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IMF Publishes Article IV Concluding Statement On Switzerland

by Ulrika Lomas, for, Brussels

07 March 2007

The International Monetary Fund on Monday published its 2007 Article IV Consultation Mission Concluding Statement regarding Switzerland.

The IMF announced that the Swiss economy is performing well as the expansion enters its fourth year. Growth is balanced, inflation is low, and employment is strong.

These developments reflect cautious monetary and fiscal policies and structural reforms in a favorable global environment, according to the statement. The key challenges are to avoid complacency and to consolidate the good performance by continuing with structural reforms.

It went on to add that:

"Prospects for 2007 remain positive and risks appear balanced. Growth likely peaked in 2006, and in 2007 is expected to ease to 2 percent. Consumer spending is supported by strong employment growth, while high capacity utilization is stimulating equipment investment. Exports are benefiting from weakness in the franc, strong sales in pharmaceuticals and precision instruments, and high earnings from financial services."

"Downside risks would emerge if external growth were to slow significantly or global imbalances unwind abruptly—thereby appreciating the exchange rate while slowing financial service exports. Upside risks would emerge if the exchange rate were to remain weak or employment accelerate further."

"Potential growth may have increased. The labor market opening to EU citizens has generated a positive supply shock, while entry by foreign firms in retail and other sectors is strengthening domestic competition. This suggests that potential growth may have shifted up in the 1½-2 percent range, and that the output gap may be small or nonexistent."

According to the IMF, external competitiveness is strong and the current account surplus is very large. The mission recommends that the authorities analyze further the factors generating this surplus.

Currency weakness, Switzerland's large stock of net foreign assets, and its position as an international financial center and provider of wealth management services, could be playing a role.

Nevertheless, deeper structural reform in the internal market, such as adopting the "Cassis de Dijon" principle, could further energize domestic demand and make a contribution, appropriate for Switzerland's size, to the reduction of global imbalances.

With regard to financial sector policies, the IMF mission observed that:

"The financial sector is performing well. The Financial Sector Assessment Program update mission found that the system is strong and prospects positive. The main downside risks are external, and related to a possible increase in volatility. Stress testing suggests that the banking sector is resilient to a variety of shocks, while some insurers remain vulnerable to equity and real estate price adjustments. Occupational pension funds are improving their funding, but aggregate coverage is not yet adequate, especially in some public sector funds."

"Switzerland is upgrading its regulatory and supervisory arrangements in recognition of evolving risks and international best practices. There remain some opportunities for enhancement."

It continued:

"Establishing a unified and independent financial regulator, the Financial Market Authority, is welcome. The draft proposals could be strengthened by providing the regulator with increased sanctioning power, while avoiding conditions that might limit its operational and prudential capacity. It is critical that the supervisor be equipped with adequate staffing and financial resources."

"Banking supervision has been strengthened. One area that requires further attention is overseeing liquidity. Given the complex nature of the banks and their systemic importance, continuing efforts should be made to evaluate regularly their evolving risk exposures and complex operating models. Advanced capital and liquidity regimes and stress testing should be implemented proactively."

The IMF statement also suggested that governance of cantonal banks could be bolstered by giving them the overriding goal of profit maximization while dedicating part of their profits through the fiscal process to achieve social objectives.

Discussing the cantons, the IMF observed that:

"While cantons have used most of the proceeds from SNB gold sales for debt reduction, they are also taking advantage of the buoyant economy to cut tax rates. In part, the tax reductions reflect improvements in the New Financial Equalization Mechanism, which provides incentives to lower the tax burden rather than maximize it as in the previous system."

"Thus, while lower taxes partly reflect the transition to the new equalization system, and contain many positive aspects, they also reflect Switzerland's competitive federalism which generates tax cuts during an upswing, without taking account of deficits in social security that need to be addressed."

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