## _cr12106

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---

### Macroeconomic context and recent developments
- Switzerland is a very open, highly productive, innovative economy with medium-term growth that has been good, low unemployment, low and stable inflation historically, sound public finances, and a large positive net foreign asset position and current account surplus.
- Global financial crisis and euro zone crisis triggered safe-haven capital inflows and strong appreciation pressures on the Swiss franc.
- SNB policy change:
  - On September 6, 2011, the SNB announced it would defend a floor of 1.2 Swiss francs per euro, abandoning the floating exchange rate regime.
  - Real exchange rate depreciated by about 11 percent since the introduction of the floor, undoing about one third of the cumulative appreciation since 2007.
  - Applying CGER methodologies yields an overvaluation estimate of 0–15 percent; adjusted CGER misalignment about 10 percent — overall assessment: moderate overvaluation.

### Growth, demand, labor market, and inflation
- GDP and demand:
  - Real GDP growth: 2010: 2.7 percent; 2011: 1.9 percent.
  - Quarterly GDP growth fell from 0.4 percent q-o-q in 2011Q1 to 0.1 percent in 2011Q4.
  - Private consumption reported growth: 0.9 percent (adjusted estimate could be 1.6 percent if cross-border shopping reallocated).
  - Cross-border shopping and private imports via courier and mail tentatively estimated at 12-14 CHF billion in 2011; tax revenue on some cross-border shopping increased by a third in 2011.
- Labor market:
  - Official unemployment rate: around 3 percent in 2011.
  - Slowdown expected to raise unemployment, especially in mechanical and electrical engineering and tourism; potential employment declines in financial sector.
- Inflation:
  - Headline inflation in March: -1 percent y-o-y.
  - Core inflation: below -1 percent y-o-y.
  - SNB forecast: moderate deflation in 2012 and moderate inflation afterwards.
  - Inflation expectations: anchored in low but positive territory (survey evidence).

### Exchange rate, SNB balance sheet, and liquidity
- Exchange rate history:
  - CHF/EUR moved from 1.6 in late 2007 to almost parity in early August 2011.
  - Cumulative real effective appreciation since 2007: over 30 percent.
- SNB interventions and balance sheet:
  - Early August 2011: massive liquidity expansion via foreign exchange swap operations, non-renewal and repurchase of SNB Bills.
  - SNB purchased foreign currency to a value of approximately CHF 17.8 billion in 2011 to enforce the minimum exchange rate.
  - SNB total assets (selected): 2010: 269,955 (millions of Swiss francs); 2011: 346,078 (millions of Swiss francs).
  - Foreign currency reserves (millions of Swiss francs): 2010: 203,810; 2011: 257,504.
  - Monetary base (millions of Swiss francs): 2010: 90,208; 2011: 137,728.
  - SNB balance sheet as percent of GDP (memorandum): 2010: 54.2; 2011: 68.3.
- Monetary stance and liquidity:
  - Near zero interest rates (SNB repo rate and 3-month Libor at low levels); liquidity ample.
  - Mortgage lending growth remained strong despite ample liquidity.

### External position and long-term external accounts
- Current account:
  - Current account balance (percent of GDP): 2011: 14.8 percent.
  - Balance of payments statistics likely overstate true economic size: correcting for retained earnings measurement biases would reduce the current account balance by about 5 percent of GDP in 2011; cross-border shopping undercounting may distort the current account upwards by of the order of 2 percent of GDP in 2011.
  - Even after adjustments, current account surplus remains sizable relative to non-commodity-exporting economies.
- Long-term drivers:
  - Swiss NFA grew from 83 percent of GDP in 1995 to 138 percent of GDP in 2010.
  - Over 2000–10, average NFA accumulation was 3½ percent of GDP per year vs. average current account surplus of over 10 percent of GDP; valuation changes affected foreign assets more negatively than liabilities.
  - Large NFA positions tend to appreciate the real exchange rate and may push up long-run exchange rate levels.

### Fiscal position, rules, and medium-term outlook
- Fiscal framework:
  - Federal “debt brake” mandates a structurally balanced budget with a compensation account and annual expenditure ceilings.
  - Most cantons have fiscal rules of varying strength; strong decentralization and no-bail-out presumption support fiscal discipline.
- Fiscal outcomes and projections:
  - General government balance (percent of GDP): 2011: 0.4; projected 2012: 0.2; 2013: 0.2.
  - Federal measures in August 2011 to counteract strong currency cost about 0.15 percent of GDP.
  - Debt-to-GDP ratio projected to fall further to some 45 percent of GDP in 2015 (GFSM-basis) (table projections show gross debt: 2011: 48.6; 2012: 48.9; 2013: 47.8).
  - Nominal GDP (billions of Swiss francs): 2008: 545.0; 2009: 535.6; 2010: 550.6; 2011: 564.8; 2012: 570.5; 2013: 583.9.
- Long-term aging costs:
  - Authorities project an increase in public aging-related expenditure of some 4 percent of GDP by 2050 (about equally split between pay-as-you-go pension pillar and health care including long-term care).
  - Pension system: mandatory second-pillar accounts for half of household saving and 15 percent of gross national saving; pension funds held assets worth more than 100 percent of GDP in 2009.

### Financial sector structure, soundness, and risks
- Size and exposures:
  - Financial sector very large and internationally exposed; Swiss banks’ foreign claims account for more than 60 percent of bank assets or three times GDP (highest among advanced economies).
  - Direct exposures of Swiss banks and major insurers to Greece, Ireland, Portugal, Italy, Spain, and Belgium: 2 percent of total assets; relative to GDP: 5 percent.
- Capital adequacy and quality:
  - Reported regulatory ratios (Basel II / Basel 2.5 basis):
    - Average Tier I capital ratio: 15 percent (large Swiss banks) vs. 12 percent (global SIFI peers).
    - Core Tier I capital ratio: 12 percent (large Swiss banks) vs. 10 percent (global SIFI peers).
  - Tangible common equity to tangible assets (TCE): Swiss SIFIs: 2.7 percent; peers: 3.7 percent.
  - Basel Committee impact study: average increase in risk-weighted assets for internationally active banks at 23 percent.
- Liquidity and funding:
  - Reliance on wholesale funding: over 70 percent (Swiss large banks) vs. less than 60 percent (peers).
  - Loan/deposit ratios: below peers; share of liquid assets: comparable to peers.
  - Compliance with Swiss liquidity requirement to cover a 30-day stressed horizon.
- Performance and profitability:
  - ROA fell by 40 percent to less than 0.3 percent after deterioration in 2011; ROE dropped from double digits to below 7 percent.
  - Cost/income ratio over 80 percent.
  - CDS spreads remain significantly below peers.
- Financial sector statistics (selected):
  - Regulatory capital as percent of risk-weighted assets (banks): 2011 (Jun-11): 16.1.
  - Regulatory Tier I capital to RWA: 2011 (Jun-11): 15.0.
  - Non-performing loans as percent of gross loans: 2010: 0.5.
  - Households share of bank credit to the private sector: 2011: 68.8 percent.
  - ROAA (gross profits as percent of average assets): 2011 (Jun-11): 0.8.
  - Liquid assets as percent of total assets: 2011 (Jun-11): 22.4.
  - Net long position in foreign exchange, % of tier I capital: 2011 (Jun-11): -35.3.

### Housing, mortgage credit, and macroprudential concerns
- Mortgage and real estate risks:
  - Mortgage rates around historic lows: about 2.5 percent on a 10-year, fixed-rate loan.
  - Housing prices high relative to income; overheating in “hot spots”: Geneva, Zurich, and Zug; condominiums particularly vulnerable.
  - Evidence of loose lending policies in some banks; insurance sector exposure to Swiss real estate: 14 percent of total assets.
- Macroprudential toolkit proposed:
  - Amend bank capital ordinance to implement early the Basel III counter-cyclical capital buffer (CCB); buffer activated by Federal Council upon SNB request; banks have up to 12 months to raise capital.
  - Improve classification of risk weights in mortgage lending; assign 100 percent weight to high risk exposures.
  - Give SNB power to request information from banks not available from FINMA.
  - Consider minimum affordability ratios forbidding mortgages with debt service-to-income (DTI) ratios above thresholds; consider LTV ratios with supervisory monitoring of valuations.
  - Consider reducing or eliminating preferential tax treatment of mortgage debt service (mortgage interest deductible; homeowners taxed on imputed rents).
- Authorities’ stance:
  - Confident planned macroprudential tools would have preventive effects; rejected affordability limits as too “market unfriendly.”
  - Saw increased capital requirements as a deterrent to mortgage growth; considered housing taxation reforms politically unlikely.

### Private banking, tax transparency, and insurance sector pressures
- Private banking and tax cooperation:
  - International push for broader cross-border tax cooperation pressures Swiss private banking and bank secrecy practices.
  - Switzerland signed withholding tax agreements (including with Austria and the U.K.); several banks investigated in the U.S. in 2011; one small bank indicted and dismantled.
  - Wealth management business saw outflows from European countries and the U.S., partly offset by inflows from other countries.
- Insurance sector:
  - Premiums grew moderately in 2011; underwriting results weak.
  - Low interest rates hit Swiss life insurers more than peers due to traditional business models.
  - Guaranteed payout rate on life insurance policies (the BVG) lowered to 1.5 percent from the beginning of 2012 after remaining at 2 percent for three years.
  - Swiss Solvency Test (SST) implementation improved risk awareness; all nonlife insurers and reinsurers and the majority of life insurers passed the 2011 SST.
  - FINMA rendered about 30 decisions on internal model approval requests in 2011, with full approval granted in 25 percent of cases.

### Outlook, scenarios, and risks
- Central scenario:
  - Economy expected to stagnate in 2012 and regain momentum in 2013.
  - GDP growth projections: 2012: 0.8 percent; 2013: 1.7 percent.
- Executive Board and authorities:
  - Executive Board viewed exchange rate floor as appropriate given slow activity and deflation risk; Directors encouraged return to freely floating once growth and inflation normalize.
  - Authorities expected GDP growth of 1.8–2.1 percent in 2013 (more sanguine than staff).
- Main downside risks:
  - Intensification of euro zone sovereign debt crisis could trigger adverse trade shock, tip economy into recession, accelerate safe-haven inflows, put the currency floor under pressure, and require large-scale SNB intervention.
  - Boom-bust in housing market: collapse of housing prices would weaken banking and insurance sectors and could call exchange rate commitments into question.
  - Recurrence of a global financial crisis: low likelihood but high impact (severe recession, potential need for public guarantees or capital injections for global SIFIs).

### Policy recommendations (staff appraisal and priorities)
- Exchange rate and monetary policy:
  - Introduction of the exchange rate floor on September 6, 2011 was appropriate given risk of contraction and deflation, zero lower bound, fiscal constraints, and limited QE options.
  - Recommendation: allow currency to float freely once inflation returns to comfortable levels and growth picks up; exit should be well-timed and carefully managed.
- Macroprudential and financial regulation:
  - Rapid implementation of Basel III and TBTF capital requirements and progress on bank resolvability are paramount.
  - TBTF legislation requires SIBs to prepare recovery and resolution plans; potential capital rebates for progress on resolvability.
  - Strengthen macroprudential toolkit for mortgage risks: early CCB, higher mortgage risk weights, minimum affordability ratios, improved access to bank information for SNB.
  - Strengthen FINMA’s in-house supervisory capacity and oversight of intra-group transactions; continue SST implementation in insurance sector.
- Fiscal policy:
  - Fiscal stance broadly neutral for 2012; fiscal policy should be ready to support aggregate demand if outlook deteriorates within fiscal rules.
  - Long-term: conservative fiscal policy and rapid progress on aging-related reform required.
  - Consider automatic adjustors for pensions (equalization of male and female retirement age; pension indexation to inflation only; linking pension age/benefits to life expectancy).
- Other:
  - Use available leeway under fiscal rules to support demand if recovery stalls; prioritize measures with higher fiscal multipliers (investment and government consumption).
  - Consider reducing tax incentives for mortgage debt to curb excessive household leverage.

### Key numeric projections and indicators (selected figures)
- Real GDP (percent change): 2008: 2.1; 2009: -1.9; 2010: 2.7; 2011: 1.9; 2012: 0.8; 2013: 1.7.
- Total domestic demand (percent change): 2008: 0.5; 2009: 0.6; 2010: 1.6; 2011: 0.9; 2012: 0.9; 2013: 2.0.
- Private consumption (percent change): 2008: 1.4; 2009: 1.4; 2010: 1.7; 2011: 1.0; 2012: 1.1; 2013: 1.5.
- Nominal GDP (billions of Swiss francs): 2008: 545.0; 2009: 535.6; 2010: 550.6; 2011: 564.8; 2012: 570.5; 2013: 583.9.
- Current account balance (percent of GDP): 2008: 2.2; 2009: 11.0; 2010: 15.0; 2011: 14.8; 2012: 11.8; 2013: 11.3.
- Consumer price index (percent change): 2008: 2.4; 2009: -0.5; 2010: 0.7; 2011: 0.2; 2012: -0.5; 2013: 0.5.
- Unemployment rate (percent): 2008: 2.6; 2009: 3.7; 2010: 3.8; 2011: 3.1; 2012: 3.4; 2013: 3.6.
- General government balance (percent of GDP): 2008: 1.9; 2009: 0.5; 2010: 0.2; 2011: 0.4; 2012: 0.2; 2013: 0.2.
- Gross debt (general government, percent of GDP): 2008: 52.6; 2009: 53.6; 2010: 50.1; 2011: 48.6; 2012: 48.9; 2013: 47.8.
- Swiss National Bank selected items:
  - Total assets (millions of Swiss francs): 2010: 269,955; 2011: 346,078.
  - Gold (millions of Swiss francs): 2010: 43,988; 2011: 49,380.
  - Foreign currency reserves (millions of Swiss francs): 2010: 203,810; 2011: 257,504.
  - Monetary base (millions of Swiss francs): 2010: 90,208; 2011: 137,728.
- Financial sector soundness (selected):
  - Regulatory capital as percent of RWA (banks): 2011 (Jun-11): 16.1.
  - Regulatory Tier I capital to RWA: 2011 (Jun-11): 15.0.
  - Households share of bank credit to private sector (percent): 2011: 68.8.
  - Liquid assets as percent of total assets: 2011 (Jun-11): 22.4.
  - Net IIP (percent of GDP, memorandum): 2011: 154.2; 2012: 162.9; 2013: 168.8.
  - Official reserves (billions of U.S. dollars, end period, memorandum): 2011: 290.

### Annex analytical findings
- VAR analysis (Annex III):
  - A one-standard-deviation REER shock causes a quarterly appreciation of about 1¼ percent on impact.
  - Cumulative effect on GDP: a one-standard-deviation shock to REER causes a loss of about 0.2 percent in the GDP level relative to baseline over 2 years.
  - Past REER movements projected to cut quarterly growth by about 1 percentage point between 2011Q4 and 2012Q4.
- Fiscal multipliers (Annex IV and OECD):
  - OECD reference multipliers for Switzerland (percentage effect on GDP of a 1 percent of GDP change):
    - Government consumption: Year 1 0.4 Year 2 0.5.
    - Investment: Year 1 0.7 Year 2 0.9.
    - Transfers to Households: Year 1 0.3 Year 2 0.5.
    - Indirect Tax: Year 1 -0.1 Year 2 -0.2.
    - Personal Income Tax: Year 1 -0.2 Year 2 -0.3.
  - KOF estimated a GDP multiplier of 0.3 in the first year of a construction stimulus.
  - Swiss Federal Finance Administration unpublished simulation: expenditure multiplier of 0.6 in the first year.

### Institutional and governance notes
- Federal fiscal framework:
  - Switzerland comprises 26 cantons and almost 2600 municipalities with considerable subnational autonomy and tax competition.
  - 2008 reform streamlined task assignments and rationalized fiscal equalization; transition compensation payments scheduled to be reduced over almost thirty years unless abolished earlier.
  - No-bail-out presumption at cantonal and municipal levels reinforced by court rulings and historical experience.
- Fiscal rules:
  - Federal “debt brake” enshrined in constitution and effective in 2003; resulted in federal debt-to-GDP falling by some 10 percentage points after inception.
  - Most cantons have fiscal rules, heterogeneous in design and enforcement.

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

*Source: 2012 ARTICLE IV REPORT SWITZERLAND (IMF).*

### 1. Selected Economic Indicators, 2008–13  _______________________________________________________  25

### 1. Selected Economic Indicators, 2008–13

### Macroeconomic context and recent developments
- Switzerland is described as a very open, highly productive, innovative economy with medium-term growth that has been good, low unemployment, low and stable inflation historically, sound public finances, and a large positive net foreign asset position and current account surplus.
- The global financial crisis and the euro zone crisis have led to safe-haven capital inflows and strong appreciation pressures on the Swiss franc, prompting a change in exchange rate policy.
- To halt appreciation pressures, the SNB announced on September 6 that it would defend a floor of 1.2 Swiss francs per euro, abandoning the floating exchange rate regime.

### Growth and demand
- GDP growth: 2.7 percent in 2010; growth slowed to 1.9 percent for 2011.
- Quarterly GDP growth fell from 0.4 percent q-o-q in 2011Q1 to 0.1 percent in 2011Q4.
- Private consumption growth: reported 0.9 percent (adjusted estimate could be 1.6 percent if cross-border shopping growth is reallocated).
- Cross-border shopping and private imports via courier and mail are tentatively estimated at 12-14 CHF billion in 2011; tax revenue collected on some cross-border shopping flows shows an increase of a third in 2011.
- Export growth slowed (exports of goods and services growth halved but remained positive); certain sectors (watch-making and pharmaceuticals) remained buoyant while tourism and bank financial services performed poorly.

### Labor market and unemployment
- Official unemployment rate fell to around 3 percent in 2011.
- The slowdown in activity is expected to raise unemployment, especially in mechanical and electrical engineering and tourism; potential employment declines in the financial sector.

### Inflation and prices
- Headline inflation in March dropped to -1 percent y-o-y.
- Core inflation was below -1 percent y-o-y.
- SNB forecasted moderate deflation in 2012 and moderate inflation afterwards.
- Inflation expectations remain anchored in low but positive territory (survey evidence).

### Exchange rate and SNB policy response
- CHF/EUR: moved from 1.6 in late 2007 to almost parity in early August 2011.
- Cumulative real effective appreciation of the Swiss franc since 2007: over 30 percent.
- SNB actions in early August 2011: massive liquidity expansion via foreign exchange swap operations, non-renewal and repurchase of SNB Bills.
- On September 6, SNB announced a floor of 1.2 Swiss francs per euro.
- Real exchange rate has depreciated by about 11 percent since the introduction of the floor, undoing about one third of the cumulative appreciation since 2007.
- Applying CGER methodologies to latest WEO projections yields an overvaluation estimate of 0–15 percent; adjusting medium-term current account projections by the SNB-identified overestimate yields a CGER misalignment of about 10 percent. Overall assessment: moderate overvaluation.

### Current account and external position
- Current account remained a large surplus of 14.8percent of GDP in 2011.
- Balance of payments statistics likely overstate the true economic size of the current account: correcting for retained earnings measurement biases would reduce the current account balance by about 5 percent of GDP in 2011; cross-border shopping undercounting may distort the current account upwards by of the order of 2 percent of GDP in 2011.
- Even after adjustments, the Swiss current account surplus is sizable relative to non-commodity-exporting economies.

### SNB balance sheet and liquidity
- SNB foreign exchange intervention sharply expanded the SNB balance sheet (instruments include gold holdings and claims from gold transactions; foreign currency investments; swaps/repo; loan to stabilization fund; other).
- Monetary policy stance: expansionary with near zero interest rates (SNB repo rate and 3-month Libor at low levels); liquidity in the system remains ample (M3 growth and money multiplier dynamics shown in figures).
- Mortgage lending growth remained strong despite ample liquidity.

### Fiscal position, rules, and outlook
- Federal “debt brake rule” mandates a structurally balanced budget; most cantons have fiscal rules of varying strength. Design features (task assignments, fiscal equalization, no-bailout presumption, subnational tax autonomy) support fiscal discipline.
- General government balance stayed in positive territory during the 2009 recession and continued to register a surplus in 2011 (estimated at 1/2 percent of GDP on a GFSM basis).
- Federal government surplus disappeared in 2011 partly due to measures introduced in August 2011 to counteract the effects of the strong currency (costs of about 0.15 percent of GDP mentioned).
- Projected fiscal stance for 2012 and beyond: broadly neutral, with a small federal deficit offset by surpluses elsewhere in general government.
- Debt-to-GDP ratio projected to fall further to some 45 percent of GDP in 2015 (on a GFSM-basis).

### Long-term fiscal challenges and contingent liabilities
- Population aging: authorities project an increase in public aging-related expenditure of some 4 percent of GDP by 2050 (about equally distributed between the pay-as-you-go pension pillar and the health care system including long-term care).
- Contingent liabilities: several second-pillar pension funds (of public entities) have a public guarantee and are partly underfunded; almost all cantonal banks benefit from an unrestricted guarantee from their respective canton.
- Tail risk: in a severe global financial crisis scenario, government support to the financial sector may become necessary.

### Financial sector: restructuring and risks
- The financial sector is very large and internationally exposed; systemic bank legislation requires higher capital buffers.
- TBTF / SIB requirements effective March: minimum 10 percent Common Equity Tier 1 capital ratio and 19 percent Total Capital; standards to be fully phased in by 2019. (Note: the 9 percent above the minimum may consist of contingent capital.)
- Banks are restructuring: reducing risk-weighted assets and increasing fee-based revenues.
- Bank performance: after improvement in 2010, performance worsened in 2011. ROA fell by 40 percent to less than 0.3 percent; ROE dropped from double digits to below 7 percent.
- Cost/income ratio is over 80 percent and comparatively high; currency appreciation has negatively affected profitability.
- CDS spreads remain significantly below those of peers, suggesting markets perceive Swiss large banks as relatively well positioned to withstand current turmoil.

*Source: 2012 Article IV Report — Switzerland (Selected sections from “1. Selected Economic Indicators, 2008–13”).*

### 14.      Although they comfortably fulfill

### _cr12106 - 14.      Although they comfortably fulfill

### Capital adequacy and capital quality
- Large banks comfortably fulfill current regulatory capital requirements but have a thin layer of high quality capital.
- Reported regulatory ratios (Basel II / Basel 2.5 basis):
  - Average Tier I capital ratio: 15 percent (large Swiss banks) vs. 12 percent (global SIFI peers).
  - Core Tier I capital ratio: 12 percent (large Swiss banks) vs. 10 percent (global SIFI peers).
- Capital quality concerns:
  - Basel II / 2.5 ratios include low quality capital (deferred tax assets and hybrids) and assign low risk weights to certain exposures.
  - Tangible common equity to tangible assets (TCE):
    - Swiss SIFIs: 2.7 percent.
    - Peers: 3.7 percent.
  - Based on TCE, large Swiss banks are below peers and have made little progress since 2009.
- Regulatory transition risk:
  - New, more stringent requirements (Basel III) and higher risk weights on trading book and counterparty exposures will increase capital needs.
  - Basel Committee impact study: average increase in risk-weighted assets for internationally active banks at 23 percent.

### Liquidity and funding risks
- Liquidity profile improved, but wholesale funding dependence remains elevated:
  - Reliance on wholesale funding: over 70 percent (Swiss large banks) vs. less than 60 percent (peers).
  - One large bank relies particularly heavily on money market funds for its U.S. dollar funding.
- Loan/deposit and liquid asset metrics:
  - Loan/deposit ratios: below peers.
  - Share of liquid assets: comparable to peers.
  - Compliance with Swiss liquidity requirement to cover liquidity needs over a 30-day stressed horizon.
- Funding structure note:
  - Heavy reliance on wholesale funding partly reflects banks’ business model and large U.S. operations; during the last crisis, large banks received SNB liquidity support via U.S. dollar swap line with the U.S. Federal Reserve.

### Housing, mortgage credit, and real estate risks
- Domestic mortgage credit and real estate prices continue to rise briskly, raising bubble risk:
  - Mortgage rates have fallen to historic lows (about 2.5 percent on a 10-year, fixed-rate loan).
  - Housing prices are high relative to income; signs of overheating in “hot spots” (Geneva, Zurich, and Zug) and in market segments (condominiums).
  - Evidence of loose lending policies in some banks.
- Exposure of domestically-oriented banks and insurers:
  - Aggressive mortgage lending and greater reliance on fixed-rate long-maturity mortgages increased interest rate and credit risk, especially for cooperative banks and cantonal banks (large variation across banks).
  - Insurance sector exposure to Swiss real estate: 14 percent of total assets.
- Macroprudential framework:
  - Authorities have warned about financial stability risks associated with mortgage lending since 2010.
  - Macroprudential framework under construction; proposed instruments may have limited preventive powers.

### Private banking and tax transparency developments
- International push for broader cross-border tax cooperation pressures Swiss private banking and bank secrecy practices.
- Switzerland has signed several withholding tax agreements (including with Austria and the U.K.).
- In 2011:
  - A number of Swiss banks (including one of the two SIBs) were placed under investigation in the U.S. for allegedly helping clients evade taxes; one small bank was indicted and dismantled preemptively.
  - Swiss parliament broadened administrative assistance offered to U.S. tax authorities under the double taxation agreement (ratification still pending in the U.S.).
- Consequences:
  - Swiss wealth management business has seen outflows from European countries and the U.S., partly offset by inflows from other countries.
  - Revision of FATF standards (including tax crimes among money laundering offenses) may impact the sector.
  - Some consolidation is expected in the private banking sector.

### Insurance sector pressures
- Insurers coping with low interest rates, strong competition, and natural catastrophes:
  - Premiums for life, non-life, and reinsurance companies grew moderately in 2011; underwriting results remain weak.
  - Low interest rates hit Swiss life insurers more than other European competitors due to more traditional business models.
  - Guaranteed payout rate on life insurance policies (the BVG) was lowered to 1.5 percent from the beginning of 2012 after remaining at 2 percent for three years.
  - For nonlife insurers: strong competition put pressure on rates; high natural catastrophe claims weakened reinsurers’ 2011 underwriting results.
  - Some insurers relied on reserve releases to boost financial results.
  - Insurers’ exposure to euro area countries under market scrutiny appears moderate.
  - Full implementation of the Swiss Solvency Test (SST) improved risk awareness; all nonlife insurers and reinsurers and the majority of life insurers passed the 2011 SST.

### Outlook and risks
- Central scenario (benign):
  - Economy expected to stagnate in 2012 and regain momentum in 2013.
  - GDP growth projections:
    - 2012: 0.8 percent.
    - 2013: 1.7 percent (and strengthen thereafter).
  - With exchange rate pass-through receding, positive growth in domestic good prices, and anchored inflation expectations, entrenched deflation risk is limited.
- Main risks:
  - Euro area developments and the large financial sector:
    - Swiss banks’ foreign claims account for more than 60 percent of bank assets or three times GDP (highest among advanced economies).
    - Major exposures to the U.S. and the U.K.; exposures to euro area countries under market scrutiny are moderate.
    - Direct exposure of Swiss banks and major insurance companies to Greece, Ireland, Portugal, Italy, Spain, and Belgium: two percent of total assets; relative to GDP: 5 percent.
    - Intensification of euro zone sovereign debt crisis could trigger adverse trade shock, tip economy into recession, accelerate safe-haven capital inflows, put the currency floor under pressure, and require large-scale intervention.
    - Currency appreciation in such a scenario would aggravate large bank losses given cost/revenue currency mismatches and dampen investment banking and wealth management.
    - Freeze in global wholesale funding markets would compound real shock.
  - Boom-bust in housing market:
    - Low interest rates and ample liquidity drive prices higher.
    - Collapse of housing prices would weaken both banking and insurance sectors and could call into question exchange rate commitments.
  - Recurrence of a global financial crisis:
    - Considered a tail-risk (likelihood low), but impact high: severe recession and potential need for public intervention (guarantees or capital injections) given presence of global SIFIs.
- Authorities’ view on outlook:
  - Authorities somewhat more sanguine; expected GDP growth of 1.8–2.1 percent in 2013 (stronger rebound than staff), reflecting more optimistic external assumptions.
  - Authorities agreed with staff that downward pressures on inflation would be contained under the baseline.

### Policy discussions and recommendations
- Overall policy stance:
  - With a benign central scenario, macroeconomic policies should focus on reducing vulnerabilities to identified risks.
  - Return to a floating exchange rate and more neutral monetary stance should be well-timed and carefully orchestrated to avoid sparking inflationary pressures or fueling excessive currency appreciation.
  - Risk of unstable housing prices should be contained through macroprudential tools (new and untried in Swiss context).
  - Monetary policy has reached limits; future external recessionary shocks should be addressed through fiscal policy using limited available space under fiscal rules.
  - Financial sector: turbulent external environment argues against a protracted timetable for transitioning to new regulatory standards.
- Monetary and exchange rate policy specifics:
  - Introduction of the exchange rate floor in 2011 was appropriate given risk of contraction and deflation, zero lower bound on rates, fiscal constraints, and limited QE options.
  - The floor stabilized the exchange rate largely via SNB credibility; available data suggests little intervention was needed to maintain it.
  - Recommendation: allow currency to float freely once inflation returns to comfortable levels and growth picks up.
    - While stagnant growth and low inflation justify the floor, delaying return to free float once conditions normalize risks stoking inflation if money supply is expanded pro-cyclically to absorb capital inflows.
    - An exit while the floor continues to bind would be difficult and should be carefully managed.
- Lessons for other countries (Box 3 highlights):
  - The Swiss approach should not be widely emulated without careful consideration of differing macroeconomic conditions, initial policy stances, and policy levers.
  - The floor was implemented in an environment with significant risk of sharp contraction and deflation; defending such a floor in contexts of above-target inflation, loose fiscal policy, or strong domestic demand could exacerbate macroeconomic imbalances and undermine credibility.

*Italic: Source — 2012 ARTICLE IV REPORT SWITZERLAND (IMF).*

### 3.      Even if exchange rate pressures occur

### 3.      Even if exchange rate pressures occur

### Alternative policy tools when inflation is low and aggregate demand is weak
- Many countries have room to lower domestic nominal interest rates to discourage inflows.
- Even with the policy rate at zero, quantitative easing or fiscal policy can be used to stimulate aggregate demand.
- Capital flow management measures might be considered.
- In Switzerland:
  - Interest rates are close to zero.
  - Quantitative easing is precluded by the small size of the domestic bond market.
  - Discretionary fiscal policy is constrained by fiscal rules.
  - Capital flow management measures would be complex to design and costly given the country’s role as an international financial center.

### C. Containing Risks in the Mortgage Market—An Appropriate Macroprudential Toolkit
- Overheating in the real estate market may hurt the economy and endanger the current monetary framework: the SNB’s willingness to expand liquidity unboundedly to fulfill its exchange rate commitment is fundamental to credibility; signs that abundant liquidity was fuelling a housing bubble could call this willingness into question.
- Monitoring and supervision in the mortgage market are being stepped up:
  - Move beyond traditional Swiss bank self-regulation.
  - New survey of lending practices and new, more precise guidelines for mortgage lending.
  - Guidelines are adopted by the industry but approved and monitored by the supervisor (FINMA).

- Proposed macroprudential instruments (joint working group of FDF, FINMA, and the SNB):
  - Amend the bank capital ordinance to implement early the counter-cyclical capital buffer (CCB) contemplated under Basel III.
    - The buffer would be activated by the Federal Council upon request of the SNB and after consultation with FINMA.
    - Banks would then have up to 12 months to raise their capital level.
  - Improve the classification of risk weights in mortgage lending:
    - Take into account the debtor’s risk profile.
    - Assign a 100 percent weight to high risk exposures.
  - Give the SNB power to request information from banks when such information is not already available from FINMA.

- Strengthening the toolkit with minimum affordability ratios:
  - Most domestically-oriented banks comfortably meet current regulatory capital requirements; the proposed CCB and new risk weights will likely result in a small increase in mortgage interest rates which might not discourage imprudent lending and borrowing behavior when interest rates are at historical lows.
  - A minimum affordability ratio forbidding mortgages with debt service-to-income (DTI) ratios above a certain threshold is proposed.
  - Loan-to-value (LTV) ratios could also be considered, but may require supervisory monitoring of real estate valuations to ensure valuations are not inflated by overly optimistic estimates.
  - The envisaged activation process for the CCB could usefully be streamlined to ensure timely deployment.

- Fiscal and tax-related considerations:
  - Broader reforms to reduce or eliminate the preferential tax treatment of mortgage debt service should be considered.
    - Mortgage interest payments are deductible from taxable income in Switzerland, creating incentives to increase mortgage debt.
    - Homeowners are taxed on imputed rents from their property (net of maintenance expenses), so a reduction in the tax benefit from mortgages would have to be balanced by a change in taxation of imputed rents.

- The authorities’ view on macroprudential measures:
  - Confident that planned macroprudential tools would have some preventive effects.
  - Rejected affordability limits as too “market unfriendly.”
  - Noted that the need to set aside more capital would discourage mortgage growth, though domestically-oriented banks were mostly well capitalized.
  - Saw measures as building buffers in the banking sector to absorb potential mortgage-related losses.
  - Considered reforms of housing taxation unlikely to muster necessary political support.

### D. Reducing Financial Vulnerabilities
- Need for more rapid implementation of Basel III and TBTF capital requirements:
  - Two large Swiss banks are still weakly capitalized relative to peers in terms of high-quality capital while facing sizable risks: direct and indirect exposures to the euro zone crisis, legal contingent liabilities, and exposure to the Swiss mortgage market.
  - Heavy reliance on wholesale funding is a vulnerability.
  - Important for banks to build capital more rapidly, including by restricting cash distributions and raising external capital as early as feasible, because subdued profitability prospects make relying on retained earnings only challenging.
  - Raising capital in current market conditions may be costly; in a stress scenario cost would likely become prohibitive.
  - Banks have moved ahead with issuance of contingent capital (CoCos); however, the loss-absorbing capacity of these instruments remains untested.
    - Note: So far, three Swiss banks have successfully issued CoCos with differing convertibility or write-down features.

- Progress on bank resolvability (TBTF strategy):
  - New TBTF legislation requires SIBs to prepare a recovery and resolution plan to ensure continuity of systemically important functions in Switzerland in case of financial distress.
  - Legislation creates incentives for banks to make further progress toward global resolvability; progress may result in rebates on capital requirements.
    - Size of rebates will depend on progress in achieving structural, financial, and operational unbundling.
  - SIBs affected by resolvability requirements in the U.S. and U.K.; recovery and resolution plans will be evaluated by supervisors in all three countries.
  - Reforms will grant FINMA new powers to intervene in distressed banks.

- Microprudential supervision:
  - FINMA has adopted a risk-based approach in all areas of supervision and increased on-site reviews and regulatory audits.
  - Outsourcing of supervisory work to auditors (hired by the banks) remains prevalent.
  - A costly “rogue trader” scandal at one of the SIBs highlighted the need to enhance oversight of risk management and internal controls of large banks.
  - Resources should be further expanded to broaden FINMA’s in-house supervisory capacity.

- Insurance sector:
  - Implementation of the Swiss Solvency Test (SST) by all insurers and reinsurers should improve risk management.
  - In 2011, FINMA rendered about 30 decisions on internal model approval requests, with full approval granted in 25 percent of the cases.
  - Supervisory focus on less transparent intra-group transactions to identify and eliminate unlimited guarantees.
  - Given relatively high level of intra-group balances, oversight of intra-group connections needs strengthening to contain contagion risk.

- The authorities’ view on financial vulnerabilities:
  - Recognize that large banks remain thinly capitalized but are confident progress under new regulatory framework will be adequate.
  - Agreed that fast progress was desirable, closely monitoring bank capital building progress, and ready to act if banks did not fulfill new requirements.
  - Expected market discipline to put pressure on banks to move faster; forcing more transparent bank reporting of capital adequacy according to full Basel III standards would foster such discipline.
  - Considered CoCos would help mitigate risk of low capitalization as these instruments would be loss-absorbing.
  - Underscored importance of rapid progress towards resolvability and stressed Swiss approach of putting banks in charge of devising convincing solutions.
  - On supervision, noted ongoing progress in building in-house capacity but pointed out reliance on external auditors allowed flexibility to quickly put into place supervisory capacity in specific areas.
  - FINMA has asked large banks to assess internal control procedures to prevent unauthorized trading against prudent practices and will take action if needed.

### E. Fiscal Policies—Standing Ready for Cyclical Support and Reforming Aging-Related Spending
- Fiscal stance and short-term support:
  - Fiscal stance is appropriately neutral given growth prospects.
  - Fiscal policy should be ready to support aggregate demand to the extent feasible under fiscal rules if the outlook deteriorates.
  - From a longer-term perspective, fiscal policy should be conservative in light of population aging and financial sector risks (including guarantees for cantonal banks and public pension funds).
  - Available leeway under fiscal rules and additional room during budget implementation should be used to prop up aggregate demand if recovery stalls.
  - Fiscal multipliers are estimated to be similar to those of other advanced small open economies (see Annex IV).

- Tackling aging-related costs and automatic adjustors:
  - Rapid progress in tackling the cost of an aging population is needed and automatic adjustors (“fiscal rules”) for pensions would be useful.
  - Specific measures to consider:
    - Equalization of the male and female retirement age.
    - Pension indexation to inflation only (rather than both inflation and wages).
    - Automatic adjustors of the pension age and/or benefits to life expectancy.
  - Health care reforms, including hospital financing reforms, are welcome and should be carefully monitored.
  - Strengthening coordination mechanisms, including across government levels, could facilitate design of additional measures.

- The authorities’ view on fiscal policy and aging:
  - Expressed skepticism about discretionary fiscal policy.
    - Philosophy behind the debt brake rule is to eschew discretionary fiscal policy and emphasize automatic stabilizers.
    - Parliament was reluctant to go beyond fiscal measures introduced in August 2011.
    - Feasible timely and targeted projects are difficult to find; infrastructure projects not advisable given high capacity utilization in construction sector.
  - Concurred with case for additional reforms on aging costs but concerned about political acceptability of automatic benefit adjustors.
    - Alternative: stipulation mandating the government to pass reforms if financial imbalances in social security funds occur (e.g., liquidity reserves of pay-as-you-go pillar fall below a certain percentage of annual expenditure).
    - Parallel temporary benefit and/or contribution measures (e.g., suspension and/or postponement of regular pension increases in line with inflation and/or wages) could ensure liquidity and build pressure for political consensus.

### STAFF APPRAISAL (Key findings and recommendations)
- Near-term economic outlook:
  - Economy is well positioned to return to moderate growth in the second part of this year, but uncertainty is high.
  - As global demand picks up and the tradable sector adjusts to the new level of the exchange rate, output growth should recover in the second part of the year.
  - Output gap should remain close to zero and unemployment increase modestly.
  - Inflation should turn positive once exchange rate pass-through effects peter out.
  - Possible financial sector ramifications of sovereign and banking sector fragilities in the euro zone are the main downside risk.

- Exchange rate floor assessment:
  - Introduction of the exchange rate floor in September 2011 was appropriate given risks of entrenched deflation and recession, negative inflation, and capital inflows.
  - Alternative policy options were limited: interest rates at the zero bound, discretionary fiscal policy limited by the debt brake rule, and quantitative easing constrained by the small domestic bond market.
  - SNB exchange rate commitment is seen as credible by markets and has stabilized the currency.

- Exit strategy:
  - Once economic conditions normalize, a return to a freely floating currency would be desirable.
  - Delaying exit risks stoking inflation, especially if money supply had to be expanded pro-cyclically to absorb renewed capital inflows.
  - A strong economy and resurgent inflation might undermine credibility of the commitment to defend the floor.

- Fiscal policy stance:
  - Current fiscal stance is appropriate but would need to be loosened if support for fragile economic growth is needed.
  - From a longer-term perspective, a conservative fiscal policy is appropriate due to potential fiscal risks related to the financial sector and aging population.
  - In the short term, broadly neutral stance is appropriate; if recovery stalls, advisable to use countercyclically the limited leeway available under fiscal rules.

- Aging-related fiscal reforms:
  - Measures to tackle financial consequences of population aging should gain center stage and include additional “fiscal rules.”
  - Under unchanged policies, increase in aging-related expenditure will start to bite around the end of this decade; time for reform preparation and implementation is running out quickly.
  - A “fiscal rule” that automatically links retirement age and/or pension benefits to life expectancy could be usefully introduced.

- Banking sector priorities:
  - Rapid implementation of Basel III and TBTF capital requirements and progress on bank resolvability are paramount.
  - TBTF legislation will substantially raise requirements for high quality capital in systemically important banks but has a relatively long implementation period.
  - Rapid progress to strengthen quantity and quality of capital in large banks is needed during the transition.
  - More capital alone cannot fully eliminate TBTF risk; progress toward improving bank resolvability should continue.

- Macroprudential toolkit for mortgage risks:
  - Broad set of macroprudential instruments is urgently needed to address rising mortgage market risks as monetary conditions may remain loose and the risk of a bubble intensifies.
  - Stepped up monitoring and supervision will help contain risks in domestically-oriented banks with high mortgage loan concentration.
  - Basel III counter-cyclical capital buffer and higher risk weights on riskier mortgages, if implemented, will increase buffers and may help prevent imprudent behavior, but their effectiveness warrants close monitoring.
  - More direct tools, such as minimum affordability ratios, should be included in the macroprudential toolkit for ready deployment if a housing bubble starts to develop.
  - Improving access to bank information would help the SNB better fulfill its macroprudential oversight responsibility.
  - Consideration should be given to reducing tax incentives for households to take on mortgage debt.

- Supervision and insurance sector recommendations:
  - Efforts to upgrade bank and insurance microprudential supervision are welcome; more progress is encouraged.
  - Adoption of a risk-based approach, increased on-site reviews, and stronger supervisory involvement in regulatory audits should improve supervision quality.
  - Resources should be further expanded to broaden in-house supervisory capacity and reduce reliance on external auditors.
  - In the insurance sector, SST implementation has helped improve solvency and risk management; oversight of intra-group connections needs strengthening to contain contagion risk.

*Source: 2012 ARTICLE IV REPORT SWITZERLAND*

### 52.      It is recommended that the next

### _cr12106 - 52.      It is recommended that the next

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

### Macroeconomic projections and key indicators (selected figures from Tables 1–4)
- Real GDP (percent change): 2008: 2.1; 2009: -1.9; 2010: 2.7; 2011: 1.9; 2012: 0.8; 2013: 1.7.
- Total domestic demand (percent change): 2008: 0.5; 2009: 0.6; 2010: 1.6; 2011: 0.9; 2012: 0.9; 2013: 2.0.
- Private consumption (percent change): 2008: 1.4; 2009: 1.4; 2010: 1.7; 2011: 1.0; 2012: 1.1; 2013: 1.5.
- Nominal GDP (billions of Swiss francs): 2008: 545.0; 2009: 535.6; 2010: 550.6; 2011: 564.8; 2012: 570.5; 2013: 583.9.
- Gross national saving (percent of GDP): 2008: 23.3; 2009: 30.3; 2010: 34.3; 2011: 34.6; 2012: 34.1; 2013: 34.3.
- Current account balance (percent of GDP): 2008: 2.2; 2009: 11.0; 2010: 15.0; 2011: 14.8; 2012: 11.8; 2013: 11.3.
- Consumer price index (percent change): 2008: 2.4; 2009: -0.5; 2010: 0.7; 2011: 0.2; 2012: -0.5; 2013: 0.5.
- Unemployment rate (percent): 2008: 2.6; 2009: 3.7; 2010: 3.8; 2011: 3.1; 2012: 3.4; 2013: 3.6.
- General government balance (percent of GDP): 2008: 1.9; 2009: 0.5; 2010: 0.2; 2011: 0.4; 2012: 0.2; 2013: 0.2.
- Gross debt (general government, percent of GDP): 2008: 52.6; 2009: 53.6; 2010: 50.1; 2011: 48.6; 2012: 48.9; 2013: 47.8.
- Three-month SFr LIBOR (percent): 2008: 0.7; 2009: 0.3; 2010: 0.2; 2011: 0.1.
- Swiss francs per U.S. dollar (annual average): 2008: 1.1; 2009: 1.1; 2010: 1.0; 2011: 0.9.
- Swiss francs per euro (annual average): 2008: 1.6; 2009: 1.5; 2010: 1.4; 2011: 1.2.

### External sector and balance of payments (selected figures from Table 2 and Annex)
- Current account (billions of Swiss francs): 2008: 125; 2009: 98; 2010: 384; 2011: 67; 2012: 66; 2013: 75.
- Goods balance (billions of Swiss francs): 2008: 15; 2009: 17; 2010: 13; 2011: 16; 2012: 10; 2013: 10.
- Exports (billions of Swiss francs): 2008: 217; 2009: 188; 2010: 204; 2011: 209; 2012: 205; 2013: 217.
- Imports (billions of Swiss francs): 2008: -202; 2009: -172; 2010: -191; 2011: -192; 2012: -195; 2013: -208.
- Current account (percent of GDP): 2008: 2.2; 2009: 11.0; 2010: 15.0; 2011: 14.8; 2012: 11.8; 2013: 11.3.
- Net IIP (in percent of GDP, memorandum): 2008: 120.6; 2009: 140.4; 2010: 137.7; 2011: 154.2; 2012: 162.9; 2013: 168.8.
- Official reserves (billions of U.S. dollars, end period, memorandum): 2008: 90; 2009: 144; 2010: 244; 2011: 290.

### Fiscal sector (selected figures from Table 3 and Table 6)
- General Government revenues (percent of GDP): 2008: 34.5; 2009: 34.9; 2010: 34.3; 2011: 35.2; 2012: 34.9; 2013: 34.8.
- General Government expenditures (percent of GDP): 2008: 32.6; 2009: 34.4; 2010: 34.0; 2011: 34.7; 2012: 34.7; 2013: 34.6.
- Federal Government (billions of Swiss francs): Revenues 2008: 62.6; 2009: 60.6; 2010: 61.3; 2011: 63.9; 2012: 63.1; 2013: 63.5; Expenditures 2008: 57.3; 2009: 58.1; 2010: 59.4; 2011: 63.5; 2012: 64.0; 2013: 64.8.
- General Government gross debt (percent of GDP, memorandum): 2008: 52.6; 2009: 53.6; 2010: 50.1; 2011: 48.6; 2012: 48.0; 2013: 46.3; 2014: 45.5.

### Swiss National Bank balance sheet (selected figures from Table 4)
- Total assets (millions of Swiss francs): 2005: 108,988; 2006: 111,813; 2007: 126,927; 2008: 214,323; 2009: 207,264; 2010: 269,955; 2011: 346,078.
- Gold (millions of Swiss francs): 2005: 28,050; 2006: 32,221; 2007: 34,776; 2008: 30,862; 2009: 38,186; 2010: 43,988; 2011: 49,380.
- Foreign currency reserves (millions of Swiss francs): 2005: 46,585; 2006: 45,592; 2007: 50,586; 2008: 47,429; 2009: 94,680; 2010: 203,810; 2011: 257,504.
- Monetary base (millions of Swiss francs): 2005: 41,871; 2006: 43,124; 2007: 44,198; 2008: 49,562; 2009: 99,087; 2010: 90,208; 2011: 137,728.
- Balance sheet, percent of GDP (memorandum): 2005: 24.2; 2006: 24.0; 2007: 26.2; 2008: 43.4; 2009: 42.8; 2010: 54.2; 2011: 68.3.

### Financial sector soundness (selected figures from Table 5)
- Regulatory capital as percent of risk-weighted assets (banks): 2004: 12.6; 2005: 12.4; 2006: 13.4; 2007: 12.1; 2008: 14.8; 2009: 17.9; 2010: 17.3; 2011: 16.1 (Jun-11).
- Regulatory Tier I capital to risk-weighted assets: 2004: 13.3; 2005: 13.0; 2006: 13.4; 2007: 11.6; 2008: 12.3; 2009: 15.2; 2010: 15.6; 2011: 15.0 (Jun-11).
- Non-performing loans as percent of gross loans: 2004: 0.9; 2005: 0.5; 2006: 0.3; 2007: 0.3; 2008: 0.5; 2009: 0.5; 2010: 0.5.
- Households share of bank credit to the private sector (percent): 2004: 65.2; 2005: 66.6; 2006: 68.5; 2007: 71.5; 2008: 65.4; 2009: 67.1; 2010: 68.3; 2011: 68.8.
- Gross profits as percent of average assets (ROAA): 2004: 0.8; 2005: 0.9; 2006: 0.9; 2007: 0.7; 2008: 0.3; 2009: 0.5; 2010: 0.7; 2011: 0.8 (Jun-11).
- Liquid assets as percent of total assets: 2004: 24.5; 2005: 24.7; 2006: 25.2; 2007: 27.1; 2008: 29.2; 2009: 27.7; 2010: 23.5; 2011: 22.4 (Jun-11).
- Net long position in foreign exchange, % of tier I capital: 2004: 15.5; 2005: 30.6; 2006: 21.9; 2007: 13.7; 2008: -16.1; 2009: -23.2; 2010: -41.1; 2011: -35.3 (Jun-11).

### Long-term perspective on Swiss external accounts (Annex I findings)
- Switzerland has run sizable current account surpluses longer than any other advanced economy; current account trended upwards since the early 1990s, peaking at 15 percent of GDP in 2006 and again in 2010–11.
- Drivers of long-term current account performance:
  - Growing surplus in the investment income account, reflecting a large net foreign asset (NFA) position and high yields on net direct investment.
  - Rising positive balances in the goods and services account, including strong export performance in technology-intensive and highly-specialized sectors (watches, medical equipment, pharmaceuticals).
  - Widening surplus in services trade largely accounted for by the merchanting sector; the banking financial services surplus has shrunk since the global financial crisis.
- Net foreign assets: Swiss NFA grew from 83 percent of GDP in 1995 to 138 percent of GDP in 2010.
- Discrepancy between accumulated current account surpluses and NFA accumulation: over 2000–10, average accumulation of NFA was 3½ percent of GDP per year vs. average current account surplus of over 10 percent of GDP; valuation changes affected foreign assets more negatively than foreign liabilities.
- Factors contributing to NFA build-up:
  - Demographics: large share of population nearing retirement tends to correlate with larger NFA positions.
  - Pension system: mandatory second-pillar retirement saving accounts for half of household saving and 15 percent of gross national saving; pension funds held assets worth more than 100 percent of GDP in 2009.
  - Role as an international financial center is associated with large current account surpluses and positive NFA positions.
- Implications for exchange rate:
  - Large NFA positions tend to be associated with more appreciated real exchange rates and long-run trade balance deterioration.
  - The large Swiss net foreign asset position may be a long-term factor pushing up the exchange rate.

*Source: 2012 ARTICLE IV REPORT SWITZERLAND, International Monetary Fund.*

### ANNEX II. SWITZERLAND: FISCAL DISCIPLINE IN A FEDERAL SYSTEM

### ANNEX II. SWITZERLAND: FISCAL DISCIPLINE IN A FEDERAL SYSTEM

### Institutional setting and inter-governmental fiscal relations
- Switzerland is a confederation of 26 cantons and almost 2600 municipalities.
- Public finances are highly decentralized; subnational governments have considerable autonomy in determining key parameters of the bulk of taxes they receive, such as the tax rate, leading to substantial heterogeneity across cantons and significant tax competition.
- Recent reform of inter-governmental fiscal relations:
  - Reform became effective in 2008 after a long preparation period.
  - Distribution of tasks across government levels was streamlined: out of 40 areas for which the confederation and cantons used to have joint responsibility, 17 are now exclusively assigned to one of the two levels.
  - Where joint responsibility remains, strategic tasks are assigned to the federal level and operational tasks to the cantons; cooperation among cantons has been enhanced.
  - Volume of ear-marked transfers was substantially reduced; fiscal equalization rationalized to two mechanisms:
    - Compensations for different fiscal resource potentials across cantons (financed by both the federal level and relatively better-off cantons).
    - Compensations for differing fiscal needs arising from socio-demographic or geographic characteristics (exclusively financed by the federal level). The socio-demographic criterion benefits mostly urban areas; the geographic criterion benefits mainly peripheral cantons with low population density.
  - Transition compensation payments to ease the shift from the old to the new system are to be successively reduced over a time period of almost thirty years unless abolished earlier by parliament during regular reform reviews.
- No-bail-out presumption:
  - A presumption of “no bail-out” at both the cantonal and municipal level avoids fiscal moral hazard.
  - Confirmed in the 1990s when several cantons faced dire financial straits due to guarantees to cantonal banks.
  - Corroborated at the municipal level in 2003 by the Swiss Federal Court decision regarding the municipality Loèche les Bains (canton Valais not responsible for its liabilities).
  - Cantonal ratings differ significantly and do not appear to assume federal bail-out support; variation of spreads across cantons suggests close link with fiscal position and strength of fiscal rules.
- Incentive effects:
  - The rationalized intergovernmental system, credible no-bail-out presumption, and high tax autonomy create a close link between spending decisions and responsibility for financing at the same government level, fostering responsible use of public resources and compliance with fiscal rules.
  - Strong elements of direct democracy also reinforce these incentives.

### Fiscal rules: design, implementation, and implications
- Fiscal rules are present at both the federal and subnational levels.
- Federal “debt brake” rule:
  - Main federal fiscal rule is the “debt brake,” essentially a cyclically-adjusted balanced budget rule with an error-correction mechanism in the form of a notional “compensation account.”
  - The compensation account accumulates deviations of budget outcomes from rule requirements and mandates additional consolidation efforts once a negative balance of 6 percent of expenditure is reached.
  - Operationalized via annual expenditure ceilings that can only be raised in exceptional circumstances out of authorities’ control (e.g., a severe recession). The severity of a recession is determined through a number of indicators and any deviation from the fiscal rule requires an absolute majority in both chambers of parliament.
  - Enshrined into the constitution and effective in 2003 after large deficits in the 1990s.
  - Result: federal debt-to-GDP ratio fell by some 10 percentage points after inception, aided by the asymmetry of the rule which allows for overperformance.
- Subnational fiscal rules:
  - Most cantons have fiscal rules, but these are heterogeneous in target, operational implementation, exemption clauses, and sanctioning mechanisms.
  - Municipal finances are subject to oversight by the respective canton.
- Long-term sustainability and aging:
  - Absorbing imminent aging-related expenditure increases would benefit from additional fiscal rules that anchor long-term sustainability.
  - In particular, the pay-as-you-go pension pillar would gain from automatic adjustors of the pension age and/or benefits to life expectancy to reduce need for repeated and difficult reform discussions and potential ad-hoc reform decisions.
- Overall assessment:
  - The rationalized intergovernmental fiscal relations (clear task assignments, rationalized financial equalization flows, a no-bail-out presumption, and significant tax autonomy) have delivered a culture of fiscal discipline and a credible commitment to and consistent compliance with fiscal rules.

### ANNEX III. The Short-Term Effect of Real Appreciation on Swiss Economic Growth: A VAR Analysis — key findings
- Context and motivation:
  - The Swiss franc appreciated in real effective terms by almost 30 percent between 2008Q3 and 2011Q3, with a similar bilateral appreciation against the euro.
  - Real appreciation is typically contractionary by shifting demand away from domestic output; despite a 2009 recession, growth recovered in 2010 and early 2011 as world recovery dominated the contractionary exchange rate effect.
- VAR model set-up:
  - Estimated a vector autoregression (VAR) with six endogenous variables and 8 lags (lag length determined by Akaike tests).
  - Model distinguishes global variables (not affected by Swiss-specific developments) and Swiss macro variables by constraining Swiss variables’ effect on global variables to nil.
  - Global variables: world GDP growth (world) and log change in oil prices in US dollars (dloilp).
  - Swiss variables: GDP growth (growth), differential in short-term interest rates between Switzerland and the euro area (Germany before euro adoption) (dshort), log change in the real effective exchange rate (dlreer), and CPI inflation (infl).
  - Sample period: 1991Q1 to 2011Q4.
  - Identification via Cholesky decomposition ordering: world GDP growth, change in oil prices, Swiss GDP growth, interest rate differential, change in the REER, CPI inflation. Swiss variables constrained out of world GDP and oil equations in the reduced form.
- Main empirical results:
  - The real exchange rate has exhibited trend appreciation with fluctuations around the trend (trend evident since at least the mid 1970s).
  - Shocks to the real exchange rate tend to vanish after a few years.
  - A typical REER shock (a one-standard-deviation shock) causes a quarterly appreciation of about 1¼ percent on impact.
  - Real appreciations have been followed by brief but economically and statistically significant reductions in the differential between Swiss franc and euro short-term rates, suggesting monetary policy responses aimed to counter REER effects on output or inflation.
  - Peak impact on GDP growth occurs in the second quarter after the REER shock (relatively short lag).
  - Cumulative effect on GDP: a one-standard-deviation shock to REER causes a loss of about 0.2 percent in the GDP level relative to baseline over 2 years.
  - Effect on inflation is small and not immediate: for a typical REER shock, the price level is less than 0.1 percentage point lower after 2 years.
- Comparative importance of shocks:
  - A typical shock to world GDP has a larger estimated effect on Swiss GDP growth than a shock to dlreer or dshort.
  - The estimated effect of the interest differential (dshort) has the opposite sign than expected.
  - Variance decomposition: at all horizons, global GDP growth dominates the contribution to Swiss GDP growth volatility relative to domestic shocks, oil prices, monetary policy, or real exchange rate.
- Contribution of recent REER movements to growth weakness:
  - Recovered structural shocks to the REER equation since 2008Q1 and computed their implied impulses to GDP growth.
  - In preferred estimates, the REER equation has explanatory power for GDP growth; its residuals since 2007 were negative for a few quarters but sharply positive over 2011.
  - According to the model, past movements in the real exchange rate will cut quarterly growth by about 1 percentage point between 2011Q4 and 2012Q4, with some of this effect offset from 2013 onwards.
  - Interpretation: the Swiss economy faces near-term headwinds from the franc’s appreciation during the last few years.

### ANNEX IV. Fiscal multipliers in Switzerland — summary
- General considerations:
  - Research shows fiscal multipliers vary widely depending on model, monetary policy assumptions, type and persistence of spending/tax cuts, financing, and degree of excess capacity in the economy or affected sectors.
- Empirical evidence and OECD findings:
  - Recent OECD work on the 2008–09 crisis confirms fiscal multipliers in Switzerland are smaller than in larger and more closed economies but are not negligible and are similar to those in other small open economies.
  - Estimates are based on an average of simulation results from various macro models surveyed in the OECD study.
  - Simulations considered assume accommodative monetary policy (consistent with current Swiss circumstances) and account for openness; multipliers should be seen as an upper bound because they are not adjusted for factors like increased propensity to save in crisis times.
  - For evaluating the 2008/2009 fiscal packages the OECD made judgmental adjustments to compute “reference multipliers.”
- Relative effectiveness by instrument:
  - Increases in government investment have the largest effect on output.
  - Government consumption increases have the next largest effect.
  - Increases in transfers or tax cuts have smaller effects.

*International Monetary Fund — ANNEX II. SWITZERLAND: FISCAL DISCIPLINE IN A FEDERAL SYSTEM (from the 2012 Article IV Report)*

### 4.      In conclusion, these results suggest

### _cr12106 - 4.      In conclusion, these results suggest

### Fiscal stimulus effectiveness and multipliers
- Conclusion: a fiscal stimulus in Switzerland would be effective in mitigating an economic downturn, even if the exact magnitude of its impact remains hard to predict.
- Swiss-specific multiplier estimates:
  - KOF estimated a GDP multiplier of 0.3 in the first year of a construction stimulus, assuming spare capacity in the construction sector.
  - Unpublished simulations of the Swiss Federal Finance Administration feature an expenditure multiplier of 0.6 in the first year.
- OECD short-term fiscal multipliers (percentage effect on GDP, averaged over the first and second year, of a 1 percent of GDP change in the relevant budget component). Selected row for Switzerland:
  - Government consumption: Year 1 0.6 Year 2 0.4
  - Transfers to Households: Year 1 0.45 Year 2 0.45
  - Investment: Year 1 0.9 Year 2 0.9
  - Indirect Tax: Year 1 -0.3 Year 2 -0.2
  - Personal Income Tax: Year 1 -0.45 Year 2 -0.45
- OECD Reference Multipliers (year-by-year breakdown). Selected row for Switzerland:
  - Government consumption: Year 1 0.4 Year 2 0.5
  - Transfers to Households: Year 1 0.3 Year 2 0.5
  - Investment: Year 1 0.7 Year 2 0.9
  - Indirect Tax: Year 1 -0.1 Year 2 -0.2
  - Personal Income Tax: Year 1 -0.2 Year 2 -0.3

### Macroeconomic outlook, projections, and risks
- Near-term macro outlook and risks:
  - Faced with euro area debt crisis and a strong currency, the economy slowed in late 2011; inflation turned negative as exchange rate appreciation was passed through to import prices.
  - Outlook for 2012: gradual recovery as foreign demand picks up, the economy adapts to the higher level of the exchange rate, and monetary policy remains accommodative.
  - Downside risks are significant, especially from external developments.
- Key monetary policy facts and actions:
  - On September 6, 2011, the SNB set a minimum exchange rate of CHF 1.20 per euro and committed to defending the limit by buying foreign currency in unlimited quantities.
  - In 2011 the SNB purchased foreign currency to a value of approximately CHF 17.8 billion to enforce the minimum exchange rate.
  - Effective September 6, 2011, the de facto exchange rate arrangement is other managed.
- Executive Board view on exchange rate floor:
  - Considered appropriate given slow activity and deflation risks; Directors encouraged returning to a freely floating exchange rate regime once growth and inflation normalize, noting dual risks of removing the floor too soon or maintaining it too long.

### Financial sector vulnerabilities and policy responses
- Main vulnerabilities:
  - Domestic mortgage credit and real estate prices continue to rise briskly; concern about a possible bubble endangering domestically-oriented banks and insurance companies.
  - Two large banks: marked performance deterioration in 2011 after improvement in 2010; income generation lagging peers; rely heavily on wholesale funding and have a relatively thin layer of high quality capital.
- Policy and regulatory responses recommended or underway:
  - Strengthen macroprudential toolkit: introduce Basel III counter-cyclical capital buffer (CCB); improve classification of risk weights in mortgage lending; broaden SNB’s power to request information from banks.
  - Passage of “too big to fail” legislation requiring systemically important banks to hold more capital than Basel III.
  - Further progress needed to bolster loss-absorbing capital of systemically important banks; scope to raise high-quality capital recognized.
  - Improve bank resolution mechanisms and strengthen financial oversight, including broadening in-house supervisory capacity.
  - Macroprudential measures prioritized to address mortgage and real estate risks given constraints on monetary policy; consider a broad toolkit including CCB, increased risk-weights for riskier mortgage loans, and other macroprudential and fiscal measures.
  - Authorities note possible use of enhanced industry standards (self-regulation) as an alternative to mandatory affordability ratios.
- Financial stability assessment:
  - Switzerland requested a mandatory Financial Sector Stability Assessment under the FSAP scheduled towards the end of 2013.

### Fiscal position, policy stance, and long-term challenges
- Fiscal stance and indicators:
  - Fiscal position healthy and government debt low; broadly neutral stance projected for 2012.
  - General government fiscal balance in surplus for the sixth consecutive year in 2011.
  - Authorities committed to debt brake rule and structurally balanced budget approach.
- Projections (Selected items from Switzerland: Selected Economic Indicators, 2008–13)
  - RGDP (percent change): 2008 2.1 2009 -1.9 2010 2.7 2011 1.9 2012 0.8 2013 1.7
  - Nominal GDP (billions of Swiss francs): 2008 545.0 2009 535.6 2010 550.6 2011 564.8 2012 570.5 2013 583.9
  - Current account balance (percent of GDP): 2008 2.2 2009 11.0 2010 15.0 2011 14.8 2012 11.8 2013 11.3
  - Consumer price index (percent change): 2008 2.4 2009 -0.5 2010 0.7 2011 0.2 2012 -0.5 2013 0.5
  - Unemployment rate (in percent): 2008 2.6 2009 3.7 2010 3.8 2011 3.1 2012 3.4 2013 3.6
  - Gross debt (percent of GDP): 2008 52.6 2009 53.6 2010 50.1 2011 48.6 2012 48.9 2013 47.8
- Policy recommendations on fiscal policy:
  - Directors saw room for additional fiscal measures to support aggregate demand should downside risks materialize, in line with existing fiscal rules.
  - To cope with long-term fiscal implications of population aging, Directors advocated further reforms to the pension system, including measures to index benefits or the retirement age to life expectancy.
  - Authorities emphasize automatic stabilizers and remain skeptical on discretionary fiscal stimulus given past mixed experience; consider structurally balanced budget best approach.

### Data, statistics, and transparency issues
- Statistical strengths and gaps:
  - Switzerland generally publishes timely economic statistics and posts data and underlying documentation on the internet; full observance of SDDS requirements.
  - Remaining gaps: reliable general government finance statistics appear with considerable lags; pension statistics published with long lag; GDP by industry appears with considerable lag.
- Ongoing and planned improvements:
  - SNB enhancements: estimation of real estate assets in 2009; revised loan survey (reference date 31 March 2009); monthly survey on cost of borrowing (2010); survey on bank credit portfolio quality (2010); customer payments data (2011); qualitative lending policy survey since Q1 2008 turned into bank lending survey in 2011.
  - Work to revise trade in services survey with collection under new survey started in 2012.
  - Federal Finance Administration revamped fiscal statistics with GFSM 2001, HRM2, and NAM; quarterly estimates for general government aggregates to start in 2012.
  - Cooperation agreement with the EU (entered into force 2007, updated 2010) to harmonize statistics with EU standards, including BOP data and national accounts enhancements.

_International Monetary Fund — Staff Report excerpts and informational annex (2012 Article IV Consultation with Switzerland)_

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12106.pdf_