## _cr06202

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### Introduction — medium-term challenges and outlook
- Switzerland’s relative economic position declined in the past 15 years, with growth averaging only 0.9 percent a year and the public debt ratio rising.
- Authorities and staff project potential output growth to drop below 1 percent a year in ten years.
- Without measures, the primary fiscal deficit could rise to 5 percent of GDP by 2030.

### Recent developments — recovery and drivers (2005–early 2006)
- Growth and output gap:
  - GDP grew by 1.8 percent in 2005, narrowing the output gap to -½ percent.
- Demand and supply drivers:
  - Exports and accommodative monetary policy supported the rebound.
  - Private consumption gained pace as unemployment stabilized.
  - Housing investment benefited from low interest rates and a shift to owner-occupied apartments.
  - Financial sector benefited from the recovery in global equities and expanded funds under management.
- Labor market:
  - Job creation lagged activity; part-time jobs expanded faster than full-time employment.
  - Foreign employment from EU countries expanded.
  - Early 2006 unemployment (s.a.) eased to 3.5 percent and vacancies increased.
- Inflation and wages:
  - CPI inflation averaged 1.2 percent in 2005 and early 2006; core inflation was 0.5 percent.
  - Nominal wages increased by 1.4 percent in 2005 and are projected to rise by 1.6 percent in 2006.
- Monetary and asset developments:
  - SNB increased the 3-month policy rate to 1 percent and 1.25 percent in December 2005 and March 2006, respectively.
  - Short-term rates remained slightly negative in real terms; long-term rates declined, flattening the yield curve.
  - Money and credit growth remained strong; equity prices rose near end-2000 peaks.
  - Real estate prices rose moderately overall; owner-occupied apartments’ prices rose sharply.
- Fiscal stance:
  - Fiscal impulse was neutral in 2005.
  - General government deficit halved to 0.6 percent of GDP but the structural deficit remained unchanged.
  - General government gross debt eased to 52 percent of GDP; when deducting SNB gold sales proceeds (4.6 percent of GDP) it dropped below 50 percent.

### Box: Fund recommendations and authorities’ responses — summary
- General:
  - Authorities pursue prudent monetary, fiscal, and financial sector policies aligned with Fund advice, but structural reforms are harder to implement due to status-quo bias and decentralized political power.
  - Authorities value Fund surveillance and suggested broader public communication (publish Concluding Statement in German and French; possibly prepare an op-ed).
- Monetary policy:
  - Fund praised the monetary framework for design, transparency, and SNB implementation.
- Fiscal policy:
  - Fund supported phasing out the federal deficit mainly through expenditure restraint and underscored risks of unfunded future entitlement costs.
  - Encouraged publication of fiscal sustainability reports; authorities preparing a long-run fiscal sustainability report and implementing expenditure adjustment plans.
- Financial sector:
  - Following 2002 FSAP recommendations, authorities enhanced surveillance and strengthened supervision and regulation of insurance.
  - A focused FSAP update planned for November 2006.
- Structural and trade policies:
  - Recurring Fund advice: strengthen competition by opening sheltered sectors, dismantling internal market barriers, further liberalizing network industries and agricultural trade.
  - Government’s 17-point growth agenda (2004) contains steps, some implemented, but unfinished reform agenda remains large; agricultural trade liberalization progress slow.

### Monetary policy stance, SNB vigilance, and exchange rate
- SNB vigilance:
  - Authorities vigilant about a possible unwinding of global imbalances; monetary policy would be relaxed appropriately if abrupt franc appreciation threatened activity and deflation.
  - SNB does not intervene in foreign exchange markets and saw scope for the franc to continue appreciating without jeopardizing competitiveness.
- Staff assessments and indicators:
  - Swiss franc is 5–20 percent below its medium-term equilibrium rate (reflecting mostly undervaluation vis-à-vis the U.S. dollar).
  - Market forward rates signal expectation that franc appreciation will resume.
  - Gradual trend real effective appreciation averaged about 0.7 percent a year.
- Policy recommendations:
  - Decouple legal link between housing rents and mortgage rates to improve policy effectiveness; authorities concurred.
  - KOSA initiative to earmark SNB profits above a certain floor for social security could compromise SNB independence; KOSA scheduled for a September 2006 vote.
- External balance drivers:
  - Earnings on large net foreign assets: 10 percent of GDP (net foreign assets equal 140 percent of GDP).
  - Gross savings recently exceeded 30 percent of GDP.
  - Gross investment strong at over 20 percent of GDP.
  - Household savings rate: 9 percent.
- Explanations for paused appreciation:
  - Domestic reforms could lower nontradables prices (sheltered sectors exceed EU prices by 30 percent).
  - Very low growth since early 1990s housing collapse relieved real exchange rate pressures.
  - Low interest rates generated negative interest rate differentials vis-à-vis the U.S. dollar.
- Outlook:
  - Strengthening domestic growth should boost absorption; tightening bias toward neutral policy interest rates should support the franc.
  - Continued domestic reforms could keep nontradables inflation subdued and lower equilibrium real exchange rate.

### Fiscal policies, short-term consolidation, and federalism
- Federal objectives and measures:
  - Authorities confident to eliminate the structural federal deficit by 2007.
  - Two short-run adjustment packages (2003, 2004) aim to restrain annual expenditure growth to 1.7 percent per year in 2006–09.
  - Debt brake mechanism functioning; automatic stabilizers allowed to operate.
- Subnational fiscal behavior:
  - Cantonal/commune adjustment more moderate; pressures rising in education and healthcare.
  - Uncertainty on extent cantons would use gold sales proceeds to retire debt.
  - SNB transferred gold sale proceeds in 2005: federation ⅓, cantons ⅔. Federation will use its share to bolster old age pension fund.
  - 18 out of 26 cantons announced tax cuts.
  - Most cantons/communes had fiscal rules and pursued prudent policies.
- Tax competition assessment:
  - Authorities not concerned about race to the bottom because of: new financial equalization scheme, limited scope of competitive cuts, threat of harmonization and public pressure.

### Social security, aging pressures, and proposed reforms
- Assessment:
  - Social security and health systems not well-calibrated for aging; debt brake not robust to aging pressures.
  - Federation approaching limits of budgetary flexibility; tax increases subject to mandatory referendum.
  - Structural fiscal reforms being prepared; comprehensive review of federal tasks and subsidies launched (reports to be prepared by year end).
- Measures under consideration:
  - Disability insurance: timelier intervention, faster reintegration, slightly higher payroll taxes, and a 0.8 percentage point increase in the VAT, earmarked for the disability fund.
  - Health care: reduce excess supply of clinics in consultation with cantons; improve hospital efficiency via benchmarking and performance pay; increase contracting freedom; consider raising copayments.
  - First pillar pensions: raise female retirement age from 64 to 65 (planned for 2009); extend working life; consider reducing indexation for pensions with safeguards.
  - Civil service pensions: split fund into one for retirees (grandfather current provisions) and one for current employees transferred to a defined contribution scheme (without grandfathering).
- Coordination and reporting:
  - Authorities preparing Long-Run Fiscal Sustainability Report; mission recommended inclusion of a preliminary public sector balance sheet estimating net present value of projected future deficits under current policies.

### Preliminary public sector balance sheet and intertemporal fiscal position (selected estimates)
- Present value of unfunded liabilities over next fifty years: 153 percent of GDP.
- Negative intertemporal net worth: 103 percent of GDP.
- Public sector net worth (billions of SwF): -432, -443, -459 (2002, 2003, proj. 2004).
- Public sector net worth (percent of GDP): -100, -102, -103 (2002, 2003, proj. 2004).
- Intertemporal financial position (A) (billions of SwF): -756, -775, -793 (2002, 2003, proj. 2004).
- Intertemporal financial position (A) (percent of GDP): -175, -178, -178 (2002, 2003, proj. 2004).
- Net present value of future fiscal balances (II) (billions of SwF): -654, -667, -681 (2002, 2003, proj. 2004).
- Net present value of future fiscal balances (II) (percent of GDP): -152, -154, -153 (2002, 2003, proj. 2004).
- Interpretation:
  - Swiss public sector owns substantial assets that offset 2004 accumulated net financial liabilities, but present value of future unfunded liabilities implies a significant intertemporal imbalance.
  - Authorities acknowledge that the debt brake alone, without structural fiscal reforms, would not be robust to aging pressures.

### Financial sector developments and supervisory issues
- Banking sector assessment:
  - Banking sector robust, adequately capitalized, profitable, liquid and dynamic.
  - Wealth management expansion noted, especially in Asia.
- Indicators:
  - Bank regulatory capital (percent of risk-weighted assets): 1999: 11.6; 2000: 11.7; 2001: 12.2; 2002: 12.3; 2003: 12.6; 2004: 12.5; 2005: 12.2.
  - Non-performing loans (percent of gross loans): 1999: 2.7; 2000: 2.4; 2001: 2.3; 2002: 1.9; 2003: 1.4; 2004: 0.9; 2005: 0.5.
  - Household debt to banks (percent of GDP): 1999: 116.0; 2000: 114.0; 2001: 114.9; 2002: 116.9; 2003: 122.3.
- Stress tests and risks:
  - SNB stress tests: an extreme scenario (recession + collapse in equity prices + rise in interest rates) would reduce sector’s excess capital without breaching regulatory minimum.
  - Supervisory focus needed on lending standards, interest rate and credit risks, and risk transfers as rates rise.
  - Large international banks vulnerable to abrupt unwinding of global imbalances.
- Supervisory and regulatory timetable:
  - Basel II implementation scheduled for January 2007.
  - FINMA intended to become operational in 2008, integrating supervision of banking, insurance, securities, and AML.
  - Supervisors began monitoring banks’ exposure to hedge funds (exposures still limited).
- Insurance sector:
  - Balance sheets improved; reserve deficiencies remain in life insurance.
  - Insurance risk-based capital requirements expected by 2011; Swiss Solvency Test introduction planned for 2008.
- Pension system (second pillar):
  - Underfunding at end-2004: 6.3 percent of GDP (4.7 percent of GDP is state guaranteed).
  - Published data likely understate underfunding due to discounting by an average technical interest rate "slightly below 4 percent."
  - Regulatory concerns: technical discount rate, guaranteed rate of return, conversion rate; conversion rate slated to be gradually reduced from 7.2 to 6.8 percent.
  - Supervision fragmented by cantons; mission welcomed plans to harmonize supervision and considered a centralized risk-based regulatory/supervisory system more appropriate.

### Macroeconomic outlook, projections, and risks
- Growth projections:
  - Staff and forecasters expect growth to accelerate to over 2 percent in 2006, closing the negative output gap; growth projected to taper off in 2007 toward potential.
  - Economy expected to grow "over 2 percent" in 2006—closing the output gap in 2006.
- Inflation projection:
  - Headline inflation projected to remain "slightly over 1 percent."
- Monetary policy expectations:
  - Authorities intend measured tightening, mindful of transmission lags and closing output gap.
  - Markets expect a gradual increase in policy rate to 2 percent by January 2007.
- Risk scenarios:
  - Downside (most serious): disorderly unwinding of global imbalances—sharp U.S. dollar fall and U.S. interest rate spike could harm Swiss exports and global equity markets, affecting Swiss financial sector.
  - Additional downside: geopolitical instability (could push up franc as safe-haven) and an avian flu pandemic.
  - Upside: buoyant global environment and successful domestic reforms could lift potential output growth.

### Fiscal position and public finances — selected 2005 figures
- General government (percent of GDP, 2005):
  - Revenue: 38.0
  - Expenditure: 38.5
  - Balance: -0.6
  - Structural balance: -0.3
  - Gross debt: 52.0
- Federal government (percent of GDP, 2005):
  - Revenue: 11.3
  - Expenditure: 11.5
  - Overall balance: -0.2
  - Structural fiscal balance (federal memorandum): -0.5
- Directors’ view:
  - Strong support for eliminating structural federal deficit by 2007.
  - Urged structural fiscal reforms for social programs given aging pressures.
  - Welcomed commitment to prepare Long-Run Fiscal Sustainability Report.
  - Noted disappointment that several cantons used their share of gold sale proceeds to lower taxes.

### Structural reforms and policy priorities
- Priorities:
  - Market-based reforms to reduce mark-ups—boost productivity in retailing, health, agriculture, and network industries.
  - Reduce regulations and red tape; substantial market opening in agriculture.
- Progress:
  - Revised Internal Market Law reduced cantonal ability to impede cross-border services.
  - Electricity market liberalization: two-stage opening (2007 for commercial consumers; 2012 for the rest).
  - Swisscom’s "last mile" monopoly suspended.
- New initiatives supported:
  - Privatizing Swisscom shares (modalities for likely referendum).
  - Adopt "Cassis-de-Dijon principle" to recognize EU-approved products.
  - Reduce red tape and simplify regulations.
- Labor market and education:
  - Flexible labor market; EU-15 opening alleviated skilled labor shortages.
  - Extension of free movement to EU-10 expected to bring further flexibility.
  - Policies to raise participation: reduce early retirement incentives, tighten disability insurance conditions, improve post-retirement employment modalities, construct more daycare centers.
  - Plans to raise tertiary participation and continuous education.

### External sector, competitiveness, and statistics
- External balances (percent of GDP):
  - Current account: 2002: 8.3; 2003: 13.3; 2004: 14.6; 2005: 13.8; 2006 (staff estimate): 13.7.
  - Trade balance: 2002: 1.2; 2003: 1.0; 2004: 1.5; 2005: 0.7; 2006 (staff estimate): 0.8.
  - Net investment income a large component of surplus; net investment income (percent of GDP) 2005: 10.9.
- External indicators:
  - Official reserves (US$ billion, excluding gold): 2003: 40.2; 2004: 47.7; 2005: 55.5; 2006 (Mar): 36.3; 2006 (staff March figure elsewhere): 34.8.
  - Nominal effective exchange rate (1990=100): 2002: 108.2; 2003: 108.6; 2004: 108.4; 2005: 108.2; 2006 (Feb): 106.9.
  - Real effective exchange rate (1990=100): 2002: 106.3; 2003: 106.4; 2004: 105.6; 2005: 104.0; 2006 (Jan): 103.3.
- Competitiveness:
  - Goods market share declining; goods exports sector remains competitive with second highest share of high technology exports in the world.
- Statistical/data issues and improvements:
  - Switzerland in full compliance with SDDS.
  - Gaps: SNB does not compile a monetary survey; general government finance statistics have long lags; internationally comparable fiscal statistics on an accrual basis not available; pension statistics published with long lag; GDP by industry delayed.
  - Steps taken/planned: SNB quarterly cost of borrowing survey (pilot completed June 2005; monthly from July 2006 planned); SNB compiling more comprehensive mutual fund statistics since September 2005; annual financial accounts for 1999–2003 published; annual national accounts upgraded to ESA95 in 2003; quarterly production account from March 2006; federal fiscal statistics revamp and accrual accounting planned with figures expected in 2009.
- Selected nominal figures:
  - Nominal GDP (billions of SwF): 2005: 456.9; 2006: 471.8 (staff estimate/projection).
  - Current account (billions of SwF): 2005: 63.0; 2006 (staff estimate): 64.6.

### Authorities’ statement — key points and policy intent
- Authorities largely agree with staff appraisal and welcome recommendations.
- Recent performance:
  - Q4 2005 GDP increased by 2.7 percent (year-to-year), bringing annual growth to roughly 2 percent.
  - In Q1 2006 employment expanded considerably; unemployment seasonally adjusted eased to 3.4 percent in April.
- Monetary policy:
  - SNB resumed tightening: three-month LIBOR raised to 1 percent in December 2005 and to 1.25 percent in March 2006.
  - SNB states 1.25 percent is "still expansionary" and "does not represent a steady-state equilibrium level for the three-month Libor."
  - SNB concurs with lifting legal link between housing rents and mortgage rates; strongly concurs KOSA initiative could compromise central bank independence.
- Fiscal policy and federal tasks:
  - Federal over-performance in 2005 yielded an essentially balanced outcome vs projected deficit of 0.4 percent of GDP.
  - Objective to contain federal budget spending growth until 2015 at level of nominal GDP growth; action plan to be completed by end-2006.
  - New financial equalization framework (NFA) nearing final preparation; constitutional amendments on vertical cooperation in education accepted by large majority on May 21, 2006.
- Pensions and financial sector:
  - Authorities welcome comparison of occupational pension pillars and plan further reforms and stronger unified supervision across cantons; government proposals to build on expert commission report (March).
  - Cross-border supervision improvements: amendment to administrative assistance in stock exchange matters entered into force on February 1, 2006.
- Structural reform priority: increase productivity growth in the domestic sector (target sectors: health, network industries, agriculture, public services, mandatory pension schemes, education, real estate and construction).

*IMF staff report and authorities’ statements excerpt from content unit _cr06202.*

### 1. Fund Recommendations and Implementation ............................................................. 8

### 1. Fund Recommendations and Implementation

### Introduction — medium-term challenges and outlook
- Switzerland’s relative economic position declined in the past 15 years, with growth averaging only 0.9 percent a year and the public debt ratio rising.
- The authorities and the staff project potential output growth to drop below 1 percent a year in ten years.
- Without measures, the primary fiscal deficit could rise to 5 percent of GDP by 2030 (IMF Country Report/05/190).

### Recent developments — recovery and drivers
- The slowdown after the equity bubble burst has ended; financial sector weakness contributed a cumulative negative contribution to growth of 1.8 percentage points of GDP during 2001–04.
- GDP grew by 1.8 percent in 2005, narrowing the output gap to -½ percent.
- Key demand/supply developments in 2005:
  - Exports and accommodative monetary policy supported the rebound.
  - Private consumption gained pace as unemployment stabilized.
  - Housing investment benefited from low interest rates and a shift to owner-occupied apartments.
  - Financial sector benefited from the recovery in global equities and expanded funds under management.
- Labor market:
  - Job creation lagged activity; part-time jobs expanded faster than full-time employment.
  - Foreign employment from EU countries expanded.
  - In early 2006, unemployment (s.a.) eased to 3.5 percent and vacancies increased.
- Inflation and wages:
  - CPI inflation averaged 1.2 percent in 2005 and early 2006; core inflation was 0.5 percent.
  - Nominal wages increased by 1.4 percent in 2005 and are projected to rise by 1.6 percent in 2006.
- Monetary conditions and asset prices:
  - The SNB increased the 3-month policy rate to 1 percent and 1.25 percent in December 2005 and March 2006, respectively.
  - Short-term rates remained slightly negative in real terms; long-term rates declined, flattening the yield curve.
  - Money and credit growth remained strong; equity prices rose near end-2000 peaks.
  - Real estate prices rose moderately overall; owner-occupied apartments’ prices rose sharply.
- Fiscal stance:
  - The fiscal impulse was neutral in 2005.
  - General government deficit halved to 0.6 percent of GDP but the structural deficit remained unchanged.
  - General government gross debt eased to 52 percent of GDP (when deducting the proceeds from the SNB gold sales, 4.6 percent of GDP, it dropped below 50 percent).

### Box: Fund Recommendations and Implementation — summary of advice and authorities’ responses
- General observation:
  - Authorities pursue prudent monetary, fiscal, and financial sector policies well aligned with Fund advice but find structural reforms harder to implement due to status-quo bias and decentralized political power.
  - Authorities value Fund surveillance and suggested broader public communication (publishing the Concluding Statement in German and French; possibly preparing an op-ed).
- Monetary policy:
  - The Fund praised the monetary framework for design, transparency, and the SNB for skillful implementation.
- Fiscal policy:
  - The Fund supported efforts to phase out the federal deficit mainly through expenditure restraint.
  - The Fund underscored risks of unfunded future entitlement costs for long-term fiscal sustainability and encouraged the publication of fiscal sustainability reports.
  - Authorities have enacted and implemented expenditure adjustment plans; are preparing a long-run fiscal sustainability report; and are developing innovative proposals to tackle aging costs.
- Financial sector:
  - Following the 2002 FSAP recommendations, authorities enhanced surveillance of the financial system and strengthened supervision and regulation of insurance.
  - A focused FSAP update was planned for November 2006.
- Structural and trade policies:
  - Recurring Fund advice: strengthen domestic competition by opening sheltered sectors, dismantling internal market barriers, and further liberalizing network industries and agricultural trade.
  - Government’s 17-point growth agenda (2004) contains steps, some implemented, but the unfinished reform agenda remains large; progress in liberalizing agricultural trade remains slow.

### Report on discussions — policy priorities and near-term outlook
- Main focus of discussions: ensuring fiscal sustainability amid population aging; fiscal federalism; effects of structural reform on prices and growth; timing of monetary withdrawal; determinants of the large current account surplus and the exchange rate; and outlook/supervision of the financial sector and occupational pension schemes.
- Consensus: policy direction broadly agreed; staff urged faster structural reforms while authorities stressed need to build political support.

Key short-term outlook and risks
- The staff and forecasters expect growth to accelerate to over 2 percent in 2006, closing the negative output gap; growth projected to taper off in 2007 toward potential.
- Upside and downside scenarios:
  - Downside (most serious but uncertain probability): disorderly unwinding of global imbalances—if the U.S. dollar fell sharply and U.S. interest rates spiked, Swiss exports and global equity markets could suffer, significantly affecting the Swiss financial sector.
  - Additional downside risks: geopolitical instability (could push up the franc as a safe-haven currency) and an avian flu pandemic.
  - Upside: continued buoyant global environment and successful domestic reforms could lift potential output growth and assist near-term expansion.

Monetary policy stance and expectations
- Authorities intend to continue tightening monetary policy at a measured pace, mindful of transmission lags and a closing output gap.
- Officials noted difficulty gauging the equilibrium interest rate due to factors that may have reduced the neutral rate (absence of wage pressures, stronger productivity growth, globalization, domestic reforms).
- Markets expect a gradual increase in the policy rate to 2 percent by January 2007.

*IMF Country Report excerpt: "1. Fund Recommendations and Implementation"*

### 15.      The authorities are vigilant about a possible unwinding of global imbalances.

### _cr06202 - 15.      The authorities are vigilant about a possible unwinding of global imbalances.

### Monetary policy stance and SNB vigilance
- The authorities are vigilant about a possible unwinding of global imbalances and emphasized that monetary policy would be relaxed appropriately in the event of an abrupt appreciation of the franc, which could undermine activity and threaten deflation.
- The SNB does not intervene in foreign exchange markets and saw scope for the franc to continue appreciating without jeopardizing competitiveness.
- Staff assessment: the Swiss franc is 5–20 percent below its medium-term equilibrium rate, reflecting mostly undervaluation vis-à-vis the U.S. dollar.
- Market forward rates signal the expectation that the franc appreciation will resume.
- The gradual trend real effective appreciation has averaged about 0.7 percent a year.

### SNB communication and policy framework features
- The SNB has a transparent and open communication strategy; market participants appreciate the quality of information and guidance provided through publications and speeches.
- Staff recommendation: it would be preferable to decouple the legal link between housing rents and mortgage rates, which hinders the effectiveness of policy rates in controlling inflation and could cause interest rate overshooting. The authorities concurred.
- The proposed popular initiative (KOSA) to earmark SNB profits above a certain floor to financing the social security system could compromise SNB independence and its ability to focus on price stability. The KOSA initiative is scheduled for a vote in September 2006.
- Note on legislation: if mortgage rates go up, landlords are entitled to raise rents; thus, monetary tightening could perversely raise inflation through the rental markets.

### External balance and exchange rate
- Current account surplus drivers and magnitudes:
  - Main contributor: 10 percent of GDP earnings on Switzerland’s large net foreign assets (140 percent of GDP).
  - Gross savings recently have exceeded 30 percent of GDP.
  - Gross investment has been strong at over 20 percent of GDP.
  - Household savings rate: 9 percent.
- Sectoral saving patterns:
  - The business sector accounts for more than half of gross national savings, reflecting favorable corporate income tax rates and a stable political and business environment attracting multinationals.
  - Household sector together with occupational pension funds account for the bulk of net lending abroad/current account surplus.
- Possible data caveats: given complexity of multinational transactions, statistical recognition of corporate savings in Swiss accounts may be overstated; preliminary data did not reveal a readily discernible significant bias.
- Reasons for pause in trend real appreciation of franc:
  - Domestic reforms could create a reverse Balassa-Samuelson effect; prices in sheltered sectors exceed those in neighboring EU countries by 30 percent, so liberalizing reforms could lower nontradables prices and depreciate the equilibrium real exchange rate.
  - Very low growth since the housing market collapse in the early 1990s led to a long period of weak absorption, alleviating the real exchange rate.
  - Monetary policy with very low interest rates for some time generated negative interest rate differentials vis-à-vis the U.S. dollar.
- Outlook and risks:
  - Strengthening domestic growth should boost absorption and a tightening bias toward neutral policy interest rates should support the franc.
  - Continued domestic reforms could keep nontradables inflation subdued and lower the equilibrium real exchange rate.

### Fiscal policies and short-term consolidation
- Federal fiscal objectives and measures:
  - Authorities confident they would meet objective to eliminate the structural federal deficit by 2007.
  - Two short-run adjustment packages in 2003 and 2004 aim at restraining annual expenditure growth to 1.7 percent per year in 2006–09 (almost half the rate of nominal GDP growth).
  - The debt brake mechanism was working well; with key measures in place, automatic stabilizers would be allowed to operate.
- Subnational (cantons and communes):
  - Adjustment was more moderate; pressures for spending in education and healthcare were increasing.
  - Uncertainty existed as to the extent cantons would use proceeds from gold sales to retire debt.
  - In 2005, the SNB transferred the proceeds from gold sales to the federal government (⅓) and cantons (⅔). The federation will use its share to bolster the old age pension fund. Most cantons would lower debt, but some were considering, or had already implemented, tax reductions.
  - 18 out of 26 cantons had announced tax cuts (especially for high income persons; some cantons have no debt).
  - Most cantons and communes had fiscal rules and tended to pursue prudent fiscal policies.
- Tax competition assessment:
  - Authorities not concerned about a race to the bottom because: (i) new financial equalization scheme links transfers to a standardized tax base, discouraging predatory tax cuts; (ii) competitive tax cuts were limited to very small cantons with minimal spillovers to large ones; (iii) threat of harmonization and public pressure would limit harmful competition.
  - Authorities view horizontal tax competition, combined with direct democracy, as having helped contain the size of government.

### Social security, aging pressures, and reform measures
- Assessment:
  - Social security and health systems were not well-calibrated to absorb pressures from aging.
  - Debt brake works well for federal budget within cyclical context but might not be robust to structural pressures from aging.
  - Federation approaching limits of budgetary flexibility; tax increases would be subject to mandatory referendum.
  - Structural fiscal reforms were needed and were being prepared; comprehensive review of federal tasks and subsidies launched (reports to be prepared by year end).
- Consequences under current policies:
  - Under current policies, aging would raise public debt to unsustainable levels (charts indicate rising primary deficit, overall deficit, general government deficit, and net public debt across 2005–2055 horizons).
- Proposed measures under consideration (some far-reaching and requiring public discussion):
  - Disability insurance: more timely intervention and faster reintegration of disabled workers, slightly higher payroll taxes, and a 0.8 percentage point increase in the VAT, earmarked for the disability fund.
  - Health care: reduce excess supply of clinics in consultation with cantons; improve hospital efficiency through benchmarking and performance pay; increase freedom to contract health and insurance providers; consider raising copayments.
  - First pillar pensions: raise the female retirement age from 64 to 65 (planned for 2009); seek to extend working life of older workers; consider reducing indexation for pensions, subject to safeguards for the needy.
  - Civil service pensions: plan to split the civil service pension fund in two—one for retirees (with grandfathering of current provisions) and one for current employees who will be transferred to a defined contribution scheme (without grandfathering).
- Coordination and reporting:
  - Authorities preparing the Long-Run Fiscal Sustainability Report to bring out policy options and separate impacts on confederation, cantons, communes, and social security funds.
  - Mission recommended the Report include a preliminary public sector balance sheet incorporating an estimate of the net present value of projected future deficits under current policies.

### Preliminary public sector balance sheet and intertemporal fiscal position
- Key aggregate estimates:
  - Present value of unfunded liabilities over the next fifty years estimated at 153 percent of GDP.
  - Negative intertemporal net worth estimated at 103 percent of GDP.
- Public sector balance sheet figures (selected table entries as presented):
  - Public sector net worth (in billions of SwF): -432, -443, -459 (2002, 2003, proj. 2004).
  - Public sector net worth (In percent of GDP): -100, -102, -103 (2002, 2003, proj. 2004).
  - Intertemporal financial position (A) examples: -756, -775, -793 (2002, 2003, proj. 2004) in billions of SwF; -175, -178, -178 (In percent of GDP).
  - Net present value of future fiscal balances (II) examples: -654, -667, -681 (2002, 2003, proj. 2004) in billions of SwF; -152, -154, -153 (In percent of GDP).
- Interpretation:
  - The Swiss public sector owns substantial assets that more than offset the 2004 accumulated net financial liabilities, but the present value of future unfunded liabilities implies a significant intertemporal imbalance.
  - The authorities acknowledge that the debt brake by itself, without structural fiscal reforms, would not be robust to aging pressures.

### Financial sector developments
- Authorities’ assessment:
  - Banking sector: robust, adequately capitalized, profitable, liquid and dynamic.
  - Switzerland retains a strongly competitive banking sector with high-quality and innovative institutions, good supervision and legal infrastructure, and excellent macroeconomic stability.
  - Wealth management expansion noted, especially rapid expansion in Asia where demand is most dynamic.
- Indicators and developments:
  - Financial soundness indicators at comfortable levels; banks’ equity prices strong (referenced Tables 5–8, Figure 11).
  - Bank profits rose in 2005, benefiting from expansion of asset management and trading activities, lower provisioning, and restructuring.
  - Intensifying competition put pressure on interest rate margins.
  - Low interest rates continued to stimulate mortgage lending but stress tests suggested limited vulnerability of households thanks to moderate levels of loan-to-value and debt-service ratios.

*Italicized source: IMF staff report excerpt from _cr06202 - 15.      The authorities are vigilant about a possible unwinding of global imbalances.*

### 29.      Risks in the banking sector appeared well contained and supervisors remained

### _cr06202 - 29.      Risks in the banking sector appeared well contained and supervisors remained

### Banking sector: risks, assessments, and supervision
- Stress tests by the SNB indicated that for the banking sector as a whole, "an extreme scenario of recession combined with a collapse in equity prices and a rise in interest rates would reduce the sector’s excess capital without breaching the regulatory minimum."
- Supervisory focus and monitoring needs:
  - Lending standards, interest rate and credit risks, and risk transfers need to be monitored carefully as banks emerge from a long period of low interest rates.
  - Large international banks are vulnerable to an abrupt unwinding of global imbalances.
- Supervisory improvements and recommendations:
  - Mission welcomed progress in assessing systemic risks.
  - Recommended that assessments include stress tests by the large banks using scenarios specified by the SNB in collaboration with the supervisory office (EBK).
- Regulatory and timetable items:
  - Implementation of Basel II was scheduled for January 2007.
  - The integrated Financial Market Supervisory Authority (FINMA) was intended to become operational in 2008, bringing under one roof supervision of banking, insurance, securities, and anti-money laundering.
  - Supervisors started to monitor banks’ exposure to hedge funds (noted as still limited) and developments in domestic and international credit risk transfer.

### Insurance sector: health, vulnerabilities, and reforms
- Sector improvements:
  - Balance sheets benefited from rising equity prices, improved risk management, higher premia, and restructuring.
- Remaining concerns:
  - Reserve deficiencies remained in life insurance.
  - Distribution of risk management expertise was uneven across the sector.
  - In reinsurance, profitability was reduced by natural disasters in the United States but capital remained adequate.
- Regulatory timetable:
  - Insurance companies will be expected to meet the risk-based capital requirements by 2011.
  - The Swiss Solvency Test, an advanced risk-based regulatory framework similar to the EU’s Solvency II, was on track to be introduced in 2008.

### Pension system (second pillar): funding, valuation, and supervision
- Funding status and valuation concerns:
  - At end-2004, underfunding amounted to 6.3 percent of GDP (4.7 percent of GDP is state guaranteed).
  - Published data likely understate underfunding because future liabilities were discounted with an average technical interest rate "slightly below 4 percent," nearly double the yield on long-term bonds, and did not adequately reflect increasing life expectancy.
- Regulatory parameters noted as problematic:
  - Technical discount rate.
  - Guaranteed rate of return.
  - Conversion rate (determining benefits at retirement) that does not seem to reflect its actuarially fair value.
  - Recently approved gradual reduction of the conversion rate from 7.2 to 6.8 percent was being considered but may be insufficient given increasing life expectancy and declining long-term interest rates.
- Supervisory structure and recommendations:
  - Supervision of pension funds has traditionally been conducted by cantons, leading to fragmentation and uneven expertise/resources.
  - Mission welcomed plans to harmonize supervision across cantons but considered that a centralized regulatory and supervisory system oriented toward risk-based regulation and supervision might be more appropriate for a small country like Switzerland.
  - Encouraged authorities to review options to relax restrictions on asset allocation (to improve portfolio performance and risk management), and to strengthen the regulatory and supervisory framework.
  - Noted regulatory differences between second pillar funds and life insurance funds created distortions.

### Macroeconomic outlook, monetary policy, and exchange rate
- Growth and inflation projections:
  - Economy expected to grow "over 2 percent" in 2006—closing the output gap in 2006.
  - Headline inflation projected to remain "slightly over 1 percent."
- Monetary policy guidance:
  - SNB’s key task: assure that inflation expectations remain firmly anchored.
  - Monetary policy needs to move gradually to a neutral stance as the output gap is closing.
  - Pace of monetary tightening should be gauged carefully against key indicators and allow benefits from reforms and increased productivity to lift growth.
  - SNB should remain flexible and willing to act promptly and decisively, in symmetrical fashion, if signs emerge of price pressures or if exchange rate volatility disturbs monetary conditions (e.g., a safe-haven shock to the franc).
- Exchange rate assessment:
  - The franc exchange rate is determined by market forces and is now below its long-run level marked by gradual appreciation.
  - Faster growth and normalization of policy interest rates are expected to strengthen the franc.
  - Success with domestic reforms could depreciate somewhat the equilibrium real exchange rate, at least for a transition period.
  - Gradual appreciation is expected to resume over the medium term.

### Fiscal outlook, sustainability, and recommendations
- Recent performance and near-term outlook:
  - Fiscal performance improved in 2005 and should consolidate further in 2006.
  - The fiscal impulse was neutral, with monetary policy largely on hold—this policy mix was considered appropriate.
  - Federal accounts expected to be in structural balance by 2007, building on the debt brake mechanism and recent adjustment packages.
- Medium-term fiscal challenges:
  - Arise from moderating potential growth and expenditure pressures from aging.
  - Debt brake mechanism is effective for cyclical pressures but not sufficiently robust to withstand structural fiscal pressures.
- Recommended actions and tools:
  - Authorities are framing potentially far-reaching and innovative structural fiscal reforms to begin containing deficits in social programs; reaching consensus will require coordination with cantons and communities and extensive public discussion.
  - Preparation of a Long-Run Fiscal Sustainability Report was welcomed and could help forge consensus.
  - The Sustainability Report could usefully include a preliminary intertemporal public sector balance sheet estimating the net present value of future implicit liabilities under the welfare state.
  - Such a balance sheet would help communicate the need for action, assess vital state assets, and provide information on long-run benefits from real and fiscal structural reforms.
- Data and monitoring issue:
  - Fiscal data for subnational governments have long delays, making monitoring difficult.

### Structural reforms and other structural issues
- Structural reform priorities:
  - Market-based reforms to reduce mark-ups could boost annual productivity growth, especially in retailing, health, agriculture, and network industries.
  - Reducing regulations and red tape, and substantial market opening in agriculture were highlighted.
- Progress under way:
  - Parliament approved a Revised Internal Market Law reducing cantonal ability to impede cross-border supply of services.
  - Liberalization of the electricity market with a two-stage opening: 2007 for commercial consumers and 2012 for the rest.
  - Swisscom’s "last mile" monopoly suspended.
- New reform initiatives supported by the mission:
  - Privatizing Swisscom shares (modalities being worked out for likely referendum).
  - Adopting the "Cassis-de-Dijon principle" to automatically recognize EU-approved products in Switzerland.
  - Reducing red tape and simplifying regulations to lower transaction costs.
- Labor market and education:
  - Switzerland has a flexible labor market; opening to the EU-15 alleviated skilled labor shortages without raising unemployment.
  - Extension of free movement to EU-10 expected to bring further flexibility.
  - Authorities aspire to raise participation by: paring incentives for early retirement, tightening disability insurance conditions, improving post-retirement employment modalities, and constructing more daycare centers to raise female participation.
  - Plans to raise participation in tertiary education and enhance continuous education were welcomed.
- Agriculture:
  - Progress in opening up agriculture is slow.
  - Marginal tariff for some products is 700 percent and direct producer support, at 2 percent of GDP, is higher than value added in agriculture.
  - Ongoing reforms aim to increase reliance on market mechanisms and replace price subsidies with direct income payments.
  - Bilateral agreements with the EU will liberalize trade in several agricultural products, in particular cheese, by 2007; further liberalizing reforms were being prepared beyond 2007.

### Other issues, external relations, and aid
- EU relations:
  - Bilateral agreements deepened ties: first package including free movement of labor took effect in June 2002 and extended to new EU members after a September 2005 referendum.
  - A second package including the EU savings directive was signed in October 2004; associate Schengen membership approved in June 2005.
  - Swiss government planned to present in 2006 a report on strategic medium-term options with the EU; electorate remains divided over full EU membership.
- Trade negotiations:
  - Officials expressed guarded optimism about the Doha round outcome; eventual outcome seen as depending on a compromise among the largest players.
  - Authorities were exploring bilateral free-trade agreements with several countries, including the U.S., Japan and Canada.
- Official development assistance and trade preferences:
  - Switzerland provides official development assistance at 0.4 percent of GNI.
  - Swiss ODA praised for high effectiveness and strong focus on poor countries.
  - Switzerland has reduced duties on agricultural imports from LDCs and supports the Multilateral Debt Relief Initiative.
- AML/CFT and statistics:
  - Switzerland underwent an AML/CFT assessment in April 2005 by FATF Secretariat members and FATF experts; the authorities are following up on recommendations.
  - Some deficiencies in the timeliness of economic statistics remain; fiscal data for subnational governments have long delays.

### Final appraisal highlights
- Growth prospects for 2006 are favorable and risks appear contained, with the economy expected to grow "over 2 percent" and headline inflation "slightly over 1 percent."
- Financial sector: appears healthy and well placed to support growth; profitability and balance sheets are favorable; supervisors should continue close monitoring as interest rates begin to rise.
- Pension second pillar: financial position improved but underfunding remains; recommended removal of regulatory restrictions (discount rate, guaranteed rate of return, conversion rate) and constraints on asset allocation; consider unifying regulatory and supervisory frameworks across cantons, introduce risk-based supervision, and strengthen disclosure requirements.
- Statistical improvements: economic policy could benefit from more timely statistics.

*Source: IMF staff report content as provided in the supplied content unit.*

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

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

### Macro outlook and recent performance
- Recovery underway in 2005, supported by a favorable external environment and accommodative monetary policy; the financial sector accounted for almost half of the rebound.
- Real GDP growth:
  - 2004: 2.1
  - 2005: 1.9
  - Staff projects growth to accelerate in 2006 to over 2 percent.
- Output gap: projected to close in 2006.
- Private domestic demand and components (selected):
  - Real total domestic demand 2005: 2.0
  - Private consumption 2005: 1.6
  - Gross fixed investment 2005: 3.1
- Employment and unemployment:
  - Unemployment rate (in percent): 2004: 3.9; 2005: 3.8; 2006 (staff estimate): 3.7
  - Employment (percent change) 2005: 0.1
- Prices and inflation:
  - CPI (year average) 2004: 0.8; 2005: 1.2; 2006 (staff estimate): 1.1
  - SNB expects inflation to accelerate in 2007 with the current interest rate (chart note).

### Monetary and financial conditions
- SNB policy and interest rates:
  - SNB resumed raising its policy interest rate as recovery gained traction; short-term interest rates remain slightly negative in real terms (chart note).
  - Three-month Libor rate (in percent): 2002: 3.1; 2003: 2.5; 2004: 2.6; 2005: 2.1; 2006 (Mar): 2.4
  - Yield on government bonds (in percent): 2002: 3.1; 2003: 2.5; 2004: 2.6; 2005: 2.1; 2006 (Mar): 2.4
- Money and credit:
  - M3 (annual average) 2003: 8.3; 2004: 3.2; 2005: 4.5; 2006 (change Feb 2005–Feb 2006): 3.8
  - Domestic credit (annual average) 2003: 0.6; 2004: 2.3; 2005: 4.5; 2006 (change Feb 2005–Feb 2006): 6.3
- Monetary conditions remained supportive due to a weakening franc and low nominal rates; yield curve has flattened.
- Financial sector soundness:
  - Regulatory capital as percent of risk-weighted assets (banks): 1999: 11.6; 2000: 11.7; 2001: 12.2; 2002: 12.3; 2003: 12.6; 2004: 12.5; 2005: 12.2
  - Non-performing loans as percent of gross loans: 1999: 2.7; 2000: 2.4; 2001: 2.3; 2002: 1.9; 2003: 1.4; 2004: 0.9; 2005: 0.5
  - Household debt to banks as a percentage of GDP: 1999: 116.0; 2000: 114.0; 2001: 114.9; 2002: 116.9; 2003: 122.3
- Directors’ view: Swiss financial system appears healthy and dynamic; welcomed regulatory and supervisory strengthening but urged improvements in pension regulation, unified supervisory framework, risk-based supervision, and disclosure standards.

### Fiscal position and public finances
- General government (percent of GDP):
  - Revenue: 2005: 38.0
  - Expenditure: 2005: 38.5
  - Balance: 2005: -0.6
  - Structural balance: 2005: -0.3
  - Gross debt: 2005: 52.0
- Federal government (percent of GDP):
  - Revenue 2005: 11.3
  - Expenditure 2005: 11.5
  - Overall balance 2005: -0.2
  - Structural fiscal balance (federal memorandum): 2005: -0.5
- 2005 specifics:
  - General government deficit halved in 2005 to 0.6 percent of GDP, but structural deficit remained unchanged due to deterioration in social security underlying position.
  - Federal government is on track to eliminate its small structural deficit by 2007.
- Directors’ recommendations:
  - Strong support for authorities’ intention to eliminate the structural federal deficit by 2007.
  - Urged structural fiscal reforms to place social programs on a sound long-term footing given aging population pressures.
  - Welcomed commitment to prepare a Long-Run Fiscal Sustainability Report.
  - Noted disappointment that several cantons used their share of gold sale proceeds to lower taxes.

### External sector and competitiveness
- Current account and external balances:
  - Current account (in percent of GDP): 2002: 8.3; 2003: 13.3; 2004: 14.6; 2005: 13.8; 2006 (staff estimate): 13.7
  - Trade balance (in percent of GDP): 2002: 1.2; 2003: 1.0; 2004: 1.5; 2005: 0.7; 2006 (staff estimate): 0.8
  - Net investment income remains a large component of the surplus (chart notes and Table 4).
- External indicators:
  - Official reserves (end of year, US$ billion, excluding gold): 2003: 40.2; 2004: 47.7; 2005: 55.5; 2006 (Mar): 36.3; 2006 (staff March figure elsewhere): 34.8
  - Nominal effective exchange rate (1990=100) 2002: 108.2; 2003: 108.6; 2004: 108.4; 2005: 108.2; 2006 (Feb): 106.9
  - Real effective exchange rate (1990=100) 2002: 106.3; 2003: 106.4; 2004: 105.6; 2005: 104.0; 2006 (Jan): 103.3
- Competitiveness and trade structure:
  - Goods market share has been declining (chart).
  - Goods exports sector remains competitive and Switzerland has the second highest share of high technology exports in the world (chart).
- Directors’ view: Short-term external risks are mostly external and appear balanced, assuming additional progress on structural reform.

### Structural reforms and labor market
- Labor market:
  - Employment rates high overall and among women; part-time employment prevalent among women.
  - Long-term unemployment is below average.
  - Labor productivity growth was low in 2001–05 (charts).
- Structural issues:
  - Prices in non-traded goods and services are much higher in Switzerland relative to EU-15 (2004).
  - Lower productivity in construction and private non-financial service sectors relative to total economy (2001).
  - Product market regulation is high and coming down slowly (1998–2003).
- Directors’ recommendations:
  - Use the recovery to advance ambitious economic reforms to boost potential growth.
  - Move forward decisively with further liberalization of sheltered sectors by reducing red tape and state regulations, lowering non-tariff barriers, and reducing high protection and subsidization in agriculture.
  - Welcome reforms opening domestic product markets and network industries.

### Statistical and data issues
- Switzerland is in full compliance with the Fund’s Special Data Dissemination Standard (SDDS) and posts metadata on the Dissemination Standards Bulletin Board.
- Published statistical gaps and deficiencies (summary):
  - SNB does not compile a monetary survey.
  - Reliable general government finance statistics appear with considerable lags due to canton and commune fiscal account compilation delays.
  - Internationally comparable fiscal statistics on an accrual basis are not available.
  - Pension statistics are published with a long lag.
  - GDP by industry appears with a considerable lag.
- Steps taken or planned to address deficiencies:
  - SNB launched a quarterly survey on the cost of borrowing in 2004; pilot completed June 2005; plans to conduct monthly from July 2006.
  - SNB started compiling more comprehensive statistics on mutual funds in September 2005.
  - SNB and Federal Statistical Office published annual financial accounts for 1999–2003; data on financial flows and non-financial assets to be published in 2007.
  - Annual national accounts upgraded in 2003 to ESA95; SECO revised quarterly national account estimates and started publishing a quarterly production account in March 2006.
  - Statistical cooperation agreement with the EU concluded in 2004 for harmonization with EU standards.
  - Federal Finance Administration preparing to revamp fiscal statistics and introduce full accrual budgeting and accounting at the federal level; figures according to new accounting standards expected in 2009.
  - Adoption of Standardized Report Forms for monetary data reporting to STA expected to enhance analytical usefulness; SNB expects to report more detailed deposit money bank data in the second half of 2006.
- Specific data table highlights (selected):
  - Nominal GDP (billions of SwF): 2005: 456.9; 2006: 471.8 (staff estimate/projection series present in tables).
  - Current account (billions of SwF): 2005: 63.0; 2006 (staff estimate): 64.6.
  - Net investment income (in percent of GDP): 2005: 10.9; earlier years shown in Table 4.

### Governance of IMF relations and consultations
- Membership and Fund relations as of March 31, 2006:
  - Joined: 5/29/92.
  - Switzerland has accepted the obligations of Article VIII, Sections 2, 3 and 4.
  - Quota: 3,458.50 (SDR Million, 100.00 percent).
- Exchange rate arrangement:
  - Swiss National Bank does not maintain margins in respect of exchange transactions; exchange system free of restrictions on payments and transfers for current international transactions.
  - Switzerland has implemented asset freezes in accordance with UN Security Council resolutions and EU measures; these restrictions have been notified to the Fund.
- Article IV consultations:
  - Switzerland is on the standard 12-month Article IV consultation cycle.
  - Recommendation: the next Article IV consultation with Switzerland be held on the standard twelve-month cycle.

*IMF staff report and Public Information Notice, Article IV consultation with Switzerland (2006).*

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

### _cr06202 - 1. On behalf of my Swiss authorities, I would like to thank the staff for the very

### Overview and authorities' position
- Swiss authorities thank staff for constructive policy discussions and a concise staff report that "gives an accurate account of the economic situation in Switzerland and the main policy challenges."
- Authorities "largely agree with the staff’s appraisal and welcome the policy recommendations."
- The selected issues paper is highlighted as a "valuable contribution" to ongoing domestic debates on fiscal federalism, government finances and pension scheme reform.

### Recent economic performance
- GDP: "In the fourth quarter of 2005, GDP increased by 2.7 percent on a year-to-year basis, bringing GDP growth to roughly 2 percent for the year as a whole."
- Growth drivers:
  - External environment stimulated export growth in 2005.
  - Domestic demand strengthened.
  - Investment growth accelerated towards the end of 2005 after being relatively slow earlier.
  - Private consumption rebounded strongly in 2005 despite the absence of a strong labor-market recovery.

### Labor market
- Labor market reaction weaker than in earlier cycles, but indicators point to an upturn since end-2005.
- Employment: "In the first quarter of 2006, employment expanded considerably and companies’ hiring intentions improved further."
- Unemployment: "seasonally adjusted, has further eased to 3.4 percent in April."
- Consumer sentiment improved markedly at the beginning of 2006.

### Monetary policy
- SNB actions and stance:
  - After a pause in early 2005, SNB resumed tightening in December 2005 by increasing the three-month LIBOR for Swiss francs to 1 percent.
  - In March 2006, the SNB increased the rate to 1.25 percent, "a level at which monetary policy is still expansionary."
  - The most recently published inflation forecast confirms that "1.25 percent does not represent a steady-state equilibrium level for the three-month Libor."
- Policy guidance:
  - Given the closing output gap, long transmission lags, and risks of keeping rates low, it is important that the SNB "signals that it has a tightening bias."
  - Pace of future tightening to be assessed based on new inflation forecasts and key indicators.
- Institutional points:
  - SNB concurs with staff that the monetary policy framework is "well designed, transparent and effective" and that communication strategy has worked well.
  - SNB supports lifting the legal link between housing rents and mortgage rates.
  - SNB strongly concurs that the KOSA popular initiative (earmarking SNB profits above one billion Swiss francs for financing the social security system) "could compromise central bank independence and the SNB’s ability to focus on price stability."

### Fiscal policy and fiscal federalism
- 2005 federal outcome:
  - Federal over-performance yielded "an essentially balanced outcome compared with a projected deficit of 0.4 percent of GDP," mainly due to lower-than-projected expenditures.
  - Expenditure growth has been curbed by consistent implementation of the debt brake and two expenditure reduction programs.
  - "Achieving structural balance at the federal level is now within reach."
- Medium- and long-term pressures:
  - Staff stresses challenges from rising social security and health spending; authorities are aware and taking steps.
- Central government task review:
  - Federal Council launched an ambitious project to review central government tasks, classifying them into 40 categories to identify areas for reduction or elimination.
  - Objective adopted to "contain the overall growth of federal budget spending until 2015 at the level of nominal GDP growth."
  - Timeline: completion of an action plan "by end-2006" for discussion with cantons and stakeholders.
- New financial equalization framework (NFA) and coordination:
  - With NFA nearing final preparation, fiscal federalism issues are more actively debated.
  - Analysis notes advantages of devolved federalism (e.g., containing size of public sector) and coordination challenges; cantons use intercantonal cooperation and cost compensation.
  - NFA encourages horizontal coordination; federal Parliament may act as an arbitrator and the constitutional amendment covers, among other things, high school and university education.
  - Popular vote on May 21, 2006: proposed constitutional amendments to enhance vertical cooperation between Confederation and cantons in education were accepted by a large majority.
- Public sector balance sheet and sustainability reporting:
  - Selected issues paper presents a preliminary public sector balance sheet with a forward-looking component incorporating population aging effects.
  - Caveats: public sector capital stock data are "hardly more than an educated guess" and intertemporal financial position estimates are sensitive to assumptions; staff notes interest in alternative-assumption sensitivity (see footnote 39 of the selected issues paper).
  - Federal Finance Administration preparing a sustainability report covering all three levels of government and social security programs (old-age pensions, disability insurance, means-tested health-insurance support).
    - Report will show effects of aging on public finances under a no-policy-change assumption over a time horizon of 50 years.
    - A sensitivity analysis for key parameters such as interest rates, productivity growth and demographic variables will be carried out.

### Financial sector and pensions
- Banking sector: authorities agree with staff that risks in the banking sector are low.
- Cross-border supervision: amendment to administrative assistance in stock exchange matters entered into force on February 1, 2006; expected to facilitate and accelerate administrative assistance for regulatory purposes in line with international minimum standards.
- Occupational pensions (second pillar):
  - Authorities welcomed the comparison of occupational pension pillars of the Netherlands, the UK and Switzerland.
  - Swiss pension system has country-specific goals and parameters; further reforms and especially strengthening of supervision are needed.
  - Options for addressing weaknesses are in a report by an expert commission published in March; government proposals will build on that report.
  - Reforms aim for uniform application of revised and stricter supervisory rules across cantons.
- Authorities look forward to discussing these issues in greater depth in the context of the FSAP update to be undertaken later this year.

### Structural reform priorities
- Top structural priority: "Increasing productivity growth in the domestic sector."
- Sectors identified for reform: health and network industries, agriculture, public services, mandatory pension schemes, the education sector, and the real estate and construction sectors.
- Ongoing reforms also target improvements to the business-friendly environment, including corporate governance and corporate taxes.

*Source: Excerpt from the Swiss authorities' statement responding to the IMF staff report (content unit: _cr06202).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06202.pdf_