The Swiss National Bank has limited options to deal with the strong franc
The Swiss National Bank is faced with an overheating currency and slumping economy following the decision to abandon the currency exchange rate cap on the Euro. Uncertainty in the EU is leading to a rush on the franc and severely hampering the export and tourism-dependent Swiss economy.
From high unemployment in southern Europe to sluggish economic growth and Grexit fears, the EU and the euro have recently taken a beating. All this uncertainty is leading some investors to seek safe havens, such as Switzerland.
Swiss stability is envied by many in the EU, with citizens in Sardinia even setting up a campaign to secede to Switzerland. Even the gallows humour permeating Greece has taken note: caught between having to choose between the Euro or drachma, some Greeks have half-jokingly opted for the franc.
Abandonment of exchange rate cap
Switzerland has long been accustomed to such trends, but the duration and proximity of the euro crisis has led to a massive overvaluation of the franc (CHF). Ever since the global financial and euro crises, the franc has steadily appreciated, leading the Swiss National Bank (SNB) to implement an exchange rate cap of 1.20CHF to the euro in September 2011. This cap had long been a core element of SNB fiscal policy, so it came as a shock when it was unceremoniously dumped in January 2015.
This was especially shocking as only days earlier the SNB assured that it would maintain the cap with unlimited forex purchases to boost competing exchange rates. SNB head Thomas Jordan even managed to catch the IMF off-guard, with Christine Lagarde stating that “Jordan did not contact me beforehand. I find this somewhat ponderous.”
Within minutes of the cap’s removal, the franc appreciated an unprecedented 30% against G10 currencies, at one point breaking parity with the euro, before stabilizing at a new norm of around 1.05CHF. This jump has led the franc to become, by far, the world’s best performing currency against the dollar for 2015.
Limited room to manoeuvrer for SNB
The extent of the franc’s appreciation has surprised even the SNB, which had assumed that the exchange rate would stabilize around the 1.10–1.15CHF mark. This has not occurred, and the SNB is forced to hope for a strengthening dollar or turnaround in the Eurozone to cool demand.
The problem for the SNB is that is has limited options to curtail demand for the franc, given that much of the pressure is coming from overseas. Uncertainty, however, has also impacted Swiss investors, with many wary of investing in the EU. To counteract this trend, the SNB has already instituted negative interest rates, raising them several times to the current -0.75%.
One option touted by Daniel Kalt, chief economist at UBS, is the imposition of capital controls such as withdrawal limits like those seen in Greece. Such measures could see individuals restricted to 100 or 500 CHF per day. Kalt states he can only envision this option being implemented if the euro reaches 0.90-0.95CHF; but given the upcoming Greek referendum, such a scenario is not out of the question.
Such a measure is a last ditch resort, as withdrawal limits would damage the reputation of Switzerland as a safe financial haven: foreign investors need to remain assured that they can access their money at any time. Another option which Kalt prefers to negative interest rates is the imposition of a potential fee – say 2% – on each cash withdrawal. This idea is not new, as in the 1970s, non-residents had to pay a fee of up to 10% per half year on withdrawals.
Swiss economy faces recession
The impact of the cap removal has had significant repercussions for the Swiss economy. For a country dependent on exports and tourism, a strong franc is deadly. Swiss GDP already shrunk 0.2% in Q12015 – the worst performance in six years – with Q2 likely to see the country slide into recession due to a further 0.2% decline. Exports in Q1 were also down 2.3%, another six year low.
Further complicating matters for the Swiss is the progress of the Trans-Atlantic Trade & Investment Partnership (TTIP) between the US and the EU. According to the World Trade Institute, a US-EU free trade agreement that focuses on reducing tariffs without an accompanying European Free Trade Area (EFTA) FTA deal could shave 0.5% from Swiss GDP.
The luxury watch industry, the poster boy of the Swiss economy which comprises over 10% of exports, reported an 8.9% decrease, according to the Federation of the Swiss Watch Industry — the worst performance since the height of the global financial crisis in November, 2009.
Manufacturing and tourism hit hard
Other important sectors of the Swiss economy, such as the machine-tool industry, are also suffering. Rolf Muster, CEO of Schaublin Machines SA, has seen a 60% drop in orders since the cap removal. Muster embodies the widespread industry anger with the SNB’s decision to remove the franc cap:
The machine-tool industry is used to weathering cyclical crises, but today the situation is really serious…the Germans, our main competitors from one day to the next became 15% cheaper without so much as having to replace a single bolt.
Cheaper EU competitors pose a serious threat to the Swiss machine-electro-metal industry, which exports 80% of national production (60% to the EU). Swissmem, the umbrella organization representing 330,000 machine, electrical, metal industry workers, notes that “a majority of companies in the industry are strongly affected by the SNB decision.” The only upside is that raw materials imports — a major expenditure given Switzerland’s lack of natural resources — are now cheaper, thus potentially bolstering Swiss manufacturers.
The Swiss tourism industry is also suffering from the strong franc, as bookings from EU guests (the largest tourist demographic) have declined by 25% since the euro exchange rate has risen to 1.05CHF. Ernst Wyrsch, president of the Grisons Hotel Association, forecasts that the industry will in the next three to four years experience a “rough and tumble phase the likes of which we haven’t seen in 30 years.”
Taking note of the silver lining of cheap imports, the Swiss hotelier industry has floated the idea of importing food for foreign guests duty-free from the EU in order to offset costs. This pragmatic proposal has been vehemently opposed by farmers, who are benefiting from high food prices. Consequently, this issue has become politically toxic as farmers can rely on full support from the Swiss People’s Party (SVP), the largest party in parliament.
Switzerland’s rock-like stability has proven too much of a good thing, with the Swiss economy and SNB now stuck between a rock and a hard place.