Switzerland: Staff Concluding Statement of the 2018 Article IV Mission
IMF News, March 26, 2018
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- Published: March 26, 2018
Overview
- Date: March 26, 2018.
- Main finding: The Swiss economy has adjusted to the large cumulative exchange rate appreciation that took place since the global financial crisis.
- Structural drivers: Switzerland’s openness, product and technology innovation, and safe-haven inflows contributed to a secular trend real appreciation and, post-crisis, a temporary overshoot of the exchange rate that slowed output and employment growth despite a broadly unchanged current account surplus.
- Recent dynamics: Efficiency gains have helped restore firms’ profit margins, positioning the domestic economy to benefit from the recent acceleration in world activity.
Outlook and risks
- Growth forecast and profile:
- GDP growth is forecast to lift to around 2¼ percent in 2018.
- Growth is expected to gradually moderate to 1¾ percent over the medium term.
- Current account:
- The current account surplus is expected to temporarily increase and settle at around 9 percent of GDP (with the caveat that adjusted for measurement issues the underlying current account would be lower).
- Inflation and labor market:
- Rising capacity utilization and a tightening labor market are projected to lift inflation to the middle of the target band.
- Upside and downside risks:
- Upside: Global upswing faster and more sustained than envisaged could raise Swiss GDP growth above forecasts.
- Downside risks include:
- Rising international trade tensions impacting an externally-oriented economy.
- Renewed safe-haven inflows sharply appreciating the franc and eroding competitiveness in less-productive sectors.
- Resurgence in global inflation triggering abrupt policy tightening by major central banks, causing volatility in financial markets and spillovers to Swiss property prices.
- Uncertainty regarding long-term Swiss-EU relations affecting cross-border flows.
- Delays in meeting international standards on corporate income taxation reducing Switzerland’s appeal as an investment destination.
Monetary and exchange rate policy
- Recent stance:
- The Swiss National Bank’s (SNB’s) two-pronged approach of negative interest rates and unsterilized foreign currency purchases supported the return of modest inflation and growth recovery while shielding the economy from safe-haven surges.
- Strengthening economy and modest reversal of appreciation pressures since mid-2017 alleviated the need for further loosening.
- Policy guidance:
- Any future tightening should depend on domestic conditions while taking account of policy decisions by major central banks.
- With GDP growth expected to overshoot potential only temporarily and underlying inflation forecast to rise more slowly than in the US or euro area, the domestic cyclical outlook does not suggest the need for a near-term tightening.
- Avoiding falling behind the curve is important to prevent a disruptive catchup response should unexpected events change the assessment.
- Exit and toolkit:
- Exit from accommodative policies is unlikely to return to the pre-crisis configuration of tools.
- If policy rates of major central banks peak well-below pre-crisis levels, scope for the SNB to raise its policy rate may be constrained.
- The SNB and other central banks are likely to maintain a considerably larger balance sheet than prior to the crisis, with divestments falling well-short of the previous buildup to avoid excessive tightening.
- Tool assignment and communication:
- A clear assignment of policy tools would enhance effective communication and avoid the impression of targeting the exchange rate.
- Recommendation: Use the interest rate for slow-moving cyclical conditions and expected inflation; reserve intervention for foreign exchange market surges that would otherwise cause temporary volatility in inflation and output, while accommodating a modest secular trend real appreciation.
Fiscal policy
- Current position:
- Fiscal position remains strong, with sustained small surpluses and declining public debt.
- The tax burden is relatively low by international comparison and spending is contained.
- A tendency to underspend budgeted allocations at the federal level leads to modest structural surpluses, reflecting a tightening bias in the design and execution of the debt brake rule (with similar rules at sub-national levels).
- The cumulative surplus in the compensation account rose to nearly 4 percent of GDP in 2017.
- Recent measures and evaluation:
- Recent measures to curtail within-year underspending are welcome, though the tightening bias in the rule’s design remains.
- New measures (including reserve funds to carry over investment allocations) are expected to gain effectiveness over time.
- Spending outside the perimeter of the debt brake can be stepped up, but at the cost of lower budget transparency and efficiency.
- Recommendation on the debt brake:
- Operate the rule’s ex post provision symmetrically—permit spending to catch up in the following year in response to a structural surplus—to achieve structural neutrality, increase annual fiscal spending moderately, and better serve the countercyclical function in a downturn.
- Consider allowing a larger (smaller) countercyclical response when debt is below (above) long-term sustainable levels.
- Fiscal space:
- Existing fiscal space affords flexibility for discretionary stimulus during a severe or prolonged downturn, supported by persistent modest structural surpluses, low public debt, and negative interest spreads on sovereign bonds.
- The debt brake rule envisages an “exceptional financial circumstances” clause allowing temporary suspension of the rule, which was invoked during the global financial crisis.
Financial stability
- Banking resilience:
- Considerable progress: Capital and liquidity buffers have increased across all bank categories.
- Macroprudential and regulatory measures introduced in 2012-14 targeted systemic risk in the real estate market.
- Too-big-to-fail regulations for global systemically-important banks are appropriately calibrated to the small size of the home economy.
- Emerging vulnerabilities:
- Sustained low interest rates are encouraging risk taking in some market segments.
- Low and flattened yield curves have reignited search for yield; competition from nonbanks pressures loan rates.
- Domestically-oriented banks increased mortgage lending and duration mismatch; lending standards have slipped with a significant share of new mortgages clustering near the indicative minimum down-payment level and falling short of loan affordability norms.
- Construction of new rental properties continues even though vacancy rates are rising.
- High concentration of bank lending into mortgages and high house prices and mortgage debt relative to income increases exposure.
- Domestic balance sheets heavily exposed to real estate directly and indirectly, creating potential adverse wealth effects amplifying a fall in real estate prices.
- Recommendations to reinforce macroprudential framework:
- Adopt stricter regulatory limits on loan-to-value and debt-to-income ratios with only limited exemptions allowed.
- Remove the tax deductibility of mortgage interest payments for private households and eliminate taxation of imputed rental income.
- Apply a surcharge on the risk weight for mortgages on investment property consistent with Basel requirements.
- Intensify monitoring of individual banks active in locally and regionally concentrated markets.
- Remove guarantees on cantonal banks.
- Subject nonbank mortgage lending to similar standards as banks to prevent regulatory arbitrage.
- Ensure financial sector oversight remains vigilant and independent.
Structural issues
- Pensions and aging:
- Life expectancy in Switzerland is 83 years; official retirement age remains 65 for men and 64 for women.
- Longer expected time in retirement encourages higher saving, compressing investment yields and inducing further saving, supported by tax incentives for pension contributions.
- Policy options to improve system viability:
- Encourage working longer or link the official retirement age to life expectancy.
- Increase immigration and raise full-time employment of women by addressing high childcare costs.
- For the second pillar, sustainability would be improved by linking the guaranteed conversion rate to the market yield on a long-term sovereign bond and life expectancy at retirement.
- Competitiveness and labor markets:
- High value-added, highly-profitable sectors pull up wages and prices, contributing to real appreciation and potential offshoring of production with re-shoring of profits.
- Labor-intensive, less internationally-mobile sectors may be affected and need productivity improvements.
- Recommendation: Adopt the recently-proposed corporate income tax (CIT) reform to lower the cost of investment for SMEs.
- Continued funding of STEM education and expanding the pool of highly-skilled Swiss and foreign workers is advised to sustain innovation and support life-long learning.
- These measures aim to preserve Switzerland’s high-and-stable share of labor income in GDP and low inequality of post-redistribution income.
- Reputation, taxation, and fintech:
- Maintaining Switzerland’s reputation as a global business destination requires regulatory certainty and continued adherence to international commitments.
- Timely compliance with international standards on CIT is critical to dispel uncertainty and avoid reputational risk that could negatively impact investment and growth.
- The CIT reform is an opportunity to revisit tax competitiveness and encourage R&D and SME investment; CIT rates are expected to become less dispersed across firms and cantons, implying some tradeoff between investment and revenue.
- Switzerland’s proactive fintech and initial coin offering regulatory approach is receptive to cutting-edge technologies; authorities recognize money laundering risks and require checks when converting into and out of fiat money.
- Recommendation: Stronger safeguards for preventing abuse of crypto assets are needed at the international level.
- Switzerland is addressing remaining deficiencies in its AML/CFT regime following its FATF mutual evaluation.
- The strengthened supervisory focus on cyber risk in the financial sector is welcome.
- Switzerland is progressing on tax transparency, with the first automatic exchange of tax information due this year and an expanding list of partner countries.
Closing acknowledgment
- The mission thanks the Swiss authorities and private sector counterparts for their hospitality and productive discussions.
Switzerland: Staff Concluding Statement of the 2018 Article IV Mission, March 26, 2018.