Public Information Notice No. 00/14

Public Information Notice: IMF Concludes Article IV Consultation with Switzerland

March 2, 2000

On February 14, 2000, the Executive Board concluded the Article IV consultation with Switzerland.¹

Background

The upswing of the Swiss economy regained momentum after weakening temporarily in the wake of the emerging markets crisis. The slump in external demand reduced GDP growth from a peak rate of 3.7 percent in mid-1997 to 1 percent for the period through mid-1999. In the third quarter of 1999, however, activity picked up as exports recovered and domestic demand strengthened, with GDP growth estimated at 1.4 percent for the year.

Unemployment has declined rapidly to below 2½ percent from its 1997 peak of over 5 percent. In its early stages, the decline was attributable mainly to increased participation in active labor market programs (made a condition for benefit eligibility) whereas the more recent decline is associated with the upswing in activity and related increase in labor demand.

After hovering around zero throughout 1998, headline CPI inflation rose to 1.6 percent in January 2000. This reflects primarily a 1 percentage point increase in the VAT rate in January 1999, the sharp rebound of oil prices, the weakening of the effective exchange rate, and higher rents associated with improving housing market conditions. Excluding the temporary effects of indirect taxes and oil price increases, inflation is estimated to have risen over the same period from ¼ percent to about ¾ percent.

The longstanding external current account surplus was above 9 percent of GDP in 1998 and is estimated to have risen further in 1999. The record-high current account surpluses of the past few years are related primarily to the high net investment income (8 percent of GDP in 1997-99) on Switzerland's large net foreign asset position (130 percent of GDP).

Monetary policy has shifted from an accommodative to a more neutral posture. Amidst faltering economic activity and deflation risks, the SNB maintained for most of 1999 an accommodative stance. In April it reduced the discount rate to 0.5 percent, which pushed the 3-month LIBOR to around 1 percent in the ensuing months; meanwhile, the monetary conditions index fell in September to its lowest level since 1997. But with increasing indications of strengthening economic activity, the edging up of inflation, and the weakening of the nominal effective exchange rate, the SNB let interest rates increase in steps since late September bringing the 3-month LIBOR to 2¼ percent by mid-February 2000. In December 1999, the SNB announced a new monetary policy framework which is geared toward price stability (defined as CPI inflation of less than 2 percent) and uses the 3-month LIBOR as the operating target.

The Swiss franc has shadowed the euro closely since January 1999, fluctuating narrowly around 1.6 Sw F/euro. To a large extent this reflects the similar cyclical positions of the Swiss and euro area economies. With the euro weakening against the dollar and, to a lesser extent, the pound and the yen, the franc depreciated by about 5 percent in nominal and real effective terms.

Following a series of deficits and rising debt through the 1990s, fiscal policy is now on a moderately contractionary medium-term path set by the 1998 constitutional commitment to balance the Confederation budget by 2001. The general government deficit is estimated at 1.4 percent of GDP in 1999.

The outlook for the Swiss economy is favorable. Real GDP growth is projected to strengthen from 1½ percent in 1999 to above-trend rates close to 2 percent in 2000-01 on the strength of faster growth of exports and investment, and buoyant growth in private consumption. Inflation is likely to rise to 1 1/3 percent in 2000, reflecting mainly the higher oil prices and the weakening of the exchange rate, and approach 1 percent on a core basis.

Executive Board Assessment

Executive Directors commended the authorities for sound macroeconomic policies, which have contributed to improved performance marked by rising output, falling unemployment, and low inflation, following a prolonged period of stagnation. Looking ahead, Directors noted that the main tasks are to maintain noninflationary economic recovery and to pursue very vigorously the structural reforms needed to strengthen Switzerland's long-term growth prospects by promoting competition and improving economic efficiency.

Directors expected the upswing to strengthen in 2000 in response to an improving external environment. They considered that the current stance of macroeconomic policies provides a fair degree of insurance against risks to medium-term price stability, given ongoing fiscal consolidation and the recent steps to tighten monetary policy by the Swiss National Bank (SNB). Directors considered that continued vigilance will be needed and some further firming of monetary conditions warranted in due course as remaining economic slack is absorbed.

Directors welcomed the new monetary policy framework that focuses primarily on the goal of medium-term price stability and uses an inflation forecast to guide policy decisions. They considered that the announcement of the inflation forecast and objectives for the three-month reference interest rate provides a useful clarification of the authorities' intentions with regard to the conduct of monetary policy. In light of the relatively wide band chosen for the reference interest rate, Directors encouraged the SNB to continue to communicate changes in its policy stance clearly and in a timely fashion. They also suggested that the authorities make periodic presentations of the analytic framework used to generate the inflation forecasts.

Directors noted the further increase in Switzerland's large current account surplus that reflects primarily income from a strong foreign asset position. They stressed that structural reforms, including the removal of product market rigidities that discourage domestic investment, would be crucial in helping to reduce the surplus and strengthen growth prospects. Some Directors underscored that such efforts would allow Switzerland to play a greater role in fostering the correction of global external imbalances. Directors agreed that, in light of the strong external position, some moderate appreciation of the Swiss franc on a multilateral basis would not be a cause for concern.

Directors welcomed the progress in reducing the budget deficit in line with the constitutional mandate to balance the Confederation's budget by 2001, and underscored the importance of a continued commitment to fiscal consolidation in order to sustain market confidence. They agreed that the fiscal policy framework beyond 2001 should aim at balancing the Confederation's budget over the business cycle and should ensure that automatic stabilizers are allowed to operate. Directors therefore welcomed the authorities' plans to set medium-term expenditure ceilings linked to the expected trend rate of economic growth, and to allow tax revenues and the deficit to fluctuate with the cycle; some Directors, however, were concerned that the planned policy might have only a limited effect at the lower levels of government, which have shown a tendency toward procyclical fiscal policy. More generally, Directors encouraged the authorities to strengthen the general budget process and control mechanisms. They also underscored the desirability of further reforming Switzerland's complex tax system and supported the authorities' emphasis on developing new mechanisms for facilitating tax base harmonization across cantons.

While acknowledging the important advantages of Switzerland's multi-pillar pension system, Directors noted that demographic developments would put significant pressure on the system's public pillar in the coming decades. They encouraged the authorities to take early action to ensure long-term sustainability.

Directors welcomed the recent ratification of the bilateral agreements with the European Union (EU). They considered that the ongoing process of European monetary and economic integration would continue to affect Switzerland significantly regardless of any future decision on possible EU accession. Several Directors noted the many benefits that closer EU integration would bring, including facilitating a reduction in Swiss price levels. While Switzerland's labor market performance is stronger than in most EU countries, product market reforms are lagging, and Directors encouraged the authorities to speed up and deepen their efforts to remove rigidities in the economy's "sheltered" sectors. They pointed in this context to agriculture, where support levels remain considerably above even those in the EU; to competition policy, where the more proactive approach of the Competition Commission and proposals to reinforce further its powers are welcome; and to utilities, where recent reforms of telecommunications, rail, and postal services are steps in the right direction, and an accelerated timetable for the opening up of the electricity sector is desirable.

Directors noted that Switzerland's banking system remains well capitalized and internationally active banks well positioned. The domestic banking sector, however, faces significant challenges as the roles of guarantees and public ownership are likely to come increasingly into question. Directors therefore endorsed the extension of the supervisory mandate of the Federal Banking Commission to these banks. They also supported the recent step to improve supervision of the internationally active banks, as well as the intensification of efforts to combat money laundering.

Directors encouraged greater trade liberalization, particularly in agriculture, to enhance efficiency in the Swiss economy and improve economic prospects for developing countries.

While commending the authorities' generous provision of humanitarian assistance, Directors encouraged Switzerland to raise official development assistance to at least its own target of 0.4 percent of GDP.

Directors urged further efforts to improve the coverage and reliability of Swiss economic statistics, especially in the area of wage and government finance statistics, so as to strengthen the basis for sound economic management.