Coronavirus pandemic: What does the national debt mean for Switzerland and its economy?

The robust trend in pharmaceutical exports, the effectiveness of government measures, and the more positive signals from economic indicators are reasons for cautious optimism. Credit Suisse economists are therefore standing by their relatively optimistic forecast this year. They expect to see a decline in gross domestic product (GDP) of “only” 4% (forecast 17.4.2020: -3.5%). Overall, the economy is expected to progress slowly, with a tilted “V shaped” recovery. GDP will not return to end-2019 levels again until the end of 2021. Like the economy, the political debate is gaining momentum. According to Credit Suisse economists, the sharp rise in national debt can be easily managed, provided fiscal policy remains sustainable over the long term. Consequently, the debt brake will continue to be a key instrument. The increased use of SNB reserves or profits is not a real solution.

With the lifting of the lockdown, the first signs of recovery are now appearing. The Purchasing Managers’ Index (Purchasing Managers’ Index, PMI) for the service sector has already regained nearly half of the value it lose. The financial position of most households is actually better than the economic slump during the lockdown would suggest. However, the income lost as a result of unemployment and short-time working is not being completely offset by government payments, according to calculations by Credit Suisse economists. That is why household income is expected to fall by almost 5% in 2020. Meanwhile, it is estimated that households have spent 20% less during the lockdown, leading to additional net savings. “We expect that households will spend a significant portion of their additional savings. More specifically, we estimate that they will put two-thirds of their accumulated funds – around CHF 5.5 billion – back into circulation, making up for approximately half of the decline in consumer spending,” says Claude Maurer, Head of Swiss Macro Economics at Credit Suisse. At the same time, public spending should rise significantly, helping to stabilize the economy.

Pharmaceuticals sector boosts export growth – silver lining visible in Asia
Foreign trade figures for the first quarter illustrate how important the heavy weighting of the pharmaceuticals sector (50% of exports) and its minimal short-term sensitivity to the business cycle are for export growth. Exports increased overall even though exports from economically sensitive industry sectors fell significantly. The latter should bottom out in the near future, however. In April, exports in the mechanical, electrical, and metals (MEM) industry to countries that were already able to ease their coronavirus restrictions that month – primarily Asia – rose again overall. This creates hopes of a quick stabilization of exports to Europe as well. Conversely, demand for Swiss MEM exports to the US will continue to fall. The easing of restrictions overseas has only just begun. Moreover, the situation for the watch industry, which is heavily dependent on international consumer sentiment and the flow of Asian tourists to Switzerland, will remain challenging for a longer period of time.

Capital spending on machinery and equipment may hit bottom
As far as capital spending on machinery and equipment is concerned, the largest part of the decline seems to have passed. Since a second lockdown in Switzerland is rather unlikely at present, companies have a more reliable basis for planning. Further, overall capital expenditure is soaring due to the pharmaceutical industry’s spending and the increased expenditure on IT as part of the more widespread reliance on home working and online shopping. Despite that, it is precisely this component of demand that is expected to see only a sluggish acceleration of growth because companies overall are focused on boosting capital reserves. Construction investment is also expected to experience a decline, partially because the rising number of vacancies in the rental apartment sector is hindering the start of new projects.

Sluggish recovery following initial spike
Following the initial spike in the economy as a result of the lockdown being eased, the recovery will continue at only a sluggish pace going forward. Four specific factors point to a titled «V-shaped» recovery, according to Credit Suisse economists. First, global demand for capital goods and watches is expected to remain subdued for the time being. That will be the case solely because restrictions on transport capacity and intercontinental travel could remain in place for even longer. Second, supply in the retail sector is physically limited because protective measures and safety precautions require space. Third, the labor market is recovering less quickly than it collapsed, and this is being accompanied by a certain restraint in terms of consumer demand. Fourth, immigration to Switzerland is slowing as a result of the borders being closed and fewer companies hiring new employees. This is impacting on a key driver of consumer spending growth (net immigration forecast in 2020: 35,000 to 40,000 individuals, compared to 53,000 in 2019).

Swiss fiscal policy measures: impressively efficient
By international standards, the scope of the fiscal measures taken in Switzerland appears rather small. They also leave questions unanswered concerning additional measures in the coming weeks and months. However, what the measures lack in scale, they make up for in their extreme efficiency of implementation, which was made possible through the use of the existing tool of short-time working and cooperation between institutions on bridging credit facilities. The previously discussed measures, amounting to approximately CHF 70 billion, will create a massive deficit in the federal budget, according to estimates by Credit Suisse economists. However, the nation’s “debt brake” rule requires it to pay off that deficit within six years. The expected level of new borrowing is significantly lower than the deficit thanks to the federal government’s large cash reserves, and total debt remains extremely low in an international comparison. Based on the simplified assumption that the level of debt owed by the cantons and municipalities remains unchanged, Credit Suisse economists estimate that the debt-to-GDP ratio will increase from 26.7% in 2019 to 34.1% in 2020 – meaning Switzerland would easily continue meeting the Eurozone’s Maastricht criteria even after the coronavirus crisis is over. Switzerland’s AAA rating on the capital market is also not really threatened by the higher debt-to-GDP ratio. Consequently, it is expected that investor confidence will be maintained and the risk premiums factored into interest rates will remain low despite the higher national debt. Weak productivity growth globally, demographic trends, and the high savings rate in Switzerland speak in favor of Switzerland even receiving interest on new borrowing thanks to negative interest rates. Paradoxically, the debt incurred due to the coronavirus is more likely to provide relief rather than placing a burden on the government budget over the coming years.

Return to the normal application of the debt brake only makes sense from 2022
Given the circumstances, Credit Suisse economists believe it is advisable to accept the one-time increase in national debt caused by the pandemic and not force a rapid debt reduction that may potentially curb growth. This calls for a significant extension of the period allotted for the repayment of debt, which is possible due to the utilization of a special provision relating to the debt brake. A subsequent return to balanced budgets starting in 2022 is nevertheless advisable and will still enable a reduction in the debt-to-GDP ratio to its pre-crisis level within a generation if interest rates stay low. Credit Suisse economists ran a simulation applying the assumption that the debt-to-GDP ratio of the federal government could fall to its 2019 level again within 17 years. A stability-oriented fiscal policy, however, remains important not only for purely economic reasons but also to protect the domestic political consensus, thus allowing the nation to take quick and effective measures in the event of another crisis.

Special disbursement from the SNB would not lower government debt
At the same time, Credit Suisse economists see serious disadvantages in paying back debt by tapping into the reserves of the Swiss National Bank (SNB). First, their calculations show that the refinancing conditions through the Federal Treasury are more favorable. Second, the market-distorting forces will be weaker if the federal government issues bonds than if the SNB augments its disbursable reserves through gains on foreign exchange transactions or negative interest. Third – and probably most importantly – a transfer of SNB profits would change nothing in the federal government’s net debt. A distribution of profits would indeed help to prevent an increase in the gross debt of the federal government. However, that would not have any effect on the net debt because the federal government would lose the retained profits of the SNB, which are counted as part of its assets. Financing the deficits by means of an extraordinary distribution of profit from the SNB will also provoke institutional concerns – after all, it would amount to the mixing of monetary and fiscal policy.

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