Public Information Notice No. 98/13

Press Information Notice: IMF Concludes Article IV Consultation with Switzerland

March 6, 1998

The IMF Executive Board on February 20, 1998, concluded the 1997 Article IV consultation¹ with Switzerland.

Background

Economic activity has stagnated since 1990, owing to cyclical and structural factors. In 1997, an export-led recovery was sparked by the significant real effective depreciation of the Swiss franc from end-1995 through early-1997 and a pick up in foreign demand, particularly in continental Europe. The contribution from the net foreign balance is estimated to amount to ¼ percentage point of GDP—the first positive contribution in three years. Domestic demand remained subdued mainly due to the prolonged slump in the construction sector, while private consumption revived and investment in machinery and equipment gathered strength. The current account surplus has remained large by historical standards, reaching about 7¾ percent of GDP in 1997.

The unemployment rate has risen sharply from ½ percent in 1990 to 5¼ percent in 1997. Around three quarters of this increase was due to a rise in the structural unemployment rate to an estimated 3½ percent in 1997 which still represents one of the lowest structural rates among advanced economies. Reflecting the slack in labor markets, nominal wage growth slowed below 1 percent in 1997. CPI inflation also abated further during 1997, declining to an annual rate of 0.5 percent, the lowest CPI inflation rate since 1960 as well as the lowest rate among industrial countries in 1997.

Following an extended period of fiscal retrenchment during 1993-96, fiscal policy adopted a moderately expansionary stance in 1997. The fiscal impulse was equivalent to about ¼ percentage point of GDP. The general government deficit is estimated to have widened by nearly 1 percentage point of GDP to 2¾ percent in 1997. Gross public debt is likely to rise to almost 51 percent of GDP in 1997 compared to only 31 percent in 1990. Looking ahead, the deficit of the general government in 1998 was projected to increase by nearly 1 percentage point of GDP to 3½ percent of GDP, likely one of the largest general government deficits among industrial countries in 1998. The fiscal impulse would increase to ½ percentage point of GDP. Spending would be boosted by a stimulus package adopted in May 1997. This package provided an investment subsidy by the Confederation to finance public investment projects by the cantons and communes during 1997-99, with the largest share of spending taking place in 1998.

Amid rising concerns about deteriorating external competitiveness and a prolonged slump in the real economy, monetary policy turned expansionary in 1995. The growth rate for base money growth increased sharply. By end-1997, the level of the monetary base was about 3½ percent above its medium-term target path, although unexpected demand shifts diminished the reliability of this indicator. The effective real exchange rate depreciated markedly from end-1995 through the first quarter of 1997, but it strengthened again during the remainder of 1997, particularly against the deutsche mark, in part due to "safe haven" effects related to the financial crisis in Asia. Short-term interest rates remained close to 1½ percent throughout 1997, while long-term bond yields fell during 1997 by almost 100 basis points to about 3 percent at end-1997. In its announcement of monetary policy intentions for 1998, the Swiss National Bank (SNB) envisaged a broadly unchanged monetary stance. In view of the recent instability in the demand for base money, the SNB announced that it would resort increasingly to other indicators including M3 growth to assess monetary conditions.

Average real GDP growth in Switzerland since the mid-1970s has lagged substantially behind the growth rates recorded in most other advanced economies. To reinvigorate this mediocre long-rung growth performance, the authorities have already undertaken significant structural reforms to strengthen competition in domestic markets for goods and services and to improve the functioning of the labor market.

As regards the outlook, real GDP is projected to increase by 1¾ percent in 1998 and 2 percent in 1999. Notwithstanding its current upward momentum, export growth is projected to slow as foreign demand slackens owing to developments in Asia. Domestic demand is envisaged to recover gradually during 1998-99, reflecting improved consumer sentiment, increased investment in machinery and equipment as capacity utilization rises in industry, and the end of the prolonged slump in construction. Only limited improvement is expected in the labor market, reflecting ongoing restructuring efforts in manufacturing and some service sectors includingbanking. Inflation is projected to be well contained by a large output gap and rising competitive pressures due to structural reforms.

Executive Board Assessment

After a prolonged period of stagnation, Directors welcomed the recovery that began in 1997 that had been sparked by a significant real effective depreciation, increased foreign demand, and supportive macroeconomic policies. They held the view that the key policy issue facing the authorities was how to nurture the nascent recovery and turn it into a sustained and vigorous expansion, while keeping inflation low. At the same time, they underscored the need to address structural rigidities in product and labor markets in order to secure a lasting return to more robust growth. Given the sizeable slack in the economy, the risks relating to developments in Asia, and possible appreciation pressures on the Swiss franc due to "safe haven" effects, most Directors considered the somewhat expansionary tilt of macroeconomic policies envisaged in 1998 as appropriate. Directors went on to note that, as the current upswing gained momentum, macroeconomic policies would need to shift carefully and progressively toward restraint. They saw this policy transition as a major challenge, given the long transmission lags of monetary policy and the institutional obstacles to conducting an effective countercyclical fiscal policy. In light of these considerations, which limited somewhat the flexibility of macroeconomic policies, several Directors attached particular importance to strong structural policies in reinvigorating the Swiss economy.

With the economy expected to gain further momentum, Directors underscored that fiscal consolidation should become the order of the day in 1999 so as to begin to reverse the recent surge in the debt-GDP ratio and to prepare for the prospective demographic pressures. In this connection, they endorsed the authorities' medium-term fiscal targets, specifically to balance the Confederation's budget by 2001 and to maintain a broadly balanced budget over the business cycle thereafter. Toward these ends, Directors emphasized the importance of making a significant step toward fiscal consolidation in 1999, and they therefore welcomed the recently proposed fiscal package. Directors also called for additional efforts aimed at improving the tax system with a view to shortening income tax collection lags, a measure promising to enhance both revenues and the operation of automatic fiscal stabilizers. In this regard, several Directors also saw room for an improved fiscal policy coordination between the various levels of government.

Directors noted that the past three years had seen an easing of monetary conditions, which was all the more welcome for not having ignited inflationary pressures. They recognized, however, the considerable uncertainty regarding the magnitude of the monetary impulse presently in the pipeline stemming from the instability in the demand for base money in recent years. Directors supported, therefore, the intention of the Swiss National Bank (SNB) to monitor more closely the trends in other monetary aggregates, in particular M3, and encouraged the SNB to monitor a broad range of other indicators, including the exchange rate, the yield curve, indicators of economic slack, and the momentum of domestic demand.However, a few Directors pointed to the sometimes conflicting signals from too broad a range of indicators. Given Switzerland's weaker cyclical position compared with the rest of Europe, Directors considered a relatively less rapid firming of monetary conditions appropriate, but underscored the need for continued attention to signs of emerging price pressures.

Directors welcomed the authorities' plan to reform Switzerland's monetary constitution by severing formally the link of the Swiss franc to gold, by recognizing the de facto independence of the SNB, and by clearly establishing price stability as a primary objective of the monetary authorities. These proposed changes would bring the constitutional law in line with longstanding monetary realities inside and outside of Switzerland.

Observing that for some two decades structural rigidities, particularly in the sheltered product markets, had acted as a drag on Switzerland's growth performance, Directors welcomed recent reforms to enhance domestic competition, and emphasized that their strict enforcement would be crucial to reap the intended benefits. Directors also saw a clear need for further measures to allow a greater play of market forces, and supported the slated deregulation of the communications, transport, and energy sectors.

Directors noted the increase in unemployment; particularly, long-term unemployment. While welcoming the recent adoption of active labor market policies designed to avoid the adverse effects of prolonged passive income support, Directors noted that further steps were necessary to improve convincingly the functioning of labor markets. They mentioned the need to limit the duration and generosity of unemployment benefits and to strengthen the link between unemployment contributions and benefits. While taking note of Switzerland's generally liberal trade policies, Directors regretted the slow pace of liberalization of the overly protective agricultural regime.

In the area of banking reform, Directors welcomed the progress in recent years, including the passage of the new money laundering law, and looked forward to the implementation of the amendment to the federal banking law that would help level the competitive playing field with cantonal banks. More generally, several Directors held the view that further progress in structural reform and deregulation was also justified in light of the growing proximity of EMU and the close ties of Switzerland with its European neighbors.

Directors noted that weaknesses in macroeconomic statistics hampered economic analysis and impeded the conduct of effective economic management. They called on the authorities to remedy the situation expeditiously, including through the provision of adequate budgetary resources.

Directors expressed disappointment over the further decline in official development assistance relative to GDP in 1997, and urged the authorities to increase official development assistance to at least their own official targets.