Switzerland lagging behind

Transcription

1 INVESTMENT SOLUTIONS & PRODUCTS Economic Research Monitor Switzerland June 216 Switzerland lagging behind Investments Sectors Swiss Electricity Market Companies so far footing the bill Page 13 Industry continuing to battle for price competitiveness Page 11 Postponed deregulation protects public finances Page 18

2 Imprint Publisher: Investment Solutions & Products Loris Centola Global Head of PB Research Tel Dr. Oliver Adler Head Economic Research Tel oliver.adler@credit-suisse.com Editorial deadline 7 June 216 Visit our website at Copyright The publication may be quoted providing the source is indicated. Copyright 216 Credit Suisse Group AG and/or affiliated companies. All rights reserved. Contribution Tomasz Limberger 2

3 Editorial Dear Reader The new Gotthard base tunnel was officially opened on 1 June. This construction is not only a masterpiece of engineering but also as the presence of prominent international figures at the opening ceremony reflects a European project par excellence: The new infrastructure serves to bring the north and south of Europe closer together and to integrate Switzerland more closely with both. While the integration of Europe from a transportation and hence an economic perspective has taken a step forward, the continent's political cohesion appears increasingly called into question. Centrifugal forces can be identified in many countries, above all in the UK that is voting this month on whether or not to remain in the European Union (EU). However, EU critics are also on the rise elsewhere, such as in some of the 'younger' EU member states of Eastern Europe and even in the three major core and founding countries. The precise causes of the 'rebellion against Brussels' are difficult to pinpoint and also seem to be contradictory in nature. On the one hand, many citizens harbor general concerns about the loss of national sovereignty or cultural identity that are exacerbated by the perception of a commanding central power. At the same time, this 'center of command' is criticized for repeatedly failing to meet its objectives even though this is largely due to a lack of cooperation among the member governments. There can be no doubt that the wave of migration over the past year and the ongoing controversy over monetary policy in the Eurozone have exacerbated both these feelings. Such circumstances serve to boost the more populist forces in Europe and make it more difficult to convince citizens of the benefits of closer economic or even political integration. We are also not always able to escape such populist simplification in Switzerland's discourse. However, we have the advantage that thanks to the intensely practiced referendum democracy the electorate is ultimately obliged to attribute the consequences of political decisions to itself. For example, the realization appears to be dawning on Swiss citizens that upholding the bilateral agreements with the EU is of great importance for our economy. This realization is likely to be reinforced by the generally still 'shaky' overall picture of the Swiss economy that is painted in this edition of Monitor Switzerland: Investment activity of businesses remains subdued due to ongoing margin pressures as well as a continued overvaluation of the Swiss franc, the prospects on the labor market and on the real estate markets are mixed, and cantonal finances are under pressure owing to both the forthcoming Corporate Tax Reform as well as the distortions on the European electricity market that are weighing down on the producers which are partly owned by the state. There is thus a greater need than ever before for pragmatic Swiss common sense solutions. We wish you an interesting read. Thomas Gottstein CEO Swiss Universal Bank Oliver Adler Head of Economic Research 3

4 Contents Global Economy 5 The global economy is displaying little momentum. However, concerns about a slump in growth have not materialized. In view of political risks, there is also not likely to be much change in the subdued momentum in the coming months. Swiss Economy 7 Cost cuts will also dominate economic activity this year. However, the labor market situation should not deteriorate any further. Altogether the Swiss economy should grow by around 1% in 216. Sectors 11 The overvaluation of the Swiss franc increased sharply with the abandonment of the EUR/CHF minimum exchange rate. The relative producer prices of the industrial sectors responded very differently to this challenge. Investments Debate 13 Unlike construction investments, investments in equipment are largely financed through cash flow. The corporate profits generated in Switzerland have reached a low point and there is no sign of any rapid improvement. Regions 15 The double profit distribution of the Swiss National Bank protected most cantons against a deficit in 215. However, red figures are set to dominate again in the years to come. Swiss Electricity Market Debate 18 The regulated area partly protects the electricity industry against the record low wholesale prices. A deregulation would put public finances under more pressure. Monetary Policy 22 A growing share of household financial wealth is held in Swiss franc deposits with banks. While this could eventually be invested abroad, there is no sign yet that such a trend could be initiated in the near future. Real Estate 25 The retail property market has recently been negatively impacted by branch closures of wellknown retailers. The strong franc and e-commerce are thwarting many retailers and there is no sign of any easing of the situation in the near future. Economic Policy Agenda 27 Conservative forces dominate the newly composed National Council. Purely center-left issues do not appear capable of gaining a majority at present. However, both the balancing effect of the Council of States and special interests are preventing radical savings measures. Forecasts and Indicators 28 4

5 Global Economy Political risks in focus The global economy is displaying little momentum. However, concerns about a slump in growth have not materialized. In view of political risks, there is also not likely to be much change in the subdued momentum in the coming months. US Fed indicates further interest rate hike in near future Improved Eurozone data taking pressure off ECB; political risks in June Further downturn in China; continued weakness in Russia and Brazil The US Fed is known for its surprises. It recently demonstrated this again: While the financial markets and we as well did not expect a base rate hike until September 216 at the earliest following generally poor US economic data and very cautious tones from Fed representatives right through to April, the central bank started in mid-may to prepare the markets for an interest rate hike in the summer. The actual timing is uncertain. However, what does seem certain is that any further interest rate hikes will initially only take place at a very cautious pace. The American economy remains subdued and inflation and wage pressure are only increasing slowly. Economic growth in the Eurozone delivered a positive surprise in the first quarter of 216. Although this implies downturn expectations for the second quarter, we think the underlying moderate but positive economic momentum is holding up. This is enabling the European Central Bank to gain urgently needed time for the stimulating effect of the measures it announced in March to develop further. However, there are two major obstacles on the political side to be overcome in June: the referendum on EU membership in the UK and then the Spanish elections. The economic picture in the main emerging markets remains extremely mixed. Following a phase of stabilization, we expect a further downturn in the Chinese economy in the next few months although no collapse. The recent depreciation trend of the Chinese yuan could accordingly continue. Brazil's economic data remains extremely weak and at best a stabilization at low levels is to be expected in the immediate future. In Russia the economy has partially recovered from the negative shocks of the sanctions and the fall in the price of oil but here too there will be a continued lack of momentum. India remains the emerging market with the most stable growth outlook. bjoern.eberhardt@credit-suisse.com Diverging monetary policy prior to impetus from US Fed In % Eurozone upturn consolidating YoY GDP growth in %, rolling four-quarter average US Federal funds rate (center) Bank of Japan policy rate ECB deposit rate USA Japan Eurozone /214 7/214 1/215 7/215 1/ Source: Datastream, Credit Suisse Source: Datastream, Credit Suisse 5

6 Global Economy l Monitor Eurozone Debt in the Eurozone still partially increasing Public debt as % of GDP Public debt in some major Eurozone countries remains very high. Although the good economy in Germany has for several years enabled the debt ratio to be reduced, other countries are less well off and the EU Commission even expects the debt ratio for Spain to reach 1% of GDP in 216. France's debt is also expected to rise further until 217, while in Italy it should at least stabilize. Although the ECB policy has greatly reduced the risk of a debt crisis, government scope for maneuver remains limited by the high debt Eurozone Greece Germany Italy 2 2 France Spain bjoern.eberhardt@credit-suisse.com Source: Datastream, Credit Suisse Japan Private consumption back at the level of 212 Index (3M MA); YoY % Japanese private consumption has stagnated since the consumption tax hike in April 214. It is not least for this reason that the government has decided to postpone further the second tax increase that was actually planned for April 217 by another two years. In combination with the improvement of the real wage situation and the planned fiscal stimulus anticipated to amount to around 1% of GDP, we expect a slight improvement in domestic demand in the next two years Global financial crisis Consumption tax hike from 5% to 8% 6 Consumption tax hike Tohoku from 3% to 5% earthquake Growth (rhs) Real consumption expenditure -6 damian.kuenzi@credit-suisse.com Brazil Since the assumption of office of the new government under interim president Michel Temer, the growth expectations for 217 have stabilized. The announcement of reforms aimed at bringing the budget deficit under control and improving the business climate was clearly an important driver here. At the same time, the ongoing weakness of the economy has led to a decrease in inflation expectations which should facilitate initial interest rate cuts. All in all we anticipate a gradual stabilization of the economy in the second half of the year. Source: Datastream, Credit Suisse Economic outlook for 217 less pessimistic Median from BCB survey (YoY %) GDP growth expectations 217 inflation expectations nora.wassermann@credit-suisse.com Source: Bloomberg, Credit Suisse 6

7 Swiss Economy Switzerland is lagging behind in terms of growth Cost cuts will also dominate economic activity in Switzerland this year. However, the labor market situation should not deteriorate any further. Altogether the Swiss economy should grow by around 1% in 216. Franc shock costs CHF 13 billion in gross domestic product Export industry adjusting to new situation Swiss economic output in the first quarter of 216 was CHF 1.2 billion or.7% up on the first quarter of 215. Switzerland therefore avoided a recession as expected. However, growth has lagged behind that of neighboring countries since the abandonment of the minimum EUR/CHF exchange rate by the Swiss National Bank (SNB) (see chart) and is less than half as high as during the period of the minimum exchange rate. Our simulation illustrates how much the strong franc is 'costing' the Swiss economy: Assuming a constant EUR/CHF exchange rate of 1.2 since the end of 214 and based on the growth actually observed in the Eurozone, in the first quarter of 216 the Swiss economy would have grown by 2.3% in comparison to the previous year. This converts into over CHF 13 billion in gross domestic product (GDP) that the appreciation of the franc has cost here in Switzerland money that today is above all missing from company coffers (see debate on page 13 Companies so far footing the bill). According to a survey carried out among the members of the professional association for procurement and supply management procure.ch, companies in Switzerland have primarily carried out two measures to counter the strong franc: firstly an enhancement of procurement and secondly a reduction of production costs (see chart). The result of these measures and the resilience of the export industry are impressive: Never before has Switzerland exported so many goods in the first three months of a year than was the case in 216 (although there are enormous differences between the sectors); see the detailed discussion of demand components starting on page 9 -> Export). Furthermore, the reduction of production costs in particular cannot be realized without investments. This explains why investments in equipment are continuing to rise (-> Investments). The downside of the record volume of exports lies in the lower profit margins: Two thirds of the companies surveyed have lower margins than was the case a year ago. Swiss economic growth lagging behind Real GDP, indexed to Q1 213 = 1 Companies focusing on procurement and costs Reaction to the Swiss franc: Survey among members of procure.ch, multiple responses possible 17 USA Eurozone Switzerland Switzerland (simulation*) Enhancement of procurement 16 Reduction of production costs 15 Transfer 14 Price increases 13 Reduction of wage costs 12 New markets 11 No measure % 2.% 4.% 6.% 8.% 1.% Source: Datastream, Credit Suisse *simulation assuming EUR/CHF = 1.2 Source: procure.ch, Credit Suisse 7

8 Profit margins as cushion for the labor market Service sector has offset job cuts in industry Economic growth altogether remains subdued The decision by many companies to sacrifice a part of their profit margins in order to uphold their price competitiveness and secure the orders resulting from this is supporting the labor market and therefore indirectly also consumption. While Switzerland today has 13, more unemployed than at the start of 215, the rise has been very gradual and has lost momentum in the past few months. The effects of the franc shock on the labor market have been extremely modest compared with the economic crises of 21 and 29, as is also reflected by the use of short-time work. Over 9% of the companies surveyed reported that they had not introduced any short-time work in the past 12 months. Most saw no economic benefit in resorting to shorttime work, not least because the order books of many of them remained well filled. Others in turn cut jobs as they did not consider the strong franc to be a temporary phenomenon that shorttime work would be suitable for bridging over. The job cuts were particularly marked in industry where since the first quarter of 215 almost 13, FTEs have disappeared (2% of total employment in industry). However, this fall in employment was offset by job creation in the service sector (healthcare and social services: +14, jobs). Employment growth is set to slow down as the year progresses as domestic sectors are increasingly also coming under cost pressure; nevertheless, it should remain positive, especially since the labor market situation in the export industry is expected to gradually ease. We accordingly no longer anticipate any further rise in the unemployment rate (-> Labor market). The risk of widespread consumption restraint due to fears of job losses thus appears to have been averted. Nevertheless, consumption growth is likely to remain subdued, as consumer sentiment is still below its long-term average. Furthermore, the key growth driver of private consumption, namely population growth and immigration (-> Immigration) is losing momentum. However, figuratively speaking, the increase in migration in 216 will still be equivalent of adding a city the size of Lugano to Switzerland's population. While the export sector has bottomed out, economic growth is being impaired by the falling momentum of the domestic economy. We forecast a growth rate of 1% for real gross domestic product in the current year. Additional impetus will at best come from the export trade. However, the domestic economy is set also to remain preoccupied with 'digesting' the franc appreciation in the future so that cost pressure and efficiency enhancements will shape 216. lukas.gehrig@credit-suisse.com claude.maurer@credit-suisse.com Healthcare supporting job growth No. of FTEs, YoY growth in % Gloomy consumer sentiment Index 2.5% 2.% Industry and construction Management consulting IT and IT services Social services Total Service sector other Architects and engineers Healthcare Public administration & education % 1.% -1.5% -2.% -.5% -3-4 Consumer sentiment Average % Source: Swiss Federal Statistical Office, Credit Suisse Source: State Secretariat for Economic Affairs (SECO), Credit Suisse 8

9 Swiss Economy l Monitor Exports Total exports in the first four months of the current year rose by 4.5% year on year in nominal terms. However, the sector differences were large. While pharmaceutical exports were a high 13.3% up on the previous year, machine exports continued to decline despite recovery tendencies (-2.9% YoY). The watch industry sustained a sharp fall in exports (-9.5% YoY). While sales in Hong Kong and China continued to decline, the number of Chinese tourists in Europe decreased. The altogether positive but somewhat mixed export performance is set to continue in the next few months. Pharmaceuticals top watches flop Nominal export growth, January April YoY and average Average export growth % 8% 4% % -4% -8% Watches Mechanical Engineering Electrical Engineering Vehicle Manufacturing Medical Technology Plastics Food Metals Measuring and Monitoring Equipment Electronics Pharmaceuticals Chemicals Bubble size = Export vol. Jan. Apr % Print and Paper -12% -8% -4% % 4% 8% 12% 16% Export growth Jan. Apr. 216, nom, in % bettina.rutschi@credit-suisse.com Consumption Source: Swiss Customs Administration, Credit Suisse Imported goods account for 1% of private consumption In CHF million Consumer demand in Switzerland remains comparatively sound. However, the rise in demand is concentrated on goods categories and services that are largely manufactured or provided in Switzerland. For example, healthcare expenditure and spending in the "housing" rubric are increasing. This situation explains firstly why the upturn in consumption is not matched by an increase in imports, secondly why jobs have been created in the corresponding domestic sectors (particularly healthcare), and thirdly why consumer growth will tend to slacken due to lower population growth. 9, 88, 86, 84, 82, 8, Private consumption Imports of durable consumer goods (rhs) 9, 8,5 8, 7,5 7, 6,5 6, 78, 5, claude.maurer@credit-suisse.com Investments Some CHF 9 billion continue to flow into investments in equipment in Switzerland each year. These have for a long time no longer just comprised 'classical' machines (allocated to the "other equipment/military" aggregate) but roughly equal proportions of investments in the "IT and IT services", "research and development" and a residual area (including electricity generation devices and vehicles). While the latter have been continuously rising for decades, classical investments have since 29 tended to decline following a 'breakout' of just five years in the course of 'reindustrialization'. Source: Swiss Customs Administration, State Secretariat for Economic Affairs (SECO), Credit Suisse Constant increase in IT and F&E investments In CHF million 3, 25, 2, 15, Other equipment/military 1, Research and development IT and IT services Residual 5, claude.maurer@credit-suisse.com Source: Swiss Federal Statistical Office, Credit Suisse 9

10 Inflation Inflation in Switzerland is no longer quite as negative as at the start of the year. This development is principally attributable to the surprisingly sharp recovery of oil prices since mid-january (+55%) and an increase in air fares due to new calculation methods. Nevertheless, almost 4% of the goods and services contained in the shopping basket for calculating the consumer price index are recording falling prices (compared with the same month of the previous year). This is a high share when compared historically that suggests a continued lack of inflation pressure. For the year as a whole we expect an average inflation rate of -.5%. The price level is therefore set to fall for the fifth year in succession. Widespread price falls Share of consumer price index basket with falling prices maxime.botteron@credit-suisse.com Immigration Source: Swiss Federal Statistical Office, Credit Suisse Less immigration, more emigration Usually resident foreign population; absolute balance (moving 12-month average) Net migration to Switzerland slowed down significantly in the first quarter of 216 (-25.8% year-on-year). Although the decline is somewhat exaggerated by a base effect, it nevertheless reflects the downturn in economic migration in line with our forecast. While the low employment momentum in Switzerland is curbing immigration (-1%), the gradual improvement of the labor market situation in Europe is boosting emigration (+11%). The increase in transfers from the asylum sector expected by us will not be reflected in the figures until the second half of , 25, 2, 15, 1, 5, Germany Italy EU-8 Rest of Europe France Portugal, Spain EU-2 Rest of world sara.carnazzi@credit-suisse.com Labor market Source: State Secretariat for Migration, Credit Suisse Stabilization of labor market indicators PMI employment: growth > 5; KOF survey: growth > The leading indicators for the labor market (KOF employment survey and purchasing managers' index) suggest that a stabilization is gradually setting in as the figures in May were at or almost at the growth threshold. However, there is no fall in unemployment in sight as this would require a sharp improvement in the order situation of the sectors heavily affected by the strong franc. We therefore expect the seasonally-adjusted unemployment rate to remain at its current level of 3.5% until the end of 216 before a gradual improvement sets in in PMI employment KOF employment survey (rhs) lukas.gehrig@credit-suisse.com Source: procure.ch, KOF Swiss Economic Institute (KOF), Credit Suisse 1

11 Sectors Industry continuing to battle for price competitiveness The overvaluation of the Swiss franc increased sharply with the abandonment of the EUR/CHF minimum exchange rate. The relative producer prices of the industrial sectors responded very differently to this challenge. Fair value rates of many industrial sectors fell after the abandonment of the EUR/CHF minimum exchange rate Franc appreciation of 9% was not offset in most sectors In last year's March issue of Monitor Switzerland we demonstrated that even a EUR/CHF exchange rate of 1.2 was too low for many industrial sectors (see Monitor Switzerland March 215). More than a year later, the franc is still significantly overvalued. The fair exchange rate for the manufacturing industry as a whole (hereafter referred to as the fair value rate or FV rate) will lie at around CHF 1.35 per EUR, while for individual industrial sectors it is even higher (see chart). However, most sector-specific FV rates fell somewhat after the abandonment of the minimum exchange rate, which means that price competitiveness has partially been restored. The FV rates decrease when Swiss producer prices (PPs) fall or the PPs of the Eurozone rise. This development varies greatly depending on the sector (see chart). For example, the FV rate of the chemical industry rose by as much as 2% compared with prior to the abandonment of the minimum exchange rate because the corresponding PPs in the Eurozone fell more sharply than in Switzerland. By contrast, Swiss PPs fell significantly in the pharmaceutical industry, while those in the Eurozone rose slightly. As a result, the FV rate of the pharmaceutical industry dropped more sharply (-9.4%) than the franc appreciated (EUR/CHF -9.% compared with the fourth quarter of 214). However, the development in these two sectors will only partially be connected to the franc shock. Falling commodity prices and statistical effects have likewise exerted a strong influence on the picture. But the decrease in FV rates in the paper, plastics, engineering and metal product industry is directly attributable to the abandonment of the minimum exchange rate. Here the PPs in the Eurozone largely remained stable, while the Swiss PPs fell sharply. This is partially also the case for the textile, clothing, printing, precision instrument and beverage industry: However, at a maximum of -2.5%, the relative price adjustments were considerably lower than the 9% appreciation of the franc. The franc shock was thus only offset to a very limited extent in terms of prices in these sectors as the companies either had very little scope for price cuts, buyers are not very price-sensitive or the companies export little to the Eurozone but a lot to the USA or China. The franc did not appreciate markedly or even depreciated compared with the currencies of these countries. andreas.christen@credit-suisse.com Fair value rates fell after franc shock Very large sector differences in FV adjustments Exchange rate and fair value exchange rates by sector Change in %, Q1 216 vs. Q EUR/CHF 1.3 Measurement/control instruments Watches 1.2 Machines Pharmaceutical products 1.1 Food and fodder Rubber and plastic products Metal products % 4% 2% % -2% -4% -6% -8% -1% -12% PPs Switzerland PPs Eurozone FV rate EUR/CHF Chemicals Food Beverages Precision instruments Printing Clothing Watches Metal production Textiles Metal products Machines Plastics Paper Pharmaceuticals Source: Swiss National Bank, Eurostat, Swiss Federal Statistical Office, Credit Suisse Source: Swiss National Bank, Eurostat, Swiss Federal Statistical Office, Credit Suisse 11

12 Sectors I Monitor Industry Crisis-resistant chemical and pharmaceutical industry Assessment of current business situation, "good"/"poor" balance in percentage points Around one and a half years after the abandonment of the EUR/CHF minimum exchange rate, a majority of industrial firms still rate their business situation as no more than satisfactory at best. Since the start of 216, positive assessments have only prevailed in the chemical and pharmaceutical industry. However, a certain easing could be observed in many sectors over the past few months. Companies altogether expect the current business situation to remain largely unchanged over the next six months. An important exception is the watch industry in which the decline in exports is set to continue over the coming months Textiles average 215 average Jan. May 216 average Wood Paper Metal industry Printing Electrical industry Watch industry Industry total Mineral products Plastics industry Food industry Engineering Chemicals/ pharmaceuticals emilie.gachet@credit-suisse.com Retail Trade Following a difficult 215, the first quarter of 216 brought some slight relief to the retail trade. The food/near-food segment recorded a nominal rise in sales of.5% (215:.1%). Sales in the non-food segment fell by 2.5% and therefore less sharply than in 215 ( 3.5%). However, the situation in the clothing segment remains very challenging. Nominal sales here were 6.8% lower in the first quarter of 216 than in the previous year despite a sharp rise in prices. The growth in sales in the food/near-food segment should hold up in the further course of the year. Meanwhile, non-food sales should altogether decline less significantly than in 215. Source: KOF Swiss Economic Institute, Credit Suisse Sales gradually stabilizing Moving three-month average, YoY change in % 4% 3% 2% 1% % -1% -2% Retail prices -3% Nominal retail sales* Real retail sales* -4% 4/214 8/214 12/214 4/215 8/215 12/215 4/216 patricia.feubli@credit-suisse.com Tourism With the exception of March (effect of early Easter), the numbers of overnight stays in the Swiss hotel industry have deteriorated further since the end of 215 (December 215 to February 216: 4.4% compared to the same period of the previous year). Due to exchange rate effects, not only European guests stayed away, but also fewer Chinese ( 9.9%) visited Switzerland over the same period. The main reasons for this were fear of terror attacks in Europe and the more restrictive visa regulations for Chinese tourists in the Schengen area. These two effects should at least level off in the course of 216. Source: GfK, Swiss Federal Statistical Office, Credit Suisse; *calendar-adjusted Terror and visa regulations putting off Chinese Overnight stays: Three-month average of growth contributions by continent 6% 4% 2% % -2% -4% Africa America Asia* Europe Oceania Switzerland Total -6% 3/214 9/214 3/215 9/215 3/216 sascha.jucker@credit-suisse.com Source: Swiss Federal Statistical Office, Credit Suisse; *share of China in overnight stays of Asians: 29% 12

13 Investments Debate Companies so far footing the bill Unlike construction investments, investments in equipment are largely financed through cash flow. The corporate profits generated in Switzerland have reached a low point and there is no sign of any rapid improvement. Investments are essential for economic growth Buildings are financed through loans, investments in equipment through cash flow Record low corporate profits allow little scope for investment Investments are the heartbeat of the economy. Around a third of the volatility of economic growth is attributable to fluctuations in investments in equipment despite the fact that these only account for just under 15% of economic output. Each year, around CHF 15 billion are invested in Switzerland more than CHF 9 billion in equipment and around CHF 6 billion in construction. Almost 9% of the investments are made by private households and companies (see chart). But what is it that drives investments? Theoretically it is the future expectations of entrepreneurs ('animal spirits') and the financing conditions. However, it appears that investments in equipment in Switzerland at least among small and medium-sized enterprises (SMEs) are largely financed through cash flow despite favorable lending conditions. This is confirmed among other things by two Credit Suisse surveys: Our 215 SME survey revealed that for almost half of SMEs equity was of central importance for the financing of investments. And according to a survey of exportoriented SMEs by S-GE, two thirds of foreign investments are financed with cash flow. On the other hand, the low interest rates of the past few years also appear to have primarily benefited the growth of mortgage loans and thus the financing of construction among companies. This is indirectly reflected by the credit volume statistics of the Swiss National Bank (SNB). The volume of loans outstanding of Swiss companies at the end of March 216 amounted to around CHF 34 billion or over 5% of gross domestic product (GDP). More than two thirds of these loans, namely 67% or CHF 228 billion, are mortgage loans. The corporate profits or 'net operating surpluses' generated in Switzerland are currently at a tenyear low, as illustrated by the statistics of the State Secretariat for Economic Affairs on GDP by income components (see chart). Particularly since 28, the cash flow source has only been bubbling moderately. The net operating surplus has fallen by a quarter compared with the start of 28. The slump was exacerbated during the global recession and the euro crisis and again after the abandonment of the EUR/CHF minimum exchange rate in January 215. Share of state in investments remains low In % Cash flow source only bubbling moderately In CHF billions, quarterly data 24% 2% 16% 12% 8% Employee compensation Net operating surplus Depreciation Remainder 4% Total investments Construction investments Investments in equipment 2 % Source: Swiss Federal Statistical Office, Credit Suisse Source: State Secretariat for Economic Affairs, Credit Suisse 13

14 No similar break in trend is to be observed in terms of either employee compensation or depreciations. The total wage bill in the economy grew constantly by around 2% per year over the same period, while depreciations have increased by an annual average of 1.4%. Above all the companies have clearly paid the price of the various crises so far. This comes as little surprise as traditionally both the range of fluctuation and the economic and exchange rate sensitivity of the net operating surplus are significantly greater than those of employee compensation (see chart). Three reasons why the net operating surplus is not set to rise significantly The 'animal spirits' need to be awakened for a positive surprise Whether the net operating surplus and therefore the cash flow is set to rise again in the near future depends on three factors: First of all the growth of gross domestic product, i.e. the total amount available to distribute. Here we expect a below-average performance as explained above (see page 7). Secondly, the development of depreciations: Only minor fluctuations are to be expected for this component as depreciations are effectively determined by the size of capital stock. Maintenance of the latter is now 'devouring' around a fifth of economic output or some CHF 136 billion each year. Thirdly, the wage bill. It is expected that companies will attempt to make savings on wage costs in order to increase their profits again. The spiral pattern of the diagram below on the right suggests that this has generally been successful in the past. However, we are not anticipating an abrupt fall in the wage bill, as this could only be achieved by means of major job cuts which as we explain on page 7 are not expected. It is therefore most likely that corporate profits will altogether only make a slow recovery so that a sharp rise in the cash flow is unlikely. The financial scope for investments thus remains tight. A positive surprise is not very likely in the present situation as the Swiss economy is undergoing a veritable dilemma. The pronounced cut in jobs (or significant wage reduction) that would be necessary to enable companies once again to generate sufficient cash flow for making widespread investments would be poisonous for consumption and likely to stifle economic growth. On the other hand, companies will lack the desired cash flow if they are not soon able to pass on the costs of the crises to their employees. Simultaneous, positive surprises regarding investments in equipment, on the labor market and in terms of economic growth can therefore only be expected if it is possible to awaken the aforementioned 'animal spirits'. This is likely to entail a marked improvement in the competitive position of the Swiss location and a sharp depreciation of the Swiss franc. There should be little lack of borrowing resources in view of the low interest rates and healthy credit market. claude.maurer@credit-suisse.com Corporate profits generally weak since the crisis QoQ change in % YoY change in % Distribution between labor and capital runs in cycles 1% 5% % -5% Employee compensation Net operating surplus -1% Depreciation Duties -15% Employee compensation 8% % 6% 5% % % % % % -2% -15% -1% -5% % 5% 1% 15% 2% Net operating surplus Source: State Secretariat for Economic Affairs, Credit Suisse Source: State Secretariat for Economic Affairs, Credit Suisse 14

15 Regions Temporary upturn in cantonal finances The double profit distribution of the Swiss National Bank protected most cantons against a deficit in 215. However, red figures are set to dominate again in the years to come. Twenty cantons with a surplus in 215 SNB tipping the scales Based on the results of the current account, 215 was a positive year for most cantons. Twenty out of 26 cantons generated a surplus which in total amounted to around CHF 1.2 billion. The losses of the six loss-making cantons cumulatively came to around CHF.2 billion. Eighteen cantons budgeted for a deficit for 215 and only eight budgeted for a surplus. How did this conversion come around? After the Swiss National Bank (SNB) had foregone its usual profit distribution to the Federal Government and cantons in 214, it decided on a double distribution totaling CHF 2 billion in 215. However, the majority of cantons had refrained from budgeting their share of the SNB profit distribution for 215. This share ranges from CHF 2.5 million (Appenzell-Innerrhoden) to CHF 234 million (Zurich) and turned a deficit into a surplus in many cantons. The SNB thus (once again) tipped the scales of the cantonal accounts. Deficits will dominate the cantonal accounts again from 216 Result of cantonal accounts as % of total earnings; B = budget ZH BE LU UR SZ OW NW GL ZG FR SO BS BL SH AR AI SG GR AG TG TI VD VS NE GE JU CTNs All 2 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 21 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 22 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 23 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 24 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 25 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 26 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 27 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 28 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 29 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 21 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 211 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 212 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 213 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 214 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 215 ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### 216B ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### ### >3% 1 3% -1% --1% -1--3% <-3% Source: Federal Finance Administration, cantons, Credit Suisse 15

16 Highest deficits in the cantons of Ticino and Zug Greatest surpluses in Basel City and Vaud Deficits again from 216 At CHF 9 million, the canton of Ticino recorded the highest deficit, followed by Zug with CHF 88 million. Ticino's negative result is the latest in a series of structural deficits. The southern canton is suffering from the economic dip, the restructuring of the cantonal pension fund and falling tax revenues due to the difficulties in the Ticino financial sector. Zug has also already recorded a series of deficits but is altogether in a considerably more healthy financial condition. While Zug is reducing its outgoings, its contributions to national fiscal equalization continue to rise (CHF 316 million in 215, which accounts for a fifth of total expenditure). Not included in the ranking is a special effect in the canton of Solothurn which due to the restructuring of the cantonal pension fund sustained an extraordinary deficit of over CHF 1, million. The greatest surpluses were generated by the canton of Basel City with CHF 43 million, followed by Vaud with CHF 194 million. The difference between budget and accounts comes to almost CHF 4 million in Basel City and is largely attributable to tax revenues exceeding expectations and various one-time effects. Basel City has recorded a continuous series of surpluses since 26. This is topped only by the canton of Vaud that has not posted a deficit since 25. The generally positive accounts in 215 are likely to remain an exception for the time being. Most cantons are budgeting deficits again for 216 and have initiated relief measures. The economic weakness in 215 is set to leave its mark on cantonal finances from 216 to 218 as taxation entails a time lag. Considerable revenue shortfalls are also to be expected with a view to Corporate Tax Reform III. The parliament is currently debating the proposal for abolishing tax privileges for so-called special status companies. This could lead to the migration of such companies. Planned tax cuts in many cantons are also likely to cause revenues to drop in the short term. simon.hurst@credit-suisse.com 16

17 Regions Monitor Fiscal Equalization Payments between 28 and 216 NFE Contributions Growing Payments of NFE donors (green) and income of NFE recipients (red) per inhabitant; selected cantons, index 1 = 28 Since the introduction of the new national fiscal equalization scheme (NFE) in 28, payments have grown by around a fifth. The total volume in 216 amounted to CHF 3.2 billion. The largest NFE recipients in absolute figures (216) are the cantons of Bern and Vaud with CHF 1.3 billion and CHF.6 billion respectively. Bern receives around 4% more per inhabitant than in 28 (CHF 1,28) and Vaud 2% more (CHF 1,9). Among the NFE donors, the per capita payments of Schwyz and Zug have increased the most: Payments in Schwyz have more than tripled (to CHF 1,19 per inhabitant) and in Zug they have grown by a factor of 1.6 (to CHF 2,84 per inhabitant) Schwyz Zug Berne Valais simon.hurst@credit-suisse.com Tax Burden of Natural Persons There has been little change to the cantonal ranking in terms of the taxation of private individuals in recent years. According to the Credit Suisse tax index for 215 that now also takes account of the secondary earner deduction, the cantons of Zug, Schwyz and Nidwalden continue to offer the lowest tax burden. The cantons in western Switzerland, Bern and the two Basels place an above-average tax burden on natural persons. Some cantons and municipalities have been obliged in the last two years to increase their tax rates. Not least owing to the foreseeable tax losses due to Corporate Tax Reform III, many places only have little scope for the relief of private individuals. Source: Federal Finance Administration, Credit Suisse Little Movement in Fiscal Ranking Income and wealth tax burden, synthetic index, CH = CH average ZG SZ NW UR OW ZH AI GL AG TG GR LU TI AR SH SG SO BS GE BL VS BE JU FR VD NE jan.schuepbach@credit-suisse.com Enlargement of Catchment Areas Source: TaxWare, Credit Suisse Neat: Additional Daytime Visitors to Ticino per km 2, daytime tourists, public transportation, changes between 216 timetable and model timetable for 22 The Gotthard and Ceneri base tunnels are set to reduce the journey time from German-speaking Switzerland to Lugano by almost an hour. This will not have a strong impact on commuter traffic as the daily travel-to-work journey times are still too long. However, daytime tourists are prepared to accept longer journeys than commuters. Ticino will therefore become considerably more attractive. Bellinzona will benefit the most: Its catchment area will increase by 38, people or 73%, with Locarno and Lugano also making strong gains. The Ticino hotel industry will likewise benefit from the shorter journey times if they gear their supply to the new situation. thomas.ruehl@credit-suisse.com Source: search.ch, Geostat, Credit Suisse 17

18 Swiss Electricity Market Debate Postponed deregulation protects public finances The regulated area partly protects the electricity industry against the record low wholesale prices. A deregulation would put public finances under more pressure. Federal Council postponing complete deregulation of electricity market Low electricity wholesale prices due to surplus capacities in Europe Profitability of Swiss electricity producers under pressure Since 29 it has been possible for large customers consuming over 1 MWh per year to select their own electricity supplier. This option was also to be made available to households and businesses as of 218. However, the Federal Council decided on 4 May 216 to defer the complete deregulation of the Swiss electricity market. As the reason it particularly cited the ongoing negotiations concerning the electricity agreement with the European Union (EU). However, the postponement can also be viewed as a response to the financial situation of the electricity producers that has deteriorated owing to the performance of the European electricity market. From a physical perspective, Switzerland is closely integrated in the European electricity market. The amount of electricity exchanged with neighboring countries (exports plus imports) exceeded domestic net production (production less consumption of storage pumps) by around 22 TWh or 35% in 215. The Swiss electricity market is thus highly dependent on developments in Europe. The European and therefore also the Swiss electricity wholesale prices have fallen sharply in recent years and currently lie at historically low levels. Furthermore, the prices on the futures market suggest barely any expectation of a significant recovery in the next few years (see chart). The reason for the price collapse lies in the surplus capacities in Europe. The state funding of renewable energies has above all in Germany led to a build-up of capacities, while low prices for combustibles (including coal, natural gas and crude oil) and CO2 certificates are creating an incentive for the continued operation of fossil-fueled power plants. At the same time, the weak European economy and improvements in energy efficiency are curbing demand. For Swiss electricity producers the strong franc poses an additional negative factor, as electricity traded on the international exchange is settled in euros while the costs are largely incurred in Swiss francs. At the start of 216, the wholesale prices converted into Swiss francs were around 7% lower than in 28. As market prices fall, the profitability of electricity producers comes under pressure. For example, at around 3.7 centimes per kwh (base load) and 4 centimes per kwh (peak load), market prices from January to April 216 were around 3% below the cost prices of an average Swiss hydroelectric power station (see chart). Electricity wholesale prices at record low Average spot market prices of base load electricity in EUR/MWh; *January-April; **Futures prices (as per 13 May 216) Production costs of hydropower higher than market price In centimes per kwh; cost prices, 58 power plants investigated; Jan.- Apr. 216 average spot market prices on the Swissix electricity exchange Germany/Austria Italy France Switzerland Switzerland (in CHF) *217**218**219** All hydroelectric power plants Run-of-river power plants Weighted average of cost prices Minimum cost prices Maximum cost prices Spot market price of base load Spot market price of peak load Storage power plants Pumped-storage power plants Source: European Energy Exchange, Gestore Mercati Energetici, Credit Suisse Source: Swiss Federal Office of Energy, European Energy Exchange, Credit Suisse 18

19 Not all electricity companies equally affected Consumer prices for electricity rising despite falling wholesale prices Not all electricity companies are suffering to the same degree from the current market conditions. Depending on their cost structure and the focus of their business model (e.g. production, trade, distribution in end customer market), they are feeling the effect of the low wholesale prices to varying extents (see box on page 21). The client structure and in particular the share of 'tied' end customers play a special role here, as Swiss electricity suppliers are able to sell electricity at cost price in so-called basic provision (i.e. to all customers who are not allowed to choose their own electricity supplier) so that there are essentially no losses incurred here due to excessively low market prices. The electricity prices paid by Swiss households have developed in the opposite direction to the trend for wholesale prices in the past three years (see chart). While the latter fell by around a third between 213 and 216, the prices paid by consumers have increased by over 5%. The discrepancy can partly be explained by the fact that the decreasing market prices in basic provision are only passed on to end consumers to a limited extent due to the binding of tariffs to the cost prices. Furthermore, energy costs only account for part of the overall electricity price (around 38% for an average household; see chart). The price increases of the past few years are therefore primarily attributable to the other tariff components, above all higher grid charges and duties for the funding of renewable energies (compensatory feed-in remuneration). The regulated electricity tariffs vary greatly by region or even municipality The Swiss electricity market comprises over 6 local utility companies. This fragmented structure explains to some extent the strong regional differences in the tariffs (see chart). The topography of the supply area, the consumer behavior of end customers and the efficiency of the individual suppliers influence the network costs. The energy costs vary depending on the electricity mix or share of own production in the electricity sold. Furthermore, there are differences between the cantons and municipalities in terms of taxes and contributions to local authorities. Regulated area offers electricity companies significant protection in the current environment... If the Swiss electricity market were to be completely deregulated, pressure would increase on those electricity companies that currently supply tied end customers at (regulated) tariffs above the market price. In the following we attempt to provide a rough quantification of the 'protection' currently enjoyed by the Swiss electricity industry through sales of basic provision. The underlying simplifying assumptions are illustrated in the table on the next page. Basic provision applies to households, business customers with an electricity consumption of fewer than 1 MWh per year and bulk consumers who could switch to the free market but do not make use of this opportunity rise in electricity prices for households Significant price differences in basic provision Consumer price: Index 28 = 1, YoY change in %; 216 electricity price for an average household in centimes per kwh (excl. VAT) electricity price of an average household YoY change (right-hand axis) Consumer price of electricity 5% 38% 6% 6% 7% 6% 5% 4% 3% 2% 1% % -1% -2% -3% -4% Grid usage Energy Duties Compensatory feed-in remuneration 216 electricity price for an average household (electricity consumption 4,5 kwh/year, 5-room apartment with electric cooker and tumble dryer) in centimes per kwh, by municipality Source: Swiss Federal Statistical Office, Federal Electricity Commission, Credit Suisse Source: Federal Electricity Commission, Credit Suisse 19

20 ... that we estimate at around CHF 1 billion per year Difficult market environment with fiscal implications Water rates influence competitiveness of the electricity industry Our average price assumptions for these groups are based on the electricity tariffs for 216 published by the Federal Electricity Commission and only take account of the energy component. For large customers in the free market we equate the energy price with the current spot market price of base load electricity on the electricity exchange (average January to April 216: 3.7 centimes per kwh). According to the Federal Electricity Commission, large customers account for around half of Swiss electricity consumption (excluding transport). Fifty-six percent of these customers are purchasing their electricity on the free market in 216 and account for an estimated 74% of large customer consumption. We calculate the amount by which the expenditure of Swiss end consumers would fall if the market were to be fully rather than just partially deregulated assuming that electricity consumption remains largely unchanged (basis: average) and all customers (have to) switch to the free market. We estimate that this case would result in reduced expenditure of over CHF 1 billion or 38%. Expenditure would only be the same in both situations at a market price of 7.4 centimes per kwh i.e. double what it is today (see table). This massive reduction in expenditure would result in even greater revenue shortfalls for electricity companies and their owners than is currently the case. As 88% of the Swiss electricity industry is owned by the public sector (above all the cantons and municipalities), the postponement of market deregulation should not least be seen as protecting their financial situation. The government in Bern is already under pressure today to alleviate the profitability problems of the electricity industry and its public sector owners. The National Council and the Council of States have therefore agreed as part of the consultations on Energy Strategy 25 to provide financial support for existing large-scale hydroelectric plants. Power plants are to receive a premium for electricity that they sell below cost price in the free market. The measure is to be funded by electricity consumers by increasing the duty for compensatory feed-in remuneration. Although owing to varying cost structures it is extremely difficult to assess the profitability and hence the effective need for support of Swiss hydropower, the pressure on the financial situation of hydropower producers would rise additionally in the event of full deregulation of the electricity market under the current market conditions. The cross-relationships between fiscal policy and the profitability of the electricity industry are also reflected in the system of water rates. Water rates are duties that the power plant operators have to pay the local authorities granting concessions (canton and/or municipality) for using the hydropower to produce electricity. The amount of the duties is calculated on the basis of gross output and is thus independent from effective production. The maximum amount is set by the Federal Government and was actually increased by 1% at the start of 215 to CHF 11/kW (see chart). The water rates form an important (fixed) component of the cost price of large-scale hydroelectric plants (up to a quarter depending on the type of power plant). If we assume that the maximum water rates are charged everywhere, this results in nationwide costs of around CHF 55 million per year. However, for mountainous regions in particular, water rates represent an important source of revenue. Basic provision offers electricity companies a certain degree of protection Estimates; electricity consumption in TWh/year (excl. transport); electricity prices in centimes per kwh (energy component only); expenditure of end consumers in CHF bn. (energy only) Use of hydropower becoming increasingly expensive Maximum water rate in CHF/kW according to Federal Law (WRA); share of cantons in total gross output (kw) in %, 215 Price scenario 2 Price scenario 1 Basic provision Free market Total Households Businesses Large customers Large customers Electricity consumption % 16% 13% 37% Electricity price (energy component) Total expenditure in partially deregulated market Total expenditure in fully deregulated market Absolute difference Difference in % -38% -49% -54% -47% % Electricity price (energy component) Total expenditure in partially deregulated market Total expenditure in fully deregulated market Absolute difference Difference in % % 2% -8% 6% % UR 5% AG 9% BE 9% Others 18% TI 1% VS 27% GR 22% Source: Credit Suisse, based on Federal Electricity Commission, Swiss Federal Office of Energy, Swiss Federal Statistical Office, European Energy Exchange Source: Systematic collection of Federal Law, Swiss Federal Office of Energy, Credit Suisse 2

21 In Valais and Graubünden, which account for almost half the installed capacity, the share of water rates in total fiscal revenues (canton and municipalities) amounts to roughly 6% to 9%. Water rates in the Graubünden municipalities of Zillis-Reischen and Rongellen even account for over 4% of revenues. If deregulation of the electricity market were to proceed, it would be more difficult to pass on the water rates to the consumers and the pressure on producers and/or the public sector would be accordingly greater. Support for the electricity industry ultimately paid for by consumers Swiss electricity producers and their public sector owners are under great financial pressure due to the European surplus of electricity. Companies focused on basic provision currently still enjoy a certain degree of protection thanks to the postponed deregulation. Additional protection is provided with the financial support of hydropower that is among other things justified with the argument of preserving the security of supplies. These measures are paid for as are indirectly also the somewhat archaic water rates by the consumer. Should the price of electricity on the European market rise significantly in the long term, e.g. due to the reduction of German subsidies for alternative energies, both the problems of Swiss producers and those of their owners would be alleviated. If this does not happen and the second stage of electricity market deregulation is ultimately carried out, it is likely that the losses of the public sector owners will have to be addressed with direct fiscal measures. oliver.adler@credit-suisse.com emilie.gachet@credit-suisse.com roman.schenk.2@credit-suisse.com The big four of Switzerland in the eye of the storm Electricity production in Switzerland is dominated by the four largest electricity companies Alpiq, Axpo, BKW and Repower. The low electricity prices substantially have impaired their profitability and cash flow generation. The four companies have sustained cumulative losses on their power plants and long-term supply contracts of almost CHF 1 billion since 211, largely due to value adjustments. However, major differences can be identified between the companies due to their deviating business profiles. Regulated earnings contributions generally result in lower but stable margins, while non-regulated areas normally display more volatility. Electricity companies have therefore suffered recently that do not have a proprietary distribution network for private customers as they are entirely exposed to the deregulated wholesale market. Alpiq has the lowest regulated earnings contribution in Switzerland. We estimate that almost 1% of its annual profitability is not regulated. As the bulk of its earnings comes from electricity production, the credit quality of Alpiq has suffered most and the company has been forced to sell assets in order to reduce its heavy debt burden and restore an appropriate balance between this and its falling profitability. Repower likewise only has a relatively small regulated distribution network in the Canton of Graubünden. Axpo benefits from a regulated distribution network through its subsidiary CKW. However, Axpo is also heavily dependent on its own production and the deregulated wholesale market in Europe. Bern-based BKW benefits most from the regulated market. Around half of its annual income comes from this area. While BKW was considered "boring" in its heyday, the company has recently benefited precisely from this. It is one of the few players in an extremely challenging environment that has succeeded in maintaining the stability of both its earnings power and credit quality. daniel.rupli@credit-suisse.com 21

22 Monetary Policy Households pile up Swiss francs A growing share of household financial wealth is held in Swiss franc deposits with banks. While this could eventually be invested abroad, there is no sign yet that such a trend could be initiated in the near future. Households hold a growing share of their wealth in cash Shift toward securities in Swiss francs SNB set to continue absorbing lack of capital outflows Household financial wealth In CHF (billions) In previous analyses we identified the sale of foreign financial assets by domestic investors and the repatriation of the proceeds to Switzerland as one of the sources of capital inflows into Switzerland that led to the appreciation of the Swiss franc (see Monitor Switzerland of March 214). While it remains difficult to quantify, our latest analysis of household financial wealth (which here excludes pension and insurance schemes as well as real estate) suggests that private investors are likely to have contributed to this trend. Between the end of 29, when the franc started to appreciate, and March 216, we estimate that household financial wealth increased by 22% from CHF 1,89 billion to CHF 1,334 billion on the basis of SNB statistics. At CHF 222 billion, the rise in currency and deposits owned by households has been by far the largest contributor to financial wealth accumulation, supporting our "asset repatriation" hypothesis. While we do not know the exact currency allocation of household deposits, we assume that the bulk is held in Swiss francs. Indeed, according to banking statistics, almost 9% of all bank deposits of domestic customers are in Swiss francs, and of the domestic customers close to 6% are households. The growth in deposits has therefore added to franc demand, and hence contributed to its appreciation. Wealth accumulation in other financial assets (such as bonds, equities and funds) has been much lower over the same period. Household wealth statistics show that households have actively reduced their holdings in bonds and equities (at least until 214). In addition, they have changed the currency allocation of their financial assets over time: Assets denominated in Swiss francs have risen from 66% of the assets held by households in bank custody accounts (excluding currency and deposits) at the end of 29 to 71% at the beginning of 216. While it is unclear whether this shift in currency allocation results from active franc purchases, it undoubtedly reflects the absence of capital flows out of Switzerland into other currency areas which could potentially weaken the Swiss franc. There is currently no sign of an imminent turnaround in household investment behavior. For the SNB, this means that an increase in capital outflows in the private sector, and among households in particular, seems highly unlikely at present. Although factors other than capital flows can move the exchange rate, this suggests that the SNB is likely to need to continue with its purchases of foreign exchange (sale of Swiss francs) in order to offset the Swiss love for domestic cash. maxime.botteron@credit-suisse.com Share of households' financial assets in CHF In % of all securities held by households in bank custody accounts 1'4 1'2 1' Currency and deposits Bonds Equities Funds Source: Swiss National Bank, Credit Suisse Source: Swiss National Bank, Credit Suisse 22

23 Money, Credit and Markets I Monitor SNB equity capital The agreement between the Federal Department of Finance and the Swiss National Bank (SNB) with regard to the annual profit distribution of the SNB to the cantons and the Confederation will be re-negotiated over the course of the year. However, assuming no major changes are made to the distribution rule, we estimate that the SNB will need more than CHF 63 billion in equity capital at the end of the year in order to distribute CHF 1 billion to the public sector. SNB earnings (and hence its equity capital) largely depend on profits and losses on its huge foreign currency reserves and are therefore difficult to predict. SNB equity capital has recovered from 215 lows In CHF billion SNB equity capital Minimum required for CHF 1 bn distribution (Credit Suisse estimates) maxime.botteron@credit-suisse.com Foreign exchange interventions Recent data suggest that the SNB has intensified its foreign currency purchases since February. Interventions on the foreign exchange market are the second pillar of the SNB s strategy to weaken the Swiss franc (or at least prevent an appreciation), the first being the negative interest rate of -.75% on money held by commercial banks at the SNB. Foreign currency purchases are the more flexible of the two measures as the SNB can step them up if the franc appreciates. Nevertheless, we expect the negative interest rate to remain in place at its current level for some time to come. Source: Swiss National Bank, Credit Suisse Intensification of foreign currency purchases Estimated monthly purchases of foreign currencies by the SNB, in CHF billion /215 6/215 1/215 2/216 maxime.botteron@credit-suisse.com Capital flows Source: Swiss National Bank, Credit Suisse Decline in CHF deposits of foreign banks CHF deposits of foreign banks with banks in Switzerland, in CHF billion One area where the increased demand for Swiss francs has been particularly noticeable lies in the franc deposits of foreign banks with banks in Switzerland. While these deposits have declined since the introduction of the negative interest rate by the SNB, they remain at an elevated level. This suggests that there is still potential for capital outflows, i.e. for foreign banks to sell Swiss francs for other currencies, a process that could weaken the franc. However, foreign banks are only intermediaries in this process, and the franc deposits held with banks in Switzerland are likely to reflect the positions of their clients Implementation of the negative interest rate by the SNB maxime.botteron@credit-suisse.com Source: Swiss National Bank, Credit Suisse 23

24 Bonds ECB expands its balance sheet further ECB balance sheet, assets, in EUR trillions In view of various political risks and the subdued growth trend, a sharp rise in bond yields seems unlikely. Instead, the expansion of the balance sheets of some major central banks is supporting bonds, particularly in Europe, where the European Central Bank (ECB) also included corporate bonds in its purchasing program at the start of June. We continue to expect premium corporate bonds to offer the best opportunities of all bond segments. We recommend a very selective approach to high-yield and emerging market bonds Securities held for monetary policy purposes Long-term refinancing operations Other assets karsten.linowsky@credit-suisse.com Currencies Source: Datastream, Credit Suisse The Swiss franc remains significantly overvalued EUR/CHF exchange rate Since the start of the year the EUR/CHF exchange rate has been fluctuating within a margin of around 1.8 to However, June looks set to bring greater volatility. First of all the EU referendum in the UK will be taking place on 23 June, and secondly the Fed has left open the option of an interest rate hike in the near future. However, the narrow spread between the euro and the Swiss franc and the lack of private capital outflows from Switzerland are likely to limit the upward potential for EUR/CHF. Our outlook therefore remains neutral despite the overvaluation of the franc hr. dev. -1 hr. dev. Fair value EUR/CHF 23/5/ marcus.hettinger@credit-suisse.com Equities Source: Bloomberg, Credit Suisse Swiss equity market has defensive characteristics Year-on-year in % The Swiss equity market has recently yielded a better return than the MSCI AC World Index. Among other things a recovery of the defensive index heavyweights, which were in demand in a weaker equity market in May, has contributed to this. Our cautious outlook for global equities is one of the main reasons why we continue to assess the defensive Swiss market positively from a relative perspective. A relatively loose SNB monetary policy and the above-average dividend yields also remain positive drivers in our opinion Swiss equities relative performance Global equities absolute performance (rhs, inverted) jin.wiederkehr@credit-suisse.com Source: Datastream, Credit Suisse 24

25 Real Estate Difficult marketing of retail property set to continue The retail property market has recently been negatively impacted by branch closures of well-known retailers. The strong franc and e-commerce are thwarting many retailers and there is no sign of any easing of the situation in the near future. Demand for retail space curbed by e-commerce and challenging business situation Cautious investment activity Sluggish marketing outside the prime locations The business outlook in the retail trade is gloomy, while at the same time e-commerce is gaining importance. Sales growth in e-commerce amounted to 7.1% in 215, while sales in overall retailing fell by 1.5%. Although sales are expected to recover somewhat in 216, the baseline position in terms of demand for retail space remains challenging. Further branch closures are likely in the non-food segment. The closures will be offset in isolated cases by expansion and market entry strategies of retail chains. Due to persistently robust population growth, the biggest boost to demand is likely to continue to be seen in the food/near-food retail segments. Altogether, however, demand for retail space will be very low. Despite the investment crisis due to the low interest rate environment, investment in retail property is still not particularly strong. Although the planning activity for new retail properties has broken away from its low, it still remains at a below-average level (see chart). The approved volume of retail properties amounts to an overall construction sum of CHF 52 million, with planning applications totaling CHF 58 million. Both figures are around 3% below the average since Despite the sharp fall in the planning activity of new properties, the marketing of properties has become even more difficult. This is evidenced by a renewed rise from an already high level in the supply of property (see chart), increasingly frenzied marketing and falling rents. Furthermore, vacancy rents went up again in 215 (see chart). The marketing difficulties look set to continue in view of the problematic demand situation. However, not all locations will be equally affected by this. Locational factors such as accessibility by public transportation and high pedestrian frequency will remain central and exert a decisive impact on marketing costs and marketability. denise.fries@credit-suisse.com Subdued planning activity of new retail properties New constructions, in CHF million (construction sum), moving 12-month average High supply of property and rising vacancy rates In m²; advertised retail space: stock (l.h.s.); vacancy rates: as per 1 June, partial survey of around 33% of the retail property market (r.h.s.) 1,4 1,2 1, Permits 2 Applications Permits, average Applications, average Source: Credit Suisse, Baublatt 35, Advertised retail space, Switzerland (l.h.s.) Vacant properties, partial survey (Switzerland) 3, 25, 2, 15, 1, 5, Source: Various statistical offices, Meta-Sys AG, Credit Suisse 12, 1, 8, 6, 4, 2, 25

26 Real Estate I Monitor Residential property Flattening of price momentum for condominiums Condominiums, annual growth, transaction prices in % Owing to the curbed demand for residential property, the price slowdown of condominiums is continuing. While the price for a medium-sized condominium rose by an average of 4.2% per year between 2 and 215, annual growth in the first quarter of 216 amounted to just.9%. The trend is more marked among upscale properties, which registered a price drop of 2.5% (compared with an average annual increase of 4.9% since 2). By contrast, the prices of downscale properties rose by 5.8%. Affordability still only poses a relatively minor obstacle here. 14% 12% 1% 8% 6% 4% 2% % -2% Average property Downscale property Upscale property -4% denise.fries@credit-suissse.com Source: Wüest & Partner, Credit Suisse Demand for residential property Demand for residential property should fall from 22 Annual additional demand for real estate (CS forecast) We have estimated the additional demand for residential property up until 24 based on the age-related preferences for owner-occupied housing and assuming prices and interest rates remain constant. Annual additional demand should develop similarly to between 212 and 214 (around +21,) until 22. However, additional demand is already set to fall from 22 to 23 (+16,) and will be even lower between 23 and 24 (+9,). Both the construction and real estate industry as well as owners must therefore brace themselves for considerably lower demand for residential property. 3, 25, 2, 15, 1, 5, p.a p.a p.a. denise.fries@credit-suisse.com Rental apartments Source: Credit Suisse, Swiss Federal Statistical Office Construction boom curbing growth in rents Quality-adjusted advertised rents (nominal), index: Q1 29 = 1 (l.h.s.) The construction boom in rental apartment construction has resulted in a significant increase in the number of vacant rental apartments since 213 and is curbing the growth in rents. Since the end of 215 the annual growth of advertised rents has been fluctuating below the 1% mark. By contrast, average growth since 211 came to 2% per year. We only expect weak growth in rents in the remainder of 216: Even a slightly negative trend in advertised rents can be expected in expensive regions and for apartments with a high standard of accommodation Annual growth Rent index 4.% 3.5% 3.% 2.5% 2.% 1.5% 1.%.5% 1.% denise.fries@credit-suisse.com Source: Homegate, Credit Suisse 26

27 Economic Policy Agenda Conservative majority with limited influence Conservative forces dominate the newly composed National Council. Purely center-left issues do not appear capable of gaining a majority at present. However, both the balancing effect of the Council of States and special interests are preventing radical savings measures. SVP and FDP with an absolute majority on the National Council Purely center-left issues face a tough time Council of States retains balancing effect, special interests remain strong Thanks to their gains in the elections in October 215, the SVP and FDP now prevail on the National Council: By closing ranks, the two parties can command 11 of the 2 seats and thus the absolute majority. However, the power relations in the Council of States remain more balanced. With a total of 19 out of 46 seats, the SVP and FDP are dependent on the CVP and by closing ranks the SP, Greens and CVP can jointly outvote the parties of the right. A glance at the issues being addressed by the Councils in the new legislative period on the one hand shows that bills depending very strongly on center-left majorities will indeed face more difficulties than before the election. For example, the newly composed National Council has reversed various resolutions passed by the previous center-left majority in the ongoing procedure for the resolution of differences on Energy Strategy 25. Among other things, the regulation of the long-term operation of nuclear power plants contained in the Nuclear Energy Act and the limited lifetime for Beznau power plant have been canceled. The SVP and FDP were supported here by a CVP majority. The National Council has likewise finally agreed on a time limitation on the financial support of renewable energies. On the other hand, the CVP has not completely lost its previous function of procuring majorities for the political right despite a theoretical absolute majority of the SVP and FDP as the two parties do not always vote unanimously and some members of parliament are normally absent at votes. For instance, alongside the SVP, the controversial tax exemption of proceeds from the sale of agricultural land was supported on the National Council by a CVP majority but only a minority of the FDP. However, the balancing effect of the two-chamber system is also evident. For example, the outcome of the debate on the 216 budget is ultimately very similar to that for the 215 budget. In both years the National Council and Council of States increased the budget beyond the proposal of the Federal Council and did so almost exclusively for the benefit of agriculture. Policyrelated cutback proposals from the right, for instance in the promotion of culture, parliamentary services or measures to ensure equal opportunities for men and women already failed to gain a majority on the National Council. Cross-sectional cutbacks in general, administrative and operating expenditures of CHF 125 million supported by the SVP and FDP were finally removed from the budget by the Council of States. bettina.rutschi@credit-suisse.com Economic Policy Outlook Motion Date Economic Policy Significance "AHVplus: for a strong AHV" popular initiative The initiative aims to increase current and future AHV pensions by 1% across the board. The supplement is to be paid out on current AHV pensions no later than two years after acceptance of the popular initiative. 25 September No binding specifications are made in the initiative for financing this 216 additional expenditure. Popular initiative "for a sustainable and resource-efficient economy (green economy)" The initiative aims to have a green recycling economy written into the 25 September constitution. Switzerland should reduce its resource consumption by at 216 least two thirds (-65%) by the year 25. Source: Credit Suisse Entry into force of the bill would cause AHV expenditure to rise by around CHF 4.1 billion each year and even by around CHF 5.5 billion by the year 23. This would exacerbate the expected AHV financing problems. For example, financing the additional costs would necessitate an increase in contribution rates and place an additional burden on the federal budget. The watering can principle of increasing pensions is thus problematic. However, the situation of those pensioners with the lowest incomes who are the focus of the initiative would not necessarily improve as their entitlement to supplementary benefits would be reduced. Achieving this massive reduction target is likely to entail far-reaching consequences for households and businesses if the focus is on consumption or production restrictions (central management of resources) and provisions. These consequences would be generally more minor in the case of control via environmental levies and price mechanisms as this would promote new opportunities for action and technologies. Whatever the case, the areas of "mobility", "housing" and "nutrition" would be affected most. 27

28 Leading Indicators Purchasing Managers' Index (PMI) Purchasing managers stand at the beginning of the production process. The PMI uses this forward-looking feature to forecast the level of economic activity. The index is based on a monthly survey conducted by procure.ch, the industry body for purchasing and supply management. Purchasing managers respond to eight questions on output, backlog of orders, purchasing volumes, purchase price, delivery times, stocks of purchases, stocks of finished goods, and employment. They indicate whether activity levels are higher, the same, or lower than in the preceding month. The percentage share of responses stating "higher" and "no change" are used to calculate the subindices, though only half of the "no change" share of responses is included. The PMI lies between and 1, with a figure of more than 5 indicating an expansion of activity compared with the previous month. Credit Suisse Export Barometer The Credit Suisse Export Barometer takes as its basis the dependence of Swiss exports on foreign export markets. In constructing the export barometer, we have drawn together important leading industry indicators in Switzerland's 28 most important export markets. The values of these leading indicators are weighted on the basis of the share of exports that goes to each country. The export barometer consolidates this information to produce a single indicator. Since the values in question are standardized, the export barometer is calibrated in standard deviations. The zero line corresponds to the growth threshold. The long-term average growth of Swiss exports of approximately 5% is at 1. Industrial Activity PMI index > 5 = growth Source: procure.ch, Credit Suisse Exports In standard deviation, values > = growth Source: PMIPremium, Credit Suisse Credit Suisse ZEW Index Financial analysts have their finger on the pulse of the economy. Since June 26, we have been conducting a monthly survey of financial analysts jointly with the Centre for European Economic Research (ZEW) in Mannheim under the heading Financial Market Test Switzerland. Analysts are questioned not only about their assessment of the current and future economic situation as well as the rate of inflation but also about financial market issues such as equity market performance and interest rate forecasts. The Credit Suisse ZEW Index represents the balance of expectations regarding the development of Swiss economic activity over the coming six months. Economic Activity Balance of expectations, values > = growth Source: Centre for European Economic Research, Credit Suisse 28

29 Swiss Construction Index The Swiss Construction Index is published once a quarter jointly by Credit Suisse and the Swiss Contractors' Association (SCA). It serves as a leading indicator for the state of Switzerland's construction sector by forecasting the volume of work in the core construction business in the coming quarter. The indicator is calculated by Credit Suisse Economic Research and is based mainly on a quarterly survey conducted by the SCA among its members. Additional data is provided by the Swiss Federal Statistical Office and Baublatt. The Construction Index was launched in the first quarter of Construction Industry Climate 1st quarter 1996 = Source: Swiss Contractor's Association, Credit Suisse Renewable Energy Index The Renewable Energy Index Switzerland is published each quarter by Credit Suisse in cooperation with the Swiss Agency for Renewable Energy and Energy Efficiency (A EE). This indicator is based on a survey of companies in the sustainable energy solutions sector (renewable energies and energy efficiency). The data is collated and analyzed in accordance with the standards of the International Federation of Purchasing and Materials Management. The Renewable Energy Index directly reflects the course of business and performance in the sustainable energy solutions sector. Launched in the first quarter of 21, the Renewable Energy Index survey is thus a valuable addition to the basic data sources for this sector. Renewable Energy Sector Index > 5 = growth Source: Agency for Renewable Energy and Energy Efficiency, Credit Suisse Blue Book Index The Blue Book Index translates the qualitative information on economic activity published by the Swiss National Bank as part of its Quarterly Bulletin into a quantitative index. The Blue Book Index (so called because the cover of the SNB Quarterly Bulletin is blue) is an aggregate of five sub-indices that capture developments in four sectors of the economy (manufacturing, construction, non-financial services, and banking), as well as the labor market. The Blue Book Index is the arithmetical average of the five equally weighted sub-indices. Each sub-index can range between a value of 1 and +1, at intervals of.25 points. We define +.25 as "normal conditions" or "moderate growth," while +1 and -1 constitute "boom" and "contraction" respectively. Quantitative translation of SNB Quarterly Bulletin Standardized index from -1 to Source: Credit Suisse 29

30 Forecasts and Indicators Forecasts for the Swiss Economy 216 Q1 216P Q2 216P Q3 216P Q4 217P Q1 217P Q2 217P Q3 217P Q4 216P 217P GDP (YoY, in %) Consumer spending Government expenditure Gross capital investment Construction investment Investment in plant and equipment Exports (goods and services) Imports (goods and services) Inflation (in %) Unemployment (in %) Employment growth FTEs (YoY, in %) Net immigration (in thousands) 7 6 Nominal wage growth (YoY, in %).5.5 Balance of payments (in % of GDP) General Government budget surplus (in % of GDP) Public debt (in % of GDP) Source: Federal Statistics Office, State Secretariat for Economic Affairs SECO, Credit Suisse Forecasts for the World Economy Forecasts Forecasts Structure Significance for Switzerland GDP YoY, in % Inflation YoY, in % Population In million GDP In USD billion Share of exports In % World ,222 73, US , Euro zone , Germany , France , Italy , UK , Japan , China ,375 1, Source: Datastream, International Monetary Fund, Credit Suisse Share of imports In % Interest Rates and Monetary Policy Data Current 3-month 12-month Current Prev. mth. Prev. year 3-month Libor (in %) to to -.7 M money supply (CHF bn) SNB target range (in %) to to to M1 money supply (%, YoY) year government bond yields (in %) to to.1 M2 money supply (%, YoY) M3 money supply (%, YoY) Foreign currency reserves (CHF bn) Source: Datastream, Bloomberg, Credit Suisse 3

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