget intentions. Further slippage in the form of new expenditure or tax relief should thus be strongly avoided, especially as they would add to the adjustment strains next year when the debt brake (Schuldenbremse) takes effect. Unbudgeted one-time revenues, for example from the buyback by Swisscom of its shares, should be used to reduce government debt and ensure consistency with the constitutionally mandated balanced budget target for 2002. They should not be used to finance new expenditures.
6. Assuming no further budget slippage this year, modest savings are likely to be needed at the federal level in coming years to comply with the debt brake. The principle of running balanced budgets over the economic cycle and stopping the accumulation of public debt is prudent given the need to plan for longer-run demographic strains; it is also backed by the overwhelming majority of the voting population. Relative to current fiscal plans, the mission projects additional budget savings of around SwF1 billion will be required in 2003, with a similar amount needed in 2005 when the family tax package goes into effect. The solution to budget constraints should not be higher taxes. Although comparative statistics routinely classify Switzerland as a low-tax country, Switzerland's edge shrinks considerably if mandatory contributions to the second pillar of the pension scheme and to health insurance are included. Besides, relatively low taxes should be seen as a competitive advantage that should not be squandered. Instead, expenditure growth needs to be restrained.
7. Successful implementation of the debt brake requires changes in behavior at all budget levels. Demands for supplementary appropriations will need to be scaled back and greater flexibility in reshuffling expenditure items will need to be exercised if high-priority supplements are to be accommodated without tax hikes. A reduction of the currently pervasive earmarking of revenues would enhance such flexibility. Fiscal discipline at the federal level will have to be matched at lower levels of government if the debt break is to prepare the economy as a whole for demographic aging. This would include social security where health care cost inflation will need to be brought more firmly under control.
8. The preliminary results of the Financial Sector Assessment Program (FSAP) exercise indicate that financial institutions overall are well-capitalized, but the risks of the current environment should not be underestimated. The large internationally active banks have suffered from the recent asset market volatility and the global economic slowdown. The domestically-oriented banks are well-capitalized, but their lower level of underlying profitability makes them sensitive to the economic cycle: in general, the domestic banking system's efficiency would be enhanced by further consolidation and the creation of a level playing field. The large insurance sector has a good track record, but strains are emerging following the September 11 terrorist attacks and lower financial market returns. If lower returns persist, some institutions could face difficulties in meeting mandatory rates of return and payout ratios on pension assets; in a sustained low interest rate environment, more flexible formulae should be introduced.
9. The lines of defense against potential financial sector problems appear to be functioning properly. Financial institutions have developed sophisticated risk management and early warning systems. The supervisory system is effective and has been strengthened in recent years. More recently, financial sector surveillance and monitoring activities have started in the context of the Competence Center for Systemic Stability in the SNB.
10. Current initiatives to further strengthen supervision are welcome. Given increasing integration of banking and insurance, a more formalized process of cooperation among financial regulators is needed, for example along the lines of the proposed single supervisory authority. The mission, while recognizing that the existing supervisory process has served the system well, would further recommend a more formalized quality assurance program for supervising external auditors and a broadening of the general regulatory framework to include all asset managers. The Swiss anti-money laundering regime in the financial supervisory area is broadly in line with international best practice. This is an important safeguard for the reputation of the Swiss financial system. The mission welcomes the authorities' ongoing initiatives to track terrorist financing.
11. Restructuring in the 1990s should have laid the ground for improved economic performance in coming years. Helped by the benefits of the bilateral agreements with the EU, medium-term potential GDP growth is estimated to have picked up to close to 2 percent a year, although over the longer term a declining working-age population will make this growth rate hard to sustain. Switzerland has a competitive export sector, including a vibrant financial services industry, which has adapted to the discipline of an upward trend in the real exchange rate for many years. It is likely that the externally-oriented sector will need to continue to live with such discipline in the future given the large balance of payments surplus. By contrast, vitality in the more sheltered domestic markets has been much less impressive and it is here that improved performance will be needed if the economy's growth potential is to be fulfilled.
12. The drive for reforms in product markets should be strengthened. On the positive side, the proposed new Competition Law should provide a significantly better framework to address some of the practices that give rise to inefficiencies and high prices in Switzerland. The draft law would benefit from provisions for punitive penalties. The mission encourages the authorities to introduce the new law promptly and provide the Competition Authority with the resources and support to implement it rigorously. In this context, new guidelines that provide a better handle against vertical agreements in the distribution chain should be fully utilized. Less positively, the momentum for liberalization in the network industries appears to be waning. Insufficient competition in the "last mile" of fixed-line telecommunications remains a problem. And support for opening up the electricity market has diminished, even though properly designed liberalization would bring significant benefits to industrial and residential consumers. Finally, agricultural liberalization remains timid. Although the shift from price support to direct payments is a welcome development, the level of support going to farmers remains significantly above even EU levels, with the result that scarce resources are deployed inefficiently. At the same time, trade barriers keep prices high for consumers.
13. The collapse of Swissair has put the spotlight on the need for higher standards of corporate governance. Transparent reporting requirements, high accounting standards, structures that allow fair representation of shareholder interests, and strong safeguards against conflicts of interest are necessary ingredients of good governance. In this regard, the code of conduct proposed by the Employers' Association is a useful first step. The mission encourages further strengthening of the code and the supporting legal framework.
14. Flexible labor markets should remain a key strength of Switzerland's economy. In recent years, policies and an open approach to foreign labor have contributed to the smooth functioning of labor markets. As economic growth will rely more and more on a skilled, well-educated population, it will be important that the education system turns out adequate numbers of suitably qualified persons.
15. The mission encourages the authorities to bring forward its target for raising official development assistance to 0.4 percent of GDP. It welcomes the authorities' initiative to eliminate trade barriers for the poorest countries of the world.
16. Economic statistics could benefit from further upgrading. Notwithstanding progress in improving the statistical infrastructure, deficiencies remain in key areas such as the national accounts, wages, and fiscal data. A small amount of additional budget resources could pay significant dividends for the quality of policy analysis.
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The mission would like to thank the authorities for their hospitality and for the stimulating discussions.
IMF EXTERNAL RELATIONS DEPARTMENT