Profile of the Swiss franc – economic overview and monetary policy
You will learn about the following concepts
- Overview of the Swiss economy
- Major trading partners
- Monetary policy
- SNB policy tools
Switzerland is one of the most prosperous economies in the world, famous for its highly skilled labour force and financial and political stability. With a gross domestic product of $371.2 billion (purchasing power parity) in 2013, it was the 37th-largest economy in the world. Although this may seem small at first glance, Switzerland ranked 11th by GDP per capita at $54,800 in 2013. Its prosperity stems mainly from technological expertise in manufacturing, particularly the chemical and pharmaceutical industries, machinery, precision instruments, watches, etc. It also has a highly developed tourism sector and a banking system well known for protecting investors’ confidentiality.
Switzerland’s political and economic stability, transparent legal system, low corporate taxes and efficient capital markets, as well as its international neutrality, have made the country a safe haven for investors, especially during the global financial crisis, adding to its currency’s value. As a result, Switzerland has become the world’s largest destination for offshore capital, making it increasingly dependent on a steady tide of foreign investment.
Apart from its vast financial sector, Switzerland has an extensive industrial sector, exemplified by companies such as food processor Nestlé, pharmaceutical giants Roche and Novartis, and personal computer and tablet accessories provider Logitech, among others. The country is also renowned for its precision instruments and is one of the global leaders in exports of high-end clocks and watches, with brands such as Hublot, Zenith, TAG Heuer, Tissot, etc.
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Due to the country’s diversified economy, the confidentiality and financial stability that attract capital flows tend to drive growth during periods of global financial crises and risk aversion, while trade flows boost the economy during times of prosperity and a risk-prone environment. Gross domestic product composition by sector of origin in 2013 was as follows:
– agriculture: 0.7%
– industry: 26.8%
– services: 72.5%
EU partner
Switzerland is heavily reliant on trade with the European Union and has brought its economic practices largely into line with the EU, which absorbs half of the country’s exports, to improve its international competitiveness. However, some trade protectionism remains, particularly for its small agricultural sector. High tariffs and subsidies stimulate domestic production, allowing the country to produce 60% of the food it consumes itself.
Germany is the main export destination for Swiss goods, accounting for 17% of total outbound shipments, followed by India with 11%, the US with 8.1%, Hong Kong with 6.0% and France with 5.6%. As for imports, four of Switzerland’s top five trading partners are in the Eurozone – namely Germany (27%), Italy (11%), France (6.6%) and Austria (3.5%). The United States ranks fourth with 6.1%.
Swiss exports amounted to $229.2 billion in 2013, up from $226 billion in 2012, ranking the country 25th worldwide, while imports rose to $200.5 billion from $197.9 billion a year earlier, placing it 26th.
According to MIT’s Observatory of Economic Complexity, Switzerland is the top exporter of gold, base-metal watches, hormones, precious-metal watches, carboxamide compounds, precious stones, other clocks and watches, hydrazine or hydroxylamine derivatives, balances and gold-clad metals.
However, the global financial crisis of 2008 put a damper on Swiss exports and pushed Switzerland into recession in 2009. Owing to the Swiss franc’s safe-haven appeal and rising value, the Swiss National Bank implemented a zero-interest-rate policy and conducted market interventions to prevent further appreciation of the franc, which would further diminish Swiss exports’ competitiveness and weaken growth prospects.
Policy maker
The Swiss National Bank (SNB) is the central bank of Switzerland. It conducts the country’s monetary policy as a completely independent central bank with the primary goal of ensuring price stability while fostering an environment conducive to economic growth. It has a three-person committee responsible for determining monetary policy. The committee comprises a chairman, a vice-chairman and a third member, and together they constitute the Governing Board of the SNB. Monetary policy is reviewed at least once every three months and, owing to the committee’s small size, each decision must be reached by consensus. Unlike most other central banks, the Swiss National Bank does not set a single official interest-rate target; rather, it defines a target range for the three-month Swiss LIBOR rate.
Another peculiarity of the SNB is that it operates as a special-statute joint-stock company. Around 55% of its shares are owned by public institutions, while the remaining stock is traded on the stock market, mostly held by private individuals. Shareholder rights are laid down in the National Bank Act, and company law applies only complementarily. A dividend not exceeding 6% of the share capital is paid from net profit, and a general meeting of shareholders is held annually in April, though the powers of decisions taken at the meeting are limited compared with those in joint-stock companies under private law.
The last organisational body of the SNB is the Bank Council. It consists of 11 members whose function is to oversee and control the conduct of business by the SNB. The term of office for members of the Bank Council is four years, and the total term cannot exceed twelve years. Six members, including the President and Vice-President, are appointed by the Federal Council, and the other five by the Shareholders’ Meeting. The Bank Council sets up four committees from its own ranks – the Audit Committee, Risk Committee, Compensation Committee and Nomination Committee.
SNB goals
Having shifted from focusing on monetary targets (M3 money supply) to an inflation target, the bank has achieved a higher level of transparency. As its main goal is to ensure price stability while supporting economic growth, the SNB ‘equates price stability with a rise in the national consumer price index (CPI) of less than 2% per annum’. However, the central bank recognises that not every price increase is necessarily inflationary; for example, some rises stem from improvements in the quality of goods and services. Such changes are not fully captured in the CPI calculation and, as a result, measured inflation tends to be slightly overstated.
The bank has clearly stated that if inflation exceeds 2% in the medium term it will tighten its monetary stance, or loosen it in an environment of deflation. The latter typically occurs during periods of global risk aversion (such as the 2008 global financial crisis), when incoming capital flows strengthen the franc, which in turn drags on Switzerland’s exports. In such cases, the SNB is not hesitant to issue verbal interventions regarding liquidity and money supply, or to intervene directly by conducting open-market operations or adjusting the target interest-rate range.
SNB tools
As noted above, the SNB conducts monetary policy by setting a target range for the three-month interest rate – the Swiss LIBOR, owing to its major importance for Swiss-franc investments. This range is reviewed at least once every three months, and any changes are accompanied by a thorough explanation linked to developments in the economic environment.
The SNB uses two types of instruments – open-market operations and standing facilities. Open-market operations include repo transactions, the issuance of SNB Bills, and the purchase and sale of SNB Bills in the secondary market. Here, the central bank is the initiator of the transaction.
Most used instrument
The Swiss National Bank’s most significant policy-adjusting instruments are repo transactions. In such a transaction, a borrower sells securities to a lender for cash, with an agreement to repurchase them at a later date at a premium; this premium is essentially the interest charged for borrowing the money. Repo transactions are commonly used when a bank has a short-term deficit or surplus of cash and usually have a maturity of between one day and a few weeks.
The SNB uses repo transactions to offset any undesired moves in the three-month LIBOR that push it outside the targeted range. If the three-month LIBOR drops below the bank’s target, the SNB will effectively reduce liquidity by increasing repo rates. Conversely, if the three-month LIBOR rises above the target, the central bank will inject liquidity into the banking system by conducting repo transactions at a lower repo rate.
The National Bank publishes its target range regularly. As a rule, this range spans one percentage point, and the SNB generally aims to keep LIBOR in the middle of the range.
Key for all interested parties, including day traders, is to closely monitor the SNB’s quarterly economic and monetary assessments, at which it reviews its policy. If required, the bank will intervene even between these scheduled events. The central bank publishes both a Quarterly Bulletin and a Monthly Bulletin, the latter containing a brief review of economic developments. Both reports should be watched closely, as they may flag changes in the SNB’s monetary stance.
Standing facilities
The SNB’s standing facilities include the intraday facility and the liquidity-shortage financing facility, both of which are initiated by commercial banks; the SNB merely sets the conditions. By using the intraday facility, the SNB provides its counterparties with interest-free liquidity during the day (intraday liquidity) via repo transactions, and the funds must be repaid by the end of the same banking day at the latest.
The liquidity-shortage financing facility is available to SNB counterparties to ease unexpected liquidity bottlenecks. It can be used until the next banking day (overnight) through special-rate repo transactions. The special rate is based on the SARON (Swiss Average Rate Overnight) plus an interest premium.