## _cr08170

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### The Context
- Swiss GDP growth of 3.1 percent in 2007; growth exceeded the euro area average in the past four years.
- Structural strengths: advanced infrastructure, a skilled and flexible workforce, openness to trade, capital, and people, low tax rates, and a small government.
- Shift toward higher value-added manufacturing and services has raised potential growth, but magnitude of increase is uncertain.
- External exposure:
  - "Just under half" of deviations of real GDP from trend are due to international shocks; another 15 percent arise from spillovers from other countries.
  - Variability in trend volatility of real GDP growth remains relatively large (only Japan is larger in the sample noted).

### Near-Term Growth Outlook and Real Sector Indicators
- Cyclical/near-term facts:
  - GDP accelerated to 3.1 percent in 2007, following a resurgence beginning in early 2004.
  - Capacity utilization in industry at 88 percent—"well above its long-term average."
  - Labor productivity growth rose markedly; employment continued to increase through 2007.
  - Unemployment fell to 2.7 percent in December 2007; vacancies and shortages in technical and IT areas.
  - Domestic private sector credit growth: 5½ percent year-on-year through summer 2007, accelerating to 7 percent thereafter.
  - Foreign lending growth contracted sharply from an elevated 70 percent annualized rate in mid-summer 2007.
- Forward-looking indicators and forecasts:
  - KoF composite leading indicator "has trended down but only slowly."
  - Consensus 2008 growth forecasts averaged "around 2.0 percent" with large variance.
  - Staff forecasts: Swiss GDP growth of 1.4 percent in 2008 and 1.3 percent in 2009.
  - Authorities’ projections: SNB projects GDP growth "between 1.5 and 2 percent in 2008"; State Secretariat for Economic Affairs point estimate "1.9 percent."
  - For fiscal planning staff and authorities use a conservative potential growth rate of 1.8 percent; under that assumption staff estimates "a positive output gap averaging some 1 percent in 2007-08."
- Sources of slowdown (sequential):
  - Exports of goods and services will slow first as U.S. and European imports decelerate; "sharp curtailment of financial service income."
  - Continued appreciation of the Swiss Franc "could have a material effect" on goods exports.
  - Drop in banks’ earnings will have a "direct and early impact on GDP growth."
  - Consumption likely to weaken in late 2008 and especially 2009 due to dented consumer confidence.

### Financial Sector Stability: Developments, Risks, and Responses
- Systemic focus on two major international banks:
  - UBS: writedowns "about $38 billion"; 2007 loss of $4 billion; reported further loss of $12 billion in Q1 2008; long-term ratings lowered (Fitch and S&P from AA+ to AA-, Moody’s from Aaa to Aa1).
  - Credit Suisse: estimated profits $7.8 billion in 2007; Q1 markdowns of $5.3 billion led to a loss of $2.1 billion.
  - Fitch’s measure: Swiss banking system slipped from A (very high) to B (high).
- Capital actions and adequacy:
  - UBS announced efforts to add SwF 19.4 billion (about $17.8 billion) to Tier-1 capital in conjunction with first-round write-offs reported in December.
  - A second round of new capital "$15 billion", to be raised in a rights issue, underwritten by major U.S. and European investment banks.
  - Two-year convertible notes for SwF 13 billion (about $12 billion) placed with Government of Singapore Investment Corporation (SwF 11 billion) and an undisclosed Middle Eastern investor (SwF 2 billion) at a "9 percent annual interest rate."
- Interbank liquidity and market tensions:
  - Interbank markets experienced periodic strains since mid-2007; three-month Libor-OIS spreads widened following July 2007.
  - Longer-maturity interbank spreads in Switzerland remain elevated relative to short-term spreads—indicating reluctance to lend for extended maturities and banks building liquidity reserves.
  - SNB provided liquidity, coordinated dollar liquidity provision with the Federal Reserve and the European Central Bank, expanded eligible collateral in June 2007.
- Supervisory challenges and actions:
  - Authorities injected liquidity and coordinated with major central banks; policy blended active liquidity management and forward-looking actions to limit banking-sector risks; emphasis on reinforcing capital buffers.
  - Persistent challenge: supervisor "at a resource disadvantage vis-à-vis the major banks."
  - Suggested supervisory supplements: transparent performance benchmarks and stronger role for host country supervisors in overseeing global operations.
- Banking regulation focus areas:
  - Four priority areas: better risk assessment and risk management; increased capital buffers; more liquidity; greater disclosure.
  - Basel II status: Basel II "came into force on January 1, 2007" and was adopted by all banks on "January 1, 2008." Pillar 3 requirements "from the start of 2008."
  - Authorities are "considering the use of a leverage ratio for large banks to supplement existing capital requirements."
  - Development of a stress-testing framework and review of contingency plans and liquidity policies is underway.

### Monetary Policy: Stance, Implementation, and Outlook
- Inflation and labor:
  - CPI inflation averaged 0.7 percent in 2007; core inflation 0.6 percent.
  - Nominal wages rose by 2 percent—a 1.3 percent real increase.
  - Inflation reached 2.6 percent in March (fueled by oil and food prices).
  - Projected average inflation: 2.0 percent in 2008, falling to 1.4 percent in 2009 (SNB assessment).
- SNB operational stance:
  - SNB raised policy rate in September 2007 to signal concern about rising inflation.
  - SNB targets the 3-month Libor, allowing movement in a 1 percentage point band; September target band was raised by ¼ percentage point, leading to cumulative increase of over 200 basis points from mid-2005 to the 2.25-3.25 percent range.
  - When 3-month Libor rose above mid-point, SNB used short-term repo operations to steer it down—e.g., lowered 1-week repo to bring 3-month Libor to 2.75 percent (mid-point).
  - SNB statement in March 2008: “on the whole, monetary conditions are tighter than they were in December” and an adjustment in the interest rate (the 3-month Libor) was “not called for under the current circumstances.”
- Staff view:
  - Staff sees "some scope for further easing of monetary policy" as inflation is expected to gradually decline while economic weakness persists.
  - Staff supported effective easing; authorities preferred “accommodative.”

### Public Finances, Fiscal Stance, and Structural Measures
- Fiscal outturns and projections:
  - 2007 general government surplus: 2.2 percent of GDP; structural surplus 1.7 percent of GDP.
  - Gross debt reduced to 44 percent of GDP in 2007.
  - 2008 federal fiscal balance projected to weaken to an overall surplus of 0.8 percent of GDP (a swing from 2.2 percent in 2007).
  - 2008 includes extraordinary expenditures of SwF 5,247 million, about 1 percent of GDP.
  - Table highlights (percent of GDP): Real GDP growth 3.1 (2007), Balance 2.2 (2007), Revenues 37.2 (2007), Expenditure 35.0 (2007), Structural balance 1.7 (2007), Debt-GDP ratio 44.0 (2007).
- Policy stance:
  - Conservative fiscal stance consistent with medium-term framework judged appropriate.
  - Authorities view a "small stimulus this year" as not helpful for reviving growth; past poorly timed stimulus largely increases imports.
  - Recommendations and proposals:
    - Identify specific measures to ensure long-term fiscal sustainability.
    - Proposed inclusion of "extraordinary" expenditures in the debt-brake rule.
    - Authorities likely to focus on (i) an increase in the VAT rate to finance disability insurance; (ii) orderly reform of social benefits; (iii) containment of health care expenditures.
    - Staff suggests savings through the Task Evaluation Program and use of an inter-temporal government balance sheet as a planning and communication tool.
  - Debt brake augmentation proposal: make authorization of extraordinary expenditures contingent on additional measures over the medium term; proposal submitted for public consultation in April and expected parliamentary approval during 2009; expected to enter application with the 2011 budget.

### External Sector and Current Account Assessment
- Current account and composition:
  - Current account surplus increased from 8 percent of GDP early in the decade to 16.9 percent of GDP in 2007.
  - Trade surplus small and relatively flat at about 1½ percent of GDP despite depreciating effective exchange rate.
  - Services balance surplus of 7½ percent of GDP in 2007, largely due to two international banks and insurance sector.
  - Investment income surged to 12 percent of GDP in 2007.
- Projections and adjustments:
  - For 2008 current account surplus projected to decline to about 14 percent of GDP.
  - Investment income expected to fall by about 1½ percent of GDP in 2008 with lower expected yields on foreign assets.
- CGER approaches and real exchange rate:
  - External stability approach suggests undervaluation of 8 percent corresponding to a 3½ percent of GDP gap between underlying and NFA-stabilizing current account surpluses (12½ and 9 percent of GDP).
  - Macro balance approach estimates undervaluation of 7 percent, reflecting a 2½ percent of GDP gap between underlying current account and the current account norm (10 percent of GDP).
  - Equilibrium exchange rate approach finds undervaluation of about 7 percent.
- Special accounting features (Box 4):
  - Retained earnings treated as income inflows inflate current account by 4-5 percentage points of GDP.
  - Dividend payout ratio chart labels indicate dividends rising from about 34% to 42% (2003–2007).

### Supervisory Reform, FINMA, and Institutional Priorities
- FINMA launch on January 1, 2009, integrating banking, insurance, and anti-money-laundering.
- Key supervisory priorities:
  - Secure adequate skills and resources for FINMA; proposed staff regulations would give flexibility on remuneration, budgeting, and strategic planning.
  - Complete appointment of board and senior management (noted as priority; remaining board members and director appointed on May 21).
  - Continue close supervision of major groups but supplement with targeted rules-based framework including transparent benchmark performance measures and linked supervisory responses for capital requirements.
  - Expand onsite activities; balance reliance on auditors with stronger supervisory onsite work.
  - Strengthen cross-border coordination and secure more active support of host supervisors for global operations.
- Resource constraints:
  - FINMA "will remain at a resource disadvantage" and "deserves to be bolstered in various ways."
  - Limited supervisory resources relative to task scale "would require careful prioritization."

### Insurance, Pensions, and Stress Testing
- Insurance sector:
  - Recent credit market events had a "much smaller impact than on the banks" but greater earnings volatility expected.
  - All companies "currently meet minimum solvency standards, on a statutory basis."
  - Swiss Solvency Test (SST) spurring risk management improvements; not binding until 2011 but applied since start of 2006 and being extended to reinsurance and smaller insurers.
  - Regulator embedding SST in a wider risk-based supervisory framework.
- Pensions:
  - Asset volume of occupational benefit plan system comfortably over 100 percent of GDP.
  - Agreement that pension funds should increase coverage and valuation reserves; legal provisions require notification of undercoverage and corrective measures.
- Stress testing and liquidity:
  - Authorities developing a stress-testing framework to improve global liquidity risk management and reviewing contingency plans and liquidity policies.
  - Recommendation for regular, mandated stress testing with the two large banks.

### Staff Appraisal, Executive Board Findings, and Recommendations
- Outlook and risks:
  - Swiss economy's resilience being tested by global shocks; expected deceleration with risks for the financial sector.
  - Policy priority: secure greater domestic financial stability; monetary and fiscal policies to play supportive roles within their frameworks.
- Key recommended policy priorities (staff and Board emphasis):
  - Continue active liquidity management to calm interbank markets.
  - Reinforce capital buffers in banks; anticipate higher capital requirements under Basel II.
  - Strengthen supervisory capacity and resource base; adopt transparent performance benchmarks and target rules-based measures for large groups.
  - Enhance cooperation with host country supervisors and international regulatory fora.
  - Use monetary policy flexibility to ease as warranted by declining inflation and persistent economic weakness.
  - Maintain conservative fiscal policy and pursue structural measures to ensure long-term fiscal sustainability, including augmenting the debt-brake rule to cover extraordinary expenditures.
- Article IV and follow-up:
  - Recommendation that the next Article IV consultation be held on the standard 12 month cycle.

*Source: _cr08170 - Executive Summary*

### Executive Summary

### _cr08170 - Executive Summary

### The Context
- The Swiss economy "performed impressively during the recent global upswing," with GDP growth exceeding the euro area average in the past four years and GDP growth of 3.1 percent in 2007.
- Structural strengths highlighted as supporting future prospects: advanced infrastructure, a skilled and flexible workforce, openness to trade, capital, and people, low tax rates, and a small government.
- The shift from traditional manufacturing to higher value-added manufacturing and services has raised potential growth, but the magnitude of the increase is uncertain.
- Switzerland is highly exposed to international shocks:
  - For Switzerland, "just under half" of deviations of real GDP from trend are due to international shocks; another 15 percent arise from spillovers from other countries.
  - Variability in trend volatility of real GDP growth remains relatively large for Switzerland (only Japan is larger in the sample noted).

### The Near-Term Growth Outlook
- Recent cyclical performance and structural change
  - GDP accelerated to 3.1 percent in 2007, capping a resurgence beginning in early 2004.
  - Capacity utilization in industry is at 88 percent—"well above its long-term average."
  - Labor productivity growth rose markedly in the cyclical upturn; employment continued to increase through 2007.
  - Unemployment fell to 2.7 percent in December 2007; vacancies continued to rise with notable shortages in technical and IT areas.
  - Strong immigration and cross-border commuter flows—with rising skill content—have supported labor supply.
- Potential growth and output gap
  - Authorities’ potential growth estimates vary widely depending on methodology.
  - For fiscal planning, staff and the authorities use a conservative potential growth rate of 1.8 percent.
  - Under that assumption, staff estimates "a positive output gap averaging some 1 percent in 2007-08."
- Risks to near-term growth
  - A marked slowdown in the United States, knock-on effects on Europe, and ongoing global financial system turbulence are expected to weigh on Swiss growth.
  - The very strengths of the Swiss economy—openness and a dynamic financial sector—also expose it to larger swings when international volatility is high.

### Maintaining Financial Sector Stability
- Systemic concerns centered on the two major international banks: UBS and Credit Suisse.
  - UBS: writedowns "about $38 billion"; ended 2007 with a loss of $4 billion and reported a further loss of $12 billion in the first quarter of 2008; long-term rating lowered (Fitch and S&P from AA+ to AA-, Moody’s from Aaa to Aa1).
  - Credit Suisse: earned estimated profits of $7.8 billion in 2007; first-quarter markdown of $5.3 billion on structured credit positions resulted in a loss of $2.1 billion.
  - According to Fitch’s measure, the Swiss banking system has slipped from A (very high) to B (high).
- Interbank liquidity and market tensions
  - Interbank markets for short-term liquidity have experienced periodic strains since mid-2007; three-month Libor-OIS spreads widened following July 2007 and have seen recurrent waves of anxiety.
  - Longer-maturity interbank spreads in Switzerland remain elevated relative to short-term spreads, indicating reluctance to lend for extended maturities and banks building liquidity reserves.
- Credit dynamics
  - Domestic private sector credit growth remained steady; domestic credit grew at a "healthy rate of 5½ percent year-on-year through the summer of 2007" and accelerated to 7 percent thereafter.
  - Foreign lending growth contracted sharply from an elevated 70 percent annualized rate in mid-summer 2007.
- Authorities’ response and supervisory issues
  - Authorities injected liquidity and coordinated with major central banks to limit knock-on effects.
  - Policy response blended active liquidity management and increasingly forward-looking actions to limit banking-sector risks; reinforcing capital buffers was emphasized.
  - A persistent challenge: strengthening the supervisor, who is "at a resource disadvantage vis-à-vis the major banks."
  - Suggested supplements to supervisory strengthening: transparent performance benchmarks and a stronger role for host country supervisors in overseeing global operations.

### Monetary Policy
- Policy actions and stance
  - The Swiss National Bank (SNB) raised its policy rate in September 2007 to signal concern about rising inflation.
  - When the 3-month Libor tended to rise above the mid-point of the target band, the authorities used short-term repo operations to steer the rate down, providing useful accommodation.
- Outlook and scope for easing
  - There is "some scope for further easing of monetary policy" because inflation is expected to gradually decline while economic weakness is projected to persist.
- Role of monetary policy
  - Monetary policy has steered "a careful course in an uncertain environment" and is expected to play a supportive role within its framework given financial-sector risks and external shocks.

### Public Finances
- Fiscal stance and framework
  - A conservative fiscal stance, consistent with the medium-term fiscal framework, is judged appropriate.
  - The authorities emphasized that despite a "small stimulus this year," they do not view fiscal stimulus as helpful for reviving growth.
  - Instead, the authorities focus on long-term fiscal sustainability, which "remains a challenge despite the recent decrease in the public debt-to-GDP ratio."
- Policy measures and rules
  - Authorities intend to identify specific measures to ensure long-term fiscal sustainability.
  - The proposed inclusion of "extraordinary" expenditures in the debt-brake rule is considered timely.

### Staff Assessment and Policy Priorities
- Primary objective: maintain financial stability to avoid negative spillovers to global finance.
- Recommended policy priorities (implicit in staff analysis and authority measures)
  - Continue active liquidity management to calm interbank markets.
  - Reinforce capital buffers in banks to limit systemic risk.
  - Strengthen supervisory capacity and resource base; consider transparent performance benchmarks.
  - Enhance cooperation with host country supervisors for oversight of global bank operations.
  - Use monetary policy flexibility to ease as warranted by declining inflation and persistent economic weakness.
  - Maintain conservative fiscal policy within the medium-term framework and pursue measures to ensure long-term fiscal sustainability, including incorporating "extraordinary" expenditures in the debt-brake rule.

*Source: _cr08170 - Executive Summary*

### 11.      As the authorities emphasized, real sector forward-looking indicators have

### _cr08170 - 11.      As the authorities emphasized, real sector forward-looking indicators have

### Real sector indicators and near-term outlook
- Real sector forward-looking indicators "have remained surprisingly positive."
- Momentum from buoyant growth in much of Europe during 2007 is still evident: industrial capacity utilization, order books, and manufactured goods’ demand from Europe and Asia have remained relatively steady.
- The KoF composite leading indicator "has trended down but only slowly."
- Lending surveys "do not yet foreshadow a credit squeeze"; some analysts view corporate liquidity and profitability as constraining demand for credit.
- Consensus forecasts for growth in 2008 "have come down since October 2007, but the average is still high—at around 2.0 percent—though with a large variance."
- Staff forecasts (reflecting assumed global developments and lag effects) project:
  - Swiss GDP growth to slow to 1.4 percent in 2008,
  - and then to 1.3 percent in 2009.
- Authorities’ projections:
  - SNB projects GDP growth of "between 1.5 and 2 percent in 2008,"
  - State Secretariat for Economic Affairs has a point estimate of "1.9 percent;"
  - both expect deceleration in 2009.

### Sources of the slowdown (sequential emergence)
- Exports of goods and services will slow first as U.S. and European imports decelerate; Switzerland’s strong export orientation implies early effects on goods’ exports and a "sharp curtailment of financial service income."
- A sharp fall in stock prices historically accompanies a sharp decline in financial service exports.
- Continued appreciation of the Swiss Franc "could have a material effect" on exports of goods.
- In the short run, recent strength in employment implies consumer spending will likely hold up GDP growth initially.
- The drop in banks’ earnings will have a "direct and early impact on GDP growth," given financial sector contribution to growth swings.
- Slowing exports, oil price inflationary effects, and global financial tensions are expected to dent consumer confidence and reduce consumption expenditures in late 2008 and especially 2009.
- Uncertainty will likely engender caution in investment despite corporate profitability and existing orders supporting machinery and equipment investment for a while.

### Financial sector policy response and supervisory actions
- Swiss authorities have:
  - injected liquidity into the banking system (often coordinating with major central banks),
  - maintained enhanced oversight of major banks and insurance companies,
  - worked with other regulators to share information, coordinate supervisory activities, and draw lessons for the future.
- SNB liquidity actions:
  - Provided necessary liquidity to ease interbank tensions; "heavier than normal doses" on days of heightened concerns or at maintenance period starts.
  - Monthly average level of commercial bank sight deposits at SNB "has not grown more rapidly than in the past" since injections and withdrawals were carefully timed.
  - Expanded list of collateral eligible for SNB repos approved in June 2007 and proved adequate.
  - Coordinated dollar liquidity provision with the Federal Reserve and the European Central Bank.

### Box 2 — Global financial conditions and Swiss growth (key analytical findings)
- Staff analysis shows a "remarkable correlation between profits at the two big banks and growth one year ahead."
- Profits at the two big banks are correlated with the term spread (difference between 10-year and 3-month interest rates).
- Historical evidence: dropping profits and shrinking term spread predicted earlier slowdowns (e.g., 2001–2003).
- For the Swiss economy:
  - The coefficient on the yield spread is statistically significant at "one percent level" and the model shows a high predictive power ("0.8 R-squared") for future GDP growth.
  - The yield spread is "particularly successful in predicting the consumption component of GDP," implying it is an early indicator of consumer sentiment.
  - These forecasts predict weakness "4-6 quarters ahead."

### Interbank liquidity (findings)
- Monetary base and bank sight deposits at the SNB "have remained relatively stable."
- Liquidity injections at maintenance period starts "have been periodically clawed back."
- An expanded collateral list and coordinated central bank actions have been central to managing interbank tensions.

### Capital adequacy and bank actions
- Banks’ business models evolved to economize on capital, raising systemic risk by holding apparently low-risk assets with low assigned risk weights while maintaining high leverage (low capital-to-total assets ratios).
- UBS in particular has sharply adjusted leverage; trends at UBS are "striking" and other European banks, including Credit Suisse, have taken similar approaches.
- Undercapitalization of UBS was an important concern:
  - UBS announced efforts to add SwF 19.4 billion (about $17.8 billion) to Tier-1 capital in conjunction with first-round write-offs reported in December.
  - A second round of new capital "$15 billion", to be raised in a rights issue following the second round of write-offs, has been underwritten by major U.S. and European investment banks; this will restore capital ratios close to pre-turmoil levels.
  - Two-year convertible notes for SwF 13 billion (about $12 billion) were placed with the Government of Singapore Investment Corporation (SwF 11 billion) and an undisclosed Middle Eastern investor (SwF 2 billion) at a "9 percent annual interest rate."
  - Initial capital injections were costly relative to ratings and other recent injections, but shareholders approved the GIC and an unnamed private investor participation.

### Banking regulation — lessons and recommended focus areas
- Four areas identified for focus:
  - Better risk assessment and risk management;
  - Increased capital buffers;
  - More liquidity;
  - Greater disclosure.
- Key regulatory observations:
  - More realistic risk assessment is crucial; calls for better governance and enhanced regulation.
  - The buildup of structured finance positions would have been lower had the Basel II framework been fully implemented.
  - The Swiss authorities have largely implemented Basel II, including the Pillar 2 (supervisory review) process.
  - Basel II regulations "came into force on January 1, 2007" and were adopted by all banks on "January 1, 2008."
  - Pillar 3 requirements (disclosure in relation to market discipline) will be implemented "from the start of 2008."
- Consideration of a leverage ratio for large banks:
  - Authorities are "considering the use of a leverage ratio for large banks to supplement existing capital requirements" to add a transparent capital buffer.
  - Staff notes limitations of a leverage ratio (e.g., incentive to move assets off-balance-sheet) but agrees that, implemented with Basel II and safeguards, it could complement the regime and strengthen supervisory response.
- Liquidity risk management:
  - Further development is a priority; authorities are developing a stress-testing framework to improve global liquidity risk management and are reviewing contingency plans and liquidity policies.
  - Collaboration with other regulators internationally to enhance global practices is underway.
- Disclosure:
  - The Swiss Federal Banking Commission recognizes lack of adequate disclosure amplified market anxieties and is working internationally on improvements.
  - Immediate focus on close monitoring of the two big banks; the Commission reports having necessary information for supervisory purposes.
  - Authorities suggest increased transparency of commercial banks’ risk positions and are pursuing options for enhanced public disclosure, particularly regarding complex financial instruments, within international discussions.

### Insurance sector developments and supervisory priorities
- Swiss insurance companies would suffer from a major global downturn despite risk-reduction efforts; insurers operate in a mature domestic market, derive a large share of premium income from overseas, and have major presence in global reinsurance.
- Recent events in global credit markets have had a "much smaller impact than on the banks," but greater earnings volatility is expected.
- All companies "currently meet minimum solvency standards, on a statutory basis."
- Swiss Solvency Test (SST):
  - Although not a binding solvency requirement until 2011, the SST is spurring improvements in risk management and supervisory dialogue.
  - The SST has been applied to major insurance companies since the start of 2006 and is being extended to reinsurance companies (and smaller primary insurers).
  - The regulator is embedding the SST within a wider risk-based supervisory framework covering corporate governance, risk management, and internal controls.
- Regulatory agenda priorities and resource issues:
  - Need to develop onsite supervision linked to risk assessment, increase supervisory resources for reinsurance, and strengthen international supervisory cooperation, particularly outside Europe.
  - Limited supervisory resources relative to the scale of tasks "would require careful prioritization."
  - Authorities emphasize risks in deferring key parts of the integrated reform program and stress maintaining adequate resources overall.

*Source: _cr08170 - 11.      As the authorities emphasized, real sector forward-looking indicators have*

### 26.      Regulatory enhancements will be of limited value without effective supervision

### _cr08170 - 26.      Regulatory enhancements will be of limited value without effective supervision

### Regulatory reform and FINMA
- FINMA launch on January 1, 2009, integrating banking, insurance, and anti-money-laundering.
- Authorities see limited scope for harmonizing regulatory requirements across sectors but envision:
  - an even more effective regulator of the domestic financial sector; and
  - a more influential voice in international regulatory fora.
- FINMA will continue implementation efforts including Basel II and new insurance solvency requirements, and will face early challenges implementing regulatory change resulting from current credit market events.

### Supervisory resourcing and skills
- Key to FINMA delivering its vision is securing adequate skills and resources.
- Under proposed staff regulations (if approved by the Federal Council), FINMA would have flexibility to offer remuneration to retain and attract skilled staff; flexibility would also extend to budgeting and strategic planning.
- Staff concern: full complement of board members and chief executive or other members of the general management had not yet been appointed; authorities recognized this as a priority.

### Supervision of major banking and insurance groups
- FINMA’s special challenge: supervising major banking and insurance groups.
- Authorities expect continuation of the existing approach relying on close supervision with extensive involvement of auditors.
- Staff recommendations and views:
  - continued expansion of onsite activities by the Swiss Banking Commission to better balance auditors’ work;
  - support for a targeted rules-based framework with transparent benchmark performance measures and linked supervisory responses for capital requirements.
- Authorities indicated openness to a targeted rules-based approach.
- Cross-border coordination: close coordination with key overseas regulators has worked well, but maintaining stability of global operations will require stronger commitments from host supervisors, especially in adverse circumstances when conflicts of interest may appear.

### Monetary policy: conjuncture and objectives
- CPI inflation averaged a modest 0.7 percent in 2007; core inflation was 0.6 percent.
- Nominal wages rose by 2 percent—a 1.3 percent real increase, below productivity gains.
- Inflation reached 2.6 percent in March (fueled by oil and food prices).
- For 2008, the average inflation rate is projected at 2.0 percent, falling to 1.4 percent in 2009, as also assessed by the SNB in the context of its March policy decision.
- SNB objective under a floating exchange rate: price stability defined as a positive headline annual inflation rate but one below 2 percent; policy guided by inflation forecasts over a three-year horizon and takes account of business cycle conditions.

### Monetary policy stance and implementation
- SNB seeks to influence the 3-month Libor, allowing that rate to move in a 1 percentage point band.
- September decision: raise the target band by ¼ percentage point, leading to a cumulative increase of over 200 basis points from mid-2005 to the 2.25-3.25 percent range.
- SNB maintained relatively stable monetary conditions as the decline in the exchange rate mirrored the increase in policy rates.
- Recognizing tight monetary conditions, SNB eased by steering down the 3-month Libor when the risk premium rose:
  - In September, market turmoil pushed Libor above the mid-point; SNB lowered the 1-week repo rate to bring the 3-month Libor down to 2.75 percent (the mid-point of the range).
  - Maintaining the 3-month Libor at or close to 2.75 percent—and preventing it from rising—was achieved through lowering shorter-term repo rates.
- SNB statement in March 2008: “on the whole, monetary conditions are tighter than they were in December” and an adjustment in the interest rate (the 3-month Libor) was “not called for under the current circumstances.”
- Operational ambiguity and communication:
  - At times the target range for the 3-month Libor and the operational 1-week repo rate have been moved in opposite directions (e.g., September), so the announced target range does not always reveal the SNB’s effective stance.
  - Comparisons of inferred SNB stance with other central banks: when compared like-for-like, SNB eased about the same as the Bank of England, with the ECB and the U.S. at the two extremes.
  - Staff views this as more than a communication issue; operational and substantive implications deserve further analysis.

### Monetary policy judgement and staff view
- Staff supported effective easing of monetary policy; authorities preferred the term “accommodative”.
- Rationale:
  - Inflation expectations remain well anchored; core inflation is below 1 percent.
  - SNB’s medium-term headline inflation forecasts are within the central bank’s definition of price stability.
  - Fiscal policy could not have responded at the necessary speed and is subject to external leakages.
- Staff conveyed support for further modest monetary easing given lower growth and contained inflation scenario.

### Public finances: recent performance and projections
- 2007 general government surplus: 2.2 percent of GDP; structural surplus improved to 1.7 percent of GDP.
- Surpluses at federal level supplemented by balanced social security accounts and surpluses at cantonal and communal levels.
- Gross debt reduced to 44 percent of GDP in 2007.
- Table of fiscal developments (percent of GDP), as presented:
  - Est. 2006 2007 2008 2009
  - Real GDP growth3.23.11.41.3
  - Balance 1/1.92.20.80.7
  - Revenues37.837.237.236.7
  - Expenditure 1/35.935.036.535.9
  - Cyclically adjusted balance 2/1.51.70.50.7
  - Structural balance 3/1.51.71.40.7
  - Debt-GDP ratio45.944.042.340.4
  - Notes:
    - 1/ 2008 includes extraordinary expenditures of SwF 5,247 million, about 1 percent of GDP.
    - 2/ Excludes cyclical items, but includes extraordinary expenditures.
    - 3/ Excludes cyclical and one-off items (extraordinary expenditures).

### Fiscal projections and policy recommendations
- 2008 federal fiscal balance projected to weaken and provide a small stimulus: overall surplus of 0.8 percent of GDP projected for 2008 (a swing from 2.2 percent in 2007).
  - About 1 percent of GDP constitutes extraordinary expenditures (bulk a transfer to the Infrastructure Fund), though only about a quarter of this will be spent in the fiscal year.
  - Another ¼ percent of GDP reflects accounting changes reporting expenditures incurred in 2007 in the 2008 budget.
  - Authorities stated the modest positive impulse was not intended; past experience shows poorly timed stimulus largely increases imports.
- Long-run sustainability concerns:
  - Staff projections suggest government net worth is improving but a long-run shortfall still exists; under current policies, debt will begin to increase in about 15 years in response to projected rise of health care expenditures and other long-term pressures.
  - The Long-Term Sustainability Report due to be published in May is an important step; needs to be followed by concrete measures to contain expenditures.
- Authorities’ focus likely to be on:
  - (i) an increase in the VAT rate to finance disability insurance;
  - (ii) an orderly reform of social benefits; and
  - (iii) containment of health care expenditures.
- Staff suggestions:
  - savings through the Task Evaluation Program could prevent aging-related expenditures from crowding out other social expenditures;
  - use of an inter-temporal government balance sheet as a planning and communication tool.
- Debt brake augmentation:
  - Proposal to augment the debt brake rule to cover extraordinary expenditures by making authorization of those expenditures contingent on additional measures over the medium term.
  - Proposal submitted for public consultation in April and expected to be approved by parliament during the course of 2009; expected to enter in application with the 2011 budget.

### Structural fiscal and competitiveness measures
- Corporate income tax reform approved to be implemented from 2009: eliminate double taxation of dividends for qualifying individual shareholders to improve investment incentives and remove bias favoring particular forms of project financing.
- Unified VAT framework proposed to eliminate exemptions, improve efficiency, reduce administrative costs, and allow for a lower rate of 6 percent (currently 7.6 percent); could become effective as of 2011 at the earliest.
- Elimination of the marriage penalty tax expected to increase labor force participation of skilled women.
- Cantons with low debt likely to continue lowering corporate tax rates.

### Assessment of external stability
- Current account surplus increased from 8 percent of GDP early in the decade to 17 percent of GDP in 2007.
- During same period, nominal and real exchange rates depreciated by about 7 and 10 percentage points respectively.
- Disconnection between current account surplus and real exchange rate:
  - trade surplus small and relatively flat at about 1½ percent of GDP despite depreciating effective exchange rate;
  - services balance surplus of 7½ percent of GDP in 2007, largely due to two international banks and insurance sector;
  - investment income surged to 12 percent of GDP in 2007—soaring profits of Swiss multinationals from rising stock of overseas investment and pension assets.
- For 2008, current account surplus projected to decline to about 14 percent of GDP.
  - Investment income expected to take the biggest hit—about 1½ percent of GDP—with lower expected yields on foreign assets.
  - Weaker goods exports and slower financial market turnover projected to lower financial service income.
- Balance of Payments table excerpts (Percent of GDP, 2002–2007):
  - Current account8.312.912.913.514.716.9
  - Goods1.21.01.50.61.01.9
  - Services5.55.65.76.16.87.7
    - Tourism0.60.50.40.30.20.5
    - Financial services2.42.42.42.52.73.0
    - Other2.52.72.93.33.94.2
  - Labor and investment income3.88.07.510.09.59.7
    - Labor-2.1-2.2-2.2-2.3-2.3-2.3
    - Investment5.910.29.712.311.812.0
      - Portfolio2.62.62.52.72.82.7
      - Direct investment2.46.76.58.68.58.4
      - Other0.91.00.71.00.50.9
  - Transfers-2.1-1.7-1.7-3.2-2.7-2.4

*Source: _cr08170 - 26.      Regulatory enhancements will be of limited value without effective supervision*

### 42.      Both sides agreed that the current account surplus mostly reflected structural

### _cr08170 - 42.      Both sides agreed that the current account surplus mostly reflected structural

### Assessment of the current account and real exchange rate
- Both sides agreed that the current account surplus mostly reflected structural factors linked to high per capita income, an aging population, and Switzerland’s role as an international financial center.
- Recent CGER estimates under three standard approaches lead to the conclusion that the real exchange rate is broadly in line with fundamentals, especially after considering the Swiss Franc’s appreciation by about 5 percent in real effective terms over the last few months.
- External stability approach:
  - Suggests an undervaluation of 8 percent.
  - Corresponds to a 3½ percent of GDP gap between the underlying and NFA-stabilizing current account surpluses (12½ and 9 percent of GDP, respectively).
  - The estimate adjusts for the accounting treatment of retained earnings (Box 4).
- Macro balance approach:
  - Estimates an undervaluation of 7 percent.
  - Reflects a 2½ percent of GDP gap between the underlying current account and the current account norm (10 percent of GDP, making the same allowance for accounting factors).
- Equilibrium exchange rate approach:
  - Staff analysis finds undervaluation of about 7 percent.

### Box 4 — Special features of the Swiss current account (key findings)
- Accounting treatment of investment income:
  - Most earnings of Swiss multinationals are kept as retained earnings rather than paid out as dividends.
  - Under IMF balance of payments accounting rules, retained earnings are treated as income inflows into Switzerland with counterpart FDI outflows through the capital account—thus inflating both capital and current accounts even though no money crosses borders.
  - Foreigners hold Swiss assets mainly as stocks, and retained earnings of the underlying companies are not treated as income outflows; this asymmetrical treatment overestimates the current account surplus by 4-5 percentage points of GDP.
  - The elimination of the double taxation of dividends for qualifying individual shareholders by 2009 may increase the payout ratio and help to lower the current account surplus in the future.
- Foreign-controlled holding companies domiciled in Switzerland:
  - These have had a minor effect on the surplus.
  - They make large direct investments abroad and have sizable direct investment liabilities with their foreign parent companies.
  - Because they earn investment income from abroad and pay investment income to the parent company, their average net impact on the current account had been less than 1 percent of GDP.
- Additional illustrative statistics and observations from the charts in the box:
  - Excluding reinvested earnings on foreign-held shares shrinks the current account surplus.
  - Dividend payout ratio of Swiss corporations: 34%, 36%, 38%, 40%, 42% (chart labels across 2003–2007 indicate one third of profits are paid out in dividends, with rest held as retained earnings).
  - Direct investment income of foreign holding companies shows receipts, expenses, and net flows (billions CHF) for 1998–2006, illustrating foreign holding companies acting as a financial turntable with little impact on the current account.

### VII. Staff appraisal — outlook, risks, and policy priorities
- Near-term outlook and risks:
  - The resilience and dynamism displayed recently by the Swiss economy is being tested by global shock and uncertainties.
  - From earlier doldrums, the Swiss economy emerged with an impressive cyclical rebound, structural change, and an increase in potential growth rate; a cyclical correction was to be expected.
  - Sharp anticipated slowdown in U.S. and European growth and ongoing financial tensions carry serious implications for Switzerland: growth is set to decelerate, perhaps quickly, with risks for the financial sector.
  - As a major international financial center, Swiss public policy actions have international consequences.
- Policy priority:
  - The policy priority is to pay due attention to securing greater domestic financial stability.
  - Monetary and fiscal policies must play supportive roles within their well-defined frameworks.
  - The tendency of monetary policy to be accommodative and impart a modest stimulus while the fiscal stance remains conservative appears to strike the right balance for now; these choices may need to be revisited as events unfold.
- Authorities’ immediate responses to financial tensions:
  - Injected liquidity into the banking system, often in coordination with other major central banks.
  - Maintained enhanced oversight of major banks and insurance companies.
  - Worked actively with other regulators to share information, coordinate supervisory activities, and draw lessons for the future.
- Strengthening buffers and supervisory frameworks:
  - Authorities are focused on increasing buffers in the financial system.
  - More comprehensive risk assessment within the Basel II framework, taking into account recent outcomes and correlations, will lead to higher capital requirements.
  - Additional capital buffers would cushion against unanticipated risks.
  - A leverage ratio approach, implemented alongside Basel II and appropriate safeguards, could serve as a useful complement to the existing regime.
  - Consistent with the May 2007 FSAP update, authorities are developing a stress testing framework to improve liquidity risk management and are actively reviewing banks’ contingency plans and liquidity management policies.
  - Progress in implementing the Swiss Solvency Test for insurance companies is being bolstered through greater emphasis on internal controls, strengthening onsite supervision, and international supervisory cooperation.
  - The extensive work program requires careful management within the existing resource envelope.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08170.pdf*

### 47.      Regulatory refinements, however, will be insufficient without boosting

### 47.      Regulatory refinements, however, will be insufficient without boosting

### Supervisory capabilities and regulatory framework
- FINMA will remain at a resource disadvantage relative to the groups it deals with and "deserves to be bolstered in various ways."
- Priority actions:
  - Complete the appointment of the board and senior management of FINMA to reinforce the vision for the new integrated regulator.
  - Retain a focus on close supervision of major groups given market concentration, but supplement this with rules that specify transparent benchmark performance measures and supervisory responses.
  - Shift further to onsite supervisory activities, with appropriate reliance on external auditors to monitor regulatory compliance.
  - Build on existing cross-border supervisory arrangements for global groups to secure more active support of host supervisors in maintaining stability of global operations.

### Monetary policy and the SNB’s operational framework
- Monetary policy balance: authorities have had to balance inflation risks in a worsening growth environment; the SNB "has steered a carefully calibrated policy course."
- Recent actions and operational notes:
  - The SNB signaled concern with regard to inflation in its September 2007 decision by raising the target band for the 3-month Libor rate.
  - The SNB lowered its 1-week repo rate to guide the 3-month LIBOR to the midpoint of the target band, engineering an effective easing appropriate given downside risks and prospective alleviation of inflation pressures.
  - The relatively contained inflation outlook provides scope for further easing.
  - The operational framework combining the 3-month Libor and shorter-term repo rates has revealed potentially useful flexibility; however, its signaling and substantive effects deserve further analysis given differences vis-à-vis other central banks.

### Fiscal stance, public finances, and structural reform
- Public finances improved in 2007; authorities remain committed to a conservative fiscal approach.
- Short-term fiscal stance:
  - A smaller surplus in 2008 implies "a small stimulus is anticipated in 2008."
  - Authorities do not anticipate a more vigorous fiscal stimulus even if growth slows markedly, citing limited past effectiveness.
- Long-term considerations and recommended measures:
  - Public debt-to-GDP ratio is declining, but long-term fiscal sustainability requires continued fiscal prudence and structural reforms.
  - Next steps should include formulation of specific actions to address sustainability.
  - Short-run savings can be achieved through the Task Evaluation Program.
  - An inter-temporal government balance sheet is recommended as a useful tool for planning and communication.
  - The proposal to extend the debt-brake rule to incorporate “extraordinary” expenditures is welcomed.

### External sector assessment
- The external current account surplus "largely reflects structural factors."
- Drivers and assessment:
  - Switzerland’s large surplus is expected to come down this year.
  - The surplus reflects high per capita income, an aging population, and Switzerland’s position as a major financial center.
  - Accounting norms and specificities of investment outflows and inflows tend to overstate the surplus relative to other countries.
  - Taking these considerations into account, "the current account surplus and the exchange rate appear to be broadly in line with fundamentals."
- Key table figures (selected):
  - GDP per capita (2006): 51,635
  - Total population (end-2006): 7.5 million
  - Current account (2005): 13.5 (in percent of GDP)
  - Current account (2006): 14.7 (in percent of GDP)
  - Current account (2007): 16.9 (in percent of GDP)
  - Net investment income (2005): 12.3 (in percent of GDP)
  - Net investment income (2006): 11.8 (in percent of GDP)
  - Net investment income (2007): 12.0 (in percent of GDP)

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

*IMF staff report excerpt (internal chapter text and accompanying tables).*

### Annex I. Switzerland: Fund Relations

### Annex I. Switzerland: Fund Relations (As of April 29, 2008)

### I. Membership and IMF Accounts
- Membership status: Joined 5/29/92; Switzerland has 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: 3,231.10 — 93.42
  - Reserve position in Fund: 227.38 — 6.57
- SDR Department (SDR Million; % Allocation)
  - Holdings: 149.14 — 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 in the foreign exchange market, and therefore 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 in place for security reasons notified to the Fund pursuant to Decision No. 144-(52/51).
- Exchange restrictions notified on April 25, 2008:
  - Restrictions imposed against certain countries, individuals, and entities in accordance with relevant UN Security Council resolutions and EU regulations.
  - UN security-related restrictions currently in place with respect to:
    - specific individuals and entities associated with the former government of Liberia, Iraq, Osama bin Laden, the Taliban, and the Al-Qaïda network;
    - specific individuals and entities posing a threat to international peace and security in Côte d’Ivoire;
    - specific individuals and entities in the Democratic Republic of the Congo (DRC);
    - persons impeding the peace process in Sudan;
    - persons engaged in the Democratic People's Republic of Korea's (DPRK) Weapons of Mass Destruction (WMD)–related programs;
    - ban on financing and financial services related to the provision of arms and related materiel to Lebanon;
    - specific individuals and entities involved in the nuclear and/or ballistic missile programs of the Islamic Republic of Iran.
  - Lists of individuals and entities subject to financial sanctions are based on decisions by the competent UN Security Council sanctions committee and are amended regularly.
  - EU regulation-related restrictions currently 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 under EU regulations are identical to the corresponding EU regulations.

### VIII. Article IV Consultation (2008)
- Consultation cycle: Standard 12-month Article IV consultation cycle.
- Mission visit: Bern and Zürich during March 3-17, 2008.
- Authorities and outreach:
  - Held discussions with Finance Minister Merz, Chairman Roth of the Governing Board of the Swiss National Bank (SNB), and other senior officials.
  - Outreach included discussions with members of parliament, NGOs, the private sector, and think-tanks.
  - Messrs. Moser (Executive Director) and Weber (Advisor) attended some meetings.
- Mission composition:
  - A. Mody (Head), K. Ross, A. Carare (EUR), K. Ueda (RES), I. Tower, and J. Tuya (MCM).
- Focus and outputs:
  - Focused on core surveillance issues; no background papers produced.
  - Held a joint press conference on the concluding statement.
  - Authorities agreed to the publication of the staff report.

### Executive Board Assessment — Key Findings and Recommendations
- Recent performance and risks:
  - Growth exceeded the euro area average in each of the past four years; employment surged; inflation remained relatively muted.
  - Strong external environment boosted high value-added manufacturing and financial sector income flows.
  - Global credit strains have impacted the financial sector: Credit Suisse and Swiss Re reported losses; UBS particularly affected with subprime losses of US$38 billion and two capital injections of about US$28 billion.
  - Deleveraging at big banks ongoing; domestic lending remained on a surprisingly steady pace.
- Growth and inflation outlook:
  - Positive output gap of about 1 percent in early 2007.
  - GDP growth: accelerated to 3.1 percent in 2007.
  - Growth projection: expected to moderate to 1.4 percent in 2008.
  - Headline inflation: averaged 0.7 percent in 2007; core inflation 0.6 percent.
  - Inflation projection: 2 percent in 2008 and 1.4 percent in 2009.
- Monetary policy and SNB actions:
  - SNB increased 3-month Libor target range by 200 basis points since mid-2005 (to 2.25-3.25 percent); repo rates reduced since September to accommodate credit strains.
  - Directors agreed monetary policy calibration balanced risks to inflation and growth; effective easing deemed appropriate given downside risks.
  - Some Directors saw scope for further easing; others considered the stance appropriate.
- Financial sector stability — recommended focus areas:
  - Better risk assessment and risk management.
  - Increased capital buffers.
  - More liquidity.
  - Greater disclosure.
- Capital and regulatory suggestions:
  - Anticipation of higher capital requirements under Basel II; additional capital may be needed.
  - A leverage ratio approach could complement Basel II if implemented alongside it with appropriate safeguards.
  - Development of a stronger stress testing framework and more active review of contingency plans and liquidity management policies welcomed.
- Insurance sector:
  - Progress on implementing the Swiss Solvency Test; strengthened on-site supervision and international supervisory cooperation welcomed.
- Regulatory and supervisory institutions:
  - Recent appointment of board and senior management of FINMA welcomed.
  - Need to ensure FINMA has appropriate supervisory capabilities and resources.
  - Recommendation to strengthen on-site supervision capabilities and appropriately rely on external auditors for regulatory compliance monitoring.
  - Emphasized building on cross-border supervisory arrangements and securing active support of host supervisors for global operations.
- Fiscal policy and sustainability:
  - Strong fiscal performance: general government achieved a surplus of 2.2 percent of GDP in 2007; debt-to-GDP ratios fell below 45 percent.
  - Aging-related expenditures expected to reverse debt reduction trend in the medium term.
  - Recommendation: continue fiscal prudence and structural reforms to ensure long-term fiscal sustainability.
  - Long-Term Sustainability Report welcomed; early formulation of specific policy measures encouraged.
  - Potential savings through consolidation of governmental responsibilities as outlined in the Task Evaluation Program.
  - Proposal to extend the debt-brake rule to incorporate “extraordinary” expenditures welcomed.
- External position and exchange rate:
  - Large external current account surplus largely reflects structural factors: high per capita income, aging population, position as a major financial center.
  - Accounting norms and specificities of investment flows tend to overstate the surplus relative to other countries.
  - Directors generally agreed the exchange rate appears broadly in line with fundamentals.

### XI. Other — FSAP and Technical Assistance
- FSAP: Update referenced as November 2006.
- Technical Assistance: None.
- Resident Representatives: None.

### Annex II. Switzerland: Statistical Issues — Adequacy and Gaps
- Overall assessment:
  - Switzerland’s economic and financial statistics are adequate for surveillance purposes.
  - Generally publishes timely economic statistics and posts most data and underlying documentation on the internet.
  - Subscribed to the Fund’s Special Data Dissemination Standard (SDDS) in June 1996; metadata posted on the Dissemination Standards Bulletin Board.
  - In full observance of SDDS requirements; availing of SDDS flexibility options on dissemination of production index data (for periodicity and timeliness) and of wages and earnings data (for periodicity).
- Main statistical gaps and deficiencies (reflect limited resources and limited authority of the Federal Statistical Office (BfS)):
  - 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 will become available for the central government in the second half 2008.
  - 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; completed pilot in June 2005; from July 2006 conducted monthly.
  - September 2005: SNB started compiling more comprehensive statistics on mutual funds.
  - October 2005: SNB published, with the Federal Statistical Office, annual financial accounts for 1999-2003 (stock data). Data on financial flows and non-financial assets published in 2007.
  - Long-run historical time series covering monetary aggregates, capital markets, and the SNB balance sheet published in conjunction with SNB’s centennial.
  - End-2007: SNB introduced new monthly survey on interest rates for various banking products.
  - Since 2007: Under agreement with SFBC on reciprocal exchange of data, SNB collecting new capital adequacy statement information in accordance with Basel II.
  - Since 2007: SNB conducting surveys of Liechtenstein-based companies when preparing its international investment position.
  - Annual national accounts upgraded in 2003 to ESA95; SECO revised quarterly national account estimates with Q4 2004 data.
  - March 2006: SECO started publishing a quarterly production account.
  - 2004: Statistical cooperation agreement concluded with the EU as part of Bilateral II for harmonization with EU standards.
  - Federal Finance Administration preparations to revamp fiscal statistics:
    - Adoption of the Government Finance Statistics Manual 2001.
    - Reform of accounting standards for cantons and communes (Weiterentwicklung der Rechnungslegung der Kantone und Gemeinden).
    - Introduction of full accrual budgeting and accounting at federal level (Neues Rechnungsmodell Bund) along the lines of IPSAS.
    - Figures according to new accounting standards expected in 2008.
    - Interim: government finance statistics for publication in the GFS Yearbook will be reported on a cash basis but presented in the GFSM 2001 format.
- Balance of payments and IIP:
  - Quarterly balance of payments and international investment position data compiled by the SNB meet international standards.
  - Monetary gold transactions relating to sales of gold reserves not required for monetary policy purposes had not been correctly reflected in the balance of payments historically; until distribution of proceeds between SNB and the Federal Department of Finance concluded in February 2005, proceeds were considered part of official reserves. After that date, proceeds appear in “other assets of the SNB” in the balance of payments.
- Financial Soundness Indicators (FSIs):
  - Switzerland participated in the Coordinated Compilation Exercise for FSIs.
  - Data and metadata on a benchmark set of indicators (for year-end 2005) have been posted on the IMF website.
- AML/CFT progress:
  - Federal Council adopted a draft law implementing the revised FATF recommendations, expected to be in force by end-2009.
  - Supervisory ordinances on private insurance, gaming, and banking commission adopted.
  - Revised banking association due diligence code expected to be in force by mid-2008.
  - Swiss authorities to report on these reforms to the FATF in October 2008.

### Table of Common Indicators Required for Surveillance (As of April 29, 2008) — Selected entries
- Exchange Rates: Date of Latest Observation Apr 08; Date Received Apr 08; 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 Mar 08; Date Received Apr 08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Mar 08; Apr 08; M; M; M.
- Broad Money: Mar 08; Apr 08; M; M; M.
- Central Bank Balance Sheet: Mar 08; Apr 08; M; M; M.
- Consolidated Balance Sheet of the Banking System: Feb 08; Apr 08; M; M; M.
- Interest Rates: Mar 08; Apr 08; D and M; M and M; D and M.
- Consumer Price Index: Feb 08; Mar 08; M; M; M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: 2007; Mar 08; A; A; A.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: 2007; Mar 08; M; M; M.
- Stocks of Central Government and Central Government-Guaranteed Debt: 2007; Mar 08; Q; Q; Q.
- External Current Account Balance: Q4/07; Apr 08; Q; Q; Q.
- Exports and Imports of Goods and Services: Feb 07; Apr 08; M; M; M.
- GDP/GNP: Q4/07; Mar 08; Q; Q; Q.
- Gross External Debt: 2007; Mar 08; Q; Q; Q.

### Switzerland: Selected Economic Indicators (staff estimates and projections)
- Real economy
  - Real GDP: 2004 2.3; 2005 2.5; 2006 3.2; 2007 3.1; 1/2008 1.4
  - Real total domestic demand: 2004 1.6; 2005 1.9; 2006 1.4; 2007 0.2; 1/2008 2.2
  - CPI (year average): 2004 0.8; 2005 1.2; 2006 1.0; 2007 0.7; 1/2008 2.0
  - Unemployment rate (in percent of labor force): 2004 3.5; 2005 3.4; 2006 3.3; 2007 3.1; 1/2008 3.1
  - Gross national saving (percent of GDP): 2004 34.0; 2005 34.9; 2006 36.9; 2007 38.6; 1/2008 36.6
  - Gross national investment (percent of GDP): 2004 21.0; 2005 21.4; 2006 22.2; 2007 21.8; 1/2008 22.5
- Public finances (percent of GDP)
  - Confederation budget balance 2/: 2004 -0.6; 2005 -0.2; 2006 0.5; 2007 0.9; 1/2008 -0.4
  - General government balance 2/ 3/: 2004 -1.0; 2005 -0.2; 2006 1.9; 2007 2.2; 1/2008 0.8
  - Gross public debt: 2004 53.4; 2005 50.5; 2006 45.9; 2007 44.0; 1/2008 42.3
- Balance of payments
  - Trade balance (in percent of GDP): 2004 1.5; 2005 0.6; 2006 1.0; 2007 1.9; 1/2008 1.4
  - Current account (in percent of GDP): 2004 14.0; 2005 13.5; 2006 14.7; 2007 16.9; 1/2008 14.1
  - Official reserves (end of year, US$ billion) 4/: 2004 55.5; 2005 36.3; 2006 38.1; 2007 42.7; 1/2008 ...
- Money and interest rates
  - Domestic credit (annual average): 2004 2.3; 2005 4.0; 2006 5.5; 2007 7.5; 1/2008 ...
  - M3 (annual average): 2004 3.2; 2005 4.2; 2006 2.5; 2007 2.0; 1/2008 ...
  - Three-month Libor rate (in percent): 2004 0.5; 2005 1.5; 2006 1.6; 2007 2.2; 1/2008 ...
  - Government bond yield (in percent): 2004 2.6; 2005 2.1; 2006 2.5; 2007 2.9; 1/2008 ...
- Exchange rate
  - Exchange rate regime: Managed float
  - Present rate (May 14, 2008): SwF 1.05 per US$1
  - Nominal effective exchange rate (1990=100): 2004 110.4; 2005 109.8; 2006 108.4; 2007 106.0; 1/2008 ...
  - Real effective exchange rate (1990=100) 5/: 2004 105.6; 2005 104.0; 2006 101.7; 2007 98.0; 1/2008 ...

*Annex I. Switzerland: Fund Relations (As of April 29, 2008) — IMF staff document excerpt.*

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

### _cr08170 - 1. On behalf of my Swiss authorities, I would like to thank the staff for the stimulating

### Growth Outlook
- Swiss economy experienced four years of solid, broad based growth, at a rate above its long-term average growth rate.
- For 2008 and 2009, a slowdown is expected given the deterioration in the international economic and financial environment, but there is still little concrete evidence of a marked slowdown.
- Authorities expect GDP growth to slow to about 2 percent in 2008 and to 1-1.5 percent in 2009.
- Switzerland’s openness and large international financial sector expose it to exogenous shocks, but the economy’s flexibility should enable it to handle such shocks.
- Lower growth prospects for the U.S. and, to a lesser extent, Europe will adversely affect Swiss exports, partially offset by continuing strong growth in Asia and the Gulf region.
- Higher oil prices have mixed effects: adverse impacts domestically but higher income in oil-exporting countries stimulates demand for Swiss investment and luxury goods.

### Maintaining Financial Sector Stability
- Authorities welcome staff focus on financial sector stability issues and regulatory questions; overall policy responses assessed positively.
- Three main priorities to support stability:
  - enhanced international cooperation,
  - close monitoring of the two large banks,
  - launch of the financial supervisory authorities (FINMA).
- SNB participated from the outset of the financial market turmoil in international cooperation and coordinates with the Federal Reserve and the European Central Bank in providing dollar liquidity.
- SNB and SFBC actively involved with foreign counterparts in enhancing information exchange and policy response.
- Switzerland is fully engaged in international efforts to strengthen regulatory standards in the Basel Committee and other relevant fora, and ready to contribute to multilateral efforts including the IMF and the FSF.
- Systemic importance of the two large banks acknowledged; SFBC and SNB are implementing pragmatic steps to improve supervision and regulation for risks and liquidity management, and to raise capital requirements.
- A regular, mandated stress testing exercise with the two large banks has been introduced.
- FINMA progress: remaining board members and its director were appointed on May 21; independence of FINMA is a prerequisite for fulfilling supervisory duties and enhancing Switzerland’s input to international cooperation.
- Insurance sector priorities: consistent implementation of the Swiss Solvency Test (SST) and monitoring companies with SST ratios of less than 100 percent; SST to be complemented by focus on corporate governance, risk management, and internal controls.
- Pension funds:
  - Asset volume of the (mandatory) occupational benefit plan system is comfortably over 100 percent of GDP.
  - Broad agreement that pension funds should have a higher degree of coverage and that valuation reserves should be increased further; many funds have significantly increased reserves.
  - Legal provisions require pension funds to notify any undercoverage to initiate corrective measures; reports on implementation and effectiveness must be submitted annually to the Federal Council.
  - One fifth of pension fund liabilities are insured with private insurance companies required to meet strict coverage and solvency requirements at all times.

### Monetary Policy
- Inflation at slightly over 2 percent in 2008 is expected to be somewhat higher than assumed in the staff report, i.e., slightly above the rate which the SNB regards as compatible with price stability.
- Inflation is expected to ease toward the end of the year and no further action from the SNB is required, though vigilance remains necessary as inflation could prove more persistent than expected.
- The scope for easing, mentioned in the staff report, needs to be qualified accordingly.
- Increasing integration with international markets, particularly Europe, has not eliminated scope for independent monetary policy responses; SNB acted differently and earlier than the ECB in 2001, 2002, 2003, and 2004.
- Inflation in Switzerland is significantly and permanently lower than in the euro area.
- SNB operational framework targets the three-month Swiss-franc Libor (as opposed to overnight or one-week repo rates used by other central banks).
  - Targeting the three-month Libor has helped offset gyrations in the risk premium and isolate the non-financial sector from financial market turmoil by incorporating an “automatic monetary stabilizer.”
  - The staff’s skepticism about this particularity is noted, but the framework has served the SNB and Swiss economy well during the recent turmoil.
  - Further theoretical and empirical analysis of these issues is warranted.

### Public Finances
- Fiscal performance in 2007 was better than budgeted for all levels of government.
- General government surplus in 2007 increased to 2.2 percent of GDP from 1.9 percent in 2006, thanks to buoyant revenues from strong economic growth.
- Expenditure control was maintained despite strong revenues.
- Surpluses in recent years have allowed significant reduction in public debt; gross debt is around 44 percent of GDP, over 10 percentage points below the historical peak in 2003.
- Long-term fiscal sustainability has improved; authorities recognize challenges from an aging population.
  - Introduction of the Long-Term Sustainability Report as a regular feature of medium-term budget planning to inform policy makers and the public about costs related to demographic change.
  - Report emphasizes the speed with which adjustment costs increase if measures are delayed; authorities are confident it will aid implementation of structural changes in social security and health care.
- Federal-level fiscal commitments:
  - Continue to stabilize federal gross debt in nominal terms and reduce expenditure growth to a sustainable level.
  - The debt brake (introduced in 2003) is the main instrument for these goals.
  - Federal Council proposed an amendment to the budget law to ensure extraordinary expenditure is taken into account by the debt brake; currently extraordinary spending under exceptional circumstances is exempted and can increase debt.
  - The amendment would require compensation of extraordinary expenditure over a period of six years with additional spending cuts above those required by the debt brake for maintaining balance in ordinary accounts.
  - The proposal is in a broad public consultation process; the Federal Council plans to submit the bill to Parliament in September 2008.
- Reduction of expenditure growth:
  - The Task Evaluation Program remains the main instrument to define specific measures and structural reforms across federal government areas.
  - Federal Council reconfirmed specific medium-term expenditure growth rates for different tasks to ensure stabilization of the current expenditure-to-GDP ratio.
  - A report outlining 50 possible reform areas was submitted to Parliament and these areas are being specified by the respective ministries.

*Source: _cr08170*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08170.pdf_