Switzerland surprised the world when it unpegged the franc. But the impact to the Swiss economy may be milder and less lasting than forecast.
The Swiss National Bank (SNB) caught the financial world by surprise in mid-January when it abruptly announced it would no longer peg the franc to a fixed exchange rate against the euro. The unexpected move prompted a rush into the franc, which immediately shot up 39% against the euro and 30% versus the dollar. The Swiss stock market, anticipating trouble ahead for the export-dependent Swiss economy, took a tumble.
All this threatened to reverse what had been a good year for the recovering Swiss economy, which posted its highest real GDP growth in 2014. Demand for Swiss goods grew 3.5%, and pharmaceuticals and chemicals, the nation’s top export items, sold 5% more than the year before, giving Switzerland, once again, a healthy trade surplus. All told, Switzerland exported US$239.3 billion worth of goods around the world in 2014, up 22.4% from 2010.
The unpegging of the franc redrew this picture, seemingly at a stroke. The eurozone accounts for 43% of Swiss exports and manufacturers fear the nation’s sales to its economically weakened neighbors will suffer. Tourism, one of Switzerland’s largest foreign exchange generators, felt the effects first, as some hotels reported a decline in bookings and some anticipated they would have to cut prices to compensate. The value of wages fell for foreign workers paid in other currencies. Already a high-priced location for manufacturers, some analysts predicted Switzerland will see an industrial exodus to less expensive regions, especially by multinationals with operations and domiciles there, weakening domestic consumption. The SNB has slashed its growth projections for 2015, from 2% real GDP to just under 1%.
That would make 2015 the country’s weakest year since the post-2008 global crisis – but not the beginning of a new recession. Indeed, the SNB expects stronger growth to return in 2016. Why?
The answer starts with the context in which the SNB made its decision to unpeg the franc. The euro itself had been falling over the past year, causing the franc to lose 12% of its value against the dollar, so letting it appreciate was not actually as serious a blow to exports as it seemed at first glance. The SNB hasn’t been idle since its action in January, either; a few days later it moved to a deposit rate of -0.25%, aiming to cool the franc’s rise, and over the next two months pushed it down to -0.75%. Thomas Jordan, Chairman of the Governing Board of the SNB, has talked it down as well, saying the franc is “significantly overvalued overall.”
The most immediate effect of the franc’s rise is on Swiss trade with the EU – still its largest trading partner. But Switzerland has long been pushing to diversify its export destinations, aiming especially to build up its trade with the expanding economies of East Asia. In 2013 it signed a free trade agreement with China, which is already Switzerland’s fifth largest export market, and it is in negotiations with six other Asian nations – Thailand, Indonesia, India, Vietnam, Malaysia and the Philippines, not to mention Costa Rica and Panama.
None of this is to say that the Swiss economy will not suffer a reduction in demand this year. The country’s red-hot property market, which grew from about 75% of GDP in 2000 to 140% at the end of last year, was already slowing at the end of 2014, as single-family homes increased in value by only 1.1%. Analysts expect the market to continue slowing this year, despite low mortgage rates. Household debt has risen since the global financial crisis, although it still amounts to little more than 15% of GDP.
Switzerland also faces challenges as a wealth management center. At US$2 trillion in assets, up14% since 2008, it commands more than 20% of the global market. But Swiss private banks lost 7% of client assets in 2014, according to a Deloitte study, while overall profit margin decreased from 40 basis points in 2008 to an estimated 24 basis points. That said, the banking sector appears to be weathering the de-pegging of the franc. UBS reported that its profits rose 88% in the first quarter over the same period last year, to US$2.1 billion, fueled in part by a 54% rise in pretax profits in its wealth management division.
But the geography of this lucrative business is changing. Switzerland is still the world’s largest wealth manager, but Hong Kong and Singapore,still only small players, were the only wealth management centers to grow their assets in 2014 – and their presence in East Asia suggests they may become more formidable competitors in years to come. This trend hasn’t been lost on Swiss financiers, however: UBS is expanding its wealth management business in Asia – 70% of its net investment is going into Asia and emerging markets, the bank said last year – and almost one-quarter of assets under management at Julius Baer Group, Switzerland’s third-largest wealth manager, are based in Hong Kong and Singapore.
Overall, Switzerland’s economic problems remain largely cyclical, not systemic, and continued efforts by the SNB to contain the franc’s appreciation while the nation loosens its dependence on the EU export market will help it to weather a lower-growth 2015.
Focus on Switzerland
With a long history as bankers to the world, Swiss banks have a strong global reputation. According to Thomson Reuters News Sentiment Analysis, trust in the top 10 Swiss banks has generally exceeded peer financial institutions globally over the past year. Notably, Swiss banking institutions hold greater than 20% of the global wealth management market.
Switzerland also scores high in global competitiveness (#1 according to the World Economic Forum), global innovation (#1 according to the World Intellectual Property Organization) and ranks among the happiest of nations (#1 according to the United Nations Happiness Index). And Switzerland spends more on research and development than its European neighbors, according to the Organisation for Economic Co-operation and Development.
Swiss exports stand apart from those of other countries. Tourism in the land of Alpine resorts has long been a high-end affair, suggesting its clientele will not desert it simply because the franc has strengthened. Pharmaceuticals, chemicals, private banking services and luxury goods such as Swiss chocolates and watches likewise tend to have low price elasticity – a study by the Federal Reserve Bank of Dallas found that Swiss goods have the lowest sensitivity to exchange rate moves of any developed country – and thus are unlikely to suffer a permanent blow from a stronger franc.
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