## _cr07186

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---

### Executive Summary — Recent developments and outlook
- Economy in fourth year of expansion with balanced growth, low inflation, and a strong external position.
- Growth and inflation:
  - Growth in 2006: GDP growth of 2.7 percent.
  - Projected growth for 2007: 2.0 percent.
  - CPI inflation in 2006: 1 percent; February 2007 inflation dropped to zero. Excluding housing rents linked to rising policy interest rates, inflation was negative.
  - Real wages grew by 0.7 percent in 2006.
- Labor market and employment:
  - Unemployment recently fell to 3 percent.
  - Full-time employment increased in manufacturing, construction, and the financial sector.
  - Opening the labor market to EU workers helped fill skill gaps and keep wage growth down.
- Monetary conditions:
  - SNB raised policy rates in five quarterly steps of 25 bp each to 2.25 percent by March 2007.
  - Real rates at 1¾ percent are now close to those in the U.S. and euro zone.
  - Market participants on average price in a slight rate increase for June 2007.
- Financial sector:
  - Financial sector accounts for 5 percent of employment and 15 percent of value added.
  - Financial soundness indicators have improved and bank profitability is strong.
  - Pension and life insurance sectors are recovering.
  - Real estate prices have increased but remain well below their peak before the crisis of the mid-1990s; no signs of price bubbles.
- Fiscal outcome:
  - 2006 general government result: surplus of 0.8 percent of GDP (versus a budgeted 1 percent deficit).
  - Gross debt reduced to 48.2 percent of GDP (with proceeds from Swisscom share sales).
- External position:
  - Current account surplus projected to remain at 16-17 percent of GDP.
  - Merchandise trade: surplus increased to 1 percent of GDP.
  - Nominal and real effective depreciation of the franc since 2002: 2½ and 6½ percent, respectively.
- Outlook and risks:
  - Staff projections in line with consensus; investment and consumption expected to remain buoyant.
  - Downside risks: disorderly unwinding of global imbalances; shocks from hedge funds or private equity; increased currency volatility linked to Swiss franc carry trades.
  - Upside potential: continued weak franc or accelerated migration and employment growth.

### Focus of policy discussions
- Potential growth
  - Reforms in goods and labor markets increased productivity and facilitated above-trend growth.
  - Authorities estimate current potential growth at 1½ percent a year; staff thought it could be closer to 2 percent for now.
- Monetary and exchange rate policies
  - SNB continuing normalizing interest rates; policy stance needs flexibility given uncertainties.
  - Tightening of monetary policy has coincided with weakening of the exchange rate—linked in part to carry trades.
  - Some SNB models indicated a neutral rate of 2.5 percent (real 1.5 percent; inflation 1 percent).
  - Exchange regime: independent float; SNB reserves the right to intervene but has not done so in years.
  - Staff concern about technical distortions: regulated link between interest rates and housing rents and political pressure on cantonal banks to keep mortgage rates stable as policy rates rise.
- Financial sector and FSAP update
  - Financial sector performing well but evolving risk exposures require close monitoring.
  - FSAP update recommends strengthening the draft Act establishing FINMA; funding and regulatory independence are crucial.
  - Swiss banks (UBS and Credit Suisse) are global enterprises in wealth management, derivatives, and as prime brokers to hedge funds and private equity firms.
- Fiscal policies and sustainability
  - Fiscal policies strong, aided by the debt brake.
  - Authorities planning substantial extraordinary budgetary expenditures outside of the debt brake in 2008.
  - Cantons cutting taxes amid strong revenues and incentives from a new equalization system.
  - Staff recommends bringing extrabudgetary expenditures under the debt brake to preserve credibility and avoid procyclical policies.
  - Authorities preparing measures to reduce long-term fiscal pressures and a Long-Run Sustainability Report to inform the public.

### Projections and long-run challenges
- Staff medium-term projections (selected):
  - Real GDP: 2006 = 2.7; 2007 = 2.0; 2008–2011 = 1.8, 1.8, 1.8, 1.8.
  - Unemployment rate: 2006 = 2.8; 2007 = 2.8; 2008–2011 = 2.8, 2.9, 2.9, 2.9.
  - CPI inflation, p.a.: 2006 = 1.0; 2007 = 0.7; 2008–2011 = 1.0, 1.0, 1.0, 1.0.
- Staff long-run potential output (average percentage change a year, selected):
  - Real GDP: 2010-19 = 1.6; 2020-29 = 1.3; 2030-39 = 1.3; 2040-49 = 1.2.
  - TFP: 2010-19 = 1.0; 2020-29 = 1.0; 2030-39 = 1.0; 2040-49 = 1.0.
  - Total Hours Worked: 2010-19 = -0.3; 2020-29 = -0.2; 2030-39 = -0.2; 2040-49 = -0.2.
  - Population, end of period (thousands): 2000 = 7,002; 2010-19 memorandum = 7,435; later periods = 7,854; 8,076; 8,156; 8,116.
- Main long-run challenge:
  - Population aging, associated fiscal pressures, and decline in potential growth.
  - Staff projects potential growth to slow to around 1¼ percent by 2020 driven by demographics.
  - Unchanged fiscal policies would generate a large primary deficit from higher entitlement costs.

### Box 1 — The Swiss Current Account Surplus (drivers and attribution)
- Overview:
  - Current account surplus entirely private sector; reflects structural and cyclical components as Swiss multinationals expand.
- Major sources and magnitudes:
  - Net foreign assets exceeding 110 percent of GDP mostly reflect pension plans’ and Swiss multinational foreign assets.
  - At moderate returns of some 6 percent, these assets alone contribute (a structural) income of 7 percent of GDP.
  - Swiss multinationals’ global profits structurally and cyclically strong, exerting large impact on balance of payments.
  - Merchandise trade: trade balance around zero in the 1990s and a small surplus more recently.
- Role of foreign-controlled entities:
  - Foreign holding companies as residents have net retained earnings abroad that constitute a Swiss surplus—grown from -1 percent of GDP in 2001 to nearly 3 percent in 2006.
- Attribution to foreigners:
  - Preliminary staff analysis suggests nearly 7 pps of GDP of the current account surplus in 2005-2006 is attributable to foreigners.

### FSAP update and financial sector vulnerabilities (paragraph 37)
- Financial sector performance and risks:
  - "The FSAP update found that the financial sector is performing well, but risks persist."
  - Stress testing indicates general resilience, but bank operations are increasingly complex with exotic instruments and high-leveraged counterparties; some insurers vulnerable to asset price adjustments; occupational pension funds underfunded and fragmented regulation.
  - Main downside risk: healthy balance sheets and profits may be building complacency, creating vulnerability to increased volatility or shocks.
- Regulatory and supervisory recommendations:
  - "Regulatory and supervisory arrangements need to be first-best."
  - The consolidated regulator (FINMA) needs operational independence and financial resources to be an effective supervisor of very large systemic institutions.
  - Continue evaluating large banks’ operating models and ensure liquidity and capital regimes are sufficient.
- Fiscal performance and medium-term priorities:
  - "Fiscal policies have been sound, generating a surplus one year ahead of schedule."
  - Debt brake functioning well; need to extend strong record into the medium term to meet aging challenges.
  - Procyclical fiscal policy should be avoided and the integrity of the debt brake maintained.
  - Fiscal policy for 2007-08 projected to be expansionary due to large extraordinary expenditures and overdue pension funding outside the debt brake; these expenditures should be compensated within the debt brake mechanism in the medium term.
  - Cantonal tax cuts illustrate competitive federalism can generate procyclical tax cuts amid unresolved social security deficits.
  - Long-run fiscal sustainability report should clarify fiscal dynamics under current policies and distributional effects of solutions.
- Data and statistical needs:
  - Policy making requires timely statistics; cantonal and local fiscal data provide long lags; inflation assessments hampered by inadequate wage data.

### Recommendation on Article IV timing (paragraph 43)
- Recommendation:
  - Next Article IV consultation with Switzerland to be held on the standard twelve-month cycle.
- Macro dynamics and growth:
  - Recovery in fourth year; Swiss and EU business cycles synchronized.
  - Expansion smaller but less volatile than previous expansion.
  - Growth drivers: exports of goods and non-factor services, investment (fixed investment growth positive), and private consumption.
- Monetary conditions and asset prices (selected):
  - Money and credit: M3 growth moderated; M3 as percent of GDP liquidity rising on trend; credit growth accelerating with mortgages prominent.
  - Financial indicators: distance-to-default improved; credit default swaps favorable for major banks and insurers; equity prices increased substantially; real estate price growth subdued and residential levels below early 1990s peak.
- External sector and competitiveness (selected shares, 2005):
  - Components of current account surplus by share: Goods 5%; Direct investment 51%; Portfolio investment 20%; Other services 25%; Financial services 19%.
- Fiscal position (selected, 2006 and 2007 projections):
  - General government (2006, percent of GDP): Revenue 38.2; Expenditure 37.4; Balance 0.8; Structural balance 0.8; Gross debt 46.2.
  - Table 2 (2007 projection, millions of SwF): Revenue 189,676; Expenditure 191,177; Balance -1,501; Gross debt 43.6 (percent of GDP).
  - Federal government (2007 projection, millions of SwF): Revenue 57,809; Expenditure 61,820; Balance -4,011; Federal government overall balance (2007 projection, percent of GDP): -0.8; Gross debt (memo, percent of GDP, 2006): 24.6.
- External accounts (Table 5, 2006):
  - Current account (2006, billions of SwF): 82.7.
  - Current account (2006, percent of GDP): 17.5.
  - Trade balance (2006, percent of GDP): 4.9.
  - Exports (2006, percent of GDP): 185.7.
  - Imports (2006, percent of GDP): -180.8.
  - Net investment income (2006, percent of GDP): 64.6.
  - Official reserves (end period, 2006, billions of US$): 38.1.
  - Reserve cover (months of imports of GNFS, 2006): 2.8.
- Financial institutions and indicators (selected, 2006 and Jun-06):
  - UBS profit (2006, SwF millions): 11,638.
  - Credit Suisse Group profit (2006, SwF millions): 8,281.
  - Zurich Financial Services profit (2006, USD millions): 4,527.
  - Total profit (2006, SwF millions): 31,106.
  - Operating Income (2006, SwF millions): 229,020.
  - Profit (percent of GDP, 2006): 6.6.
  - Regulatory capital to risk-weighted assets (2005): 12.4; (Jun-06): 12.7.
  - Regulatory Tier I capital to risk-weighted assets (2005): 13.3; (Jun-06): 13.0.
  - Non-performing loans as percent of gross loans (2005): 0.5.
  - Household debt to banks as percent of GDP (2005): 114.4.
  - Total real estate loans as percent of total loans (global level, Jun-06): 29.4.
- Real estate annual increases (selected years): 2001 3.1; 2002 5.6; 2003 4.9; 2004 2.6; 2005 1.8.

### Public Information Notice — Executive Board Concluding Statement (PIN No. 07/63, June 1, 2007) — Key assessments and recommendations
- Board assessment:
  - Commended authorities for prudent economic management and sound policy frameworks.
  - Main policy challenge: strengthen potential growth and address long-term structural and fiscal issues given population aging.
- Monetary policy:
  - Commended SNB for keeping inflation under control; gradual tightening appropriate.
  - Monetary policy should remain flexible.
  - Recommended removal of regulated link between interest rates and housing rents.
- Exchange rate and spillovers:
  - Reviewed franc weakness despite rising policy rates; carry-trade effects noted.
  - Supported independent floating exchange rate regime; advised monitoring franc-denominated lending in Eastern Europe.
- Structural reform:
  - Recommended deeper internal structural reforms to strengthen domestic demand and potential growth, and further liberalization of sheltered sectors, including agriculture.
- Financial sector supervision:
  - Welcomed FSAP update; emphasized continued vigilance and highest supervision standards.
  - Supported tripartite supervisory cooperation with the UK and the US.
  - Recommended FINMA be assured both financial and regulatory independence.
  - Encouraged evaluation of large banks’ operating models and appropriate liquidity and capital regimes.
  - Urged strengthening supervision for insurers with heightened risks and addressing underfunding in pension funds.
- Fiscal policy and debt brake:
  - Commended debt brake; stressed fiscal stimulus should be avoided and integrity maintained.
  - Many Directors concerned about large one-time expenditures in 2008 treated outside the debt brake; welcomed authorities’ commitment to compensate in the medium term.
  - Suggested cantons build reserves for future aging-related expenditure needs rather than cut taxes.
  - Looked forward to publication of long-run fiscal sustainability report.
- Data and statistics:
  - Encouraged authorities to improve timeliness and quality of some key data sources.

### Annex I — Fund relations (As of February 28, 2007) — Selected entries
- Membership: Joined 5/29/92; accepted the obligations of Article VIII, Sections 2, 3 and 4.
- Quota (SDR Million; % Quota): Quota 3,458.50 — 100.00.
- Fund holdings of currency: 3,156.12 — 91.26; Reserve position in Fund: 302.38 — 8.74.
- Outstanding Purchases and Loans: None; Financial Arrangements: None; Projected Obligations to Fund: None.
- Exchange rate arrangement:
  - Exchange rate determined by supply and demand and classified as an independently floating exchange rate regime.
  - SNB reserves the right to intervene; all settlements at free market rates.
  - Switzerland maintains an exchange system free of restrictions on payments and transfers for current international transactions, except security-related restrictions notified pursuant to Decision No. 144-(52/51).
- Article IV (2007):
  - Consultation cycle: Standard 12-month Article IV consultation cycle.
  - Mission visit: Bern and Zürich during February 26–March 5, 2007.
  - Principal interlocutors: Finance Minister Merz; Chairman Roth of the SNB Governing Board; Interior Minister Couchepin; other senior officials.
  - IMF team composition: B. Traa (Head), K. Ross, A. Carare (EUR); B. Johnston (MCM) for FSAP update.
  - Authorities agreed to publication of the staff report.

### Annex II — Statistical issues — Key points and planned actions
- General assessment:
  - Switzerland generally publishes timely economic statistics and posts most data on the internet.
  - Subscribed to SDDS in June 1996; in full observance of SDDS requirements with flexibility options for production index data and wages and earnings data.
- Identified gaps:
  - Reliable general government finance statistics have considerable lags due to cantonal and commune compilation delays.
  - Internationally comparable fiscal statistics on an accrual basis not available.
  - Pension statistics and GDP by industry published with long lags.
- Steps taken or planned:
  - SNB initiatives: quarterly survey on cost of borrowing (pilot completed June 2005; monthly since July 2006); more comprehensive mutual funds statistics since September 2005; annual financial accounts 1999-2003 published October 2005; data on flows and non-financial assets to be published in 2007.
  - National accounts upgraded in 2003 to ESA95; SECO revised quarterly national account estimates with Q4 2004 data and started publishing a quarterly production account in March 2006.
  - Federal Finance Administration preparing to adopt GFSM 2001; reform of cantonal and communal accounting; introduction of full accrual budgeting and accounting at federal level (Neues Rechnungsmodell Bund) with figures according to new standards expected in 2008.
  - Balance of payments and IIP: quarterly BOP and IIP compiled by SNB meet international standards; historical treatment of monetary gold proceeds adjusted after February 2005.
  - Financial Soundness Indicators: Switzerland participated in Coordinated Compilation Exercise; benchmark indicators for year-end 2005 to be posted on IMF website.
- Table of Common Indicators Required for Surveillance (As of April 4, 2007) — selected latest observation dates:
  - Exchange Rates: Date of Latest Observation: Mar 07.
  - International Reserve Assets and Reserve Liabilities: Date of Latest Observation: Feb 07.
  - Consolidated Balance Sheet of the Banking System: Date of Latest Observation: Jan 07.
  - Consumer Price Index: Date of Latest Observation: Feb 07.
  - Revenue, Expenditure, Balance – General Government: Date of Latest Observation: 2006.
  - External Current Account Balance: Date of Latest Observation: Q3/06.
  - GDP/GNP: Date of Latest Observation: Q4/06.

*Executive Summary — IMF staff report content unit*

### Executive Summary

### Executive Summary

### Recent developments and outlook
- The economy is in its fourth year of expansion with balanced growth, low inflation, and a strong external position.
- Growth and inflation:
  - Growth in 2006: GDP growth of 2.7 percent.
  - Projected growth for 2007: 2.0 percent.
  - CPI inflation in 2006: 1 percent; February 2007 inflation dropped to zero. When excluding housing rents linked to rising policy interest rates, inflation was negative.
  - Real wages grew by 0.7 percent in 2006.
- Labor market and employment:
  - Unemployment recently fell to 3 percent.
  - Full-time employment increased in manufacturing, construction, and the financial sector.
  - Opening the labor market to EU workers helped fill skill gaps and keep wage growth down.
- Monetary conditions:
  - The SNB raised policy rates in five quarterly steps of 25 bp each to 2.25 percent by March 2007.
  - Real rates at 1¾ percent are now close to those in the U.S. and euro zone.
  - Market participants on average price in a slight rate increase for June 2007.
- Financial sector:
  - Financial sector accounts for 5 percent of employment and 15 percent of value added.
  - Financial soundness indicators have improved and bank profitability is strong.
  - Pension and life insurance sectors are recovering.
  - Real estate prices have increased but remain well below their peak before the crisis of the mid-1990s; no signs of price bubbles.
- Fiscal outcome:
  - 2006 general government result: surplus of 0.8 percent of GDP (versus a budgeted 1 percent deficit).
  - Gross debt reduced to 48.2 percent of GDP (with proceeds from Swisscom share sales).
- External position:
  - Current account surplus projected to remain at 16-17 percent of GDP.
  - Merchandise trade: surplus increased to 1 percent of GDP.
  - Nominal and real effective depreciation of the franc since 2002: 2½ and 6½ percent, respectively.
- Outlook and risks:
  - Staff projections are in line with consensus; investment and consumption expected to remain buoyant.
  - Downside risks: disorderly unwinding of global imbalances; shocks from hedge funds or private equity; increased currency volatility linked to Swiss franc carry trades.
  - Upside potential: continued weak franc or accelerated migration and employment growth.

### Focus of the policy discussions
- Potential growth
  - Ongoing reforms in goods and labor markets increased productivity and facilitated above-trend growth.
  - Authorities agree that opening the labor market to EU workers and stronger retail competition has kept inflation in check, but are hesitant to assume permanently higher potential growth.
  - Authorities estimate current potential growth at 1½ percent a year; staff thought it could be closer to 2 percent for now.
- Monetary and exchange rate policies
  - SNB continues normalizing interest rates; policy stance needs to remain flexible given uncertainties.
  - Tightening of monetary policy has coincided with a weakening of the exchange rate—linked in part to carry trades.
  - Some SNB models indicated a neutral rate of 2.5 percent (real 1.5 percent; inflation 1 percent).
  - The exchange regime: independent float; SNB reserves the right to intervene but has not done so in years.
  - Staff concern about technical distortions: the regulated link between interest rates and housing rents (higher rates causing rental inflation) and political pressure on cantonal banks to keep mortgage rates stable as policy rates rise.
- Financial sector and FSAP update
  - Financial sector performing well but increasingly sophisticated and evolving risk exposures require close monitoring.
  - The FSAP update recommends strengthening the draft Act establishing the unified financial market supervisor (FINMA).
  - Authorities agree that funding and regulatory independence of FINMA are crucial.
  - Swiss banks (UBS and Credit Suisse) are global enterprises in wealth management, derivatives markets, and as prime brokers to hedge funds and private equity firms.
- Fiscal policies and sustainability
  - Fiscal policies have been strong, aided by the debt brake.
  - Authorities are planning substantial extraordinary budgetary expenditures outside of the debt brake in 2008.
  - Cantons are cutting taxes amid strong revenues and incentives from a new equalization system.
  - Staff recommends bringing extrabudgetary expenditures under the debt brake to preserve its credibility and avoid procyclical policies.
  - Authorities are preparing measures to reduce long-term fiscal pressures and a Long-Run Sustainability Report to inform the public.

### Projections and long-run challenges
- Staff medium-term projections (selected):
  - Real GDP: 2006 = 2.7; 2007 = 2.0; 2008–2011 = 1.8 each year (2008 onward listed as 1.8, 1.8, 1.8, 1.8).
  - Unemployment rate: 2006 = 2.8; 2007 = 2.8; 2008–2011 = 2.8, 2.9, 2.9, 2.9.
  - CPI inflation, p.a.: 2006 = 1.0; 2007 = 0.7; 2008–2011 = 1.0, 1.0, 1.0, 1.0.
  - Savings and investment (percent of GDP) and other tabulated projections are presented in staff medium-term tables.
- Staff projections of long-run potential output (average percentage change a year, selected):
  - Real GDP: 2010-19 = 1.6; 2020-29 = 1.3; 2030-39 = 1.3; 2040-49 = 1.2.
  - Total Factor Productivity (TFP): 2010-19 = 1.0; 2020-29 = 1.0; 2030-39 = 1.0; 2040-49 = 1.0.
  - Working age population and hours worked projections indicate downward pressure: Total Hours Worked 2010-19 = -0.3; 2020-29 = -0.2; 2030-39 = -0.2; 2040-49 = -0.2.
  - Population, end of period (thousands): 2000 = 7,002; 2010-19 period memorandum shows 7,435; later periods show 7,854; 8,076; 8,156; 8,116 (as presented in staff tables).
- Main long-run challenge:
  - Population aging, associated fiscal pressures, and a decline in potential growth.
  - Staff projects potential growth to slow to around 1¼ percent by 2020 driven by demographics.
  - Unchanged fiscal policies would generate a large primary deficit from higher entitlement costs.

*Executive Summary — IMF staff report content unit*

### Box 1.  The Swiss Current Account Surplus

### Box 1.  The Swiss Current Account Surplus

### Overview
- The current account surplus is entirely private sector and reflects both structural and cyclical components that have grown with globalization and as Swiss multinationals expand.
- The surplus does not connect in a simple way to domestic absorption, or even to Swiss nationals.

### Major sources and magnitudes
- Net foreign assets exceeding 110 percent of GDP mostly reflect pension plans’ and Swiss multinational foreign assets.
- Even at moderate returns of some 6 percent, these assets alone contribute (a structural) income of 7 percent of GDP.
- Swiss multinationals are very profitable. The global upswing has boosted profitability of Swiss firms in chemical, pharmaceutical, machine tool, and financial services industries. They are world leaders in their field, conducting mostly business overseas. Their global profits are structurally improving and also currently cyclically strong, thus exerting a large impact on the Swiss balance of payments.
- Merchandise trade: the trade balance was around zero in the 1990s and a small surplus more recently, reflecting slow average growth. Going forward, absorption is likely to increase as the economy continues to strengthen, and reforms further liberalize internal markets. Investment is picking up and consumption taxes are low, yet stronger absorption could only reduce part of the large external surplus.

### Role of foreign-controlled entities
- Foreign holding companies are attracted by location, a stable political system, excellent legal, physical, and financial infrastructure, and moderate tax regime. As residents, their profits are recorded in the Swiss balance of payments.
- Most of their earnings are in-and-out, but their net retained earnings abroad are a Swiss surplus—these have grown from -1 percent of GDP in 2001 to nearly 3 percent in 2006.

### Attribution to foreigners
- Not all of the surplus is “Swiss.” Balance of payments data reflect residency. Many firms in Switzerland are fully (foreign holdings) or partially (foreign share ownership in Swiss firms) owned by foreigners.
- A preliminary staff analysis based on data received from the authorities suggests that nearly 7 pps of GDP of the current account surplus in 2005-2006 is attributable to foreigners.

*IMF staff box summarizing drivers and attribution of the Swiss current account surplus.*

### 37.      The FSAP update found that the financial sector is performing well, but risks

### _cr07186 - 37.      The FSAP update found that the financial sector is performing well, but risks

### Financial sector performance and risks
- "The FSAP update found that the financial sector is performing well, but risks persist."
- "While stress testing indicates that the financial sector is generally resilient to shocks, bank operations are increasingly complex, involving exotic instruments and high-leveraged counterparties; some insurers remain vulnerable to asset price adjustments; and occupation pension funds continue to experience underfunding and fragmented regulation."
- "The main downside risk is that healthy balance sheets and profits may be building a degree of complacency, creating vulnerability to increased volatility or shocks."

### Regulatory and supervisory recommendations
- "Therefore, regulatory and supervisory arrangements need to be first-best."
- "The new consolidated regulator (FINMA) needs to have the operational independence and financial resources to be a constructive and appropriately forceful supervisor and regulator of the very large systemic financial institutions."
- "Continuing efforts are needed to evaluate the large banks’ operating models and to ensure that liquidity and capital regimes are sufficient."

### Fiscal performance and short-term outlook
- "Fiscal policies have been sound, generating a surplus one year ahead of schedule."
- "The debt brake has functioned well and the authorities are to be commended in their steadfast implementation of the two sizable expenditure reduction programs."
- "This strong record needs to be extended into the medium term to meet the challenges of population aging."

### Fiscal risks, policy stance, and medium-term priorities
- "Procyclical fiscal policy should be avoided and the integrity of the debt brake maintained."
- "Fiscal policy for 2007-08 is projected to be expansionary, reflecting large extraordinary expenditures and overdue pension funding outside the debt brake."
- "These expenditures should be compensated within the debt brake mechanism in the medium term."
- "Similarly, while cantonal tax cuts partly reflect the move to a new equalization system, they demonstrate how Switzerland’s competitive federalism can generate procyclical tax cuts—in the face of unresolved longer-term social security deficits."
- "The main fiscal challenge is to resolve structural spending pressures."
- "The debt brake applies only to the confederation and is not robust to pressures from population aging."
- "The authorities have taken important steps to limit future obligations, but more will be needed."
- "The long-run fiscal sustainability report needs to offer insight into fiscal dynamics under current policies and provide the public with clear tools to understand the impact and distributional effects of possible solutions."

### Data and statistical needs
- "Policy making requires timely statistics."
- "Cantonal and local governments provide fiscal data with long lags."
- "Inflation assessments are hampered by inadequate wage data."

*Source: _cr07186 - 37.      The FSAP update found that the financial sector is performing well, but risks*

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

### _cr07186 - 43.      It is recommended that the next Article IV consultation with Switzerland be held on

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

### Macro dynamics and growth
- Recovery is in its fourth year; Swiss and EU business cycles are synchronized.
- The current expansion is described as smaller but less volatile than the previous expansion.
- Growth drivers cited:
  - Exports of goods and non-factor services initiated the rebound.
  - Investment supported the recovery (fixed investment growth positive).
  - Private consumption has contributed to the expansion.
- Average Real GDP Growth, 2002-06: (figure referenced; narrative: below average growth performance).

### Labor market
- Unemployment declined (registered unemployment and non-unemployed job-seekers series shown).
- Vacancy rate increased, suggesting unemployment could fall further.
- Employment growth was average in 2004-06.
- Full-time employment has rebounded.
- Both Swiss nationals and foreigners have benefited from employment gains.

### Inflation, prices, and monetary conditions
- Consumer price inflation is low (headline CPI and core inflation series).
- SNB expects inflation to fall in 2007 with the current interest rate (SNB forecast as of Mar., 2006 and Mar., 2007 shown).
- Producer price inflation has increased, while domestic and non-oil imported goods inflation remained low.
- Monetary conditions:
  - Policy rate uptick noted, but nominal interest rates remain low.
  - Yield curve has flattened.
  - Intermediation spread has been declining (lending minus deposit rates).
  - Weakening of the franc contributed to easing monetary conditions.
  - Real lending rates shown against historical average.

### Money, credit, and liquidity
- M3: money growth has moderated recently.
- M3 as percent of GDP: liquidity continues rising on trend.
- Credit growth: sharply raising credit expansion; mortgages and credit growth series shown.
- Credit to enterprises has rebounded.
- Real lending rate series indicate borrowing costs have eased relative to earlier averages.

### Financial sector indicators and asset prices
- Distance-to-default indicators improved from 2003 lows.
- Credit default swaps reflect favorable market perceptions for major banks and insurers.
- Unsecured claims against customers as a share of total claims (including mortgages) have increased.
- Banks' and insurance sectors:
  - Banks' relative share prices have picked up.
  - Insurance sector relative prices remain depressed.
- Equity prices increased substantially; P/E ratios declined as earnings rose faster.
- Real estate price growth is subdued; current residential price levels remain below early 1990s peak.
- Leading indicators (KOF Business Cycle Barometer, PMI, UBS leading indicator, consumer confidence) continue to signal expansion.

### External sector and competitiveness
- Current account surplus has increased.
- Components of the current account surplus (net values 2005) by share:
  - Goods, 5%
  - Direct investment, 51%
  - Portfolio investment, 20%
  - Other services, 25%
  - Financial services, 19%
- High surplus arises mostly from strong net financial and other services performance, and net investment income.
- Swiss goods market share has been declining (goods market share index series).
- Terms of trade have stagnated, though goods exports sector remains competitive.
- Switzerland has the second largest share of high technology exports in the world (country ranking figure).

### Fiscal position and public finances
- General government (2006, percent of GDP):
  - Revenue 38.2
  - Expenditure 37.4
  - Balance 0.8
  - Structural balance 0.8
  - Gross debt 46.2
- Table 2 (General Government Finances; staff projections):
  - General government Revenue (2007 projection): 189,676 (millions of SwF)
  - General government Expenditure (2007 projection): 191,177 (millions of SwF)
  - General government Balance (2007 projection): -1,501 (millions of SwF)
  - Gross debt (2007 projection, percent of GDP): 43.6
- Federal government (Table 3, staff projections):
  - Revenue (2007 projection): 57,809 (millions of SwF)
  - Expenditure (2007 projection): 61,820 (millions of SwF)
  - Balance (2007 projection): -4,011 (millions of SwF)
  - Federal government overall balance (2007 projection, percent of GDP): -0.8
  - Gross debt (memo, percent of GDP): 24.6 (2006 in Table 3)
- Preliminary public sector balance sheet (Table 4):
  - Public sector net worth (2006, Billions of SwF): -254
  - Intertemporal financial position (2006, percent of GDP): -586 (panel A)
  - Financial net worth (2006, percent of GDP): -98 (panel I)
  - Gross debt (2006, percent of GDP): 228 (panel I)

### External accounts and balance of payments (selected figures from Table 5)
- Current account (2006, in billions of SwF): 82.7
- Current account (2006, percent of GDP): 17.5
- Trade balance (2006, percent of GDP): 4.9
- Exports (2006, percent of GDP): 185.7
- Imports (2006, percent of GDP): -180.8
- Net investment income (2006, percent of GDP): 64.6
- Official reserves (end period, 2006, billions of US$): 38.1
- Reserve cover (months of imports of GNFS, 2006): 2.8

### Financial institutions and soundness indicators (selected figures)
- Major institutions (Table 6, 2006):
  - Union Bank of Switzerland profit (2006, SwF millions): 11,638
  - Credit Suisse Group profit (2006, SwF millions): 8,281
  - Zurich Financial Services profit (2006, USD millions): 4,527
  - Total profit (2006, SwF millions): 31,106
  - Operating Income (2006, SwF millions): 229,020
  - Profit (percent of GDP, 2006): 6.6
  - Operating Income (percent of GDP, 2006): 48.4
- Banking sector indicators (Table 7 and 8):
  - Regulatory capital as percent of risk-weighted assets (2005): 12.4; (Jun-06): 12.7
  - Regulatory Tier I capital to risk-weighted assets (2005): 13.3; (Jun-06): 13.0
  - Non-performing loans as percent of gross loans (2005): 0.5
  - Sectoral distribution of bank credit to private sector (2005): Households 66.6 percent
  - Capital as percent of assets (leverage ratio, Jun-06): 4.9
  - Foreign currency loans as percent of total loans (Jun-06): 60.7
  - Customer deposits as percent of total (non-interbank) loans (Jun-06): 73.7
  - Gross asset position in derivatives as a percentage of tier I capital (Jun-06): 115.7
  - Gross liability position in derivatives as a percentage of tier I capital (Jun-06): 119.0
  - Household debt to banks as a percentage of GDP (2005): 114.4
  - Total real estate loans as percent of total loans (global level, Jun-06): 29.4

### Real estate and asset price dynamics
- Equity price indices: Swiss SMI and international comparators show substantial increase since 1990.
- P/E ratios for Swiss SMI declined as earnings rose.
- Growth in real estate prices subdued; residential price levels below early 1990s peak.
- Annual increase of real estate prices (selected years): 2001 3.1, 2002 5.6, 2003 4.9, 2004 2.6, 2005 1.8 (Table 8).

### Key summary statistics (from Table 1: Basic Data; selected entries)
- Total area: 41,293 square kilometers
- Total population (end-2006): 7.5 million
- GDP per capita (2006): 50,176
- GNP per capita (2006): 54,063
- Nominal GDP (2006, billions of SwF): 487.2
- GDP (2006, percent change): 2.7
- Employment (percent change, 2006): 0.6
- Unemployment rate (in percent, 2006): 3.3
- Consumer price index (2006): 1.0
- Nominal wage growth (2006): 1.8
- Unit labor costs (total economy, 2006): -0.2
- Broad money (M3) (growth figure series, table entry): 3.0
- Domestic credit (2006 table entry): 6.3
- Three-month rate (2006 table entry): 0.8
- Yield on government bonds (2006 table entry): 2.5
- SwF per US$ (annual average, 2006): 1.25
- SwF per euro (annual average, 2006): 1.58

*IMF staff report extracts and figures as presented in the provided content.*

### Annex I. Switzerland: Fund Relations

### Annex I. Switzerland: Fund Relations (As of February 28, 2007)

### I. Membership and Fund Position
- Membership: Joined 5/29/92; accepted the obligations of Article VIII, Sections 2, 3 and 4.
- General Resources Account (SDR Million; % Quota):
  - Quota: 3,458.50 — 100.00
  - Fund holdings of currency: 3,156.12 — 91.26
  - Reserve position in Fund: 302.38 — 8.74
- SDR Department (SDR Million; % Allocation):
  - Holdings: 189.88 — N/A
- Outstanding Purchases and Loans: None
- Financial Arrangements: None
- Projected Obligations to Fund: None

### VII. Exchange Rate Arrangement and Restrictions
- Exchange rate regime:
  - The exchange rate of the Swiss franc is determined by supply and demand and classified as an independently floating exchange rate regime.
  - The Swiss National Bank reserves the right to intervene in the foreign exchange market.
  - All settlements are made at free market rates.
  - Switzerland maintains an exchange system free of restrictions on the making of payments and transfers for current international transactions, except for restrictions for security reasons notified pursuant to Decision No. 144-(52/51).
- Notifications and current restrictions (as of March 13, 2007):
  - Restrictions imposed in accordance with relevant UN Security Council resolutions and EU regulations.
  - UN-related restrictions in place with respect to specific individuals and entities associated with: the former government of Liberia, Iraq, Osama bin Laden, the Taliban, the Al-Qaïda network, specific individuals and entities posing a threat to international peace and security in Côte d’Ivoire, in the Democratic Republic of the Congo (DRC), impeding the peace process in Sudan, suspected of involvement in the bombing that killed former Lebanese Prime Minister Rafik Hariri, engaged in the DPRK’s WMD-related programs, ban on financing and financial services related to the provision of arms and related materiel to Lebanon, and specific individuals and entities involved in the nuclear and/or ballistic missile programs of the Islamic Republic of Iran.
  - EU-related restrictions in place with respect to: specific individuals associated with the previous government of the former Republic of Yugoslavia, Zimbabwe, Myanmar; ban on financing and the provision of financial services related to military activities in Uzbekistan; specific individuals and entities associated with the government of Belarus.
  - Lists of targeted individuals and entities are based on UN Security Council sanctions committees and corresponding EU regulations and are amended regularly.

### VIII. Article IV Consultation (2007)
- Consultation cycle: Standard 12-month Article IV consultation cycle.
- Mission visit: Bern and Zürich during February 26–March 5, 2007.
- Principal interlocutors: Finance Minister Merz; Chairman Roth of the SNB Governing Board; Interior Minister Couchepin; other senior officials; outreach with members of parliament, NGOs, private sector, and think-tanks.
- IMF team composition: B. Traa (Head), K. Ross, A. Carare (EUR); B. Johnston (MCM) for FSAP update; Messrs. Moser (Executive Director) and Weber (Advisor) attended some meetings.
- Focus: Core surveillance issues; no background papers produced.
- Publication: Mission held a joint press conference on the concluding statement; authorities agreed to publication of the staff report.

### IX–X. Technical Assistance and Resident Representation
- Technical Assistance: None
- Resident Representatives: None

### XI. FSAP Update
- FSAP update conducted in November 2006 (brief mention; no further details in this unit).

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### Annex II. Switzerland: Statistical Issues

### General assessment
- Switzerland generally publishes timely economic statistics and posts most data and underlying documentation on the internet.
- Subscribed to SDDS in June 1996; metadata posted on the Dissemination Standards Bulletin Board.
- Switzerland is in full observance of SDDS requirements and uses flexibility options for:
  - Production index data (periodicity and timeliness)
  - Wages and earnings data (periodicity)

### Identified statistical gaps and deficiencies
- 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 a considerable lag.

### Steps taken or planned to address deficiencies
- SNB initiatives:
  - Launched in 2004 a quarterly survey on the cost of borrowing; pilot phase completed June 2005; from July 2006 conducted monthly.
  - September 2005: started compiling more comprehensive statistics on mutual funds.
  - October 2005: published, with BfS, annual financial accounts for 1999-2003 (stock data). Data on financial flows and non-financial assets to be published in 2007.
- National accounts:
  - Annual national accounts upgraded in 2003 to ESA95.
  - With release of Q4 2004 data, SECO revised quarterly national account estimates.
  - SECO started publishing in March 2006 a quarterly production account.
  - Main innovations: more detail on investment (ICT), reclassification of hospitals to private sector for consumption, use of chain price indices (without adjustment for quality).
- EU cooperation:
  - 2004 statistical cooperation agreement with the EU (Bilateral II) to harmonize several Swiss statistics with EU standards.
- Fiscal statistics and accounting reforms:
  - Federal Finance Administration preparing to revamp fiscal statistics with adoption of GFSM 2001.
  - Reform of accounting standards for cantons and communes (Weiterentwicklung der Rechnungslegung der Kantone und Gemeinden).
  - Introduction of full accrual budgeting and accounting at the federal level (Neues Rechnungsmodell Bund) along lines of IPSAS.
  - Figures according to new accounting standards expected in 2008.
  - Interim: government finance statistics for GFS Yearbook will be reported on a cash basis but presented in GFSM 2001 format.
- Balance of payments and IIP:
  - Quarterly BOP and IIP data compiled by SNB meet international standards.
  - Monetary gold transactions relating to sales of gold reserves not required for monetary policy purposes have not been correctly reflected historically:
    - For legal reasons and until distribution of proceeds of gold sales between SNB and Federal Department of Finance concluded in February 2005, proceeds not needed for monetary purposes were considered part of official reserves in BOP.
    - After February 2005, they appear in the position “other assets of the SNB” in the BOP.
- Financial Soundness Indicators:
  - Switzerland participated in the Coordinated Compilation Exercise for FSIs.
  - Data and metadata on a benchmark set of indicators for year-end 2005 to be posted on the IMF website.

---

### Table of Common Indicators Required for Surveillance (As of April 4, 2007) — Key entries
- Exchange Rates:
  - Date of Latest Observation: Mar 07
  - Date Received: Mar 07
  - Frequency of Data: D and M
  - Frequency of Reporting: M and M
  - Frequency of Publication: D and M
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities:
  - Date of Latest Observation: Feb 07
  - Date Received: Mar 07
  - Frequency of Data/Reporting/Publication: M / M / M
- Reserve/Base Money, Broad Money, Central Bank Balance Sheet:
  - Date of Latest Observation: Feb 07
  - Date Received: Mar 07
  - Frequency: M / M / M
- Consolidated Balance Sheet of the Banking System:
  - Date of Latest Observation: Jan 07
  - Date Received: Mar 07
  - Frequency: M / M / M
- Interest Rates:
  - Date of Latest Observation: Feb 07
  - Date Received: Feb 07
  - Frequency of Data/Reporting/Publication: D and M / M and M / D and M
- Consumer Price Index:
  - Date of Latest Observation: Feb 07
  - Date Received: Mar 07
  - Frequency: M / M / M
- Revenue, Expenditure, Balance and Composition of Financing – General Government:
  - Date of Latest Observation: 2006
  - Date Received: Mar 07
  - Frequency of Data/Reporting/Publication: A / A / A
- Revenue, Expenditure, Balance and Composition of Financing – Central Government:
  - Date of Latest Observation: 2006
  - Date Received: Mar 07
  - Frequency: M / M / M
- Stocks of Central Government and Central Government-Guaranteed Debt:
  - Date of Latest Observation: 2006
  - Date Received: Mar 07
  - Frequency: Q / Q / Q
- External Current Account Balance:
  - Date of Latest Observation: Q3/06
  - Date Received: Jan 07
  - Frequency: Q / Q / Q
- Exports and Imports of Goods and Services:
  - Date of Latest Observation: Jan 06
  - Date Received: Mar 07
  - Frequency: M / M / M
- GDP/GNP:
  - Date of Latest Observation: Q4/06
  - Date Received: Mar 07
  - Frequency: Q / Q / Q
- Gross External Debt:
  - Date of Latest Observation: 2006
  - Date Received: Mar 07
  - Frequency: Q / Q / Q

(Note: Frequency codes — Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A), Irregular (I), Not Available (NA).)

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### Public Information Notice (PIN) No. 07/63 — Executive Board Concluding Statement (June 1, 2007)
### Background and recent performance
- Economy performing well: expansion entered fourth year with above average growth and employment, few signs of inflation.
- Drivers: vibrant external environment (including global financial markets), strong macropolicies, structural reforms in retailing and labor markets.
- Growth:
  - Estimated growth: 2.7 percent in 2006 — closing the output gap.
  - Growth drivers in 2006: pickup in consumption and investment; marked increase in exports linked to EU recovery and weakness in the franc.
  - Outlook: expected to remain strong but somewhat slower at about 2 percent (in line with main trading partners).
- Inflation:
  - 2006 inflation: 1 percent
  - Expected to be slightly lower in 2007.
  - Containment factors: opening labor market to EU workers, reduced exchange rate pass through, increased productivity, lower oil prices, increased domestic competition, and policy interest rates.
- Labor market and current account:
  - Unemployment: has fallen to 3 percent.
  - Current account surplus: reached over 17 percent of GDP.
- Monetary policy:
  - SNB normalized interest rates in 2006 and early 2007.
  - Five quarterly step increases of 25 basis points.
  - Policy rate: now stands at 2¼ percent or about 1¾ percent in real terms.
- Fiscal position:
  - 2006 fiscal balance exceeded budget target.
  - General government achieved a surplus of 0.8 percent of GDP.
  - Gross debt fell to 48.2 percent of GDP (together with asset sales).
- Financial sector:
  - Performing well in favorable cyclical setting.
  - Bank profitability strong; FSIs improved.
  - Two large Swiss banks are global players in wealth management and derivatives; exposure to global financial market volatility highlighted.
  - Insurance and pension sectors recovering from prior pressures and low interest rates.

### Executive Board Assessment and Recommendations
- Commended authorities for prudent economic management and sound policy frameworks.
- Main policy challenge: seize opportunities to strengthen potential economic growth and address long-term structural and fiscal issues given population aging.
- Monetary policy:
  - Commended SNB for keeping inflation under control.
  - Recent gradual tightening considered appropriate.
  - Monetary policy should remain flexible to respond to inflation signals.
  - Removal recommended of regulated link between interest rates and housing rents (distorts inflation signals and affects publicly-owned banks).
  - SNB’s rolling three-year inflation forecast communications strategy viewed as effective.
- Exchange rate and spillovers:
  - Reviewed factors behind recent weakness of the Swiss franc despite rising policy rates.
  - Noted carry-trade effects could temporarily weaken the franc below equilibrium.
  - Supported independent floating exchange rate regime to handle uncertainties.
  - Advised close monitoring of franc-denominated lending in Eastern Europe due to spillover risks.
- External competitiveness and structural reform:
  - Swiss external competitiveness strong.
  - Large stocks of foreign assets of domestic pension funds and high-earning multinationals contribute to structurally large current account surplus; interpreting the surplus is complex.
  - Recommended deeper internal structural reforms to strengthen domestic demand and potential growth, and further liberalization of sheltered sectors, including agriculture.
- Financial sector supervision:
  - Welcomed FSAP update conclusions reaffirming soundness of Swiss financial system and supported recommendations.
  - Emphasized need for continued vigilance and highest standards of financial supervision given sector size and complexity.
  - Supported tripartite supervisory cooperation arrangement with the United Kingdom and the United States.
  - Recommended that Financial Market Supervisory Authority (FINMA) be assured both financial and regulatory independence.
  - Encouraged evaluation of large banks’ operating models and ensuring liquidity and capital regimes remain appropriate.
  - Urged strengthening supervision for some insurance companies identified with heightened risks in last year’s Swiss Solvency Test and addressing underfunding in selected pension funds.
- Fiscal policy and debt brake:
  - Commended strong fiscal performance guided by the debt brake fiscal rule.
  - Stressed fiscal stimulus should be avoided; integrity of the debt brake must be maintained.
  - Many Directors concerned about large one-time expenditures in 2008 treated outside the debt brake; welcomed authorities’ commitment to compensate in the medium term.
  - Suggested cantons use strong tax receipts to build up reserves for future aging-related expenditure needs rather than cut taxes.
  - Looked forward to publication of long-run fiscal sustainability report to inform consensus on key fiscal challenges and needed actions.
- Data and statistics:
  - Encouraged authorities to improve timeliness and quality of some key data sources.

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### Switzerland: Selected Economic Indicators (staff estimates and projections where noted)
- Real economy:
  - Real GDP: 2003: -0.2; 2004: 2.3; 2005: 1.9; 2006: 2.7; 2007 (staff projection): 2.0
  - Real total domestic demand: 2003: 0.4; 2004: 1.6; 2005: 1.2; 2006: 2.2; 2007: 2.2
  - CPI (year average): 2003: 0.6; 2004: 0.8; 2005: 1.2; 2006: 1.0; 2007: 0.7
  - Unemployment rate (percent of labor force): 2003: 3.4; 2004: 3.5; 2005: 3.4; 2006: 3.3; 2007: 2.8
  - Gross national saving (percent of GDP): 2003: 34.2; 2004: 34.9; 2005: 37.9; 2006: 39.0; 2007: 38.2
  - Gross national investment (percent of GDP): 2003: 20.9; 2004: 20.9; 2005: 21.3; 2006: 21.5; 2007: 20.9
- Public finances (percent of GDP):
  - Confederation budget balance2/: 2003: -0.9; 2004: -0.6; 2005: -0.2; 2006: 0.5; 2007: 0.3
  - General government balance2/3/: 2003: -1.4; 2004: -1.0; 2005: -0.1; 2006: 0.8; 2007: 0.6
  - Gross public debt: 2003: 53.7; 2004: 53.4; 2005: 51.4; 2006: 48.2; 2007: 46.2
- Balance of payments:
  - Trade balance (percent of GDP): 2003: 1.0; 2004: 1.5; 2005: 0.7; 2006: 1.0; 2007: 1.4
  - Current account (percent of GDP): 2003: 13.3; 2004: 14.0; 2005: 16.6; 2006: 17.5; 2007: 17.3
  - Official reserves (end of year, US$ billion)4/: 2003: 47.7; 2004: 55.5; 2005: 36.3; 2006: 38.1; 2007: ...
- Money and interest rates:
  - Domestic credit (annual average)5/: 2003: 0.6; 2004: 2.3; 2005: 4.5; 2006: 6.3; 2007: ...
  - M3 (annual average)5/: 2003: 8.3; 2004: 3.2; 2005: 4.2; 2006: 3.0; 2007: ...
  - Three-month Libor rate (in percent): 2003: 0.4; 2004: 0.5; 2005: 0.8; 2006: 1.5; 2007: ...
  - Government bond yield (in percent): 2003: 2.5; 2004: 2.6; 2005: 2.1; 2006: 2.5; 2007: ...
- Exchange rate:
  - Exchange rate regime: Managed float (as reported)
  - Present rate (April 3, 2007): SwF 1.22 per US$1
  - Nominal effective exchange rate (1990=100): 2003: 110.0; 2004: 110.4; 2005: 109.8; 2006: 108.4; 2007: ...
  - Real effective exchange rate (1990=100)6/: 2003: 106.4; 2004: 105.6; 2005: 104.0; 2006: 101.7; 2007: ...

Sources: IMF, International Financial Statistics; IMF, World Economic Outlook; and IMF staff projections. Staff estimates and projections noted where applicable.

*Annex I and Annex II, Switzerland: Fund Relations and Statistical Issues (As of February 28, 2007) — material excerpted from IMF staff documents and the Public Information Notice No. 07/63 (June 4, 2007).*

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

### _cr07186 - 1. On behalf of my Swiss authorities, I would like to thank the staff for the stimulating

### Opening remarks
- The Swiss authorities thank staff for "stimulating and constructive discussions and the useful reports."
- Both the staff report for the Article IV Consultation and the Financial System Stability Assessment (FSAP) "add considerable value to the domestic policy discussions in Switzerland."

### Macroeconomic outlook and key indicators
- "The Swiss economy is in very good shape and the outlook is favorable."
- After three years of solid recovery, growth is "broad based" and the economy is "operating at full capacity."
- Labor, inflation, fiscal, and debt indicators:
  - Unemployment rate: "below 3 percent"
  - Inflation: "well below 2 percent"
  - General government budget: "in surplus"
  - Public debt: "reduced to less than 50 percent of GDP"
- Financial sector: FSAP confirms "the Swiss financial sector is performing well" and "strong financial soundness indicators reflect the resilience of the financial system to the most relevant stress events."

### Monetary policy and the exchange rate
- SNB policy stance:
  - The Swiss National Bank (SNB) continues "gradual interest-rate normalization initiated in December 2005."
  - The inflation forecast from the March 2007 quarterly review indicates a central target for the reference interest rate (i.e., 3-month Libor) "fixed at 2.25 percent" is "still somewhat on the expansionary side" and "the normalization process is not yet completed."
  - Some SNB models indicate a neutral interest rate of "2.5 percent," but the SNB places limited weight on a specific neutral-rate figure because such figures are "model-dependent and cannot be estimated with precision."
- Exchange rate assessment:
  - SNB and staff agree "the recent behavior of the exchange rate is difficult to reconcile with fundamentals (i.e., high growth, low inflation, rising interest rates)."
  - The franc is "relatively weak against the Euro and the pound sterling" but "remains quite strong against the US dollar and the Japanese yen."
  - Current fluctuations "do not appear to be extraordinarily high by historical standards."
  - Some depreciation "might be due to enhanced competition and productivity in the non-traded goods sector."
- Safe-haven status and other drivers:
  - SNB is cautious about concluding the franc "may have lost some of its safe haven status" and notes "there have hardly been any serious tests for such an assumption."
  - SNB does not believe the currency’s legal decoupling from gold or gold sales diminished safe-haven status, noting the gold link was "already broken in the 1970s."
  - Insufficient data to confirm or reject the role of "carry trades and hedge funds in causing franc weakness."

### Current account interpretation
- Authorities and staff agree interpreting the "large current account surplus is complex" and "does not connect in a simple way to domestic absorption."
- On domestic versus foreign origin of the surplus:
  - In 2005 "nearly 7 pps of GDP of the surplus may be attributable to foreigners."
  - Authorities believe the 2005 figure is "inflated as a result of unusually high direct investment income of foreign holdings."

### Fiscal policy
- 2006 outcomes:
  - General government surplus: "1.1 percent of GDP" (latest estimates) versus a budgeted deficit of "1 percent."
  - Federal level surplus: "0.5 percent of GDP" which "allowed the target of a structural balance to be achieved one year ahead of schedule."
- Drivers and institutions:
  - Better-than-projected outcome mainly due to higher revenues; "expenditure growth continues to be contained."
  - Debt brake (introduced in "2003") remains "the key instrument" for achieving and maintaining a balanced budget over the cycle at the federal level; it has "strong support in the population and in parliament."
  - Authorities are "considering ways to further strengthen the debt brake by extending the application of rule-based expenditure restrictions to areas not yet covered."
- Extraordinary expenditure concerns and proposals:
  - Extraordinary expenditure due to exceptional circumstances is "usually of a one-off nature and can be substantial" and could unduly compress regular spending if accommodated within the annual spending ceiling of the debt brake.
  - Conditions for claiming exceptional circumstances are specified in the budget law and "have to be approved by a majority in both houses of parliament."
  - Authorities emphasize a "restrictive approach to extraordinary spending" and deny using it to circumvent the debt brake; noted cumulation of such spending in 2008 is "coincidental" but has raised awareness of potential undermining of the debt brake’s spirit.
  - Authorities are "considering ways to introduce a rules-based system to compensate extraordinary spending with medium-term surpluses."
- Subnational finances:
  - Debt brake applies only to the Confederation; less concerning because lower levels of government have "traditionally been sound."
  - "Most cantons have various types of instruments to prevent serious fiscal imbalances, such as fiscal rules and financial referenda."
- Long-term fiscal work:
  - Authorities agree with staff that work on long-term fiscal challenges (as listed in paragraph 30) must continue.
  - Two projects initiated:
    - A long-term Fiscal Sustainability Report projecting public sector finances (federal, cantonal and local levels, including social security) "up to 2050" under a no-policy-change assumption, with sensitivity analyses for productivity growth, interest rates, and demographics.
    - A separate document, based on the Fiscal Sustainability Report, to discuss alternative policy options as part of the medium-term financial plan of the Federal government.
  - An ambitious project to systematically review the full range of tasks of the central government should "help reduce spending pressures."

### Financial sector: assessment and reforms
- Overall assessment:
  - Authorities welcome the FSAP update and "the overall positive assessment of the health and resilience of the Swiss financial system."
  - They acknowledge "the size, complexity, and systemic importance of the two large banks represent a major challenge."
- Priority recommendations being followed up:
  - SFBC is conducting a "thorough assessment of the capital situation of the two large banks as part of the implementation of the second pillar of Basel II, with a focus on stress tests."
  - SNB and SFBC will "initiate a regulatory project to improve the supervision and regulation of liquidity risk at the large banks" to ensure liquidity is "commensurate with their risks."
  - SNB will endeavor to "further improve international cooperation with its foreign counterparts," focusing on "the provision of liquidity in exceptional situations."
  - Authorities affirm international cooperation "can effectively contribute to reducing the probability and costs of a systemic crisis."
- Institutional reform and FINMA:
  - Authorities agree the planned unified financial supervisory authority (FINMA) "should be strong and functionally, institutionally, and financially independent and adequately staffed."
  - Authorities argue the draft FINMA Act provides:
    - A "comprehensive and effective set of sanctioning measures" with harmonized and refined regime and new instruments ("confiscation of assets, occupational ban, and 'naming and shaming'").
    - Civil money penalties are not permitted under the Swiss legal system to be imposed by the supervisory authority; existing mechanisms (fines by the Federal Finance Department and the cantons via criminal prosecution) "have proved effective and no change is envisaged."
    - No provisions in the draft FINMA Act are believed to "impinge on FINMA’s operational independence or prudential powers"; provisions aim for efficient, effective supervision and respect "the principle of proportionality."
- Cantonal banks:
  - Authorities partly dissent from recommendation five of the assessment: while agreeing "there is scope for cantonal banks to strengthen their governance structures," they "do not see clear evidence of distortions in the market conduct of cantonal banks" given intense competition in Swiss retail banking.
- Insurance sector:
  - Authorities agree "significant improvements have been made in the regulatory framework" and that financial difficulties in early 2003 have been overcome.
  - Going forward, the insurance supervisor should focus on insurers identified as having "heightened risks" by last year’s Swiss Solvency Test (SST) field test.
  - Supervisory authorities will "continue to consult with the reinsurance sector on the introduction of the SST."
- Pension funds:
  - Occupational Benefit Plan system asset volume: "comfortably over 100 percent of GDP."
  - Consensus that pension funds "should generally have a higher degree of coverage and that valuation reserves should be increased further."
  - Many pension funds "have recently significantly increased their valuation reserves."
  - Legal provisions require pension funds to notify any undercoverage to initiate corrective measures, with reports on implementation and effectiveness submitted annually to the Federal Council.
  - On supervision, authorities prefer a decentralized and relatively liberal system in line with Swiss tradition; a central supervisory authority "is currently not on the political agenda."
  - Improvements expected through strengthening the existing federal supervisory authority:
    - The envisaged new High Supervisory Board will be able to "issue binding standards and regulations" and "carry out on-site inspections of the regional supervisory authorities," ensuring uniform procedures and pre-defined standards.

*Prepared on behalf of the Swiss authorities in response to the staff reports referenced in the source content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07186.pdf_