Switzerland is an exception when analysing the level of its debt. According to the IMF, gross public debt was equivalent to 41.8 percent of GDP in 2017 of which 14.5 percent of GDP is borne by the Confederation and the remainder by the cantons.
This is the lowest level of public debt in Switzerland since 1991 and is well below the average debt level of the EU or the euro area. While other countries have tended to increase their debt as a proportion of their GDP in recent years, Switzerland has seen its debt decrease every year. This decrease in debt follows a succession of budget surpluses in previous years which has been positive almost every year except 2013 and 2014.
For 2019, the Confederation's budget could lead to at least a surplus of 1.3 billion francs. More surprisingly, the Swiss Confederation ends each year with a larger budget surplus than expected at the beginning of the year in the budget. As an example, in 2018, the Swiss Confederation recorded a budget surplus of 2.94 billion francs, ten times more than expected, thanks to tax revenues which exceeded expectations, while spending remained under control.
A debt brake in the constitution
The main cause of Switzerland's low indebtedness is a mechanism introduced by the Confederation to stabilise the federal debt known as "the debt brake". The principle behind it is that public spending should not exceed revenues over a full economic cycle. The formula allows for a deficit during a recession, offset by surpluses during an expansion period.
However, the implementation of this system has resulted in a significant debt reduction, rather than just stabilisation. This is because the rule is applied asymmetrically and expenditure tends to be overestimated each year, while revenue is analytically underestimated.
Almost every year since the beginning of this system, federal authorities have missed their goal by overestimating expenditures or underestimating revenues.
Paid to get into debt
This mechanism is largely supported by the Swiss population and illustrates a certain mentality which considers that debt is bad and that it is necessary to reduce debt as much as possible. Each year, the government uses the budget surplus to reduce the debt pile, which leads to a progressive deleveraging of the Swiss public authorities.
Nevertheless, this run of deleveraging poses major questions of economic policies, given current market conditions. Indeed, deleveraging implies a reduction in the supply of Swiss government bonds. However, Swiss debt is considered by the markets to be extremely safe and the demand for these securities is huge, especially when conditions lead to a "flight to safety".
The consequence of this strong demand and weak offer is that interest rates on Swiss debt are extremely low, the lowest in the world. The Swiss Confederation borrows with an interest rate of -0.31 percent at 10 years, -0.62 percent at 5 years, -0.02 percent at 15 years. Only state bonds with a maturity of 20 years or more imply a positive interest rate for the Confederation.
With negative rates, the Swiss state is actually paid to go into debt. Hence, the paradox is that by reducing its debt, Switzerland is missing out on budget revenue.
Is it time to change?
Monetary policy in Switzerland is currently extremely accommodative, with a negative interest rate and interventions on the foreign exchange market to weaken the currency when necessary. Despite a very accommodative policy, price stability remains a major challenge because inflation remains very low and the risks of deflation have never been averted.
Given the global economic context, it won’t be possible for the Confederation to raise rates for several years. Against this backdrop, the room for manoeuver of monetary policy to fight against a possible future recession is very thin. It seems, therefore, that calls for a less restrictive fiscal policy and a more appropriate policy mix will grow louder.
For now, however, the debate has not reached the political level in Switzerland. As long as every budget is well debated and parties have their own priorities for spending, the debt brake rule doesn't seem to be in question. Still, there are some signs that the debate could gain momentum in the coming months and years.
This article was issued by Maria Fenech, investment management support officer at Calamatta Cuschieri. For more information visit, https://www.cc.com.mt/ . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.