Mission Concluding Statement 

Switzerland: Staff Concluding Statement of the 2019 Article IV Mission

April 1, 2019

The renewed prospect of global “low-for-long” interest rates and the possibility of a resurgence in international economic and political risk could trigger safe haven pressures on the Swiss franc and push inflation into negative territory. To increase policy space, the current balance between the utilization of monetary and fiscal policies—stretched monetary policy and underutilized fiscal policy—should be adjusted. Assigning a greater role to fiscal policy, including by increasing public sector spending within the existing framework, would better cushion the economic cycle, support longer-term growth, and prepare the economy for demographic and technological change.

A persistent low growth—low inflation environment is sustaining search for yield and driving risks in the real estate market, especially for residential investment properties. The financial sector’s large exposure to real estate calls for measures to dampen risks, along the lines of those recently proposed. Given the vulnerabilities and the large size and complexity of the Swiss financial system, continual upgrading of regulatory and supervisory frameworks and capacities is strongly encouraged.

Outlook and risks

Weak external demand, which began in the second half of last year, combined with subdued domestic demand and the absence of biennial international sporting events, is expected to slow GDP growth to around 1.1 percent in 2019. However, the softening of growth is expected to be temporary, with a recovery to about 1½ percent forecast for 2020. Inflation is projected to remain just-below one percent and the output gap is estimated to remain modest as immigration continues to ease skilled labor shortages and capacity constraints. The current account surplus is expected to stay around 10 percent of GDP.

External and domestic risks to the outlook are pointed to the downside. A more sustained regional slowdown, intensification of global trade tensions and a disruptive Brexit would adversely affect the highly-open Swiss economy. A persistent low growth—low inflation environment would sustain search for yield pressures and drive risks in the real estate market, especially for residential investment property. Uncertainty regarding the finalization of a framework agreement with the European Union could weaken investor sentiment and trigger counter-measures. Uncertainty over outcomes of the reform agenda, including corporate taxation and old-age pensions, could increase volatility for business operations.

Macroeconomic policy mix

The current deployment of monetary and fiscal policies should be rebalanced. With the Swiss franc a safe haven currency, the policy interest rate in negative territory and international reserves at a high level, monetary policy is being stretched, while fiscal policy remains underutilized even within the debt brake rule. Assigning a greater role to fiscal policy would better cushion the economic cycle and support longer-term growth. Borrowing costs for the Swiss government remain among the lowest in the world, and rates on 10-year government bonds have moved back into negative territory. In this setting, benefits from continuing to reduce already-low public debt are minimal, while raising the share of public spending in GDP within the existing debt drake rule, would partially offset subdued external demand. Moreover, fiscal policy is more potent when interest rates are low. The current dip in economic growth provides a good opportunity to deploy the existing room under the federal-level debt brake rule to increase public spending, together with increased investment by cantons, with a focus on helping to prepare the economy and the population for technological change and aging. It would also avoid over-reliance on monetary policy.

Fiscal policy

The fiscal position remained very strong in 2018. The federal-level surplus rose to about ½ percent of GDP, driven by higher-than-projected withholding tax revenue and underspending relative to the budget. With the output gap broadly closed, the structural surplus was of a similar size, considerably higher than the balanced position mandated by the debt brake rule. Systematic conservative implementation of the rule during periods of low growth places a drag on the economy.

The countercyclical role of the debt brake rule—one of its key features—should be strengthened. To strengthen the countercyclical capacity of the rule, the systematic surplus in the fiscal outturn should be allocated to raising spending, rather than to cutting taxes. Fiscal multipliers are also usually larger when spending is increased than when taxes are lowered. However, proposals currently under consideration would allocate the surplus to reducing taxes, some of which would disproportionately benefit wealthy taxpayers. As it is typically more difficult to raise than to lower taxes, reducing rates in the near term could, in effect, relinquish public resources that may be difficult to subsequently recoup to address future spending needs, including shortfalls in the pension system. The stabilizing function of the rule would also be enhanced if revenue forecasting were further improved and the output gap estimate were based on GDP excluding the effects of biennial international sporting events.

Population aging and technological change will likely increase demands on public resources. Rising longevity and fewer people of working age in the total population will require adjustments to the pension system, including equalizing male and female retirement ages and subsequently raising the retirement age in tandem with life expectancy, as well as higher tax revenue. Demands on public finances will also increase to cover aging-related health care expenses, as well as costs of continuing to upskill the population and smooth potentially more-frequent employment transitions for workers. This additional public spending would be an investment in Switzerland’s future, and by boosting future growth, would be partly self-financed.

Monetary policy

Since early 2015, the Swiss National Bank’s dual instruments (a negative policy rate and unsterilized foreign currency intervention) have been effective at deterring safe-haven inflows and allowing inflation to remain within its definition of price stability, albeit mainly on the lower side. The SNB’s actions allowed the real exchange rate with Switzerland’s trading partners to appreciate broadly in line with its long-term trend, despite several episodes of volatility triggered by international risk aversion.

Continuation of accommodative policies by major central banks could constrain the flexibility of Swiss monetary policy, although the SNB retains the needed policy space to continue to achieve its price stability objective, despite somewhat less room than in the past. If needed, moving further into negative interest rate territory remains feasible to address persistent low inflation. Doing so would strengthen the already-pressing need for prudential measures to contain excessive risk-taking in the real estate sector. Foreign currency intervention should be reserved mainly for addressing large exchange market pressures that would otherwise cause excessive volatility in inflation and output, and provided that the modest secular trend real appreciation is maintained.

Financial stability

In recent years, Switzerland has made considerable progress in strengthening the resilience of the banking sector. Stress tests performed in the context of the IMF’s Financial Sector Assessment Program finds Swiss financial institutions to be well capitalized and liquid, and resilient to severe shocks, although some banks would breach their capital buffers under a very adverse scenario. The financial sector’s increasing exposure to riskier forms of real estate lending calls for measures to dampen risks. Despite high-and-rising vacancy rates in some parts of the country, deteriorating mortgage affordability and residential property prices near historical highs, credit-driven demand for real estate remains strong due to low market interest rates, search for yield caused by compression of banks’ interest margins, and expectations of future price gains. Risks are especially pronounced in the residential investment property segment. Moreover, high private saving and low amortization requirements have led to large direct and indirect exposure to real estate on the asset and liability sides of households’ balance sheets. Around 85 percent of banks’ domestic assets are concentrated in mortgages. Pension funds and insurance companies also have significant exposure to real estate. Therefore, shocks to property prices could resonate through the economy, with significant financial stability, economic and social costs.

Recent proposals to dampen risk-taking in the investment property segment are therefore welcome. The IMF and others have alerted to the growing risks for some time, and the renewed prospect of global “low-for-long” interest rates exacerbates these financial stability concerns. The recent announcement by the Swiss Bankers’ Association that it is considering to tighten existing demand-side self-regulation measures on residential investment properties demonstrates an ability to act, despite the belated willingness to do so. If appropriately calibrated, these measures would help curtail demand for the most-risky residential investment mortgages by reducing loan-to-value ceilings and amortization periods. Simultaneous preparation by the government of a capital ordinance to raise risk weights on mortgages for residential investment property would provide a contingent buffer in the event that self-regulation enhancements are insufficient. Nonetheless, we continue to have reservations concerning the concept of self-regulation by banks, and urge that the toolkit for mandated demand and capital-based macroprudential measures be expanded in order to facilitate prompt and appropriately-calibrated policy actions within a more agile and accountable decision-making process

High household leverage poses a risk. Swiss households’ debt relative to GDP is among the highest in the world, while they also hold a very large stock of financial assets. Leveraging up of households’ balance sheets is encouraged by generous amortization requirements and low interest rates. Proposals for eliminating the tax on imputed rent should be accompanied by removal of mortgage interest deductibility or else it may encourage further indebtedness. This would also maintain tax neutrality on owner-occupied housing. Strengthening the amortization requirement beyond the current one-third ceiling is also recommended.

Financial sector oversight

The complexity and large size of the Swiss financial system calls for continual upgrading of regulatory and supervisory frameworks and capacities. Considerable progress has been made to strengthen supervision, although important deficiencies remain. To better manage conflict of interest and objectivity concerns, FINMA should have the authority to directly contract and pay audit firms for supervisory audits of banks, and should itself conduct more on-site inspections, especially of the largest banks. In addition, preserving the autonomy of FINMA is critical to maintaining the strong international reputation of the Swiss financial sector and to limiting contingent fiscal liabilities. Increasing the independence of FINMA’s governance framework and upholding its authority to set binding prudential requirements are critical to maintaining financial stability. Progress in strengthening financial-sector safety net and crisis management arrangements has been made, but more work is needed to further improve banks’ recovery and resolvability and to create a publicly-mandated and fully-funded bank deposit insurance agency, in line with international norms.

Structural issues

Persistent wage differences between Switzerland and its neighboring countries reflect strong fundamentals and appear not to have been dampened by international labor mobility. Higher Swiss productivity accounts for much of the persistent cross-country difference in wages, while large appreciations temporarily widen the gap. In addition, the increase in foreign workers, most of whom are highly skilled, has contributed to net job creation for Swiss workers while also boosting average wages which, in turn, stimulates faster productivity growth. Addressing shortages of skilled labor by maintaining the standard of excellence in Swiss education and remaining open to foreign labor is likely to continue to benefit the Swiss economy and its population.

Switzerland is encouraged to continue to make progress on its international commitments, including removal of preferential regimes in the corporate tax system. Meeting these obligations is critical to dispel investor uncertainty and avoid reputational risk. Switzerland volunteered to be assessed under the IMF’s Enhanced Governance Framework on the supply and facilitation of corruption. In this regard, the authorities are encouraged to continue enforcement actions against foreign bribery, further enhancing the effectiveness of AML/CFT frameworks to tackle the proceeds of foreign corruption, and further increasing international cooperation.

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We thank the Swiss authorities and our private sector counterparts for their hospitality and productive discussions.