## _cr10140

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### Executive summary and staff appraisal
- A recovery is ongoing; GDP is expected to grow by about 1½ percent in 2010 with a further strengthening in 2011.
- With substantial slack, and Swiss franc appreciation, inflation should remain muted.
- Uncertainties related to global developments are large; medium term prospects are uncertain as financial activity and immigration flows—two key drivers of recent growth—may slow down.
- Given uncertainties and in the absence of near-term threats to price and public finance stability, an exit from the current accommodative fiscal and monetary stance should be cautious.

### Monetary policy: normalization, exchange rate intervention, and SNB actions
- Policy stance and challenges:
  - SNB lowered the target range to 0 to 0.75 percent in March 2009, and targeted 0.25 percent; repo rate at 0.05 percent; 3-month Libor at about 0.25 percent.
  - The challenge is to normalize interest rates while exiting exchange rate interventions; inherent tension between appreciation pressures and desire to raise interest rates.
  - Authorities intend to return over time to a free floating currency regime; interventions, if any, should be limited to resisting short-term disruptive pressures.
  - Interest rates should not be raised too early—or without regard to a fundamental strengthening in the currency.
- Operational measures and balance sheet:
  - Extended maturity of repo operations and range of eligible counterparties.
  - Provided liquidity through SFr/EUR swaps jointly with the ECB, the National Bank of Poland and the National Bank of Hungary; last such operation undertaken in January 2010.
  - Engaged in SFr/USD swaps with the Federal reserve, which expired on February, and provided USD liquidity.
  - Implemented unconventional policy measures—including exchange rate intervention, and purchases of Swiss private bonds—to stabilize monetary and financial conditions.
  - Shifted to exit mode and has been scaling back liquidity since April 2009; since mid-December, bond purchases have ceased and only excessive appreciation vis-à-vis the Euro has been prevented.
  - Foreign currency reserves increased from about SFr 45 billion in 2007 to SFr 95 billion by-end 2009, and to SFr 125 billion by end-March 2010.
  - The loan corresponding to the funding of the StabFund remains on SNB’s balance sheet; the first loss buffer of about $4 billion has been exhausted.
  - SNB plans to increase provisions drawn from annual profits in 2009–13 and to reduce amounts distributed to cantons as dividends.
- Exchange rate and inflation indicators:
  - Effective appreciation in the currency of about 4 percent in 2009, and 13 percent since the beginning of the crisis.
  - Since December (year not specified in extract), authorities are only preventing excessive appreciation of the Swiss Franc vis-à-vis the euro; during this period the SFr/euro rate has appreciated by 4 percent and the effective appreciation by 3 percent.
  - Studies indicate that a 1 percent exchange rate appreciation leads to a decline of 0.18 pps in headline inflation after twelve months.
  - Staff and authorities project inflation in 2010–11 to remain under 1 percent given the sizable slack in the economy, muted wage demands, and pass-through from past currency appreciation.
  - Under a no policy change assumption, SNB projects inflation to gradually pick up and exceed 2½ percent by mid-2012.
- Policy tools if credit/financial-stability risks materialize:
  - Supervisory/prudential tools (e.g., loan to value restrictions, added capital charges under Pillar II) may be best suited to address mortgage credit or financial stability risks.
  - SNB monitoring includes quarterly survey on credit standards and a specific survey on newly issued mortgages to households.

### Fiscal policy, debt brake, and fiscal outlook
- Recent fiscal measures and outcomes:
  - Stimulus measures of around ¾ percent of GDP were implemented in 2009 and 2010.
  - Fiscal stimulus estimated at around ¾ percent of GDP in 2009 and 2010; authorities estimate discretionary measures and automatic stabilizers provided a combined fiscal stimulus of around 1.6 percent of GDP in 2009 and of 1.3 percent of GDP in 2010 (authorities’ survey).
  - In spite of the recession and stimulus efforts, local authorities and the federal government still registered surpluses in 2009.
  - General government registered a surplus in 2009 amounting to 0.7 percent of GDP (authorities); staff notes a small surplus in 2009 expected to turn to a limited deficit in 2010.
  - Since the start of the debt brake in 2003–04, the general government balance swung from a 2 percent of GDP deficit to a surplus of about1 percent in 2008.
  - Federal revenues were more resilient than expected and expenditures—notably interest outlays—lower.
  - Since 2004, the federal debt brake’s notional reserve account accumulated approximately SFr 13 billion, or about 2.2 percent of GDP.
  - Debt to GDP ratio shrank from about 55 percent in 1998 to just above 40 percent in 2009.
- 2010–2013 projections and consolidation:
  - In 2010, general government balance is projected to swing into a small deficit; authorities project a general government deficit of 1.2 percent of GDP for 2010.
  - Federal government Ordinary balance (% of GDP): 2008: 1.3; 2009: 0.5; 2010 Proj.: 0.2; 2011 Proj.: 0.4.
  - Federal government Cyclically adjusted balance (% of GDP): 2008: 1.2; 2009: 0.7; 2010 Proj.: 0.4; 2011 Proj.: 0.6.
  - General government Ordinary balance (% of GDP): 2008: 2.0; 2009: 0.3; 2010 Proj.: -1.0; 2011 Proj.: -0.8.
  - General government Cyclically adjusted balance (% of GDP): 2008: 1.7; 2009: 1.0; 2010 Proj.: -0.3; 2011 Proj.: -0.2.
  - For 2011–13, planned permanent tax reductions will amount to SFr 1.3 billion per annum.
  - Government estimates the necessary effort required to maintain expenditures below potential revenues under the debt brake to be between SFr 1.3 to 2 billion over 2011–13.
  - Staff noted consolidation in the short run should be calibrated to what the debt brake rule requires; less consolidation might be needed given consistent under-evaluation of some revenues in recent years.
- Debt brake mechanics (Box 5 summary):
  - Introduced in 2003; sets an annual upper limit on federal expenditure based on projected cyclically-adjusted federal revenues and uses a notional compensation account; if a negative balance in excess of 6 percent of expenditure builds up, it must be reduced below this threshold within three years.
  - Rule amended as of 2010 to include extraordinary one-off expenditures with a separate notional account where deficits must be compensated within six years.

### Financial sector stabilization, “Too Big to Fail”, and prudential/regulatory reforms
- Stabilization measures and outcomes:
  - Transfer of illiquid UBS assets into SNB stabilization fund (StabFund) completed ($39 billion in total).
  - By year end (2009), the overall risk for the SNB was reduced by about one third.
  - In August (2009), the government sold its 9 percent stake in UBS for a 33 percent profit.
  - Deposit insurance coverage expanded from SFr 30,000 to 100,000 per depositor; cap on system-wide liabilities increased from SFr 4 billion to SFr 6 billion; banks required to hold assets in Switzerland equaling 125 percent of covered deposits; quicker payout mechanism implemented.
- Banking sector resilience and risks:
  - Banks shed some SFr 1½ trillion in assets from mid-2007 to end-2009, de-risked balance sheets, and strengthened funding and capital positions.
  - At end-2009, Tier 1 capital ratios at UBS and Credit Suisse stood at 15 and 16.3 percent respectively—an improvement of 4 and 3 pps over the year.
  - Leverage ratios (Tier 1 capital to total assets) improved to 2.3 and 3.5 as of end-2009, for UBS and Credit Suisse respectively.
  - Dependence on wholesale funding remains elevated; further asset deterioration cannot be ruled out.
  - Banks particularly exposed to turbulences in the Euro area through counterparties and knock-on effects on the Swiss economy.
  - Only about 64 percent of the current capital structure of the two large Swiss banks qualifies for the Core Tier 1 definition according to current Basel proposals.
- Supervisory and regulatory reforms:
  - FINMA announced new prudential rules for large banks to be effective by 2013: cyclically adjusted capital rules (200% of Basel II norms in good times; 150% in bad times); a leverage ratio cap (set at 5 in good times, 3 in bad times).
  - FINMA announced progressive tightening of capital requirements on Cantonal and Regional banks, from 1 January 2010.
  - In April 2010, FINMA and the SNB announced a new liquidity regime for the big banks, effective on 30 June 2010, requiring banks to cover outflows estimated in a stress scenario over a period of at least 30 days.
  - Reduce moral hazard and TBTF: implement new Basel standards once issued, include sufficient add-ons for systemic institutions, consider simplifications in organization and legal structure of large banking institutions (which may require additional legislation).
  - Enhance FINMA effectiveness by expanding its in-house supervisory capability and strengthen independence of external auditors (e.g., payments to auditors come directly from FINMA).
  - Develop an effective macro-prudential framework with clarity on responsibilities, access to information, and enforcement power; clarify delineation of responsibilities between the SNB and FINMA. SNB/FINMA Memorandum of Understanding is a step in the right direction.
- TBTF working group and measures:
  - A “Too Big to Fail” working group issued an interim report on April 22; final report expected during the summer (year implied 2010).
  - Possible measures described: added capital and liquidity buffers, a tighter limit on risk concentration, changes in organizational structure to aid orderly resolution; calibration remains to be addressed.
  - Working group proposals identified possible measures: imposing higher capital buffers, reinforcing liquidity requirements, defining more stringent limit on single counterparty exposure, requiring organizational structures that would allow for orderly resolution, contingent capital instruments could play a useful role.
- Legal/institutional needs:
  - FINMA has statutory basis for raising capital and liquidity requirements for systemically relevant banks, but a legislative framework is needed to implement mandatory additional requirements, define criteria for systemic relevance, and strengthen legal basis to address group structures.
  - SNB considers it necessary to be able to independently examine the two large banks and to implement prudential measures; both institutions concerned that decisions could be legally challenged.

### Financial sector value added, insurance, and pensions
- Financial intermediation and contributions:
  - Financial sector accounted for 7.3 percent of total value added (10.3 percent including insurance and pensions); accounted for 6 percent of employment.
  - Financial intermediation 1/ as percent of value added: 2007: 9.5; 2008: 8.2; 2009: 7.3.
    - o/w fees / commissions: 2007: 3.8; 2008: 3.3; 2009: 2.9.
    - o/w FISIM: 2007: 5.7; 2008: 4.9; 2009: 4.4.
  - Insurance and pension: 2007: 3.1; 2008: 3.0; 2009: 3.0 (percent of value added).
- Insurance and pension fund developments:
  - Some life insurance companies and a re-insurer have been weakened by market developments.
  - About 26 percent of the registered pension funds remained underfunded at end-2009, versus 46.5 percent at end-2008 (4.2 percent, end-2007).
  - The overall funding gap was about SFr 35 billion (6.5% of GDP), of which pension funds with a state guarantee accounted for 73 percent of the total deficit.
  - The Swiss Solvency Test expanded application, to be fully implemented in 2011.

### Labor market measures and outcomes
- Short-time work programs:
  - Subsidies for short-time employment cover 80 percent of reduced hours.
  - Duration of short-time work benefits lengthened from 12 to 18 months in April 2009, and to 24 months effective April 2010.
- Employment and unemployment:
  - Employment remained around 3.9 million, with job losses in manufacturing offset by gains in service and construction sectors.
  - Unemployment rate increased by about 2 pps, from 2.5 percent in mid-2008 to 4.5 percent in February (year not specified).
  - Labor hoarding encouraged by short-time work programs contributed to muted labor market reaction.
  - Authorities concerned that depending on growth prospects, workers in short-time regimes could be pushed into unemployment.

### Macroeconomic developments, outlook, and risks
- Recent performance and shocks:
  - Real GDP contraction in 2009 was -1.5 percent; economy exited a year-long recession in the second half of 2009.
  - Industrial production fell by about 19 percent from its peak to its trough, before recovering by about 8 percent in the latter half of 2009.
  - Capacity utilization stood at 76 percent, 6 percentage points below its long-run average, at end-2009.
  - Financial intermediation value added declined by close to 25 percent (or by some 3 percent of GDP) due to the crisis, before recovering somewhat by the end of the year.
  - The 2008 current account surplus was revised downward—from 10 to 2 percent of GDP—in August 2009 once financial losses became clear.
  - Direct investment income fell from SFr 60 to 8 billion, causing net investment income to move into deficit for the first time ever.
  - For 2009, the current account surplus is projected to have increased to about 9 percent of GDP as the trade and service surplus expands and net investment income moves back to balance.
- Credit, housing, and balance sheets:
  - Mortgage lending (about 80 percent of total credit) grew by more than 5 percent by end-2009.
  - Households and corporations entered the recession with relatively strong balance sheets; households’ gross debt-to-income ratios have remained stable and matched by large financial and non financial wealth.
  - Domestic credit has been relatively dynamic; smaller domestically oriented banks picking up lending helped support credit supply.
- Baseline projections:
  - Real GDP is projected to expand by 1.6 percent in 2010 and by 1.8 percent in 2011.
  - Forecast table snippets (percent): IMF SEC O KoF Consensus 1/ RGDP 1.6 1.4 1.7 1.5; Private consumption 1.4 1.3 2.1 1.1; Investment 2/ 1.4 2.0 2.4 -2.3; Exports 2.9 4.5 3.0 ...; Imports 3.1 3.2 3.2 ...
  - Memorandum items: German 2010 growth 1.2 1.3 1.1 1.7; Swiss 2011 growth 1.8 2.0 2.2 1.8.
- Key uncertainties and downside risks:
  - Uncertainty mainly related to global recovery and developments on financial markets.
  - Large uncertainties from the impact of exits from accommodative policies, which could affect growth prospects in partners and the value of the Swiss franc.
  - Further market turmoil in the euro area could have significant repercussions due to financial and trade links with the euro area; safe haven effects on the franc may not be long lasting.
  - Monetary policy has little margin of maneuver; accommodation would need to be achieved mainly through fiscal policy.

### Potential growth, production function analysis, and labor supply
- Historical and projected contributions to RGDP growth (period / growth / Capital / Labor / TFP):
  - 1976-2009: 1.66 / 0.67 / 0.24 / 0.75
  - 1976-1990: 2.34 / 0.84 / 0.55 / 0.95
  - 1991-2003: 0.92 / 0.64 / -0.18 / 0.47
  - 2004-2008: 2.80 / 0.41 / 0.97 / 1.42
  - 2009- : 1.53 / 0.35 / 0.27 / -2.15
- Staff preliminary estimates:
  - Potential growth has declined to around 1¼ percent in the short-run, mainly due to lower potential employment and capital accumulation.
  - Potential growth could return to a medium term growth of around 1 ¾ percent.
- Production function assumptions and components:
  - Labor supply: a "0.95 million, representing 7 percent drop in labor supply" shock noted; short run labor growth expected to decline to about 0.8 percent during 2010–11 before gradually increasing to its long run rate; medium run migrant inflows decline from 4 percent to 2 percent annually.
  - Capital: investment expected to remain muted given lower employment growth, reduced availability and higher cost of credit, and substantial slack in capacity utilization.
  - TFP: forecast to decline moderately; assumption that TFP will grow at about 0.5 percent and then steadily return to a long-time trend of 0.8 percent.
  - Aggregated impact: combining effects yields potential growth around 1¼ percent in 2009–11, followed by gradual rebound to 1 ¾ percent; uncertainty exceptionally high.

### Swiss real estate cycles
- Historical experience and structural context:
  - Severe boom-bust cycle during 1987–91 which spilled over to the broader economy, leading to numerous foreclosures and consolidation in regional banking (some 200 banks were absorbed), and a long recession through most of the 1990s.
  - General government debt rose from 31 to 55 percent of GDP from 1990 to 1998—one key factor behind the creation of the debt brake rule.
- Recent price dynamics and fundamentals:
  - Swiss real estate price inflation has recently been low by international standards and not extremely volatile.
  - Real estate prices have gradually increased in a linear fashion since 2000.
  - Real estate inflation rates during this period have averaged between 4–5 percent per year, resulting in an increase in prices of single family homes and owner occupied apartments over the last 5 years between 20–25 percent.
  - Ratio of real estate prices relative to rental prices revealed a strong upward trend from the early 1990s to 2000, but a flattening since then.
  - Affordability measures have not deteriorated in the past 10 years despite price increases.
  - Market observers expect some possible decline in 2010 due to a slowdown in immigration, hence demand, in a market where supply remains dynamic.
- Structural factors:
  - Homeownership is at around 37 percent, reflecting nationwide rent control and tax policy (e.g. real estate is subject to wealth, income and capital gain taxes).
  - Studies suggest much of the recent price increase can be attributed to fundamentals, in particular the rising number of immigrants.

### Deposit insurance, reforms, and outcome
- Crisis-era deposit insurance measures are set to expire by end-2010.
- Proposed reforms (prior to rejection) included creating a partial ex-ante funding mechanism and shortening repayment periods to address pro-cyclicality.
- The proposal to overhaul the deposit insurance system was rejected due to concerns over costs from banks.
- Authorities are considering converting the temporary 2008 deposit insurance measures into law.

### Authorities’ response and policy dialogue highlights
- Authorities thanked staff for a "well-researched staff report" and described policy dialogue as "excellent"; they "share staff’s opinion on the challenges going forward in most respects."
- Monetary policy:
  - Authorities "fully share the staff’s appraisal of the Swiss monetary policy stance."
  - Acceleration in mortgage lending activity creates "a serious risk that appreciation may become a source of disequilibrium between economic sectors."
  - SNB will "continue to act decisively to prevent an excessive appreciation of the Swiss franc" because "the danger of deflation cannot entirely be ruled out."
- Financial stability and TBTF:
  - Authorities emphasize continued momentum to strengthen the domestic financial stability framework and will include substantial add-ons to internationally agreed capital and liquidity requirements.
  - An expert committee commissioned by the government is considering TBTF and will produce a final report for end-August 2010 with proposals for changes to the Banking Law.
- Fiscal stance:
  - Authorities reported a general government surplus of 0.7 percent of GDP in 2009 and project a general government deficit of 1.2 percent of GDP for 2010.
  - From 2011 onwards, "a consolidation effort of 0.3 percent of GDP is needed at the federal level to meet the requirements of the debt brake."
  - Authorities remain committed to the debt brake and medium-term fiscal consolidation.

*Source: Staff Report for the 2010 Article IV Consultation—Informational Annex (April 29, 2010).*

### 1. Swiss Real Estate Cycles ............................................................................................

### Swiss Real Estate Cycles

### Executive summary and staff appraisal
- A recovery is ongoing; GDP is expected to grow by about 1½ percent in 2010 with a further strengthening in 2011.
- With substantial slack, and Swiss franc appreciation, inflation should remain muted.
- Uncertainties related to global developments are large; medium term prospects are uncertain as financial activity and immigration flows—two key drivers of recent growth—may slow down.
- Given uncertainties and in the absence of near-term threats to price and public finance stability, an exit from the current accommodative fiscal and monetary stance should be cautious.

### Monetary policy: normalization and exchange rate intervention
- The SNB has applied an expansionary monetary stance with unconventional policies, given deflation risks and zero interest rates.
- The challenge is to normalize interest rates while exiting exchange rate interventions; there is an inherent tension between appreciation pressures and the desire to raise interest rates.
- Findings/assessments:
  - The real appreciation reflects continuing trade surpluses, improving growth prospects, and safe haven effects, but model based assessments indicate that the Swiss franc is broadly in line with fundamentals.
  - The authorities’ intentions to return over time to a free floating currency regime are welcome; interventions, if any, should be limited to resisting short-term disruptive pressures.
  - Interest rates should not be raised too early—or without regard to a fundamental strengthening in the currency. Inflationary pressures are subdued and the long established credibility of the SNB limits the possibility of de-anchoring of expectations.
- Policy tools:
  - If mortgage credit or financial stability risks materialize, supervisory/prudential tools (e.g., loan to value restrictions, added capital charges under Pillar II) may be best suited to address these risks.

### Fiscal policy and the debt brake
- Stimulus measures of around ¾ percent of GDP were implemented in 2009 and 2010.
- The small surplus in 2009 is expected to only turn to a limited deficit in 2010.
- To comply with the debt brake rule, some consolidation is being contemplated for 2011–13.
- Recommendations:
  - Fiscal consolidation should be limited to what is needed to respect the debt brake rule, while giving more attention to longer term issues.
  - Prudent fiscal policies resulting in low debt levels are warranted given large potential liabilities related to the banking sector and ageing effects.
  - Consistent underestimates of revenue suggest an increase in potential revenues and point to a possible lesser need of fiscal retrenchment in the short run.
  - Reforms are needed to address the medium term sustainability gap.

### Financial sector stability, supervision, and “Too big to fail”
- The authorities’ package of measures helped stabilize the financial system but exposed contingent liabilities and moral hazard related to systemic banks.
- Key risks and recent developments:
  - Although the two largest banks have strengthened funding and capital positions, dependence on wholesale funding remains elevated and further asset deterioration cannot be ruled out.
  - Turbulences in the Euro area would be a particular concern through spillovers to Swiss banks and the economy.
  - Tax amnesties in third countries and full acceptance of article 26 of the OECD model tax convention may put pressures on wealth management and private banking.
  - In insurance, some life insurance companies and a re-insurer have been weakened by market developments.
  - Coverage ratios in the second pillar pension sector have picked up to some degree, but underfunding remains and may require adjustment.
- Supervisory and regulatory recommendations:
  - Continue strengthening supervisory and regulatory frameworks; the momentum to reinforce financial stability should not be lost.
  - The effectiveness of FINMA could be further enhanced by expanding its in-house supervisory capability to engage more actively on-site with high impact institutions.
  - The independence of external auditors carrying out on-site supervision could be strengthened, inter alia by having payments to auditors come directly from FINMA.
  - Building on prior initiatives, reinforce the regulatory framework to address the TBTF problem: implement new Basel standards once issued, include sufficient add-ons for systemic institutions, consider simplifications in organization and legal structure of large banking institutions (which may require additional legislation).
  - Develop an effective macro-prudential framework with clarity on responsibilities, access to information, and enforcement power; further clarify delineation of responsibilities between the SNB and FINMA. The new SNB/FINMA Memorandum of Understanding is a step in the right direction.

### Context and recent macroeconomic developments
- Recession and recovery:
  - GDP contraction in 2009 was -1.5 percent.
  - The economy exited a year-long recession in the second half of 2009 as declines in exports abated and financial intermediation and manufacturing bottomed out.
- Trade and financial shocks:
  - Manufacturing exports and production declined sharply with the drop in external demand but picked up in the second half of 2009.
  - Industrial production fell by about 19 percent from its peak to its trough, before recovering by about 8 percent in the latter half of 2009.
  - Capacity utilization stood at 76 percent, 6 percentage points below its long-run average, at end-2009.
  - Financial intermediation value added declined by close to 25 percent (or by some 3 percent of GDP) due to the crisis, before recovering somewhat by the end of the year.
  - The 2008 current account surplus was revised downward—from 10 to 2 percent of GDP—in August 2009 once financial losses became clear.
  - Direct investment income fell from SFr 60 to 8 billion, causing net investment income to move into deficit for the first time ever.
  - For 2009, the current account surplus is projected to have increased to about 9 percent of GDP as the trade and service surplus expands and net investment income moves back to balance.
- Credit and lending:
  - Domestic credit has been relatively dynamic; effective stabilization measures and smaller domestically oriented banks picking up lending helped support credit supply.
  - Mortgage lending (about 80 percent of total credit) was stimulated by lower interest rates and grew by more than 5 percent by end-2009.
- Balance sheets and resilience:
  - Households and corporations entered the recession with relatively strong balance sheets.
  - Swiss households’ gross debt-to-income ratios have remained stable in recent years and are matched by large financial and non financial wealth.
  - Non-financial corporate net debts to income ratios declined prior to the crisis and remained relatively low.

### Swiss real estate cycles (Box 1)
- Historical experience:
  - Swiss real estate experienced a severe boom-bust cycle during 1987–91 which spilled over to the broader economy, leading to numerous foreclosures, consolidation in regional banking (some 200 banks were absorbed), and an unusually long recession with protracted unemployment throughout most of the 1990s.
  - General government debt rose from 31 to 55 percent of GDP from 1990 to 1998—one of the key factors behind the creation of the debt brake rule.
- Recent price dynamics:
  - Swiss real estate price inflation has recently been low by international standards and not extremely volatile.
  - Real estate prices have gradually increased in a linear fashion since 2000.
  - Real estate inflation rates during this period have averaged between 4–5 percent per year, resulting in an increase in prices of single family homes and owner occupied apartments over the last 5 years between 20–25 percent.
- Misalignment indicators and fundamentals:
  - Basic misalignment indicators are inconclusive due to rules and regulations (many implemented after the 1990s bust) that complicate equilibrium assessment.
  - The ratio of real estate prices relative to rental prices revealed a strong upward trend from the early 1990s to 2000, but a flattening since then.
  - While real estate price increases have been somewhat more dynamic than nominal incomes in recent years, affordability measures have not deteriorated in the past 10 years.
  - Market observers expect some possible decline in 2010 due to a slowdown in immigration, hence demand, in a market where supply remains dynamic.
- Structural factors:
  - Homeownership is at around 37 percent, reflecting nationwide rent control and tax policy (e.g. real estate is subject to wealth, income and capital gain taxes).
  - Studies suggest much of the recent price increase can be attributed to fundamentals, in particular the rising number of immigrants.

*Source: IMF staff report excerpt — Swiss Real Estate Cycles chapter.*

### 16.      A broad range of macroeconomic policy actions, and financial sector

### _cr10140 - 16.      A broad range of macroeconomic policy actions, and financial sector

### Overview of policy response
- A broad range of macroeconomic policy actions and financial sector stabilization measures were taken to stabilize the financial sector, ensure ample liquidity, avoid excessive tightening of monetary and financial conditions, support demand, and limit labor market adjustment.
- Measures taken in partner countries reinforced domestic effects.

### Monetary policy and SNB actions
- SNB lowered the target range to 0 to 0.75 percent in March 2009, and targeted 0.25 percent.
- SNB operational actions:
  - Extended maturity of repo operations and range of eligible counterparties.
  - Provided liquidity through SFr/EUR swaps jointly with the ECB, the National Bank of Poland and the National Bank of Hungary; last such operation undertaken in January 2010.
  - Engaged in SFr/USD swaps with the Federal reserve, which expired on February, and provided USD liquidity.
  - Implemented unconventional policy measures—including exchange rate intervention, and purchases of Swiss private bonds—to stabilize monetary and financial conditions.
  - Shifted to exit mode and has been scaling back liquidity since April 2009; since mid-December, bond purchases have ceased and only excessive appreciation vis-à-vis the Euro has been prevented.
- Exchange rate and market indicators:
  - Effective appreciation in the currency of about 4 percent in 2009, and 13 percent since the beginning of the crisis.
  - Since December (year not specified in extract), authorities are only preventing excessive appreciation of the Swiss Franc vis-à-vis the euro; during this period the SFr/euro rate has appreciated by 4 percent and the effective appreciation by 3 percent.
- SNB balance sheet and risks:
  - Foreign currency reserves increased from about SFr 45 billion in 2007 to SFr 95 billion by-end 2009, and to SFr 125 billion by end-March 2010.
  - SNB views increased foreign exchange reserves and private sector bonds as a more permanent part of its balance sheet and acknowledges exposure to currency and credit risk.
  - The loan corresponding to the funding of the StabFund remains on SNB’s balance sheet.
  - The first loss buffer of about $4 billion has been exhausted.
  - SNB plans to increase provisions drawn from annual profits in 2009–13 and to reduce amounts distributed to cantons as dividends.

### Financial sector stabilization and regulatory measures
- StabFund and UBS:
  - Transfer of illiquid UBS assets into SNB stabilization fund (StabFund) completed ($39 billion in total).
  - By year end (2009), the overall risk for the SNB was reduced by about one third.
  - In August (2009), the government sold its 9 percent stake in UBS for a 33 percent profit.
- Prudential and regulatory measures:
  - FINMA announced new prudential rules for large banks to be effective by 2013: cyclically adjusted capital rules (200% of Basel II norms in good times; 150% in bad times); a leverage ratio cap (set at 5 in good times, 3 in bad times).
  - FINMA announced progressive tightening of capital requirements on Cantonal and Regional banks, from 1 January 2010.
  - In April 2010, FINMA and the SNB announced a new liquidity regime for the big banks, effective on 30 June 2010, requiring banks to cover outflows estimated in a stress scenario over a period of at least 30 days.
- Deposit insurance and related measures:
  - Deposit insurance coverage expanded from SFr 30,000 to 100,000 per depositor.
  - Cap on system-wide liabilities increased from SFr 4 billion to SFr 6 billion.
  - Banks required to hold assets in Switzerland equaling 125 percent of covered deposits.
  - Quicker payout mechanism implemented.
- Governance, TBTF and remuneration:
  - A “Too Big to Fail” (TBTF) working group issued an interim report on April 22; final report expected during the summer (year implied 2010). The report defined TBTF institutions and described broad features of possible measures—added capital and liquidity buffers, a tighter limit on risk concentration, and changes in organizational structure to aid orderly resolution. Calibration remains to be addressed.
  - New standards for remuneration schemes of financial institutions with at least SFr 2 billion in capital implemented; guidelines stress transparency and risk incentives and give greater responsibility to boards of directors.
  - FINMA-SNB memorandum of understanding (MoU) revised and cooperation guidelines codified.

### Labor market response and outcomes
- Short-time work programs:
  - Subsidies for short-time employment cover 80 percent of reduced hours.
  - Duration of short-time work benefits lengthened from 12 to 18 months in April 2009, and to 24 months effective April 2010.
- Employment and unemployment:
  - Employment remained around 3.9 million, with job losses in manufacturing offset by gains in service and construction sectors.
  - Unemployment rate increased by about 2 pps, from 2.5 percent in mid-2008 to 4.5 percent in February (year not specified).
  - Labor hoarding encouraged by short-time work programs contributed to muted labor market reaction.
  - Resilience of employment, together with strong wage growth, helped cushion consumption during the recession.
- Authorities’ concern:
  - Depending on growth prospects, workers in short-time regimes could be pushed into unemployment.

### Fiscal measures
- Fiscal stimulus:
  - Authorities allowed automatic stabilizers full play and enacted the last of three stimulus packages consisting of public investment (infrastructure, applied research, alternative energy production) and targeted labor market measures (extension of short-time work duration, incentives to hire young entrants).
  - Fiscal stimulus estimated at around ¾ percent of GDP in 2009 and 2010.
  - Further stimulus at canton and municipal levels.
- Structural fiscal measures:
  - Debt brake rule expanded to cover extraordinary expenditure effective as of 2010.
  - A higher VAT rate to finance disability insurance was approved.

### Outlook, projections, and risks
- Baseline growth projections:
  - Real GDP is projected to expand by 1.6 percent in 2010 and by 1.8 percent in 2011.
  - Outlook details: manufacturing will strengthen; firms’ investment will lag given excess capacity in some sectors; construction should continue to grow; real wage and income growth expected to be sluggish; consumption overall expected to grow in line with GDP.
- Forecast table snippets (percent):
  - IMF SEC O KoF Consensus 1/ RGDP 1.6 1.4 1.7 1.5
  - Private consumption 1.4 1.3 2.1 1.1
  - Investment 2/ 1.4 2.0 2.4 -2.3
  - Exports 2.9 4.5 3.0 ...
  - Imports 3.1 3.2 3.2 ...
  - Memorandum items: German 2010 growth 1.2 1.3 1.1 1.7; Swiss 2011 growth 1.8 2.0 2.2 1.8
  - Sources: SECO, KoF, Consensus forecasts, and IMF WEO. 1/ March 2010 Consensus forecast. 2/ Machinery and equipment investment for SECO and KoF.
- Key uncertainties and downside risks:
  - Uncertainty mainly related to global recovery and developments on financial markets.
  - Large uncertainties from the impact of exits from accommodative policies, which could affect growth prospects in partners and the value of the Swiss franc.
  - Further market turmoil in the euro area could have significant repercussions due to financial and trade links with the euro area; safe haven effects on the franc may not be long lasting.
  - If downside external risks materialize, unemployment would rise as firms have less incentive to hoard labor.
  - Monetary policy has little margin of maneuver; accommodation would need to be achieved mainly through fiscal policy.

### Potential growth and medium-term considerations
- Staff preliminary estimates:
  - Potential growth has declined to around 1¼ percent in the short-run, mainly due to lower potential employment and capital accumulation.
  - Potential growth could return to a medium term growth of around 1 ¾ percent—somewhat smaller than growth observed in the years preceding the crisis.
- Uncertainty:
  - Uncertainty around estimates of potential output during a crisis is large, especially regarding total factor productivity and future immigration flows.

### Exit challenges and policy priorities
- Exit from accommodative stance:
  - Exit will need to be accompanied by structural measures to strengthen financial stability.
  - While little short-term fiscal consolidation is needed, exit from current monetary stance is more challenging.
- Remaining financial system issues:
  - Disproportionate size of contingent liabilities and moral hazard from too big to fail institutions remain to be addressed.
- SNB intentions:
  - SNB signaled intention to raise interest rates over time and to exit current exchange rate policy.
  - Under a no policy change assumption, SNB projects inflation to gradually pick up and exceed 2½ percent by mid-2012.
  - Authorities view current policy stance as incompatible with long-run price stability if maintained.
  - Staff endorsed intention to return to free floating currency regime and noted interventions, if any, should be limited to resisting disruptive short-term movements in the effective exchange rate.

### Competitiveness
- Switzerland is described as a highly competitive economy:
  - Exports to GDP have increased over time; external trade contributed about a third to average 1990–2008 growth.
  - Trade balance surplus expanded; current account surplus quickly snapped back after 2008 decline in financial flows.
  - Market shares and export prices generally remained stable during the drop in global trade.
- CGER and other approaches:
  - External Sustainability approach implies a strong competitive advantage (medium term current account surplus substantially exceeds what is required to keep net foreign asset level stable).
  - Macrobalances approach implies a small competitive advantage.
  - Equilibrium Exchange Rate approach indicates a minor competitive disadvantage; ULC-based real exchange rates may overstate that disadvantage.
  - On net, the average of the three methodologies suggests the currency could be slightly undervalued.
  - Staff and authorities view the currency as not appearing to be misaligned.
- Export dependence:
  - Exports of goods and services have been high and rising (graphical evidence cited).

*Source: IMF staff report excerpt contained in the supplied PDF content.*

### 27.      There is agreement on the inherent tension between raising interest rates and the

### _cr10140 - 27.      There is agreement on the inherent tension between raising interest rates and the

### Monetary policy and inflation outlook
- Agreement on the inherent tension between raising interest rates and the appreciation pressures, and on subdued inflation prospects in the short-term (Figure 6).
- Inflation and inflation expectations have picked up, but staff and the authorities project inflation in 2010–11 to remain under 1 percent given:
  - the sizable slack in the economy,
  - muted wage demands,
  - pass-through from past currency appreciation.
- Studies indicate that a 1 percent exchange rate appreciation leads to a decline of 0.18 pps in headline inflation after twelve months.
- Authorities saw current stance as incompatible with price stability in the medium-term, but judged uncertainty high and considered it too early to raise rates.
- Preliminary indications suggested lending standards have not materially deteriorated; prudential tools could be useful if this risk materialized.
- The SNB is monitoring the situation and in addition to its quarterly survey on credit standard, is conducting a specific survey on newly issued mortgages to households.

### Fiscal policies: recent outcomes and near-term projections
- In spite of the recession and stimulus efforts, local authorities and the federal government still registered surpluses in 2009.
- Since the start of the debt brake in 2003–04, the general government balance swung from a 2 percent of GDP deficit to a surplus of about1 percent in 2008.
- A surplus was still registered in 2009.
- Federal revenues were more resilient than expected and expenditures—notably interest outlays—lower.
- Since 2004, the federal debt brake’s notional reserve account accumulated approximately SFr 13 billion, or about 2.2 percent of GDP (Box 5).
- The debt to GDP ratio shrank from about 55 percent in 1998 to just above 40 percent in 2009.
- Swiss general government debt remained stable and is about 30 percentage points below the EU average.
- The solid fiscal position is reflected in a low risk premium, similar to Germany.

### 2010–2013 fiscal outlook and policy measures
- In 2010, general government balance is projected to swing into a small deficit.
- Federal government balance is estimated by the government to swing into a small federal deficit reflecting:
  - lagged effects of the recession on revenues,
  - stimulus related measures,
  - a marginal impact of tax measures (0.1 percent of GDP).
- Social security is expected to register a higher deficit of -0.6 percent of GDP, after -0.2 percent in 2009.
- Local authorities are expected to see their situation deteriorate.
- The government expects federal balance to turn into a small structural deficit in 2011 and expects some consolidation need of around 0.3 percent of GDP.
- For 2011–13, planned permanent tax reductions, including tax allowances for large families and adjustment to income tax brackets, will amount to SFr 1.3 billion per annum.
- Government estimates the necessary effort required to maintain expenditures below potential revenues under the debt brake to be between SFr 1.3 to 2 billion over 2011–13.
- Staff noted that consolidation in the short run should be calibrated to what the debt brake rule requires; less consolidation effort might be needed given consistent under-evaluation of some revenues in recent years.
- Withholding tax revenues estimate—currently an average of the last 10 years performance—could better reflect more recent outcomes; authorities acknowledged the possibility but highlighted withholding taxes’ volatility and merits of strong smoothing.

### Box 5 — Switzerland’s Debt Brake Rule (summary)
- Introduced in 2003 after large deficits in the 1990s.
- Sets an annual upper limit on federal expenditure, based on projected cyclically-adjusted federal revenues; allows deficits when economy is below potential and requires surpluses otherwise.
- Cyclical position estimated using a modified HP filter with a lower smoothing parameter for the last two observations to correct end-point bias.
- Ex-post balances feed into a notional compensation account to ensure slippages do not accumulate and nominal debt is contained.
- If a negative balance in excess of 6 percent of expenditure builds up, it must be reduced below this threshold within three years.
- Rule amended as of 2010 to include extraordinary one-off expenditures; the balance between extraordinary expenditure and extraordinary revenue is maintained in a separate notional account with deficits to be compensated within six years.
- Application to lower levels of government is being contemplated.
- Table (percent of GDP) — Federal government and General government projected balances:
  - Federal government Ordinary balance: 2008: 1.3; 2009: 0.5; 2010 Proj.: 0.2; 2011 Proj.: 0.4
  - Federal government Cyclically adjusted balance: 2008: 1.2; 2009: 0.7; 2010 Proj.: 0.4; 2011 Proj.: 0.6
  - General government Ordinary balance: 2008: 2.0; 2009: 0.3; 2010 Proj.: -1.0; 2011 Proj.: -0.8
  - General government Cyclically adjusted balance: 2008: 1.7; 2009: 1.0; 2010 Proj.: -0.3; 2011 Proj.: -0.2
- Sources: Swiss Federal Finance Administration and staff estimates.

### Medium-term fiscal challenges from ageing
- Dependency ratio projected to double by 2060, in line with the European average.
- According to the 2008 Long-Term Sustainability report, public expenditures will increase by 5 percent of GDP by 2050 as a result of ageing, with roughly equal increases in:
  - old age and disability insurance expenditures,
  - health and long term care.
- The first pillar pension system will swing into deficit within 5–10 years.
- Regarding disability insurance, the temporary increase in VAT will cover its deficit for the next six years.
- Authorities agreed on the need to address medium-term fiscal pressures from ageing and concurred that ambitious reforms would be needed (e.g., parametric adjustments in the old-age insurance system).

### Financial stability: banking sector developments and risks
- Banks have largely written down their losses, shed some SFr 1½ trillion in assets from mid-2007 to end-2009, de-risked balance sheets, and strengthened funding and capital positions.
- At end-2009, Tier 1 capital ratios at UBS and Credit Suisse stood at 15 and 16.3 percent respectively—an improvement of 4 and 3 pps over the year.
- Leverage ratios (Tier 1 capital to total assets) improved to 2.3 and 3.5 as of end-2009, for UBS and Credit Suisse respectively.
- Despite risk reduction, further asset deterioration could be substantial given sizeable exposures of Swiss banks.
- Banks particularly exposed to turbulences in the Euro area through counterparties and knock-on effects on the Swiss economy; dependence on wholesale funding still appears elevated.
- Business models will come under pressure:
  - favorable refinancing conditions expected to subside,
  - net new money flows remained negative in one of the banks,
  - potential stricter ring-fencing of capital and liquidity for subsidiaries in third countries may affect risk and liquidity management and profitability,
  - full acceptance by Switzerland of Article 26 of the OECD model tax convention, together with tax amnesties and disputes over tax-related client data, likely to result in further outflows of banking assets and expose the private banking industry to consolidation pressures.
- New Basel proposals would imply lower leverage and lower return on equity:
  - Only about 64 percent of the current capital structure of the two large Swiss banks qualifies for the Core Tier 1 definition according to current proposals.
  - Exclusion of hybrid capital and deferred tax assets from Core Tier 1 would particularly affect the two large Swiss banks.
  - Higher capital requirements for trading portfolio and higher capital charges for OTC derivatives not cleared through central counterparties would likely put pressure on earnings.
  - More stringent liquidity coverage requirements could increase funding costs.

### Insurance sector and pension funds
- Some weaknesses linger in the insurance sector:
  - Life insurance companies affected by low interest rates and financial market developments, weakening financial health of some.
  - Non-life insurers’ situation improved reflecting better investment outcomes and higher premiums.
  - Reinsurance sector strengthened through de-risking and capital increases; residual risks from securitized products remain.
- Occupational pension funds:
  - About 26 percent of the registered pension funds remained underfunded at end-2009, versus 46.5 percent at end-2008 (4.2 percent, end-2007).
  - The overall funding gap was about SFr 35 billion (6.5% of GDP), of which pension funds with a state guarantee accounted for 73 percent of the total deficit.

### Regulation, supervision, and macroprudential arrangements
- FINMA has reviewed supervisory actions and is drawing lessons from underestimation of systemic risks from rapid on and off-balance sheet expansion prior to the crisis.
- FINMA has:
  - increased focus on major institutions, oversight of auditors, governance and risk management practices,
  - expanded cross border cooperation through supervisory colleges,
  - expanded application of the Swiss Solvency Test and will implement it fully in 2011,
  - increased headcount to the projected 355 full-time equivalents and is creating a surplus to build a one year budgetary reserve fund.
- Broad agreement that financial turmoil highlighted risks posed by large financial institutions and the need to address the “too big to fail” problem.
- A broad based advisory working group issued on April 22nd an interim report outlining possible measures to reduce probability and impact of failures; the working group will produce a final report in the summer of 2010.
- Working group proposals identified as possible measures (seen as more suitable than new taxes):
  - imposing higher capital buffers,
  - reinforcing liquidity requirements,
  - defining more stringent limit on single counterparty exposure,
  - requiring organizational structures that would allow for orderly resolution,
  - contingent capital instruments could play a useful role.
- Modalities still to be defined:
  - internal banking structures should allow continuation of vital functions in case of crisis without rescuing the entire group,
  - authorities plan to re-examine risk weights, definitions of higher quality capital, and liquidity requirements depending on Basel outcomes and will maintain top-ups on forthcoming international standards,
  - working group noted capital add-ons should be adjusted to degree of systemic relevance and intends to work on progressiveness of such add-ons,
  - calibration of requirements will determine capacity to address moral hazard and discourage excessive risk-taking.
- Legal and institutional framework issues:
  - FINMA has a statutory basis for raising capital and liquidity requirements for systemically relevant banks, but a legislative framework is needed to implement mandatory additional requirements, define criteria for systemic relevance, and strengthen legal basis to address group structures.
  - SNB and FINMA have deepened collaboration: signed a Memorandum of Understanding establishing a high level Steering Committee, mechanisms for SNB to request information from FINMA and to ask it to take measures, and foreseeing joint, co-chaired work.
  - SNB considers it necessary to be able to independently examine the two large banks and to implement prudential measures.
  - Both institutions concerned that decisions to implement differential capital and liquidity requirements could be legally challenged; further consideration could be given to revising the legislative framework to align mandates and powers.

*IMF staff report content unit from the provided PDF chapter.*

### 43.      As the proposal to overhaul the deposit insurance system has been rejected,

### _cr10140 - 43.      As the proposal to overhaul the deposit insurance system has been rejected,

### Context and timing
- Crisis-era deposit insurance measures are set to expire by end-2010.
- Authorities are considering options to strengthen the deposit insurance framework in light of the upcoming expiration.

### Proposed reforms (prior to rejection)
- Create a partial ex-ante funding mechanism.
- Shorten repayment periods.
- Authorities viewed these measures as a way to address the current pro-cyclicality of the system.

### Outcome and reasons
- The proposal to overhaul the deposit insurance system was rejected.
- Rejection rationale cited: concerns over costs from banks.

### Current consideration and next steps
- Under the circumstances of the rejection, authorities are considering converting the temporary 2008 deposit insurance measures into law.

*Source: IMF staff report excerpt.*

### 0.95 million, representing 7 percent drop in

### _cr10140 - 0.95 million, representing 7 percent drop in

### Contributions to Real GDP Growth (Switzerland)
- RGDP contributions by factor (Period / growth / Capital / Labor / TFP):
  - 1976-2009: 1.66 / 0.67 / 0.24 / 0.75
  - 1976-1990: 2.34 / 0.84 / 0.55 / 0.95
  - 1991-2003: 0.92 / 0.64 / -0.18 / 0.47
  - 2004-2008: 2.80 / 0.41 / 0.97 / 1.42
  - 2009- : 1.53 / 0.35 / 0.27 / -2.15
- Source: SNB; and staff estimates.

### Financial shocks and potential growth: key findings
- The financial sector:
  - Accounted for 7.3 percent of total value added (10.3 percent including insurance and pensions).
  - Accounted for 6 percent of employment.
  - Directly contributed about 1 percentage point to Swiss real GDP growth between 2004 and 2007.
- Two channels for financial turbulence to affect potential growth:
  - Direct channel: reduction in intermediation value added via lower fees and commissions, and interest income.
    - Financial sector value added, as a percentage of total value added, has declined by 2 percentage points since 2007.
    - Declines reflect lower fees/commissions (due to lower wealth management valuations, volumes, turnover) and lower income from lending and deposit services.
    - Reduction in volumes of assets under management may imply a permanent loss.
  - Indirect channel: fast-growing sectors are more dependent on external finance; the Swiss economy structure suggests these sectors could be affected if credit availability declines.
- Contrary to many other countries, the impact on credit flow in Switzerland has been limited and credit has continued to expand because:
  - The crisis mainly affected external operations of large Swiss banks.
  - Banks with a domestic focus (and the large banks’ domestic operations) have been relatively unscathed.

### Financial sector value added (in percent of value added)
- 2007 / 2008 / 2009:
  - Financial intermediation 1/ : 9.5 / 8.2 / 7.3
    - o/w fees / commissions: 3.8 / 3.3 / 2.9
    - o/w FISIM: 5.7 / 4.9 / 4.4
  - Insurance and pension: 3.1 / 3.0 / 3.0
- 1/ Sources: SECO and staff estimates.
- 2/ In percent of value added.
- 3/ Financial intermediation services directly measured reflects fees and commissions. Indirect measurement (FISIM) reflects lending and deposits, as well as interest rate effects.

### Production function approach: assumptions and projections
- Overview:
  - Over 2004–08, growth was about 2.8 percent, with contributions:
    - Labor: 0.4 percentage points
    - Capital stock: 1.0 percentage points
    - Total factor productivity (TFP): 1.4 percentage points
  - Given absence of major imbalances and dissimilarities with the 1990s recession, staff estimate recession impacts on factor inputs and potential growth.

- A. Labor supply
  - Labor supply shock noted: "0.95 million, representing 7 percent drop in labor supply."
  - Short-run expectations:
    - Employment growth projected to slow reflecting higher unemployment and decline in foreign worker flows.
    - Employment stagnated since second half of 2008 and unemployment surged.
    - Growth of foreign workers decelerated but remained strong during 2009; labor made a strong positive contribution in 2009.
    - Short run: large labor hoarding and reduced inflows of foreign workers should curb labor supply.
    - Higher unemployment may weigh on labor force participation; prolonged unemployment increases skill mismatch.
  - Medium run assumption:
    - Annual growth rate of migrant worker inflows declines from 4 percent in booming years to 2 percent.
    - Labor growth expected to decline to about 0.8 percent during 2010–11 — resulting in labor contributions close to the ones estimated by the SNB (0.5 percent) — before gradually increasing to its long run rate.

- B. Capital stock
  - Investment expected to remain muted in the short run due to:
    - Lower employment growth (higher capital to labor ratio).
    - Reduction in availability and higher cost of credit and increased risk aversion.
    - Substantial slack in capacity utilization.

- C. Total Factor Productivity (TFP)
  - Forecast: overall TFP will decline moderately.
  - Reasons:
    - Financial crisis likely reduces productivity growth in the financial sector and economy-wide as the financial sector alters business models, some innovative activities decline, and positive spillovers decline with lower global growth.
    - Given size of financial sector (~10 percent of total output) and small impact on domestic credit, expected decline in TFP is modest.
  - Assumptions:
    - TFP will grow at about 0.5 percent and then steadily return to its long-time trend of 0.8 percent.
    - Large uncertainty acknowledged in projecting TFP after financial crises.

- D. Aggregated impacts on potential growth
  - Overall estimate:
    - Potential growth appears to have declined to about 1 ¼ percent in 2009–11.
    - Combining effects of employment, capital, and TFP yields potential growth around 1 ¼ percent, followed by a gradual rebound to long term average growth of 1 ¾ percent.
  - Uncertainty:
    - Uncertainty around estimates is exceptionally high.
    - In times of regime change, past observations may not provide valid inferences; large degree of imprecision noted.

### Staff and IMF assessment highlights (selected)
- 2009:
  - Real GDP contraction of 1.5 percent in 2009; economy exited recession in mid-2009.
  - Switzerland avoided a boom-bust credit and real estate cycle; households and firms were in comfortable financial condition before crisis.
- Policy responses:
  - SNB left 3-month Libor target range at 0 to 0.75 percent since March 2009 and pursued quantitative easing, including foreign exchange intervention.
  - Fiscal: automatic stabilizers allowed to operate and last of three stimulus packages enacted (public infrastructure, labor market measures increasing short time work benefits).
  - Financial sector: strengthened capital requirements for the two largest banks; transfer of illiquid assets to a “bad bank”; expanded deposit insurance; tightened capital requirements for cantonal and regional banks; reduced StabFund risk by about one third; new remuneration guidelines; creation of a “Too big to Fail” working group.
  - SNB/FINMA: revised memorandum of understanding to clarify cooperation on financial stability.
- Outlook and Director views:
  - Staff projections: economic growth expected to increase to 1.6 percent in 2010 and to 1.8 percent in 2011.
  - Inflation turned positive but expected to remain under 1 percent.
  - Directors supported a cautious exit from accommodative fiscal and monetary stance; recommended not raising interest rates prematurely and using prudential tools to address deterioration in lending standards.
  - Directors encouraged continuing efforts to strengthen financial supervision (including FINMA capabilities and auditor independence) and to address TBTF via higher capital buffers, reinforced liquidity requirements, and possible organizational/legal simplifications for large banks.

*Source: Staff Report for the 2010 Article IV Consultation—Informational Annex (April 29, 2010).*

### 1. On behalf of the Swiss authorities, we would like to thank staff for once again

### _cr10140 - 1. On behalf of the Swiss authorities, we would like to thank staff for once again

### Summary and Policy Dialogue
- Authorities thank staff for a "well-researched staff report" providing "thorough, objective, and insightful analysis of the macro-economic situation."
- Policy dialogue described as "excellent"; authorities "share staff’s opinion on the challenges going forward in most respects."
- Authorities welcome the "candid policy recommendations" that contribute to domestic policy discussions.

### Economic Outlook and Recent Developments
- Authorities agree with staff that "Switzerland will experience a gradual recovery after a shallow recession."
- Domestic demand "has held up especially well throughout the recent crisis period."
- Exports for the first three months of 2010 grew at 4.3 percent.
- Industry surveys indicate continued optimism for coming months.
- Unemployment rate experienced "an earlier than expected drop."
- Authorities' current GDP growth forecast is "in line with staff’s."

### Monetary Policy
- Authorities "fully share the staff’s appraisal of the Swiss monetary policy stance."
- Key concerns:
  - Normalizing interest rates while exiting intervention has become more difficult due to recent pressure on the Swiss franc.
  - Appreciation of the Swiss franc implies a tightening of monetary conditions and reduces room for normalizing interest rates.
  - Acceleration in mortgage lending activity creates "a serious risk that appreciation may become a source of disequilibrium between economic sectors."
- Current stance described as "very loose" with a need to normalize interest rates over time.
- Exact policy rates and ranges:
  - Repo rate at 0.05 percent.
  - 3-month Libor at about 0.25 percent.
  - Target range set at 0 percent and 0.75 percent since March 2009.
- Inflation outlook:
  - "Latest inflation forecast published by the Swiss National Bank (SNB) shows that price stability is not threatened in the short run."
  - "Inflation should remain contained in 2010 and 2011."
  - "Assuming no policy change, inflation is forecast to exceed 2 percent by 2012."
  - Such an outcome is "not compatible with what the SNB considers as price stability."
- Deflation risk:
  - SNB will "continue to act decisively to prevent an excessive appreciation of the Swiss franc" because "the danger of deflation cannot entirely be ruled out" if external shocks persist.

### Financial Stability
- Authorities emphasize continued momentum to strengthen the domestic financial stability framework.
- Capital and liquidity standards will "continue to include substantial add-ons to internationally agreed requirements," reflecting systemic importance of large and complex financial institutions.
- Organizational and legal changes for large banks are sought so authorities can "preserve those functions of a bank that are essential for the real economy and are not forced to rescue the bank in its entirety."
- Expert committee work:
  - An expert committee commissioned by the government is "considering the challenges posed by 'too big to fail' institutions" and has published an interim report.
  - Interim report outlines core elements endorsed by the government: increases in capital, liquidity, and risk diversification requirements to reduce likelihood of insolvency of a systemically important bank.
  - Final report expected for end-August 2010, to propose an overall package including concrete proposals for changes to the Banking Law.
- Strategic positioning of the financial center:
  - Financial sector generates "about one tenth of Switzerland’s overall value added" and contributes "nearly six percent to total employment."
  - A report "Strategic directions for Switzerland’s financial market policy" proposes measures to enhance competitiveness and market access and mitigate risks.
  - Public policy limited to assuring "a conducive and coherent regulatory and supervisory framework."
  - Switzerland committed to implementing agreed international standards and will conduct a peer review by the Financial Stability Board in 2011.

### Fiscal Policy
- 2009 fiscal outcome:
  - General government registered a surplus in 2009 amounting to 0.7 percent of GDP.
  - Discretionary measures and automatic stabilizers provided a combined fiscal stimulus of around 1.6 percent of GDP in 2009 and of 1.3 percent of GDP in 2010 (estimates based on a survey carried out by the authorities in 2009 and noted as higher than staff estimates).
  - Debt-to-GDP ratio declined further to below 40 percent.
- 2010 outlook and subsequent years:
  - Authorities project a general government deficit of 1.2 percent of GDP for 2010 (slightly higher than staff’s projections).
  - Cantons, municipalities, and social security institutions are expected to narrow their deficits from 2011 onwards.
  - Authorities project a faster recovery in cantonal finances than staff, mainly due to lower projected growth in expenditure.
  - Gross debt levels expected to decrease at federal and sub-national levels, with more cantons adopting fiscal rules similar to the debt-brake.
  - From 2011 onwards, "a consolidation effort of 0.3 percent of GDP is needed at the federal level to meet the requirements of the debt brake."
- Tax reforms and revenue outlook:
  - Deterioration in the federal fiscal balance mainly due to implementation of several tax reforms which will result in annual structural revenue losses of roughly 1.6 billion Swiss francs according to the latest estimates.
  - Staff argues revenues have been consistently underestimated in recent years; authorities judge "potential revenues have not increased significantly."
  - Authorities remain "firmly committed not to compromise the consolidation efforts of previous years" and will implement the fiscal rule consistently to ensure a balanced budget over the medium term.

*Source: Swiss authorities' response to IMF staff report (content unit: _cr10140 - 1).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10140.pdf_