Profile of the Swiss Franc – Economic Overview and Monetary Policy

Switzerland is one of the most prosperous economies in the world, famous for its highly-skilled labor force and financial and political stability. With a Gross Domestic Product of $371.2 billion (purchasing power parity) in 2013, it is the 37th biggest economy in the world. Although this would 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 chemicals and pharmaceuticals industries, machinery, precision instruments, watches etc. It also has a highly-developed tourism sector and a banking system well known for protecting the confidentiality of its investors.

Switzerlands political and economic stability, transparent legal system, low corporate taxes and efficient capital markets, as well as international neutrality have made the country a safe haven for investors, especially during the global financial crisis, adding to its currencys 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, well known for companies such as food processor Nestlé, pharmaceutical companies Roche and Novartis, personal computer and tablets accessories provider Logitech, and others. The country is also famous for its precision instruments and is one of the leaders in exports of high-end clocks and watches with companies such as Hublot, Zenith, TAG-Heuer, Tissot etc.

Due to the countrys diversified economy, the confidentiality and financial stability which attract capital flows tend to drive growth during times 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 conformity with the EU, which soaks half of the countrys 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 self-grow 60% of the food it consumes.

Germany is the main export destination for Swiss goods, accounting for 17% of total outbound shipments, followed by India with 11%, the U.S. with 8.1%, Hong Kong with 6.0% and France with 5.6%. As for imports, four out of Switzerlands top five trading partners are from 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, occupying the 26th place.

According to the MITs 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 in recession in 2009. Due to the Swiss francs save-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 that would additionally reduce Swiss exports competitiveness and weaken growth prospects.

Policy maker

The Swiss National Bank (SNB) is the central bank of Switzerland. It conducts the countrys monetary policy as a completely independent central bank with a primary goal to ensure price stability, while ensuring the appropriate environment for economic growth. It has a three-person committee responsible for determining monetary policy. The committee consists of a chairman, vice-chairman and a third member who constitutes the Governing Board of the SNB. Monetary policy is reviewed at least once every three months and due to the committees small size, each decision must be passed by reaching a consensus. Unlike most other central banks, the Swiss National Bank does not set an official interest rate target, rather a target range for the 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 owned by private individuals. The rights of the shareholders are embodied in the National Bank Act and company law is applied merely complementarily. A dividend not exceeding 6% of the share capital is paid from the net profit and general meeting of shareholders is held annually in April, but the power of decisions made at the meeting is limited compared to that in joint-stock companies under private law.

The last organizational body of the SNB is the bank council. It consists of 11 members and its function is to oversee and control the conduct of business by the SNB. The term of office of the members of the Bank Council is four years and the full term of office 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 – Audit Committee, Risk Committee, Compensation Committee, Nomination Committee.

SNB goals

Having shifted from focusing on monetary targets (M3 money supply) to an inflation target, the bank has achieved a better level of transparency. As its main goal is to ensure price stability while securing 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 takes into consideration the fact that not every price increase is necessarily inflationary, with problems stemming from the improvement in quality of goods and services, for example. Such changes are not fully taken into account in the CPI calculation, thus, as a result, measured inflation tends to be slightly overstated.

The bank has clearly stated that if inflation exceeds 2% in the mid-term, it will tighten its monetary stance, or loosen it in an environment of deflation. The latter is observed during times of global risk-aversion (like the 2008 global financial crisis), when the incoming capital flows strengthen the franc, which in terms drags on Switzerlands exports. In such cases, the SNB is not hesitant to use verbal remarks on liquidity and money supply or by directly intervening by conducting open market operations or changing 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 due to its major importance for Swiss franc investments. It is revised at least once every three months and changes are accompanied by a thorough explanation linked to changes 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, as well as 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 Banks most significant policy adjusting instrument are repo transactions. In these transactions, a borrower sells securities to a lender for cash with an agreement to repurchase them back at a later date with a premium, thus the premium is basically the interest rate 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 rate, which have brought it outside of the targeted range. If the three-month LIBOR drops below the banks target, the SNB will effectively reduce liquidity by increasing the repo rates. Conversely, if the three-month LIBOR goes above the target, the central bank will inject liquidity in 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 extends over 1 percentage point, and the SNB generally aims to keep the Libor in the middle of the range.

Key for all interested parties, including day traders, is to closely monitor the SNBs quarterly economic and monetary assessments at which it reviews its policy. If required, it will intervene even between these scheduled events. The central bank releases a Quarterly Bulletin, but also a Monthly Bulletin containing a short review of economic developments. Both reports need to be kept a close watch on as they may contain information on a change in the SNBs monetary stance.

Standing facilities

SNBs standing facilities include the intraday facility and the liquidity-shortage financing facility, both of which are initiated by the commercial banks while the SNB only sets the conditions. By using the intraday facility, the SNB provides its counterparties with interest-free liquidity during the day (intraday liquidity) by means of repo transactions, and the funds must be repaid by the end of the same bank working day at the latest.

The liquidity-shortage financing facility is available to SNB counterparties for easing unexpected liquidity bottlenecks. It can be used until the next bank working day (overnight) through special-rate repo transactions. The special rate is based on the SARON (Swiss Average Rate Overnight) plus an interest premium.