Mission Concluding Statement 

Switzerland: Staff Concluding Statement of the 2021 Article IV Mission

April 7, 2021

Washington, DC: An International Monetary Fund (IMF) mission, led by Mark Horton, conducted virtual discussions on the 2021 Article IV Consultation with Switzerland during March 17-April 7, 2021. The mission has issued the following statement:

Switzerland has navigated the Covid-19 pandemic well. The pandemic has had major social and economic impacts, but an early, strong, and sustained public health and economic policy response has helped contain the contraction of activity relative to other European countries. While recovery commenced in Q3:2020, the Swiss economy has been impacted by second and third waves of infections. High uncertainty and downside risks remain. The authorities are rightly extending fiscal support to households and firms in 2021, while the roll-out of vaccines is expected to pick up pace as supplies increase. Policies should focus on ensuring a strong and sustained recovery, protecting vulnerable groups, mitigating labor market dislocation and scarring, and ensuring that viable firms stay in business. Avoiding an early withdrawal of fiscal support or headwinds from too-rapid adjustment is important. Monetary policy should remain accommodative, and financial sector risks, while manageable, should be closely monitored. The authorities should continue their focus on long-term challenges, including pension reforms, decarbonization, and climate-change mitigation and adaptation.

Economic outlook and risks

In 2020, the Swiss economy contracted by 2.9 percent, less than other European advanced economies. This reflected strong fiscal, financial, and household buffers, highly-competitive export industries (e.g., pharma, chemicals), a large and well-capitalized financial sector, low dependency on contact-intensive sectors (e.g., tourism), a well-resourced health system, carefully-targeted containment measures (e.g., no widespread closure of manufacturing), and ongoing adaptation.

A strong, swift, and sustained policy response also helped. The authorities quickly put in place emergency measures exceeding 10 percent of GDP and targeting support for households and firms. Actions by the Swiss National Bank (SNB) and financial regulator FINMA helped sustain franc and dollar liquidity and bank credit. Non-mortgage lending increased last year at the fastest rate in over a decade. Non-performing loans (NPLs) remained at very low levels. The coordinated response stemmed a loss of purchasing power and a rise of unemployment and bankruptcies, while countering deflationary pressures. In H1:2020, the SNB made sizable foreign exchange (FX) purchases to counter large safe-haven inflows, which subsequently eased. Still, the franc appreciated by 6 percent and 4 percent, in nominal and real effective exchange rate (ER) terms. The external current account surplus was sharply lower—3.8 percent of GDP versus 6.7 percent in 2019—due to lower net exports of goods (gold, watches) and services and investment income.

Growth should reach 3.5 percent and 2.8 percent in 2021 and 2022, led by an improved global environment and higher private consumption and investment. A boost is also expected from continued accommodative policies—especially very low interest rates and further support from the short-time work program (STWP), income compensation for the self-employed, and extended unemployment insurance. Roll-out of federal-cantonal “hardship” loans and grants will also help. Inflation should remain subdued. The external current account surplus is expected to at least partially recover, although there is significant uncertainty on the recovery of key items.

Uncertainty remains high, with risks tilted to the downside. Near-term risks are dominated by pandemic dynamics, including more contagious or virulent strains and slow or incomplete vaccination. The crisis is likely to have scarring effects, especially in sectors where demand may recover more slowly (e.g., hospitality, events). Although unemployment, NPLs, and bankruptcies have not risen sharply, this could change when support is withdrawn. A weaker global recovery, more adverse risk sentiments and a tightening of global financial conditions (possibly associated with higher debt levels), worsening trade frictions, and faster deglobalization would adversely affect the outlook. Progress in discussions with the European Union is needed to secure continued EU market access on favorable terms. Upside risks include positive spillovers from the large U.S. fiscal package and from stronger than expected growth in the EU. Once vaccination is advanced, activity may come back stronger and quicker than expected.

Maintaining adequate fiscal support

Fiscal policy should remain accommodative until there are signs of sustained recovery. The authorities are rightly extending exceptional support in 2021. In light of continuing uncertainty and availability of fiscal space, the authorities should expand support if needed. Strengthening federal-cantonal coordination would increase the efficiency, effectiveness, and timeliness of intervention. As recovery is secured and risks abate, extraordinary support should be increasingly targeted and scaled back. Extraordinary support is scheduled to phase out at the end of 2021; this will help ensure that prolonged support does not impede post-Covid reallocation and transformation. But if recovery is not secure, support should be extended to avoid cliff effects.

More generally, expansionary fiscal policy would help address needs and support domestic demand if needed (i.e., in response to a crisis). It could also help ease pressure on monetary policy. In the longer term, Switzerland should continue—and enhance, where possible—its efforts to support green and digital growth, in an efficient and targeted way and with particular attention to low-income earners. Adjustments under the existing fiscal framework would be a helpful first step. The debt-brake rule envisages offsetting extraordinary outlays over six years. To avoid headwinds for recovery, consideration is rightly being given to a longer amortization period and offsetting Covid-19 spending against past surpluses (recorded in the “compensation account”). Other adjustments to the existing framework would help mitigate a built-in bias to surpluses and a tighter-than-budgeted stance. These could include less-conservative revenue forecasts (progress has been made in this area), greater in-year calibration, and spending ceilings that contain a built-in buffer or margin, are more flexible (e.g., multi-year), or are contingent on developments. These changes to spending ceilings would aim to address and limit underspending. Down the road, there is merit in continued—and where possible, additional targeted and efficient—outlays to support climate mitigation and adaptation, digital transformation, innovation and R&D, and productivity gains. These outlays would build on existing programs and plans, correspond to big “green new deal” programs in Europe and the U.S., and may necessitate a review of the fiscal framework. Concerning taxation, stamp duty and withholding tax reforms under consideration would ease tax and compliance burdens and improve capital market functioning.

Accommodative monetary policies should continue

In light of risks of an extended period of very low or negative inflation, monetary policy should remain accommodative, including unconventional policies via unsterilized FX intervention (FXI) in case of substantial safe-haven flows and particularly strong appreciation pressures that would worsen deflation risks. Like other major central banks, the SNB should continually review its monetary policy framework and tools, especially in light of the Covid-19 experience, to consider whether adjusting or extending targets, instruments, and communications would enable it to continue to respond to new challenges that Switzerland might face. The SNB should continue to assess the extent to which other instruments—such as the purchase of a wider range of assets for quantitative easing or funding-for-lending programs (following on the successful Covid-19 refinancing facility)—may also help to secure price stability. A review of greater “home bias” of Swiss investors over the past decade (increased holdings of Swiss franc assets rather than foreign assets)—e.g., regulatory impediments, asset management guidelines, tax considerations—may identify actions to help ease appreciation pressures.

Reinforcing financial stability

The Swiss banking sector entered the Covid-19 crisis with strong buffers, but continued close monitoring of asset quality is warranted. Banks have incurred limited losses so far, but have benefited from monetary and prudential measures and indirectly from fiscal support (loan guarantees, STWP, etc.). Asset-quality deterioration is a risk, although bank exposure to contact-intensive sectors is limited, and federal-cantonal hardship grants will help. The deactivation of the countercyclical capital buffer requirements at the outset of the crisis was appropriate and helpful, but should remain temporary, with buffers in place for potential real estate market developments. Residential property price rises have continued, increasing affordability concerns and risks; this should be monitored, especially as income support is withdrawn. Commercial real estate also faces risks, given negative pandemic effects and likely changes in occupancy, rents, and valuations. New macro-prudential tools may be needed, along with more resources for high-quality data collection and oversight, including of fintech activities. Financial firms have reacted to negative interest rates and low margins by reducing costs and seeking higher returns. The authorities are rightly monitoring risk controls and buffers and should take early action if needed.

Addressing structural challenges

Labor market policies should remain protective to prevent scarring and inequality. The Covid-19 shock has had greater effects on contact-intensive sectors and workers with lower skills. To limit scarring and preserve jobs, crisis-related changes to the eligibility, coverage, and duration of STWP support should remain in place, along with extended support for self-employed and unemployment insurance provisions, until sustained recovery is underway. Policies should also and increasingly support labor mobility, as structural changes—some accelerated by Covid-19 such as telework and e-commerce—call for enhanced training, lifelong learning, career guidance, language instruction, and high-quality care in kindergartens and schools (to retain women in the labor force). Efforts to support apprenticeships helped dampen youth-unemployment and should continue. Disincentives for hiring or retaining older workers should be identified and removed. At the same time, it should be recognized that keeping support measures too long may impede the necessary post-Covid 19 transformation.

The Swiss pension system is not well-aligned with demographic (aging, life expectancy) or economic trends. Without decisive reforms, the first pillar will run into sizable funding gaps by 2030, while low interest rates and an above-market mandatory conversion rate are putting strains on second-pillar pension funds. Progress has been made to identify and advance reforms that would enhance sustainability while maintaining pension levels and improving benefits for low-income earners, part-timers, and those with multiple jobs. Post-retirement-age incentives to stay in the labor force are also being considered, along with greater flexibility in retirement. However, the reforms have faced political headwinds. More far-reaching reforms are needed, including a more ambitious retirement age increase and linkage of the retirement age to life expectancy. The reduction of conversion rates should go further. Continued optimizing of pension fund investment practices—while accounting for pension-fund risk profiles and risk-return trade-offs—and strengthening pension fund governance arrangements would help improve performance and reduce costs; a further reduction of the number of funds would help achieve economies of scale.

An ambitious new climate strategy was approved in January, based on the revised CO₂ law and with guidelines and sectoral targets for decarbonization through 2050. The revised CO₂ law incorporates new requirements for vehicle fuel efficiency and fuel importers, standards for new construction, and a phased increase of the CO₂ tax on heating fuels. To meet the targets, investment needs are substantial, including for the energy system, transportation, and especially, building renovation. The strategy will also need to be firmed up for the agriculture and financial sectors from 2030 and for international aviation and supply chains connected to Swiss imports. Achieving the targets for 2030–50 will require carbon capture and negative-emissions technologies that have not yet been developed. A new Climate Fund, financed through a CO₂ levy on heating fuels and new air-travel levies, will help fund decarbonization, mitigation, adaptation, and R&D.

A clear, monitorable emissions action plan is needed to support the climate strategy and to address gaps and risks. Other advanced economies in Europe and North America are devising large “green new deal” programs to meet climate targets (and digitization and inclusive growth objectives). The programs involve investments in public transport, green and renewable energy generation and storage, building retrofits, R&D, and digital infrastructure. While recognizing that the Swiss authorities are undertaking and planning green investments in public transport, roads, and rail, consideration should be given to further targeted measures. This could involve an examination of whether investments should be increased or accelerated, notably in the energy sector and in building renovation, transport, R&D, adaptation, and mitigation to help ensure that Switzerland meets its ambitious CO₂ targets and retains competitiveness. Transformative investments in other areas—especially agriculture—could also be considered. These efforts should take into account synergies with ongoing programs, as well as ensure appropriately high effectiveness and efficiency of any new measures.

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The mission thanks the Swiss authorities and other counterparts for the very constructive policy dialogue and productive collaboration.