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IMF Concludes Article IV Consultation With Switzerland

by Ulrika Lomas, for, Brussels

06 June 2007

The Executive Board of the International Monetary Fund (IMF) has concluded its Article IV consultation with Switzerland, it has emerged.

According to the results of the consultation, which was concluded on Friday, the Swiss economy is performing well. The expansion moved into its fourth year with above average growth and employment, and few signs of inflation.

The IMF suggested that this favorable outcome can be traced to a vibrant external environment, including in global financial markets, strong macropolicies and key structural reforms in retailing and labor markets.

The report also suggested that the financial sector is performing well in a favorable cyclical setting, and observed that bank profitability is strong, and financial soundness indicators have improved.

It observed that the two large Swiss banks are global players in wealth management and derivatives markets, and as prime brokers to hedge funds and private equity firms, need to watch global financial market volatility.

In a statement, the IMF Board announced that:

"Executive Directors commended the Swiss authorities for their prudent economic management and sound policy frameworks. In this setting, Switzerland's economy continues to perform well, with low inflation and strong employment growth backed by flexible labor markets, and the short-term growth outlook is strongly positive. The main policy challenge going forward is to seize the opportunities provided by these favorable developments to further strengthen potential economic growth, and to address long-term structural and fiscal issues given population aging."

"Directors commended the Swiss National Bank's success in keeping inflation well under control in recent years, and considered the recent gradual tightening appropriate. They recognized the importance of ensuring that inflation expectations remain well anchored, especially in view of the strong run-up in capacity utilization."

"In this context, Directors agreed that monetary policy will need to remain flexible to respond appropriately to inflation signals. With the economy possibly transitioning to a higher level of potential growth, and absent signs of inflation, Directors considered that the Swiss National Bank (SNB) should continue to monitor economic conditions closely, and be prepared to adapt policy as necessary. Directors also recommended a removal of the regulated link between interest rates and housing rents, noting its distortionary effects on inflation signals and for publicly-owned banks. Directors noted that the SNB's communications strategy, with its rolling three-year inflation forecast, continues to serve Switzerland well."

"Directors reviewed the factors affecting the recent weakness of the Swiss franc, despite rising policy rates and strong fundamentals. They noted that carry-trades could be temporarily weakening the franc to a level below its equilibrium, and considered that the present independent floating exchange rate regime is best to handle these uncertainties. These developments in carry-trades could also imply important spillover risks for other countries, especially in Eastern Europe, where the Swiss franc—by virtue of its low volatility and the low Swiss interest rate—is the currency of choice for loans that are contributing to rapid credit expansion. Directors accordingly supported close monitoring of such lending to limit related risks."

It continued:

"Directors noted that Swiss external competitiveness is strong. In addition, the large stocks of foreign assets of domestic pension funds and high-earning multinational corporations in Switzerland have contributed to a structurally large current account surplus. Thus, Directors noted that interpreting the surplus is complex and its connection to domestic demand is not straightforward. Going forward, Directors considered that deeper internal structural reforms could strengthen domestic demand and potential growth, and make a contribution — appropriate to Switzerland's size — to an orderly resolution of global imbalances. In this context, Directors noted the importance of further liberalization of sheltered sectors, including agriculture."

"Directors welcomed the conclusions of the FSAP update that reaffirm the soundness of the Swiss financial system, and supported its recommendations. The crucial importance of the Swiss financial sector to both the domestic economy and the global financial system — as well as its large size and increasing complexity — heighten the need for continued vigilance and for the highest standards of financial supervision. In this context, several Directors welcomed the tripartite arrangement for supervisory cooperation between Switzerland, the United Kingdom, and the United States."

"With regard to actions to strengthen financial sector supervision, Directors emphasized that the new supervisory authority, the Financial Market Supervisory Authority (FINMA), should be assured both financial and regulatory independence. Continuing efforts will also be important to evaluate large banks' operating models and to ensure that liquidity and capital regimes remain appropriate to changing circumstances. Directors also encouraged the authorities to take the opportunity of current favorable cyclical conditions to strengthen supervision for some insurance companies for which heightened risks were identified in last year's Swiss Solvency Test and to address underfunding in selected pension funds."

The statement concluded:

"Directors commended the authorities for their strong fiscal performance guided by the valuable debt brake fiscal rule. Looking forward, they stressed that fiscal stimulus should be avoided and the integrity of the debt brake maintained. In this regard, many Directors were concerned about the large one-time expenditures in 2008 that would be treated outside the debt brake. They therefore welcomed the authorities' commitment to compensate for this spending in the medium term."

"Also, several Directors suggested that, in the current conjuncture, it would be appropriate that the cantons use their strong tax receipts to build up reserves to absorb future expenditure needs related to population aging — rather than to cut taxes. Directors looked forward to the publication of the long-run fiscal sustainability report, which should help to develop a consensus on the key fiscal challenges and the needed actions."

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