Pity the Swiss National Bank. At the central bank’s policy meeting last week, it acknowledged that the exchange rate it manages is overvalued, which means it is likely to undermine economic growth, turn away tourists and hold back long-term prosperity. Yet the SNB refrained from doing anything about it, and the franc immediately appreciated even more, adding to the challenges facing the bank and Switzerland.
Because the exchange rate is a relative, not absolute, price, the SNB’s predicament is indicative of far more than domestic issues. In this particular case, the franc’s strength also points to a regional misalignment that has vexed Swiss authorities for quite a while: how to retain Switzerland’s traditional standing as a safe harbour and its role as a home for foreign capital while the European Central Bank has adopted experimental monetary policies involving large-scale purchase of securities and significant expansions of its balance sheet.
The SNB cares about the exchange rate because excessive overvaluation of the currency could lead to deindustrialisation and gradually hollow out its service industry, including tourism. Small businesses suffer the most, adding to the discomfort.
Unlike multinational companies and many middle-sized ones, Switzerland’s small businesses aren’t able to relocate their production facilities abroad. And many don’t rely on sufficient quantities of imported components to compensate for their currency-induced loss of competitiveness against foreign products.
Over the past few years, the SNB has tried many ways to deal with its predicament. It even took the once-unthinkable step of implementing a currency floor to ensure that the franc wouldn’t strengthen beyond a certain level against the euro. Yet, what was meant as a short-term measure had to be maintained for quite a while, causing distortions elsewhere. And when the SNB felt obliged to abandon this arrangement in January, the decision led to unprecedented market volatility that raised doubts, at least temporarily, about the central bank’s reputation as a guardian of stability.
The SNB has also opted for negative policy interest rates – a once unthinkable step as well. In doing so, it has been taxing Swiss savers as it seeks to discourage inflows of foreign funds and encourage some of the non-resident capital to go elsewhere.
Last week, the central bank decided not to adopt any additional policy actions. It refrained from taking policy rates further into negative territory, concerned about the impact on the functioning of the domestic financial sector. It still has no appetite for implementing capital controls on incoming funds, a restriction that would seek to limit the inflow of foreign capital. And it doesn’t wish to impose taxes on such capital or subject it to a managed exchange rate once again.
The SNB is, in effect, trying to wait out the storm. And pending the normalisation of ECB monetary policy, it hopes Switzerland will be able to cope by showing its traditional combination of resilience and agility.
Switzerland is a wealthy country and can rely on its past earnings to maintain living standards. It is also agile enough to partially counter the impact of exchange-rate overvaluation through a gradual internal devaluation – that is, the acceptance by workers of lower nominal wages. And the population would accept these steps, at least for now, as part of the challenge of being a small independent and prosperous country in a tumultuous region.
The problem for Switzerland is that eurozone monetary policy normalisation is quite far away. The Greek crisis is unlikely to be resolved decisively any time soon. As a result, the ECB’s next policy step is likely to involve more unconventional stimulus.
What the SNB is going through reflects a reality facing small, open economies that is also a particularly consequential challenge for those in the emerging world that don’t possess Switzerland’s mix of resilience and agility.
It is difficult for small economies to come up with optimum policy responses when the big economic powers have opted to over-rely on their central banks’ use of unconventional monetary policy rather than implement well-balanced policy packages. With the credibility of financial institutions such as the IMF hampered by the unwillingness of big shareholders to adopt meaningful reforms, this test isn’t being answered at the multinational level, either.
Mohamed El-Erian is chief economic adviser at Allianz and chairman of Barack Obama’s Global Development Council
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