Switzerland -- 2004 Article IV Consultation, IMF Concluding Statement
March 8, 2004
1. After having flirted with recession for two out of the three past years, there are signs that the economy has started to grow. An improvement in the external environment provided a positive impetus in the second half of 2003, with preliminary estimates showing annualized real GDP growth of 2 percent. With support from easy monetary conditions and improving expectations, investment appears to have picked up. Moreover, there is some evidence that consumption may be gaining strength. Overall, the recovery remains nascent. And, although unemployment has stabilized, employment has continued to decline in absolute terms. The recent national account estimates, which show a more broad-based recovery, should be interpreted with caution at the time of transition to a new estimation methodology.
2. Economic growth should strengthen this year, but major uncertainties need to be acknowledged. Externally, the prospects for recovery in major export markets have improved and, domestically, monetary conditions are relaxed. Several quarters of moderate growth are expected to buoy investment and trigger an increase in consumption. Moreover, after some restructuring, the economy appears to be well placed to take advantage of improving external demand. Against this background, the mission projects GDP growth of 1¾ percent in 2004. The main downside risks to this growth projection lie in a faltering recovery in key trading partners and adverse shocks to the exchange rate.
3. Inflation is expected to remain low in the near term, due to declining foreign prices and the considerable slack in economic activity. The risks to the forecast are asymmetric with the upside risks more likely. With inflation hovering at the lower end of the SNB's range of price stability, the prospects for damaging deflation seem to have receded, although brief episodes of negative inflation cannot be excluded. On the upside, rapid growth combined with a weakening of the exchange rate could lead to a rapid acceleration in inflation.
4. The easing of monetary policy in the face of weak demand has been timely and appropriate. By promptly lowering interest rates and allowing monetary aggregates to expand, the Swiss National Bank (SNB) has laid a solid base for future growth. This has been reinforced by transparent communications to the market which have served to anchor expectations. The mission considers that the present stance of monetary policy is appropriate until the recovery is secured.
5. While the recent build up in liquidity has been helpful in supporting the recovery, it needs to be monitored closely. Broad money is increasing at a pace of nearly 10 percent per year. As the output gap is closed over the medium run, financial risks and inflationary pressures may reappear. Monetary policy needs to be re-examined periodically and, if necessary, proactively modified. If the exchange rate were to appreciate significantly, the SNB might contemplate unsterilized foreign exchange operations.
6. While the federal budget weakened in 2003, reflecting, in some measure, the desirable operation of automatic stabilizers, the public finances remain under control and will continue to be so if additional consolidation measures are taken. Specifically, recent downward trends in withholding taxes and stamp duties are a concern; the uncertainty regarding the cyclical and structural components of this decline in revenue should not be underestimated and the authorities need to be alert and ready to adjust their policy. In the current environment in Switzerland, this means that the bulk of the adjustment should be in carefully targeted expenditure cuts rather than tax increases, which would jeopardize Switzerland's attractiveness as a location for global business.
7. Over the medium term, Switzerland will need to reduce the structural deficit if it is to preserve the credibility of the debt brake. The debt brake, which requires a balanced budget over the business cycle, is particularly important in a country where the population is aging. In this regard, the proposed supplementary fiscal package, which involves a reduction of CHF 2.8 billion in targeted expenditure cuts and an increase of CHF 0.5 billion in revenues, is a significant move in the right direction, but staff estimates that additional measures, possibly substantial, could be needed beyond the CHF 2.5 billion currently envisioned by the authorities. With the benefit of hindsight, the debt brake was introduced at a time when the structural deficit was larger than thought. This meant that some short term deviations were unavoidable. However, in implementing the debt brake, it is important that fiscal measures be realistic, transparent, and binding so that the credibility of this instrument can be preserved.
8. The state of the banking sector has improved considerably but supervisors have to remain vigilant. Banks have reduced operating costs, strengthened risk management, and expanded the share of collateralized loans in their portfolios. Profitability has improved and capitalization remains strong by international standards. However, banks' risk appetite appears to have increased lately and, in certain sectors, credit has been expanding rapidly. For the international banks, intensifying global competition could be a drag on profitability over the medium term and would place a premium on prudent risk management, good reputation, and cost containment. The authorities are acting on the Financial Sector Assessment Program (FSAP) recommendations and their own initiatives to strengthen the regulatory framework. In this context, we encourage plans to integrate banking and insurance supervision. We also support an increase in resources for the supervisory authorities and their ongoing efforts to strengthen oversight of bank auditors. The anti-money laundering ordinances that came into effect last year are welcome and will further strengthen the reputation of Switzerland's financial sector.
9. Strains in the pension and insurance sectors have subsided but some weaknesses remain. Conditions in the industry have stabilized with the rebound in equity prices and the decrease in the minimum guaranteed interest rate. The mission would welcome a rule-based mechanism in setting the minimum rate. There is also a real need to strengthen supervision, especially for the second pillar, and improve accounting standards. Regulations should be introduced that provide for a level playing field between pension funds and life insurers and that eliminate regulatory arbitrage in the second pillar.
10. The main policy challenge in the medium-term is to boost growth. In this regard, structural reform in product markets is critical. The enactment of the Competition Law is a good first step; its provisions for fining and breaking up cartels and vertical restraints reflect international best practices. However, the effectiveness of the law is hampered by an inordinate amount of regulation at the lower levels of government. We therefore fully support the authorities' plan to reform the Internal Markets Act. Creating a leaner and truly uniform regulatory environment for product and services markets across Switzerland should be a top priority. The package of 17 measures to increase growth is another step that the mission welcomes. Restrictive practices have led Swiss prices for non-traded goods and services to be among the highest in the world and liberalizing these markets will result in both lower prices and higher output. Staff estimates that structural reforms of these types could raise GDP growth by at least one half percent a year in the medium term.
11. We hope that official development assistance (ODA) will be spared from budget cuts and urge the government to keep to its target of raising ODA to 0.4 percent of GDP by 2010. Help to the poorest nations will also come from the authorities' initiative to eliminate trade barriers. We encourage the government to press within the new WTO trade round for lower levels of agricultural protection.
12. Additional resources need to be allocated to the improvement of economic statistics to strengthen the basis for sound economic analysis and policy. The upgrading of the national accounts, and the compilation of the external current account on a quarterly basis, are welcome, but gaps and quality deficiencies remain in monetary statistics, government finance statistics, production accounts, quarterly national account estimates, and the flow of funds. In particular, we urge the authorities to compile wage data on a monthly basis in conformity with best international practices.
Finally, the mission would like to thank the authorities for their traditional hospitality and for the candid and open discussions.