Last week I wrote about the UK (see: The UK: down and out?) arguing that even though UK's green shoots have been greener than elsewhere I remain worried about the medium term prospects: In short, I do not see how the UK can get back on a sustainable growth path already and think that the positive economic surprises are purely down to a more pronounced macro-economic stimulus (especially via a weaker GBP) and will prove temporary. Rather, the structural problems are very pronounced and will take a long time to be reduced with trend growth falling significantly in turn. In combination with the huge fiscal and current account deficits, the risk remains that foreign investors will take money out of the UK again.
On the other side, I am less worried about the medium term prospects of Switzerland despite the current severe recession with the SNB expecting growth this year around -3%. Yes, similar to Germany and Japan, Switzerland is one of those countries with limited domestic imbalances but a significant dependence on exports. In fact, Switzerland is even more dependent on foreign demand than Japan or Germany as exports account for almost 50% of GDP (with the current account deficit in 2008 close to 10%) and according to the latest data for May, exports are down 21% from a year ago. Clearly, there is much more downside ahead for exports given that 60% of Switzerland's exports go to the EU with Europe's fall in demand only finding its way into Switzerland with a delay. Furthermore, with UBS, the largest bank continues to struggle. Finally, the cracks in the banking secrecy for non-residents are becoming larger and might threaten the status of Switzerland as an offshore financial centre.
However, there are several positives. First, while house prices rose steadily during the current decade, there was no real boom and the housing market does not appear significantly overvalued. Consumers as well do not appear overly stretched (as the overindebted, undersaving and overconsuming US and UK consumers). With respect to the state of the banking sector, UBS appears to be rather the exception than the rule and for example the state-near cantonal banks (in contrary to the German Landesbanks) have not been hurt significantly. More importantly, I think that besides the current cyclical weakness, the structural story for Switzerland as a refuge for rich individuals and international corporations has become even better. Yes, the bank secrecy is becoming a bit weaker for non-residents. But this is not the case for residents. Furthermore, the Swiss tax system remains extremely competitive internationally and given that taxes are rising (as in the UK) or likely to rise (as in the US) for the high-income earners, stable and low taxes in Switzerland are becoming even more competitive. The combination of higher taxes and higher tax-evasion hurdles for non-residents renders moving to Switzerland more attractive. For corporations a similar logic applies (with some hedge funds moving to Swizterland amid a threat of tougher EU-wide regulation) and just today McDonalds announced to be moving its European headquarters to Geneva from London amid more preferntial intellectual property tax laws (see here: Swiss tax rules lure McDonalds from UK).
This erodes the tax base of the affected countries but increases the tax base of Switzerland, helping to keep fiscal deficits in check without having to resort to tax increases, a positive feedback loop for Switzerland. Furthermore, the movement of people and corporate headquarters is increasing demand for the already scare land and houses, supporting their prices. Overall, therefore, I think that despite the significant cyclical weakness of the export-dependent Swiss economy, the medium term outlook is superior compared to the rest of Western Europe. Especially, scarce land/houses should do well over the medium term amid an increase in demand for high-priced office space and high-end housing. Domestically focused high-end corporates should see rising demand for their services. Additionally, the SNB will continue to struggle to fight the inherent strength of the CHF. Selling GBP vs. CHF looks attractive on a longer term horizon. However, export-dependent companies will continue to face a mix of weaker demand and an increasingly uncompetitive exchange rate.