Switzerland Ratings Affirmed At 'AAA/A-1+'; Outlook Stable

  • We expect Switzerland's real GDP growth will moderate toward 1.5% on average in the next few years, in line with softer global growth.
  • In our view, Switzerland's ample external and fiscal buffers, coupled with its significant monetary flexibility, will enable the economy to absorb potential shocks.
  • We are affirming our 'AAA/A-1+' long- and short-term ratings on Switzerland.
  • The outlook is stable.
On Feb. 22, 2019, S&P Global Ratings affirmed its unsolicited 'AAA/A-1+' long- 
and short-term foreign and local currency sovereign credit ratings on 
Switzerland. The outlook is stable.

The stable outlook reflects our view that Switzerland will continue to post 
fiscal and external surpluses, and preserve its effective policymaking and 
institutional strength.

We could lower the ratings on Switzerland if we observed an unexpected 
deterioration in the effectiveness and predictability of policymaking, with 
potential major economic implications. A severe drop in global demand for 
Swiss exports could also put pressure on the ratings. However, we currently 
view these downside scenarios as unlikely over our outlook horizon.

Our ratings on Switzerland reflect the country's high prosperity and its 
resilient and highly competitive economy. Continually high current account 
surpluses and the Swiss franc's status as an actively traded currency also 
support the ratings on Switzerland. Our assessment incorporates the 
credibility of the Swiss National Bank's (SNB's) monetary policy. 
Switzerland's institutional stability and its track record of fiscal prudence 
further underpin the ratings.

Institutional and Economic Profile: The domestic policy agenda for 2019 is 
  • Switzerland will consider important economic issues such as corporate taxation reform, limiting immigration, and the country's framework for relations with the EU.
  • The country and its institutions remain a pillar of stability, and demonstrate predictable policymaking, in our view.
  • Economic growth is set to moderate in the coming two to three years at below 2% on average, mainly supported by domestic demand.
After a strong start to 2018, we note that growth slowed markedly in the 
second half of the year. We believe this reflects weakened demand for Swiss 
exports, particularly from China and emerging markets, but also from Germany, 
Switzerland's most important trading partner. Switzerland's highly competitive 
export sector, notably pharmaceutical and chemical products, precision 
instruments and watches, and machinery, is a key pillar of its economy. While 
this slowdown underlines Switzerland's susceptibility to a softening in global 
trade, we think domestic factors will continue to support growth, with a 
tightening labor market, rising productivity, and low inflation supporting 
real disposable income growth. Furthermore, high capacity utilization will 
likely continue to support business investment. As a result of these factors, 
we project growth rates will moderate to 1%-2% in 2019-2022. 

Switzerland's domestic policy agenda continues to address important and 
contentious issues. Switzerland faces the challenge of adopting a 
long-discussed reform of corporate taxation. The reform is necessary because 
certain cantonal tax privileges for corporates will no longer be 
internationally accepted going forward. This means that without new 
legislation, Switzerland could come under international pressure, with legal 
uncertainty for businesses and private investment potentially arising as a 
result. In order to achieve a compromise across the political spectrum, 
parliament has combined the reform with a contribution to the first pillar of 
the retirement scheme. The proposal will go to referendum in May 2019, and 
while it is backed by major political players, we note that its preceding 
reform proposal was rejected by the population in a 2017 referendum.

Another difficult yet critical issue for Switzerland is the country's 
relationship with the EU. Relations remain a field of constant bilateral 
negotiation and an issue of contention domestically. Switzerland has 
negotiated an institutional framework agreement with the EU. This agreement 
aims to codify, among other things, how Switzerland's bilateral agreements 
with the EU will be adapted to reflect changes in EU law, in order to provide 
a framework for Switzerland's access to the common market. The drafted 
proposal has been on the table since December 2018, but the Swiss government 
has initiated a consultation process with domestic stakeholders, and intends 
to decide on the next steps in spring 2019. The draft agreement continues to 
face criticism across the political spectrum, for example due to unions' 
concerns regarding labor protection laws in relation to the free movement of 
persons agreement, or regarding the role of the European Court of Justice in 
resolving disputes.

A further area of domestic contention regarding Switzerland's relationship 
with the EU is the limitations on immigration. A vote on a popular initiative 
to cancel the free movement of persons agreement could be held in the coming 
one to two years. However, ease of EU market access is of high importance for 
Swiss companies, and therefore Swiss policymakers have been trying to preserve 
bilateral agreements with the EU. 

We note that Switzerland has agreed a new trade agreement with the U.K., which 
is Switzerland's sixth most important goods exports destination, allowing 
businesses to trade freely after Brexit. For most areas of business, the 
agreement will ensure that trade relations are on par with what was previously 
agreed under EU bilateral agreements. However, some Swiss exporters could face 
nontariff trade barriers, depending on the outcome of EU-U.K. negotiations.

The Swiss political system has a long-standing tradition of incorporating 
direct democracy (popular referenda and initiatives). Swiss policymaking has a 
formidable track record of responding to economic and societal priorities, 
which in part explains Switzerland's top positions in various 
business-environment rankings. The country's institutional effectiveness and 
stability, rule of law, and business environment add to its reputation as a 
safe haven even during crisis periods.

Flexibility and Performance Profile: Switzerland's fiscal and external buffers 
remain a key credit strength
  • We expect Switzerland's current account surplus will remain above 6% on average in 2019-2022.
  • We expect net general government debt will decline steadily to 14% of GDP by 2022, backed by general government surpluses.
  • The Swiss franc will retain its safe-haven appeal, and the SNB's path toward monetary policy normalization will be complex.
Switzerland's current account surplus has been persistently high at about 8% 
on average over the past three years. We have observed that Switzerland's 
exports have proved to be relatively price-insensitive, even in periods of 
strong franc appreciation, which we view as reflective of Switzerland's high 
competitiveness. Therefore, we expect Switzerland will continue to post a 
sizable and stable current account surplus of about 7% of GDP on average 
throughout our forecast horizon.

Switzerland's primary income balance swung to deficit in 2017, likely related 
to earnings on direct investments in Switzerland. The investment income 
surplus reduced significantly compared with previous years as a result of 
rising expenses, adding to the persistently negative labor component of the 
income balance. We also project the country will remain a net external 
creditor, well in excess of 100% of current account receipts (CARs) regardless 
of potential valuation effects on Switzerland's international investment 
position. By a narrower measure of external debt, net of public- and 
financial-sector external assets, we expect Switzerland will remain in a 
modest debtor position, averaging 10% of CARs during our forecast horizon. 

We view the Swiss franc's status as an actively traded currency as an 
important credit strength. It holds almost a 5% share in spot foreign exchange 
transactions, according to the Bank for International Settlements' Triennial 
Central Bank Survey in 2016. The key pillars of the SNB's monetary policy are 
negative interest rates and its interventions in the foreign exchange markets. 
These measures were introduced to stem the strong appreciation of the franc 
following the decision to abandon its cap against the euro in 2015. Over the 
course of 2018, the franc appreciated in times of perceived heightened 
international risk, reflecting safe haven inflows. Due to SNB's balance-sheet 
expansion, the bank has become more exposed than any major central bank 
globally to valuation effects, in particular because of its large holdings of 
eurozone government bonds and U.S. equities. As a result of this exposure, the 
SNB reported a loss of Swiss franc (CHF) 15 billion (some 2% of GDP) in 2018. 
Although there is intense public discourse on the SNB's balance sheet 
expansion and on negative rates, the bank's independence is steadfast, as 
demonstrated by its surprise announcement in 2015 that it was removing the 
franc's cap. 

Inflation increased to 0.9% in 2018, and we expect it will average about 1% 
over our forecast horizon. However, consumer price developments remain 
susceptible to pressure from the appreciation of the franc. Negative interest 
rates have had unintended consequences, including rich valuations in the 
property sector. Prices could come under pressure when interest rates rise 
again. However, we do not expect a sharp correction in the real estate market, 
since economic prospects remain intact. At the same time, regulatory measures 
and slower population growth will likely help decelerate house price growth 
going forward.

Switzerland's prudent fiscal policy is underpinned by a track record of budget 
outperformance in recent years. We project general government surpluses will 
continue, but will decline somewhat over the coming three years as fiscal 
pressures emerge, mainly as a result of tax reform. Consequently, we expect 
net general government debt will decrease to about 14% of GDP by 2022 from 17% 
in 2018. We expect the current corporate tax reform proposal will, if 
implemented, cost the central government about CHF1.4 billion annually from 
2020 (0.2% of GDP). The largest projected effects would stem from the 
contribution to the retirement scheme, which has been coupled with the 
corporate tax proposal and the higher share of direct federal taxes accruing 
to the cantons. The latter highlights that the reform will also largely affect 
Swiss cantons, because they might opt to lower corporate taxes to remain 
internationally competitive when the internationally disputed tax privileges 
are abolished. The reform will also impact the concurrent overhaul of the 
fiscal equalization system, which will have to reflect the new tax policies. 
In that regard, we note that Swiss public finances are highly decentralized. 
Cantons and municipalities account for about one-half of total general 
government revenues and spending. 

Switzerland has a prominent financial sector, with total assets representing 
over 5x GDP, strongly driven by the two largest Swiss banks, UBS AG and Credit 
Suisse AG. Domestic assets denominated in francs are about 3x GDP. Since the 
financial crisis and subsequent substantial government support for UBS, the 
government has taken regulatory measures to reduce systemic risk and improve 
the resolvability of systemic banks, which should help contain future 
contingent liabilities for the sovereign. 

We think that growth in residential real estate prices and mortgage lending 
over the past several years could pose a risk, especially for Swiss banks 
focusing on the domestic market and with large exposures to the Swiss real 
estate market. House prices remain at historically high levels. Affordability 
has further deteriorated and vacancy rates have risen markedly, while mortgage 
lending continued to rise by 2.7% as of October 2018. We think, however, that 
ongoing efforts by the central bank and the Swiss regulator to contain 
mortgage debt growth will limit a further buildup of imbalances. We expect 
house price and private-sector credit growth will slow relative to GDP growth. 

Another potential risk for the banking sector remains its need to adapt to the 
negative-interest-rate environment. We assume that banks will continue to 
apply rational pricing for core banking products, as well as stringent cost 
management, thereby mitigating continued pressure on net interest margins. 
Under our Banking Industry Country Risk Assessment, we classify Switzerland in 
group '2' (on a scale of '1' to '10', with group '1' denoting the lowest-risk 
banking systems), one of the strongest worldwide. We currently view the 
government's contingent liabilities from its financial sector and 
government-related entities as limited.
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