## _cr05190

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### Recent developments and recovery
- Real GDP expanded by 1.7 percent in 2004, narrowing the output gap to 1 percent.
- Recovery described as fragile and dependent on external demand; business indicators in early 2005 remained relatively weak.
- Staff projection: growth of 1¼ percent in 2005 (authorities project 1½ percent).
- Moderate recovery since mid-2003 driven by supportive monetary and fiscal policies and growing external demand; investment and construction benefited from low interest rates.
- Unexpected dip in investment contributed to a contraction of GDP in the last quarter of 2004.
- Employment: flat in 2004; unemployment rose to 3.9 percent in 2004; unemployment rate reported as 3.8 percent in April 2005 in another section.

### Inflation, monetary policy, and exchange rate
- Headline CPI: 1.4 percent (early 2005).
- Core inflation: rose from ¼ to 1 percent.
- Average wages: 0.9 percent (2004); likely around 1¼ percent (2005).
- SNB policy actions: three-month policy rate kept at 0.25 percent for more than a year, then raised by 25 basis points in June 2004 and by 25 basis points in September 2004 (policy rate level reported as 0.75 percent after two rises in one section; three-month rate noted historically low at 0.25 percent in another).
- Three-month rate remained negative in real terms.
- SNB average inflation since 2000: 0.9 percent.
- Exchange rate changes since end-2003: franc appreciated by 3.7 percent in real effective terms and by 1.2 percent in nominal terms.
- SNB communication: quarterly 3-year-ahead inflation forecast; objective to keep headline CPI inflation over a three year horizon “below 2 percent but positive.”
- SNB estimate scenario: a 40 percent increase in crude oil prices for a three year period would lower growth by 0.4 percentage points and add 0.6 percentage points to prices.

### External sector and current account
- Current account surplus: 12 percent of GDP in 2004.
- Three-quarters of the 12 percent current account surplus in 2004 reflects investment income from large net foreign assets.
- Net investment income (billions SwF, 2000–2007 sequence in table): 44.0; 32.9; 25.9; 45.8; 41.7; 43.8; 46.1; 48.5.
- Net external assets (billions SwF, selected): 521.5; 596.5; 583.7; 580.5; 633.5 (2000–2004 sequence shown).

### Fiscal developments, gold sales, and short-run fiscal strategy
- General government deficit: narrowed to 1 percent of GDP in 2004.
- Federal authorities plan to eliminate the structural federal deficit in the short run under the debt-brake rule while allowing automatic stabilizers to operate.
- Two expenditure-based consolidation programs (Entlastungsprogramme 2003 and 2004) aim to slow annual expenditure growth to 1.5 percent.
- SNB gold-sale proceeds: transfer to government equal to 4.6 percent of GDP in 2005; allocation: ⅓ federal, ⅔ cantons.
- Authorities’ stance on gold proceeds: federal authorities indicated intention to apply proceeds to debt reduction; cantons projected to use 80-85 percent of their allocation for debt reduction (but cantons cannot be forced).
- Memorandum note: 1/ Excludes in 2005 transfers from SNB gold sales of SwF 21 billion, 4.6 percent of GDP.

### Long-term sustainability, aging, and social security
- Potential growth: estimated at 1½ percent; projected to decline in the medium term to ¾ percent due to population aging.
- Staff projection: Switzerland’s old-age dependency ratio projected to increase by 16 percentage points over the next thirty years.
- Pension and healthcare combined deficit (before budgetary subsidies): over 5 percent of GDP.
- Staff estimate: net present value of future liabilities of first-pillar pension and health programs at 180 percent of GDP, roughly equivalent to a 7½ percentage point hike in the VAT.
- Baseline assumption in extended DSA: general government runs a primary surplus of 6 percent of GDP (excluding transfers to the pension system and healthcare).
- Staff recommendation: supplement the debt-brake rule with a long-run fiscal framework encompassing all levels of government and the social security system, specifying a path for the debt-GDP ratio consistent with long-term sustainability.
- Political economy note: more than half of the electorate will be over 50 years of age by 2010, posing challenges to reform.

### Healthcare specifics and projected subsidy pressure
- Ratio of health costs to GDP: 11.5 percent in 2003.
- In real per-capita terms, health expenditures grew by 3 percent per year.
- Staff calculation: share of subsidized households would rise from 34 now to over 60 percent in 2015 and 90 percent in 2050 if trends continue.

### Financial sector, pensions, and supervision
- Banking sector: resilient, adequately capitalized; 2004 bank profitability rose; lending patterns show increasing household credit but declining credit to enterprises.
- Stress tests: internationally active banks exposed to a depreciation of the dollar and a correction in the US real estate market.
- Insurance sector: conditions improved; life insurers constrained by low asset returns relative to regulatory minimum guaranteed returns.
- Second-pillar pension funds: in 2003, 12 percent of the funds were underfunded with a total shortfall equivalent to 6 percent of GDP; progress made in 2004 aided by higher equity prices and regulatory adjustments.
- Parliament approved gradual reduction in annuity conversion rate from 7.2 to 6.8 percent.
- Supervisory reforms: revised Banking Act effective July 1, 2004; intention to make FINMA operational by the beginning of 2007; revised Insurance Supervision Act adopted moving to risk-based supervision.
- Staff recommendations: shift second-pillar pension regulation toward actuarial and risk-based assessments; harmonize supervision across cantons; uniform rating of debtors; bolster the quality of external audits.

### Structural reforms, product markets, and trade policy
- Unfinished product market reform agenda; non-tariff barriers widespread; agricultural protection remains very high.
- Switzerland has the second highest level of export subsidies in the world (Trade Policy Review, WTO, November 2004); marginal tariff for some agricultural products cited as 700 percent.
- Direct producer support exceeds the value added of agricultural production.
- Authorities’ measures and proposals:
  - Amendment to the Internal Market Law to reduce cantonal impediments to cross-border supply of services and empower the Competition Authority.
  - Bill for liberalization of the electricity market: commercial consumers choose supplier starting in 2007; remaining customers five years later.
- Staff recommendation: open sheltered sectors, eliminate non-tariff barriers, lower agricultural protection, and intensify competition.

### EU bilateral relations and labor mobility
- First package of bilateral agreements (including free movement of labor) took effect June 2002.
- Extension to new EU members approved subject to a referendum scheduled for September (year context 2005).
- Second package signed October 2004 (including EU savings directive and associate Schengen membership); a referendum on Schengen membership scheduled for June.
- Labor market opening timing: complete opening by 2007 for existing EU members; gradual opening by 2011 for new EU members; Switzerland could impose restrictions until 2014 if disruptive influx occurs.
- Labor market features: employment and participation ratios among top OECD; unionization low; active labor market policies relatively effective.

### Key macroeconomic projections and selected numeric highlights
- Staff growth projection: 1¼ percent (2005).
- Authorities’ growth projection: 1½ percent (2005).
- Potential growth: 1½ percent (current); projected to decline to ¾ percent (medium term).
- Headline CPI: 1.4 percent (early 2005); CPI (year average) 2004: 0.8; 2005 (staff projection): 1.2.
- Unemployment rate: 3.9 percent (2004); 4.2 percent (2005, table).
- Current account surplus: 12 percent of GDP (2004).
- General government deficit: 1 percent of GDP (2004).
- Pension and healthcare combined deficit: over 5 percent of GDP.
- SNB gold-sale proceeds: 4.6 percent of GDP transferred to government; allocation: ⅓ federal, ⅔ cantons; cantons projected to use 80-85 percent for debt reduction.
- Nominal GDP (memorandum table, SwF billions): 444.6; 455.2; 469.8; 484.7; 499.4 (values presented as sequence in overview table).
- Memorandum indicators (selected sequences shown in table):
  - GDP growth (annual percent, 2000–2007): 3.6; 1.0; 0.3; -0.4; 1.7; 1.2; 2.0; 1.9.
  - Employment (percent change): 1.0; 1.7; 0.6; -0.1; 0.2; 0.7; 0.9; 0.8.
  - Unemployment rate (percent): 1.8; 1.7; 2.5; 3.7; 3.9; 4.2; 4.0; 3.8.
  - Current account (percent of GDP): 12.4; 8.0; 8.4; 13.2; 12.0; 11.1; 11.3; 11.2.

### Staff appraisal and policy priorities (summarized recommendations)
- Monetary policy: maintain accommodative stance until recovery gains traction; be prepared to withdraw stimulus when recovery firms.
- Fiscal policy:
  - Continue fiscal consolidation at the federal level to eliminate the structural deficit under the debt-brake rule.
  - Apply SNB gold-sale proceeds mainly to debt reduction; avoid creating permanent expenditures at the cantonal level from one-off receipts.
  - Develop a comprehensive long-run fiscal framework covering all levels of government and social security, specifying a path for the debt-GDP ratio consistent with sustainability.
- Structural reform:
  - Advance reforms to open sheltered sectors, bolster competition, reduce non-tariff barriers, and lower agricultural protection to strengthen potential growth.
  - Pursue public information efforts to build support for reform.
- Pensions and healthcare:
  - Reevaluate first-pillar pension entitlements and recalibrate parameters such as retirement age and replacement rate.
  - Shift second-pillar pension regulation toward actuarial and risk-based assessments; harmonize supervisory standards across cantons; resolve underfunding.
  - Contain healthcare costs using economies of scale and competition among providers and pharmaceuticals.
- Financial sector supervision: remain vigilant; implement risk-based supervision and improve audit quality and uniform debtor assessment.

*Source: IMF staff report — Executive Summary and selected excerpts (data and text as presented).*

### Executive Summary ......................................................................................................

### Executive Summary

### Recent developments and recovery
- The Swiss economy returned to growth in 2004, supported by external demand and domestic policies.
- Real GDP expanded by 1.7 percent in 2004, narrowing the output gap to 1 percent.
- The recovery is fragile and dependent on external demand; business indicators in early 2005 remained relatively weak.
- Growth is projected to continue in 2005, with staff projecting growth of 1¼ percent (from 1.7 percent in 2004), with some risks on the downside.
- A moderate recovery has been in place since mid-2003, driven by supportive monetary and fiscal policies and growing external demand. Investment and construction benefitted from improving prospects and low interest rates, while household consumption was held back by a soft labor market and rising energy costs.
- An unexpected dip in investment contributed to a contraction of GDP in the last quarter of 2004.
- Labor market: employment was flat in 2004 as productivity improved before hiring; unemployment rose to 3.9 percent in 2004. Employment declines were concentrated in manufacturing; labor supply growth was muted by workers moving into training and retirement.

### Inflation and monetary policy
- Inflation is projected to remain well inside the 0-2 percent range of price stability.
- The Swiss National Bank (SNB) has been pursuing an accommodative monetary policy and has appropriately placed monetary policy on hold given the soft patch in the recovery and strong credibility anchoring inflation expectations.
- Staff recommendation: maintain the accommodative stance until the recovery gains traction.

### Fiscal developments and short-run fiscal strategy
- The general government fiscal deficit was contained to 1 percent of GDP.
- Federal authorities plan to eliminate the structural federal deficit in the short run under the debt-brake rule while allowing automatic stabilizers to operate along this path.
- The authorities are undertaking a review of public expenditures to reduce the size of government and achieve longer-lasting savings.
- Proceeds from gold sales are expected mostly to be applied toward debt reduction; cantonal governments need to guard against creating new permanent expenditures with gold-sale proceeds.
- The new constitutional structure for fiscal federalism improves the allocation of tasks between levels of government and removes some incentives for excessive spending.

### Long-term sustainability and aging
- Potential growth is estimated at 1½ percent and is projected to decline in the medium term to ¾ percent as a result of population aging.
- More needs to be done to address rising pressures on public finances from population aging.
- The sustainability of the first pillar pension system and healthcare remains to be established.
- Recommendation: supplement the debt-brake rule with a long-run fiscal framework encompassing all levels of government and the social security system that includes a path for the debt-GDP ratio consistent with long-term sustainability.
- Political economy challenge: more than half of the electorate will be over 50 years of age by 2010, swelling the constituency averse to reform.

### Financial sector and pensions
- The financial sector appears healthy and dynamic, although underfunding continues in some second pillar pension funds.
- Supervisors remain appropriately vigilant and proactive.
- Further reforms recommended: uniform rating of debtors, and the shift to actuarial and risk-based assessments of second-pillar pension schemes.

### Structural reform and product markets
- The unfinished product market reform agenda remains long and the cost of inaction is large—placing undue pressure on fiscal policies in the context of aging.
- Non-tariff barriers are widespread and, despite some progress, agricultural protection remains very high.
- Recent Fund advice has had mixed implementation: monetary, fiscal, and financial sector policies aligned with Fund advice; structural reform recommendations have met with less success due to complacency from high living standards, entrenched vested interests, diffuse political power, and frequent referenda.

### Staff appraisal and policy priorities
- Maintain an accommodative monetary stance until a firmer recovery is evident.
- Continue fiscal consolidation at the federal level to eliminate the structural deficit, apply gold-sale proceeds mainly to debt reduction, and avoid using one-off receipts to create permanent expenditures at the cantonal level.
- Develop a comprehensive long-run fiscal framework that covers all levels of government and social security and specifies a path for the debt-GDP ratio consistent with sustainability.
- Advance structural reforms to open sheltered sectors, bolster competition, reduce non-tariff barriers, and lower agricultural protection to strengthen potential growth.
- Reform second-pillar pension regulation toward actuarial and risk-based assessments and ensure uniform debtor rating standards.

*Source: IMF staff report — Executive Summary (data and text as presented).*

### 5.      Inflation remained low, the oil shock notwithstanding. In early 2005, headline CPI

### _cr05190 - 5.      Inflation remained low, the oil shock notwithstanding. In early 2005, headline CPI

### Inflation dynamics and labor costs
- Headline CPI inflation picked up to 1.4 percent in early 2005; core inflation rose from ¼ to 1 percent.
- Second-round effects have been virtually absent.
- Average wages rose by 0.9 percent in 2004 and are likely to increase by around 1¼ percent in 2005.
- Inflation is projected to remain below 2 percent through 2006, reflecting the SNB’s strong credibility and flexible labor markets.

### Monetary conditions and interest rates
- The SNB raised the three-month policy rate in June and September 2004 by 25 basis points each after having kept it at 0.25 percent for more than a year.
- The three-month rate remained negative in real terms.
- Long-term interest rates hardly moved as markets remained confident about inflation.
- Rapid monetary growth of previous years subsided and credit expansion was tame: increasing credit to households was tempered by declining credit to enterprises.
- Equity prices improved to 30 percent below their peak of end-2000.
- Average real estate prices remained subdued.
- Staff view: patience with policy rates was warranted given the negative output gap and absence of price pressures; SNB left the policy rate unchanged in its March assessment.

### Exchange rate and monetary stimulus
- Since end-2003, the franc appreciated by 3.7 percent in real effective terms and by 1.2 percent in nominal terms, reflecting appreciation vis-à-vis the US dollar (the franc-euro rate remained stable).
- The franc is now close to its long-term upward trend.
- The strengthening of the franc has withdrawn some monetary stimulus.
- Authorities noted concern that a rapid appreciation of the franc against the U.S. dollar could push inflation toward negative territory; with low interest rates, the SNB would have little room for maneuver and would include foreign exchange intervention among its options.
- Staff estimates suggest the franc might be slightly undervalued (macroeconomic balance, fundamental equilibrium, and PPP panel estimates adjusted for terms of trade and net factor income).
- The long-run trend appreciation has reduced manufacturers’ export market shares but has been offset by improving terms of trade as Swiss firms focus on high value-added markets.

### External sector and current account
- The external current account surplus remained high: current account surplus of 12 percent of GDP in 2004.
- Three-quarters of the current account surplus of 12 percent of GDP in 2004 reflects investment income from large net foreign assets.
- The surplus was also supported by a trend improvement in the terms of trade as exporters oriented toward specialty high-value-added markets.

### Short-run outlook and risks
- Staff cautiously optimistic: easing in late 2004 seen as a temporary soft patch to be overcome in 2005 with renewed external demand and continued monetary support.
- Staff growth projection: 1¼ percent in 2005, with activity gaining strength in the second half.
- Authorities’ projection: 1½ percent in 2005.
- Downside risks include: weaker-than-expected upturn in 2005, trimmed euro area growth (comprising 60 percent of Swiss exports), a safe-haven appreciation of the franc if global imbalances unwind, corrections in international financial markets affecting the financial sector, and persistently high oil prices reducing partner countries’ growth.
- SNB estimate (scenario): a 40 percent increase in crude oil prices for a three year period would lower growth by 0.4 percentage points and add 0.6 percentage points to prices.

### Monetary policy stance and forward guidance
- Monetary policy applied pragmatically: with inflation projected moderate through 2006, SNB maintained accommodative stance and paused further rate increases after mid-2004 moves.
- Staff and SNB agreed further withdrawals of monetary stimulus would be needed at some point; the key issue is timing.
- Markets expected little tightening in 2005.
- The SNB enhanced communication: releasing quarterly its 3-year ahead inflation forecast together with an assessment of monetary conditions; submitting an annual report to parliament on fulfillment of tasks under the new National Bank Act.
- Monetary policy framework objective: keep headline CPI inflation over a three year horizon “below 2 percent but positive.” Average inflation since inception in 2000: 0.9 percent.

### Fiscal policy, long-term challenges, and consolidation
- Federal government deficit was below budget due to tax buoyancy and lower interest payments; subnational governments consolidated finances.
- General government deficit is estimated to have narrowed to 1 percent of GDP in 2004, despite some widening of the social security deficit.
- Public finances managed carefully, but long-term strains visible: pension and healthcare systems running a combined deficit (before budgetary subsidies) of over 5 percent of GDP.
- Absent policy changes, demographic shift and rising healthcare spending projected to widen fiscal deficit and increase public debt to unsustainable levels over the medium term (extended debt sustainability analysis to 2060 in Selected Issues).
- Baseline paths assume the general government runs a primary surplus of 6 percent of GDP (excluding transfers to the pension system and healthcare).

- Federal fiscal policy guided by the debt-brake rule:
  - Objective: eliminate the recent federal structural deficit in the short run, allowing automatic stabilizers to operate.
  - Two expenditure-based consolidation programs (Entlastungsprogramme 2003 and 2004) aim to slow annual expenditure growth to 1.5 percent (slightly below nominal GDP growth).
- Subnational governments: consolidated in 2004 but expected to spend a share of gold sales in 2005-06 and face increasing healthcare spending pressures; additional measures may be needed to offset federal consolidation spillovers.

### SNB gold sales and suggested use of proceeds
- An important 2005 event: transfer to the government of 4.6 percent of GDP in proceeds from SNB gold sales.
- The government decided that ⅓ of these proceeds will be transferred to the federal government and ⅔ to the cantons.
- Staff strongly urged the authorities to apply these amounts to debt reduction.
- Federal authorities indicated their intention to apply proceeds to debt reduction; they projected cantons would use 80-85 percent of their allocation for debt reduction but noted they could not force cantons to do so.
- Staff and SNB view: the gold sale is a one-time event that reduces future SNB profit distributions, and the proceeds should therefore be saved.

### Key fiscal and macro numeric points (as stated)
- Headline CPI: 1.4 percent (early 2005)
- Core inflation: rose from ¼ to 1 percent
- Average wages: 0.9 percent (2004); likely around 1¼ percent (2005)
- Three-month policy rate historically low at 0.25 percent
- Franc appreciation since end-2003: 3.7 percent (real effective), 1.2 percent (nominal)
- General government deficit: narrowed to 1 percent of GDP in 2004
- Current account surplus: 12 percent of GDP in 2004
- Staff growth projection: 1¼ percent (2005); authorities: 1½ percent (2005)
- SNB average inflation since 2000: 0.9 percent
- Pension and healthcare combined deficit: over 5 percent of GDP
- Baseline assumption: general government primary surplus of 6 percent of GDP
- SNB gold-sale proceeds transferred to government: 4.6 percent of GDP; allocation: ⅓ federal, 2/3 cantons; cantons projected to use 80-85 percent for debt reduction
- Nominal GDP (memorandum item): 444.6, 455.2, 469.8, 484.7, 499.4 (values presented in the overview table)

*IMF staff report excerpts as presented in the source text.*

### 23.      The authorities felt that risks to the medium-term fiscal outlook were

### _cr05190 - 23.      The authorities felt that risks to the medium-term fiscal outlook were

### Fiscal outlook and near-term risks
- Authorities judged risks to the medium-term fiscal outlook as manageable.
- Staff cautioned that competition from other financial centers could erode withholding taxes and stamp duties.
- Staff cautioned that the current level of profit distribution from the SNB would decline in future.
- Authorities acknowledged pressures on financial (and corporate) taxes and indicated that revenue losses would need to be compensated with expenditure cuts.
- Debt-brake rule: viewed as very valuable as a guide for fiscal policy, but annual adjustment programs were causing adjustment fatigue; authorities were searching for structural longer-lasting solutions in an expenditure review for the federal government.
- SNB gold sales and holdings:
  - Between May 2000 and March 2005, and in coordination with other central banks, the SNB sold 1,300 tons of gold.
  - The SNB still holds 1,290 tons of gold, corresponding to ⅓ of its foreign exchange reserves.
  - There is no intention to reduce gold holdings further.

### Long-run fiscal pressures from population aging and social security
- Staff projection: Switzerland’s old-age dependency ratio is projected to increase by 16 percentage points over the next thirty years.
- Under current policies, the first pillar of the pension system and the health care system are on a path of sharply rising deficits.
- Staff estimated the net present value of future liabilities of these programs at 180 percent of GDP, roughly the equivalent of a 7½ percentage point hike in the VAT.
- Authorities were reviewing social security entitlements and had begun to frame proposals to strengthen the finances of disability insurance.

### Strategy for long-term fiscal sustainability (findings and recommendations)
- Officials agreed long-term fiscal sustainability required a coordinated strategy embracing fiscal consolidation and reforms.
- Staff noted the financing gap of social security was too large to be closed by fiscal consolidation alone; tax increases could worsen distortions and adversely affect Switzerland’s slow output growth.
- Authorities indicated a potential rise in the retirement age would need to be accompanied by creation of work opportunities for older workers.
- Consensus on a viable strategy involving:
  - A balanced mixture of pension and healthcare reforms to reduce social security deficits.
  - Product market reforms to raise output and employment growth.
  - Expenditure-based fiscal consolidation to close any remaining gap.
- Staff recommended aiming fiscal policies at a downward path for the public debt-to-GDP ratio beyond 2007.
- Staff recommended publication of comprehensive periodic reports on long-run sustainability of public finances to guide policy, improve public awareness, and catalyze reform.

### Healthcare costs (Box 2): current status and risks
- Switzerland is the second most expensive country for health care in the world.
- Ratio of health costs to GDP was 11.5 percent in 2003—more than double its level in 1970.
- In real per-capita terms, health expenditures grew by 3 percent per year.
- Characteristics and drivers:
  - High prices rather than large quantities characterize the Swiss health sector, suggesting supply-side distortions.
  - System suffers from regional fragmentation with small units, financial fragmentation, supply-pushed demand in medications and treatments, and insufficient competition.
- Financing and redistribution:
  - Switzerland’s health care system is financed largely by the private sector.
  - High growth in insurance premia and out-of-pocket payments have a regressive effect on income distribution; government subsidizes low-income households to counter this and to keep non-wage labor costs low.
- Future subsidy pressure (staff calculations):
  - Share of subsidized households would rise from 34 now to over 60 percent in 2015 and 90 percent in 2050.
- Implication: Little cost control implies healthcare subsidies in public finances could grow rapidly in the future.

### Intergovernmental fiscal reform (Box 3)
- Proposals for overhauling Switzerland’s system of intergovernmental fiscal relations were accepted in a referendum.
- Staff viewed the reform as strengthening fiscal federal relations by:
  - Improved assignment of tasks and responsibilities between federal and subnational governments.
  - Improved inter-regional equity.
  - Sharply reduced perverse spending incentives for poor cantons.
- Constraints noted:
  - Given pronounced cantonal autonomy and the relatively small size of the federal government (representing less than ⅓ of general government spending), running a coordinated fiscal policy stance will remain difficult unless cooperation between federal and cantonal governments is further strengthened.
- New Financial Equalization Scheme (NFA) highlights:
  - Replaces project subsidies with simple grants based on cantonal per-capita tax revenues and mountainous area extent—improves transparency and reduces incentives for unnecessary projects.
  - Better defines cantonal and federal tasks (examples: old age pensions, disability insurance, military expenses, interstate highways financed exclusively by federal government; health care and airports by cantons).
  - Full implementation timeline: constitutional changes approved November 2004; specific laws planned in 2006-07; if accepted in referenda—implemented in 2008-09; full implementation will take another four years.

### Financial sector stability: banking, insurance, pensions, and supervision
- Banking sector:
  - Authorities underscored banking sector remained resilient, adequately capitalized, and dynamic.
  - 2004: bank profitability rose helped by cost cuts and consolidation; balance sheets strengthened further.
  - Low interest rates stimulated rapid mortgage lending to households; supervisors’ simulations suggest a rise in interest rates would not impair households’ ability to service debts as loan-to-value ratios were moderate and real estate price increases had remained subdued.
  - Lending to enterprises has been declining for several years; supply declined as banks tightened lending practices and introduced risk-based interest rates; demand moderated due to lower investment and enterprises strengthening balance sheets.
  - Increased lending from regional banks mitigated the overall decline without apparent compromise of lending standards.
  - Supervisors viewed the capital base as robust.
  - Stress tests suggested internationally active banks were exposed to a depreciation of the dollar and a correction in the US real estate market.
  - For all banks, potential stress sources: a domestic economic downturn and stronger than anticipated interest rate increases.
  - A tendency of some institutions to increase their risk profile in search for yield was being monitored closely.

- Insurance sector:
  - Financial conditions improved with recovery of global capital markets and cost cuts, but weaknesses remained.
  - Nonlife insurers: profitability increased reflecting better underwriting performance and higher premia.
  - Life insurers: profitability improved but low interest rates on assets vis-à-vis regulatory minimum guaranteed returns on life insurance policies limited progress.
  - Authorities saw scope for further consolidation.
  - Risk management being strengthened with a new risk-based capital adequacy regime anticipating EU Solvency II requirements.

- Second pillar pension funds:
  - 2003: 12 percent of the funds were underfunded, with a total shortfall equivalent to 6 percent of GDP.
  - Additional progress in 2004 helped by higher equity prices and a reduction in the regulatory minimum return on assets.
  - Undercapitalized funds were allowed to reduce further the return on assets and levy supplementary contributions, including from pensioners.
  - Some funds reduced the discount rate used to determine the present value of pension liabilities.
  - Parliament approved gradual reduction from 7.2 to 6.8 percent of the rate at which accumulated savings are converted into annuities (recognizing longer life spans) and required more transparent accounting standards for pension liabilities.
  - Further reforms underway to harmonize supervision across cantons.
  - Authorities agreed supervisory system would benefit from a shift of emphasis towards actuarial and risk-based assessments.

- Supervisory framework developments:
  - On July 1, 2004, the revised Banking Act came into force, harmonizing under the sole responsibility of the Swiss Federal Banking Commission the supervision, reorganization and liquidation of banks.
  - Officials reaffirmed intention to make the Financial Market Supervision Authority (FINMA) operational by the beginning of 2007.
  - Consideration of extending supervision to independent asset managers, brokers and foreign exchange dealers, and improving coordination with supervision of second pillar pension funds (which remained separate).
  - From 2005, external auditors of banks and brokers required to prepare risk analysis/audit reports.
  - Parliament adopted the revised Insurance Supervision Act, moving to risk-based supervision and aligning Swiss legislation with EU directives.
  - To implement revised FATF recommendations, authorities preparing amendments to the Money Laundering Act to extend its application to professions and activities outside the financial sector, and improve transparency of owners of bearer shares.
  - An evaluation by FATF was scheduled for 2005.

### Structural issues and growth policy
- Authorities agreed improving Switzerland’s growth performance remains a priority due to slow growth over the past quarter century eroding per capita GDP standing.
- Multifactor productivity growth has been among the lowest in industrial countries; with participation rate already high and working age population set to decline, policies to spur productivity growth are key.
- Earlier staff research suggested reforms could add ½ percentage points to growth; OECD found similar effects from opening health, agriculture, electricity, and gas sectors.
- Authorities adopted a growth package aiming at:
  - Opening up sheltered sectors.
  - Intensifying external economic relations.
  - Reducing the role of the state.
  - Raising further labor market participation.
  - Improving the education system.
- Specific measures prepared:
  - Amendment to the Internal Market Law that, if adopted, would (i) significantly reduce the ability of cantons to impede cross-border supply of services and (ii) empower the Competition Authority to challenge at the Federal Court cantonal and local governments’ rules and regulations that constitute barriers to market entry.
  - Bill for liberalization of the electricity market in two steps: commercial consumers able to choose supplier starting in 2007, and the rest five years later.
- Staff welcomed these reforms and urged stronger efforts to eliminate ubiquitous nontariff barriers for a host of services and products.

*Source: IMF staff report excerpt contained in content unit _cr05190 - 23.      The authorities felt that risks to the medium-term fiscal outlook were*

### 34.      The authorities negotiated some important bilateral agreements with the EU.

### _cr05190 - 34.      The authorities negotiated some important bilateral agreements with the EU.

### Bilateral agreements with the EU
- A first package of bilateral agreements, including the free movement of labor, took effect in June 2002.
- Extension of these agreements to the new EU members, with transitional safeguards, has been approved subject to a referendum scheduled for September.
- A second package of agreements—including the EU savings directive and associate Schengen membership—was signed in October 2004; a referendum on Schengen membership is scheduled for June.
- Labor mobility timing under the agreement: complete opening of the labor market by 2007 for existing EU members and gradual opening by 2011 for the new EU member countries; Switzerland could impose restrictions until 2014 in case of a disruptive influx.

### Labor market—performance and implications
- The Swiss labor market is described as quite flexible and not considered a main source of distortions.
- Employment and participation ratios are at the top among OECD countries; unionization is low; employment legislation is flexible; active labor market policies are relatively effective (Figure 11).
- Opening up the labor market vis-à-vis the EU could attract skilled labor, which in previous upswings had been a drag on growth.
- Extension of free labor mobility to the new EU members could help to ameliorate the effects of population aging.

### Agriculture protection and trade policy
- Very high agriculture protection remains a notable feature of the Swiss trade regime.
- Switzerland has the second highest level of export subsidies in the world (Trade Policy Review, WTO, November 2004).
- The marginal tariff for some agricultural products is 700 percent.
- Direct producer support exceeds the value added of agricultural production.
- Price support is being dismantled in favor of direct payments, but staff noted it would take years at the current pace before protection dropped even to the high EU level.
- Authorities acknowledge increasing public questioning of the very high price level in Switzerland relative to neighbors, especially for food products.
- Staff recommendation: authorities are encouraged to lower the levels of agricultural tariff and non-tariff protection and to eliminate trade barriers, including those in agriculture under the Doha trade round.

### Official development assistance (ODA)
- Official development assistance (ODA) is nearly 0.4 percent of GNI.
- This figure does not include sizeable international assistance (such as for refugees) that is not classified as ODA.
- Swiss ODA is seen by DAC as effective and well-focused on poor countries.
- ODA is about average (Figure).

### Economic statistics
- Despite welcome improvement, deficiencies remain in the quality and coverage of economic statistics (Appendix II).
- Authorities explained the pace of improvements is determined by budgetary constraints.
- Staff recommendation: additional resources need to be allocated to the improvement of economic statistics.

### Staff appraisal—key findings, projections, and policy recommendations
- Key judgment: The Swiss economy is wealthy with a robust external sector, flexible labor markets, and sound monetary and fiscal policy frameworks; however, some strains are showing as a result of sustained slow growth (para 39).
- Growth outlook: Economic growth in 2005 is projected to continue, albeit at a slower pace; weaker demand in the euro area and the U.S. dollar depreciation have dented the modest recovery. External factors are projected to improve as the year unfolds but downside risks remain: persistent euro-area softness, higher oil prices, and potential for a disorderly adjustment of international imbalances (para 40).
- Inflation and monetary policy: Inflation is expected to remain low despite higher oil prices. The SNB can afford to be patient; policy rates were raised slightly in 2004 and then held as the economy softened. Inflation expectations are well anchored; inflation is projected to remain inside the price stability range until 2006, supporting a continued accommodative stance (paras 41–42).
- Exchange rate: The franc’s gradual appreciation reflects a fundamental longer-term trend; this has not been a drag on the external current account given higher value-added exports, benefits to the international financial system, and persistently very high net factor income (para 43).
- Fiscal policy and public finances:
  - Public finances were stronger than expected in 2004 and need to continue improving in the medium term.
  - The objective to eliminate the federal government structural deficit is well placed; low average real GDP growth and mounting pressure on social security require fiscal prudence (para 44).
  - The proceeds from SNB gold sales are one-time flows and should be used to reduce debt; the federal government’s decision to use proceeds for debt reduction is welcome and should be replicated by the cantons (para 45).
  - A multi-year fiscal framework is needed to ensure intertemporal consistency in addressing population aging; it should encompass all levels of government, stipulate a path for the public debt-to-GDP ratio consistent with long-term fiscal sustainability, and include provisions for fiscal policy coordination (para 47).
  - Fiscal consolidation should focus on reducing expenditures; options will need to include different mixtures of revenue increases, expenditure cuts, entitlement rationalization (protecting the most vulnerable), and structural reforms to bolster growth (para 48).
  - The new constitutional structure for fiscal federalism is welcome; it better assigns tasks across levels of government and removes some incentives for spending (para 49).
- Pensions and healthcare:
  - A considerable task remains to ensure sustainability and efficiency of the pension and healthcare systems (para 46).
  - Pension recommendations: reevaluate affordability of first-pillar pension entitlements; recalibrate parameters such as retirement age and replacement rate; reassess roles/relations between first and second pension pillars; align annuity conversion rate with actuarially neutral value; align discount rate with market interest rates; if market interest rates stay low, the regulatory minimum interest rate may need to be brought down further; harmonize standards across cantons and shift to actuarial assessments with more timely disclosure of financial statements (paras 46, 51).
  - Healthcare recommendations: contain costs by using economies of scale and encouraging competition for providers and pharmaceuticals (para 46).
- Financial sector and supervision:
  - Financial system appears generally healthy and dynamic, but supervisors’ continued vigilance is important given the large size of the sector (para 50).
  - Banks are comfortably capitalized but run some risks—especially if global imbalances unwind suddenly and asset prices fall sharply.
  - Domestic lending to households has been strong, mainly for mortgages, but without signs of pressure on real estate prices so far.
  - Authorities’ proactive supervisory attitude is commendable; staff recommends bolstering the quality of external audits and facilitating uniform assessments of debtors.
  - The switch to risk-based supervision should bring considerable benefits to insurance (para 50).
- Structural reform and public consensus:
  - Efforts to advance structural reforms to boost growth have met with limited success; building consensus around such policies has proven difficult (para 39).
  - A significant effort is needed to impress upon the public the need for a long-run fiscal strategy; regular publication of fiscal sustainability reports could enhance public awareness (para 48).

*IMF staff report excerpt (paragraphs 34–53).*

### 54.      It is recommended that the next Article IV consultation with Switzerland be held on

### _cr05190 - 54.      It is recommended that the next Article IV consultation with Switzerland be held on

### Recommendation on Article IV consultation
- It is recommended that the next Article IV consultation with Switzerland be held on the standard twelve-month cycle.
- Switzerland is on the standard 12-month Article IV consultation cycle.

### Macroeconomic summary and projections (selected indicators)
- Total area: 41,293 square kilometers
- Total population (end-2004): 7.3 million
- GDP per capita (2004): 49,146$
- GNP per capita (2004): 52,645$
- Percentage changes at constant prices (annual):
  - Total domestic demand: 2.2; 2.3; -0.8; 0.2; 1.0; 1.1; 1.5; 1.7 (2000–2007 sequence per table)
  - Private consumption: 2.3; 2.0; 0.3; 0.5; 1.3; 0.8; 1.3; 1.7
  - Public consumption: 2.6; 4.2; 3.2; 1.4; 1.2; 0.2; 0.2; 1.0
  - Gross fixed investment: 4.3; -3.1; 0.3; -0.4; 3.4; 0.8; 2.1; 1.8
  - Final domestic demand: 2.8; 1.0; 0.7; 0.4; 1.8; 0.7; 1.3; 1.6
  - Inventory accumulation (change as percent of previous year's GDP): 2/ -0.6; 1.2; -1.3; -0.2; -0.7; 0.3; 0.1; 0.1
  - Foreign balance (change as percent of previous year's GDP): 2/ 1.5; -1.2; 1.1; -0.5; 0.8; 0.1; 0.6; 0.3
  - Exports of goods and nonfactor services: 12.2; 0.2; -0.2; 0.0; 6.6; 3.7; 5.5; 5.1
  - Imports of goods and nonfactor services: 9.6; 3.2; -2.8; 1.4; 5.6; 3.9; 4.8; 5.1
  - GDP: 3.6; 1.0; 0.3; -0.4; 1.7; 1.2; 2.0; 1.9
  - GNP: 5.2; -2.0; -1.1; 3.1; 0.8; 1.4; 1.9; 2.4
- Nominal GDP (billions of SwF): 415.5; 422.5; 431.1; 433.4; 444.6; 455.2; 469.8; 484.7
- Employment and labor market:
  - Employment (percent change): 1.0; 1.7; 0.6; -0.1; 0.2; 0.7; 0.9; 0.8
  - Unemployment rate (in percent): 1.8; 1.7; 2.5; 3.7; 3.9; 4.2; 4.0; 3.8
  - Output gap (in percent of potential): 1.9; 1.5; 0.4; -1.3; -1.1; -1.4; -1.0; -0.7
- Prices and incomes:
  - GDP deflator: 0.8; 0.6; 1.7; 0.9; 0.9; 1.2; 1.2; 1.3
  - Consumer price index: 1.6; 1.0; 0.5; 0.6; 0.8; 1.2; 1.0; 1.3
  - Nominal wage growth: 1.3; 2.5; 1.8; 1.2; 1.3; 1.4; 1.8; 2.2
  - Unit labor costs (total economy): 0.8; 3.1; 2.0; 1.5; -0.2; 0.9; 0.7; 1.1
- Monetary and credit data (selected): Broad money (M3): -1.8; 3.1; 3.8; 8.3; 3.0; .........; Domestic credit: 1.7; 1.5; -0.5; 0.6; 2.3; .........
- Interest rates (selected): Three-month rate: 3.1; 2.9; 1.2; 0.4; 0.5; .........; Yield on government bonds: 3.8; 3.3; 3.1; 2.5; 2.6; .........
- Exchange rates (annual average): SwF per US$: 1.69; 1.69; 1.56; 1.36; 1.25; .........; SwF per euro: 1.56; 1.51; 1.48; 1.51; 1.54; .........; Nominal effective rate (avg., 1990=100): 100.0; 103.7; 108.2; 108.6; 108.4; .........; Real effective rate (avg., 1990=100) 5/: 99.8; 102.8; 106.6; 106.2; 105.2; .........

### Current account and balance of payments highlights
- Current account (in billions of SwF): 51.7; 33.8; 36.2; 57.1; 53.2; 50.7; 52.9; 54.3 (2000–2007 sequence)
- Current account (In percent of GDP): 12.4; 8.0; 8.4; 13.2; 12.0; 11.1; 11.3; 11.2
- Trade balance (in billions SwF): -4.2; -4.6; 5.1; 4.5; 3.9; -1.1; -2.9; -4.4
- Service balance (in billions SwF): 27.3; 23.4; 23.3; 24.0; 24.7; 25.2; 27.0; 27.6
- Net investment income (in billions SwF): 44.0; 32.9; 25.9; 45.8; 41.7; 43.8; 46.1; 48.5
  - Net investment income (in percent of GDP): 10.6; 7.8; 6.0; 10.6; 9.4; .........
- Net external assets (in billions SwF): 521.5; 596.5; 583.7; 580.5; 633.5; .........
  - Net external assets (in percent of GDP): 125.5; 141.2; 135.4; 133.9; 142.5; .........
- Official reserves (billions of US$, end period): 32.3; 32.0; 40.2; 47.7; 55.5; .........
- Reserve cover (months of imports of GNFS): 3.8; 3.7; 4.4; 4.6; 4.3; .........

### General government finances (levels and percent of GDP)
- General government (In millions of SwF, 2000–2007 sequence):
  - Revenue 1/: 163,703; 163,940; 163,232; 163,476; 167,244; 172,198; 176,746; 181,057
  - Expenditure: 154,591; 163,563; 168,582; 170,417; 171,889; 178,764; 182,538; 187,287
  - Balance: 9,112; 377; -5,349; -6,941; -4,645; -6,566; -5,792; -6,230
- General government (In percent of GDP): Revenue: 39.4; 38.8; 37.9; 37.7; 37.6; 37.9; 37.6; 37.4; Expenditure: 37.2; 38.7; 39.1; 39.3; 38.7; 39.3; 38.9; 38.7; Balance: 2.2; 0.1; -1.2; -1.6; -1.0; -1.4; -1.2; -1.3
- Structural balance 4/ (In percent of GDP): 0.6; -0.1; -0.8; -0.8; -0.2; -0.3; -0.3; -0.6
- Gross debt (In percent of GDP): 49.9; 50.5; 54.5; 55.4; 55.6; 50.6; 49.8; 49.2
- Federal government (2000–2007, in millions of SwF):
  - Revenue 1/: 51,994; 49,434; 47,658; 47,511; 48,933; 51,013; 52,373; 53,699
  - Expenditure: 48,256; 51,191; 51,979; 51,287; 51,566; 53,076; 52,792; 53,294
  - Balance: 3,738; -1,757; -4,321; -3,776; -2,633; -2,063; -418; 405
- Federal government (In percent of GDP): Revenue: 12.5; 11.7; 11.1; 11.0; 11.0; 11.2; 11.2; 11.1; Expenditure: 11.6; 12.1; 12.1; 11.8; 11.6; 11.7; 11.2; 11.0; Overall balance: 0.9; -0.4; -1.0; -0.9; -0.6; -0.5; -0.1; 0.1
- Memorandum items:
  - Structural fiscal balance: 0.6; -0.1; -0.8; -0.8; -0.2; -0.3; -0.3; -0.6
  - Note: 1/ Excludes in 2005 transfers from SNB gold sales of SwF 21 billion, 4.6 percent of GDP.

### Financial sector: banks, insurance, and system soundness indicators
- Major financial institutions (2002–2004, selected):
  - Union Bank of Switzerland (SwF millions): Profit 2/: 3,530; 6,239; 8,044; Operating Income: 34,107; 33,790; 37,402; S&P Credit Ratings: AA+; AA+; AA+
  - Credit Swiss Group (SwF millions): Profit 2/: -4,448; 770; 5,628; Operating Income: 47,245; 51,353; 54,014; S&P Credit Ratings: AA-; A-1; A-1
  - Zurich Financial Services (US$ millions): Profit USD millions 2/: -3,503; 3,611; 3,786; Operating Income: 40,302; 57,208; 59,678; S&P Credit Ratings: AAA-
  - Swiss Life (SwF millions) 1/: Profit 2/: -1,847; 477; 1,009; Operating Income: 20,624; 21,088; 22,342; S&P Credit Ratings: A-; A-; A-
  - Swiss Re (SwF millions): Profit (SwF millions) 2/: -911; 1,702; 2,475; Operating Income: 34,415; 36,430; 36,093; S&P Credit Ratings: AA+; AAA; AA
  - Total Profit (SwF millions) 2/: -8,316; 14,051; 21,916; Profit (percent of GDP): -1.9; 3.3; 6.6; Operating Income (SwF millions): 199,206; 219,700; 224,881; Operating Income (percent of GDP): 46.6; 51.0; 67.8
  - Source: Company reports; and IMF staff calculations.
- Core FSIs and banking sector ratios (1999–2004, selected indicators):
  - Regulatory capital as percent of risk-weighted assets: 11.3; 12.7; 11.8; 12.1; 11.2; 11.0
  - Regulatory Tier I capital to risk-weighted assets: 10.2; 12.7; 12.0; 12.6; 12.2; 11.6
  - Non-performing loans net of provisions as percent of tier I capital: 43.0; 28.2; 27.4; 23.3; 16.5; 12.1
  - Non-performing loans as percent of gross loans: 4.9; 4.1; 3.6; 3.1; 2.3; 1.6
  - Gross profits as percent of average assets (ROAA): 1.1; 1.4; 1.1; 1.1; 0.9; 0.9
  - Net interest income as percent of gross income: 32.1; 34.4; 37.2; 37.6; 42.9; 38.6
  - Liquid assets as percent of total assets: 28.5; 23.4; 23.3; 21.6; 26.1; 27.0
  - Sectoral distribution of bank credit to the private sector (percent of total credit):
    - Households: 56.7; 57.3; 58.8; 61.3; 64.1; 65.5
    - Industry and manufacturing: 5.7; 5.4; 5.2; 5.1; 4.6; 4.1
    - Commercial real estate, IT, R&D: 12.8; 13.3; 12.4; 12.3; 12.2; 12.2
- Encouraged FSIs and other indicators (1999–2004, selected):
  - Capital as percent of assets (simple ratio): 4.9; 6.0; 5.6; 5.4; 5.2; 5.0
  - Customer deposits as percent of total (non-interbank) loans: 114.3; 102.6; 98.4; 98.4; 104.8; 105.0
  - Foreign currency loans as percent of total loans: 23.8; 31.6; 31.6; 31.6; 31.6; 31.6
  - Household debt to banks as a percentage of GDP: 82.5; 81.4; 84.3; 85.7; 88.5; 90.1
  - Mortgage loans as percent of total loans: 66.1; 65.1; 65.8; 69.9; 71.5; 69.7
- Structure of financial system (selected counts and volumes):
  - Banks (number): 372; 375; 369; 356; 342; 338
  - Assets, Banks (In SwF billions): 2,244; 2,125; 2,227; 2,252; 2,237; 2,491
  - Deposits, Banks (In SwF billions): 988; 885; 937; 932; 974; 1,044

### Statistical issues and data quality
- Compliance and dissemination:
  - Switzerland is in full compliance with the Fund’s Special Data Dissemination Standard (SDDS) and its metadata are currently posted on the Dissemination Standards Bulletin Board.
- Identified statistical gaps and deficiencies:
  - The SNB does not compile a monetary survey.
  - Wage statistics are available only on an annual basis.
  - Reliable general government finance statistics appear with considerable lags, mainly due to delays in compiling fiscal accounts at the level of cantons and communes.
  - Internationally comparable fiscal statistics on an accrual basis are not available.
  - Pension statistics are published with a long lag.
  - GDP by industry appears with considerable lag.
  - Capital stock data and flow-of-funds statistics are not yet available.
  - Data on deposit money banks submitted by the SNB to STA for IFS lack adequate sectorization and instrument breakdown.
- Planned or ongoing statistical improvements:
  - SNB launched in 2004 a monthly survey on the cost of borrowing; pilot phase expected to be completed by mid-2005.
  - In Q3 2005, SNB will introduce revised and more comprehensive statistics on mutual funds.
  - In October 2005 the SNB will publish, in collaboration with the Federal Statistical Office, annual financial accounts for 1999-2003 (stock data only). Data for 2004 and flows will be published in the spring 2006.
  - Annual national accounts were upgraded in 2003 to the European System of Accounts 1995 (ESA95); with release of Q4 2004 data, SECO revised its quarterly national account estimates and started compiling a quarterly production account.
  - In 2004, a statistical cooperation agreement with the European Union (part of Bilateral II) will lead to harmonization of several Swiss statistics with EU standards.
  - Federal Finance Administration preparations: revamping fiscal statistics with adoption of GFSM 2001 classification, reform of accounting standards for cantons and communes, and introduction of full accrual budgeting and accounting at federal level (Neues Rechnungsmodell Bund) along the lines of IPSAS. Figures according to the new accounting standards are expected in 2008. In the interim, government finance statistics for publication in the GFS Yearbook will be reported on a cash basis but presented in the GFSM 2001 framework.
- Balance of payments and international investment position data are compiled by the SNB and meet international standards.
- Table of Common Indicators Required for Surveillance (as of May 4, 2005) indicates timely reporting for many series (exchange rates, reserves, reserve/base money, broad money, central bank balance sheet, consolidated banking system balance sheet, interest rates, CPI, government finance, external current account, exports/imports, GDP/GNP, gross external debt) with frequencies and latest observations listed (e.g., Exchange Rates Apr 05; International Reserve Assets Apr 05; Reserve/Base Money Mar 05; Broad Money Feb 05; GDP/GNP Q4/04).

### Fund relations and other IMF-related items (as of March 31, 2005 / documents)
- Membership Status: Joined 5/29/92; Switzerland has accepted the obligations of Article VIII, Sections 2, 3 and 4.
- General Resources Account:
  - Quota: 3,458.50 (SDR Million) 100.00 percent
  - Fund holdings of currency: 2,343.49 (SDR Million) 67.76 percent
  - Reserve position: 1,115.01 (SDR Million) 32.24 percent
- SDR Department:
  - Holdings: 2,13 SDR Million N/A
- Outstanding Purchases and Loans: None
- Financial Arrangements: None
- Projected Obligations to Fund: None
- Exchange Rate Arrangement:
  - The Swiss National Bank does not maintain margins in respect of exchange transactions.
  - The Swiss National Bank has intervened when warranted by the circumstances.
  - Switzerland's exchange system is free of restrictions on the making of payments and transfers for current international transactions.
  - Switzerland has frozen financial assets and economic resources of persons and entities associated with the Taliban, Osama bin Laden and Al Qaeda, as well as those of the former regimes in Iraq and Liberia, and, in accordance with EU measures, certain persons related to the former regime in the Federal Republic of Yugoslavia, and certain persons with important government functions in Myanmar and Zimbabwe. Swiss regulations usually also include a prohibition to make available to the targeted persons or entities, directly or indirectly, financial assets or economic resources. These restrictions have been notified to the Fund.
- Technical Assistance: None
- Resident Representatives: None
- Other: FSAP, October 2001.

*Statement by Fritz Zurbrügg, Executive Director for Switzerland; Tables and appendices as presented in the original document.*

### 1. On behalf of my Swiss authorities, I would like to thank staff for the constructive

### _cr05190 - 1. On behalf of my Swiss authorities, I would like to thank staff for the constructive

### Overview and recent economic performance
- GDP growth in 2004: 1.7 percent (whole year).
- Year-on-year growth: fourth quarter of 2004 was 1.2 percent; first quarter of 2005 was 0.7 percent.
- Quarter-to-quarter: GDP recovered from slightly negative to zero compared to the previous quarter.
- Consumer demand strengthened by 0.2 percent (quarter-to-quarter).
- Investment “was now able to hold its level.”
- Exports decelerated by 1 percent (quarter-to-quarter) from a high level; imports declined by 1.1 percent (quarter-to-quarter).
- Unemployment rate in April 2005: 3.8 percent (PIN reports 3.9 percent in broader text and table shows 3.9 percent for 2004 and 4.2 percent for 2005).
- Consumer sentiment index unchanged since January 2005, suggesting a possible decrease in GDP growth for 2005.
- Downside risks: weaker growth in trading partners and oil prices.

### Monetary policy
- Three-month CHF Libor had been kept at 0.25 percent for more than a year before two rises of 25 basis points each.
- Policy rate level after rises: 0.75 percent.
- Real stance: “current level is 0.75 percent remains negative in real terms.”
- SNB and staff concur that monetary policy has supported the recovery and that timing of movement toward a more neutral rate is the main question.
- SNB is more cautious than staff about the room for continued patience in raising rates, citing:
  - Particularly long transmission lags of monetary policy impulses to the real economy and to prices in Switzerland.
  - A relatively strong rally of the dollar since the beginning of 2005.
- SNB communication measures:
  - Newly introduced quarterly publication of three-year inflation forecasts with an assessment of monetary policy conditions.
  - SNB emphasizes willingness to act based on economic analysis and the inflation forecast even if markets do not expect it.

### Fiscal policy
- Federal fiscal balance improved markedly due to large expenditure cuts and higher revenues.
- Consolidation program 2003 implemented; consolidation program 2004 under discussion in parliament.
- Consolidation program 2004 aims to improve the federal budget by CHF2.0 billion until the year 2008 mainly through lower spending.
- The 2005 federal budget: the third to comply with the debt-brake.
- Cantons: many have introduced instruments similar to the debt brake; further efforts may be needed to offset spillovers from reduced federal transfers.
- New Financial Equalization scheme promotes better inter-cantonal cooperation.
- Longer-term fiscal challenges: aging population strains health system and pay-as-you-go pillar.
  - Rejection by popular vote of amendments proposed last year was a setback for pay-as-you-go reform.
  - Authorities proposed a more focused revision retaining key parts such as harmonizing the pension age at 65.
  - Switzerland’s three-pillar system noted as more resilient because the funded mandatory second pillar plays a significant role.
- Health system reforms aiming at improving cost control were sent to parliament.
- Ministry of Finance is considering a periodic long-run public finance sustainability report.

### Financial sector
- Priority: further improve regulatory and supervisory framework in line with international standards and practices.
- Recent reforms implemented:
  - Revision of the Insurance Supervision Act.
  - Adoption of measures to tackle underfunding of private pension funds.
- Advanced projects: revised rules for granting administrative assistance relating to stock exchange dealings; revised Act on Collective Investment Schemes.
- Draft legislation on an integrated financial market supervisory authority: fundamental decisions taken on structure and organisation; parliamentary process to start in 2006.
- Anti-money-laundering and counter-terrorist financing:
  - Drafting legislation to implement revised FATF recommendations.
  - Switzerland’s third mutual evaluation by FATF members is underway.
- Private pension system legal framework improvements to strengthen the second pillar:
  - Reform proposals to be drafted by an expert commission focusing on strengthening supervision, recapitalization of public pension funds, and assessing need for a new legal form tailored to pension funds.

### Structural issues and external relations
- Main growth challenge: raising growth potential via a more efficient domestic market and a more efficient public sector.
- Reforms progressed in 2004; referendums scheduled on a second package of bilateral agreements (including extension of free movement of labor to new EU members) in June and in September.
- Agricultural policy:
  - 2003 policy enacted an almost complete switch from price support to direct payments, compatible with ecological and animal welfare criteria.
  - Total expenditures for agriculture projected to decline in nominal terms until 2007; further reductions of support expected.
  - Tariff reductions for remaining agricultural products of interest to least developed countries amount from 55 to 75 percent.
  - Work on the last phase of the preference scheme’s extension to all least developed country products to start in early summer of 2005; implementing the scheme will need parliamentary approval.
- Official Development Assistance (ODA):
  - Swiss ODA for 2004 projected to be 0.41 percent of GNI after methodological alignment with other OECD countries.
  - In terms of GNI, Switzerland's development expenditures ranked 8th out of 22 OECD countries in 2003.
  - Authorities focus on increasing effectiveness of Swiss ODA and harmonizing activities with other donors; fiscal consolidation programs have safeguarded development outlays.

### IMF staff projections and Executive Board assessment (Public Information Notice highlights)
- Staff growth projection for 2005: 1¼ percent, from 1.7 percent in 2004.
- Potential growth estimated at 1½ percent and projected to decline in the medium term to ¾ percent due to population aging.
- Executive Directors’ observations and recommendations:
  - Commended sound macroeconomic management, flexible labor markets, low inflation and unemployment, and a strong external position.
  - Noted downside risks from demand softening in trading partners, higher oil prices, and further franc appreciation.
  - Identified growth constraints: segmentation of internal product markets, substantial non-tariff import barriers, lack of domestic competition.
  - Urged opening up sheltered sectors, intensifying competition, and eliminating non-tariff barriers; recommended public education campaign to build support for structural reforms.
  - Monetary policy: current accommodative stance considered appropriate while recovery fragile; some monetary tightening will be needed as recovery firms.
  - Fiscal policy: welcomed plans to phase out federal structural deficit, supported debt-brake rule, called for fiscal prudence given aging pressures and potential financial-tax revenue loss.
  - Recommended a comprehensive evaluation of public sector activities to focus resources and reduce expenditure on transfers and subsidies.
  - Encouraged use of proceeds of gold sales exclusively for debt reduction.
  - Emphasized early and decisive action on aging-related fiscal pressures; monitor first-pillar pension entitlements and recalibrate parameters such as retirement age and replacement rate.
  - Urged resolution of underfunding in second-pillar pensions and harmonization of supervisory standards across cantons.
  - Advised checking health care cost rise via economies of scale and competition among providers.
  - Encouraged development of a multi-year fiscal framework encompassing all levels of government and social security and publication of periodic fiscal sustainability reports.

### Selected economic indicators (as presented)
- Real GDP: 2000 3.6; 2001 1.0; 2002 0.3; 2003 -0.4; 2004 1.7; 2005 1.2 (staff estimates and projections).
- Real total domestic demand: 2000 2.2; 2001 2.3; 2002 -0.8; 2003 0.2; 2004 1.0; 2005 1.1.
- CPI (year average): 2000 1.6; 2001 1.0; 2002 0.6; 2003 0.6; 2004 0.8; 2005 1.2.
- Unemployment rate (percent of labor force): 2000 1.8; 2001 1.7; 2002 2.5; 2003 3.7; 2004 3.9; 2005 4.2.
- Gross national saving (percent of GDP): 2000 35.6; 2001 31.6; 2002 29.7; 2003 33.9; 2004 33.6; 2005 34.2.
- Gross national investment (percent of GDP): 2000 23.2; 2001 23.7; 2002 21.3; 2003 20.8; 2004 21.6; 2005 23.1.
- Confederation budget balance (percent of GDP, excluding privatization revenue and gold sale): 2000 0.9; 2001 -0.4; 2002 -1.0; 2003 -0.9; 2004 -0.6; 2005 -0.5.
- General government balance (percent of GDP, including confederation, cantons, communes, and social security): 2000 2.2; 2001 0.1; 2002 -1.2; 2003 -1.6; 2004 -1.0; 2005 -1.6.
- Gross public debt (percent of GDP, assumes gold sales used to reduce the debt in 2005): 2000 49.9; 2001 50.5; 2002 54.5; 2003 55.4; 2004 55.6; 2005 50.8.
- Trade balance (percent of GDP): 2000 -1.0; 2001 -1.1; 2002 1.2; 2003 1.0; 2004 0.9; 2005 -0.2.
- Current account (percent of GDP): 2000 12.4; 2001 8.0; 2002 8.4; 2003 13.2; 2004 12.0; 2005 11.1.
- Official reserves (end of year, US$ billion, excluding gold): 2000 32.3; 2001 32.0; 2002 40.2; 2003 47.7; 2004 55.5; 2005 55.0 (figures for 2005 refer to March).
- Domestic credit (end of year): 2000 1.7; 2001 1.5; 2002 -0.5; 2003 0.6; 2004 2.3; 2005 4.5.
- M3 (end of year): 2000 -1.8; 2001 3.1; 2002 3.8; 2003 8.3; 2004 3.0; 2005 2.0 (figures for 2005 refer to February for some series).
- Three-month Libor rate (in percent): 2000 3.1; 2001 2.9; 2002 1.2; 2003 0.4; 2004 0.5; 2005 0.8 (figures for 2005 refer to March).
- Government bond yield (in percent): 2000 3.8; 2001 3.3; 2002 3.1; 2003 2.5; 2004 2.6; 2005 2.3 (figures for 2005 refer to March).
- Exchange rate regime: Managed float.
- Present rate (May 4, 2005): SwF 1.19 per US$1.
- Nominal effective exchange rate (1990=100): 2000 100.0; 2001 103.7; 2002 108.2; 2003 108.6; 2004 108.4; 2005 109.5.
- Real effective exchange rate (1990=100, based on consumer prices): 2000 99.8; 2001 102.8; 2002 106.6; 2003 106.2; 2004 105.2; 2005 105.0 (figures for 2005 refer to February).

*Public Information Notice (PIN) No. 05/74 — FOR IMMEDIATE RELEASE — June 10, 2005 — IMF Executive Board Concludes 2005 Article IV Consultation with Switzerland*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05190.pdf_