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Wednesday, July 16, 2003

Deflation 'Practically Impossible' in Switzerland.............Or Is It?

Another country high on the deflation hit list, this time both the IMF's and mine, is wobbling. Switzerland, according to sources in the Swiss Economics Ministry is again entering recession. We watch, and wait.

Switzerland's economy risks contracting this year as Germany, its largest trading partner, struggles to emerge from a slump and the franc's gains curb exports, an adviser to Economics Minister Joseph Deiss said. Europe's seventh-largest economy may not recover until early next year, said Aymo Brunetti, a ministry economist, in an interview in Bern, the seat of the Swiss government. The government may in early August revise its estimate that the economy won't grow for a second year in 2003, he said. "There are clear risks to the economy -- the situation in Germany is certainly not very positive,'' Brunetti said. "We expect a recovery toward the end of this year but it's very possible it will be delayed by a couple of months.''

The Swiss economy probably stalled in the second quarter after shrinking in the first three months of the year, Swiss National Bank President Jean-Pierre Roth said in June. The central bank has cut interest rates seven times to 0.25 percent since March 2001 to revive the economy and stem the franc's gains. "We would be in a severe recession if the central bank hadn't been so expansive,'' Brunetti said. With exports accounting for almost half of Swiss gross domestic product, growth will hinge on a recovery in Germany, which buys about a fifth of Swiss goods sold abroad, the government has said. The U.S. buys about 11 percent of exports.

The Swiss currency gained 5.9 percent against the dollar in the year's first five months, making exports more expensive for the world's largest economy. Exporters including Swatch Group AG, the biggest watchmaker, and Clariant AG, the world's second- largest specialty chemicals maker, have seen earnings dwindle following the franc's appreciation. A slump in exports was the main reason why the Swiss economy slipped into its second recession in as many years. Companies scaled back production and curbed investment amid concern about the Iraq war and rising unemployment held consumers from spending. With interest rates close to zero, Swiss National Bank policy makers have said they're ready to stem an increase in the franc by buying foreign currencies, such as euros. The bank hasn't used the measure since 1978.

"It's striking that the SNB is clearly indicating that it would combat an increase in the franc -- it's credible because it would be technically possible without any problems,'' Brunetti said. Another increase in the franc would "undoubtedly'' hurt economic growth, he added. The Swiss currency tends to rise in times of political and economic crisis because of Switzerland's perceived stability. The country's government coalition has been unchanged for the past 44 years. The franc surged 5 percent against the euro in the 10 days after the Sept. 11 attacks.

Brunetti also repeated comments by the SNB's Roth that deflation -- declining prices combined with economic stagnation - was "unlikely'' as long as the franc doesn't surge. Deflation is "practically impossible'' as long as the central bank takes measures against it, he said. The economy has also been hurt by a rising jobless rate. Unemployment rose to 3.8 percent in June, adjusted for seasonal changes, following job cuts at companies including UBS AG, Syngenta AG and Swiss International Air Lines Ltd. The unadjusted jobless rate was unchanged at 3.6 percent. Companies will probably cut more jobs in coming months, with the jobless rate expected to further increase towards the end of the year on both "economic and seasonal reasons,'' Brunetti said. He said he expects unemployment to peak in January or February of 2004.
Source: Bloomberg

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