Press Release No. 15/239

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Switzerland

May 27, 2015

On May 18, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Switzerland.

Switzerland’s economy has performed relatively well in the aftermath of the global financial crisis, with growth reaching 2 percent in 2014. However, the economic environment became more complicated in late 2014, as increased capital inflows forced the Swiss National Bank (SNB) to start intervening heavily to defend its exchange rate floor of 1.20 francs per euro. The SNB eventually exited the floor on January 15, 2015, while also cutting its policy rate (the interest rate on deposits at the SNB exceeding 20 times required reserves) to -0.75 percent. Following these moves, the exchange rate appreciated substantially before stabilizing at around 1.05 francs per euro.

In the near term, economic growth in Switzerland is likely to slow, as the strong franc, which is now likely overvalued, reduces net exports. Consistent with this view, leading economic indicators have declined so far in 2015. For the full year, GDP growth is projected to slow to about 0.75 percent and to about 1.25 percent in 2016. This growth slowdown is expected to increase unemployment, but only modestly, in part due to the cushioning effects of short-time work arrangements. Inflation, which is already very low at -1.1 percent as of April 2015, is expected to fall further in 2015, as the effects from exchange rate appreciation and the recent decline in oil prices continue to pass through into final prices.

Over the medium term, the economy is expected to recover gradually. As the economy adjusts to the exchange rate appreciation, growth is projected to rise gradually back to around 2 percent over the medium term while inflation increases to around 1 percent. Switzerland’s fiscal rules are expected to keep the structural fiscal deficit near zero and government debt low.

However, this central scenario is subject to important risks. One key risk is that very low levels of inflation may complicate the operation of monetary policy by making it more difficult to reduce real interest rates as necessary in response to shocks. Indeed, yields on 10-year government bonds are negative and the lowest in the world, indicating significant risks of a protracted period of very low inflation and sluggish growth. Other important risks include uncertainty about future immigration policy and its effects on EU relations, global and regional economic developments, the effects of ongoing changes in the international financial regulatory landscape, and the potential for price reversals in the housing market, which has been buoyant in recent years.

To help address risks and medium-term challenges, the authorities have recently undertaken or proposed a numbers of reforms. These include various financial sector reforms (e.g., adoption of tighter lending standards for mortgages), proposed reforms to bolster the sustainability of the pension system, and proposed reforms of corporate taxation and financial controls to help comply with international initiatives aimed at limiting money laundering and cross-border tax evasion and avoidance.

Executive Board Assessment²

Executive Directors commended Switzerland's continued strong economic fundamentals underpinned by sound policy management. Directors noted, however, that following the exit from the exchange rate floor earlier this year and the subsequent appreciation of the franc, the economy faces currency overvaluation and weakened near-term growth and low inflation prospects.

Directors agreed that further monetary easing would support growth and reduce exchange rate overvaluation. In addition, they noted that moving inflation closer to the upper end of the target range over the medium term could mitigate risks associated with low inflation. However, a number of Directors considered that controlling inflation to this extent may not be feasible for the small and open Swiss economy.

Given the limited room for conventional monetary easing, Directors saw need to explore various options. In this regard a pre-announced program for asset purchases could be an option, although many Directors were not convinced about the effectiveness of such a program at this juncture. Looking ahead, Directors agreed that the policy rate should be maintained at its current level for now, as this has been helpful in reducing deflationary pressures. More broadly, they encouraged the central bank to further enhance communication of its monetary policy framework and to continue to prioritize provisioning over transfers to its distribution reserve to ensure that its capital remains in line with risks.

Directors commended Switzerland’s fiscal rule which has helped maintain low deficits and debt. They concurred that for fiscal policy to support growth, automatic stabilizers should be allowed to operate fully, as permitted under Switzerland’s debt-brake rule, while avoiding budgeting over-performance against the rule. Directors generally agreed that in the event of a severe or protracted recession, discretionary fiscal stimulus could be employed by triggering the rule’s temporary escape clause to help boost growth and inflation and avoid overburdening monetary policy.

Directors welcomed the progress made in financial sector reforms and encouraged further action in line with the Brunetti Report and the FSAP update. They highlighted the need to closely monitor financial stability risks in the housing market and adopt further prudential measures as needed. These could include raising minimum leverage ratio requirements of the two large international banks and improving their resolvability, increasing banks’ disclosure of information of risk weights, further refining FINMA’s use of external auditors, and overhauling deposit insurance. Directors also called for continued monitoring of the effects of the low-interest rate environment, especially for life insurers and defined-benefit pension plans.

Directors underscored the need to sustain structural reforms to support medium-term growth and address challenges. In this regard, they called for action to reduce uncertainty related to future immigration policy and its effect on relations with the European Union. Directors looked forward to the timely completion of the corporate tax reforms and financial controls, consistent with international initiatives aimed at limiting money laundering and cross-border tax evasion and avoidance. Reforms to boost full-time female labor force participation, such as lowering marginal tax rates on second incomes, could also enhance potential growth. Directors welcomed the proposed pension reforms, which would help ensure the sustainability of the social safety net and its continued availability for future generations.