Why Switzerland is not a currency manipulator

In this Macro Flash Note, GianLuigi Mandruzzato looks at the US Treasury criteria defining a currency manipulator and concludes that Switzerland does not really qualify for such designation.

The Swiss economy is struggling to recover from the shock of the Coronavirus pandemic. GDP rebounded more than expected in the third quarter but the recovery has lost speed in recent weeks. SECO's weekly indicator shows a decline in the most recent period, consistent with moderate GDP growth on a quarterly basis (see Chart 1). However, downside risks to growth estimates in early 2021 are evident due to the worsening of the global pandemic and the containment measures taken by governments, including in Switzerland.

Source: Swiss State Secretariat for Economic Affairs (SECO).

In this context, inflation is set to remain low. In Switzerland, the inflation rate has been negative since last spring, below the 0-2% range by which the SNB defines its price stability objective. Moreover, in the two-month period October-November it was below the projection published by the SNB in September. It is therefore likely that the central bank will revise down the inflation outlook.

The persistence of very low inflation is a strong reason for the SNB to increase the monetary policy accommodation. However, the SNB has exhausted the room for manoeuvre on interest rates, which will be confirmed at -0.75% at the SNB meeting today. Interventions on the foreign exchange market to counter the appreciation of the Swiss franc and to reduce the risk of deflation will remain a key part of SNB's monetary policy.

However, many commentators fear the central bank may be less determined in its currency intervention after US Treasury designated Switzerland a currency manipulator on December 16^th. But this should not and, we think, will not, be the case because, simply said, Switzerland is not actually a currency manipulator.

While, Switzerland met the three quantitative criteria set by the US Treasury, that did not happen as a result of keeping the exchange rate low and gaining an unfair competitive advantage. The three criteria set by the US treasure are:

- a bilateral trade surplus with the US of more than USD 20bn;

- a current account surplus of more than 2% of GDP;

- persistent one-sided currency intervention, adding to 2% of GDP over the last six to 12 months.

Switzerland had a bilateral trade surplus of USD29bn with the US in the 12 months to October (see Chart 2). However, the growth in Switzerland's bilateral surplus is mainly due to the export of pharmaceutical goods, a sector in which Switzerland is among the world's leaders and which is meeting growing US demand, also linked to the ageing of its population.¹

Source: Refinitiv, SECO, and EFGAM calculations.

Switzerland's current account surplus was 8.8% of GDP in the 12 months to June (see Chart 2). But this reflected Switzerland's specialisation in high-tech sectors such as pharmaceutical and chemicals, precision engineering and luxury watches. In addition, the analyses of international competitiveness, like those of the World Economic Forum and the Institute for Management Development, have constantly seen Switzerland among the world's most competitive economies thanks to its innovation capacity and high number of new patents.

Currency interventions intensified in 2020 as the coronavirus pandemics triggered a surge in safe haven flows into Swiss franc (see Chart 3). The SNB revealed it bought foreign currencies for almost CHF90bn in the first six months of 2020.² Based on weekly data on sight deposits at the central bank, it can be estimated that in the 12 months to end-November the SNB purchased a total of around CHF 120 bn, or nearly 17% of Swiss GDP.

Source: Refinitiv, SNB, and EFGAM calculations.

Undoubtedly,Switzerland met by a large margin all the quantitative criteria set by the US Treasury to designate a currency manipulator. However, the Omnibus Trade and Competitiveness Act of 1988 requires that, when considering if countries manipulate their exchange rate against the US dollar to gain an unfair competitive advantage in international trade, the Treasury Secretary analyse a broad range of factors, including currency developments and monetary policy. Both these factors does not support the US Treasury's conclusions over Switzerland.

The Swiss franc has appreciated strongly vis-a-vis the US dollar since mid-2019 and the USD/CHF exchange rate fell below 0.89 in December, the strongest the franc has been since January 2015. Furthermore, the franc appears to be more than 4% overvalued against the US dollar based on the Purchasing Power Parity (PPP), the strongest overvaluation since early 2016 (see Chart 4). Although the Swiss franc would have probably strengthened further without the SNB’s currency interventions, it is not undervalued and cannot be seen as giving Switzerland an unfair competitive advantage.

Source: Refinitiv and EFGAM calculations.

With respect to monetary policy, it is evident that the SNB must run an expansive monetary policy if inflation falls below its target range. Having reduced interest rates to a level that many see as the effective lower bound, the SNB, as other central banks in developed economies, including the Federal Reserve, had to resort to unconventional monetary policies as asset purchases to inject liquidity in the system. Given the small size of the Swiss domestic bond markets, the SNB must pursue unsterilised purchases of foreign assets which result in an increase of its balance sheet, as mirrored in rising sight deposits. Hence, the SNB currency interventions are targeted at meeting its monetary policy mandate rather than gaining a competitive advantage in international trade.

To conclude, the SNB will confirm the accommodative monetary policy at its quarterly meeting today, highlighting the role played by negative interest rates and currency market interventions in pursuing its price stability mandate. Despite the central bank activism and the large external surpluses led the US Treasury to designate it a currency manipulator, it is hard to imagine that SNB will deflect from using all the available tools to achieve its legal mandate. And, although there is a risk that the US treasury decision reflects badly on Swiss Companies, that could be excluded from US government procurement contracts, president-elect Biden seem unlikely to retaliate on Switzerland once in office.

¹ See GianLuigi Mandruzzato’s Infocus “Swiss growth resilience and export specialisation”, September 2020.

² At the end of September, the SNB published data on foreign exchange intervention on a quarterly basis for the first time, in fact following a recommendation from the US Treasury for greater transparency in this regard. Previously, data were only published in the SNB's annual report.