More than an economic downturn?

Transcription

1 INVESTMENT SOLUTIONS & PRODUCTS Economic Research Monitor Switzerland March 216 More than an economic downturn? Labor Market Economic Policy Monetary Policy Is Unemployment Set to Is Switzerland Still Being Who pays negative Fall Again Soon? Invested in? rates? Page 11 Page 17 Page 21

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 8 March 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 Manuel Moser 2

3 Editorial Dear Reader The equity markets started 216 with a heavy fall. For example, the Swiss Market Index lost 15% between the start of the year and its low in mid-february following an already weak December 215. As particularly financial securities especially in Europe came under strong pressure, skeptics began to voice fears about the outbreak of a renewed financial crisis. What is to be made of these anxieties? The prevailing situation in the financial sector is a very different one today to that at the start of the financial crisis in 28. The capital resources of most "systemically important" banks, including our own, are today much more robust and the balance sheet risks considerably lower. Furthermore, mechanisms have been introduced in both the Eurozone and Switzerland to enable banks in the event of an emergency to be duly wound up. A repetition of the crisis seen in 28/9 is therefore extremely unlikely. However, we think it would be reckless to dismiss the turbulence on the markets as purely psychological a view that is also underpinned by our articles in this edition of Monitor Switzerland. The global economy is facing major cyclical and structural challenges, and although Switzerland is in many ways mastering these better than other countries, our economy is also under pressure. First of all, the continued slowdown in China and other major emerging markets is also exerting a negative impact on our economy. On top of this comes the global weakness of corporate investments. This is also reflected in a lower inflow of direct investments to Switzerland (see p. 17). Specific factors such as the strong franc, the uncertainty concerning access to skilled labor, negative interest rates and corporate taxation reform are additionally contributing to the restraint of international investors in Switzerland. Finally, the Swiss economy and not least the financial sector is also being faced with rapid technological advancements (key word 'digitalization' see page 15). There can be no doubt that these changes alongside the prevailing trend toward offshoring to countries with lower unit labor costs will lead to job losses in Switzerland. On the other hand, as our debate on page 11 illustrates, the Swiss labor market has always mastered structural changes well in the past and fully offset job losses by new jobs within a few years. However, in view of the weak global growth and subdued investment activity, this process could prove less smooth in the current cycle. It is all the more important under the present underlying economic conditions to maintain as much flexibility as possible and invest systematically in our human capital. We wish you an interesting read. Thomas Gottstein CEO Swiss Universal Bank Oliver Adler Head of Economic Research 3

4 Contents Global Economy 5 Financial market turbulence and concerns that monetary policy could be approaching its limits are currently in focus. The economic outlook of most developed countries has dampened slightly, while for the emerging markets it remains weak. Swiss Economy 7 The Swiss economy is set to grow by 1% in 216. Although the export sector has bottomed out, the rising unemployment rate is negatively impacting consumption. Economic output per capita decreased in 215 and is likely to fall further in 216. Labor Market Debate 11 A large number of jobs that were lost due to the strength of the franc are likely to be replaced again. However, at least in industry, more long-term processes such as outsourcing and automation have been accelerated by the franc shock. Sectors 15 The digitalization level of the Swiss economy is set to increase strongly in the future. The growth potential of the IT sector is therefore well above average. Economic Policy Debate 17 Despite the strength of the franc and political uncertainty, there has so far been no collapse in investment in Switzerland. However, the momentum of foreign direct investments has declined. Regions 19 Countries exert an influence on prosperity and value creation with their underlying conditions for business. Swiss federalism is a success model in this respect. However, financial equalization and tax reform are reducing the role of the cantons in fiscal policy. Monetary Policy 21 The burden of negative interest rates varies considerably between banks, depending on each bank's specific business model. According to our estimates, banks with a stronger focus on retail customers pay proportionately less. Real Estate 24 The investment crisis caused by the low interest rates continues to drive forward the construction of rental apartments in an unbridled manner. While the resulting supply is still being met by high demand, this isthe latter is shaped by a considerably lower willingness to pay. Economic Policy Agenda 26 The collapse in corporate profits due to the appreciation of the franc will exert a negative impact on tax revenues. Deferred legacies mean that with a view to the budget of the Federal Government there will be much need to save in the years to come. Forecasts and Indicators 27 4

5 Global Economy Uncertainty has returned Financial market turbulence and concerns that monetary policy could be approaching its limits are currently in focus. The economic outlook of most developed countries has dampened slightly, while for the emerging markets it remains weak. US recession worries greatly exaggerated; next Fed interest rate hike in the summer ECB remains under pressure to act China causing uncertainty with its currency policy; Russia and Brazil in recession The US Fed may also have noted with concern how rapidly sentiment on the financial markets can change. While the first base rate hike in almost ten years was carried out without any major turbulence in December 215, only a few weeks later the question arose as to whether there could even be a second interest rate hike. However, we consider the fear of a US recession circulating among some investors to be greatly exaggerated. Although some sectors are suffering strongly from the low oil price, for others (e.g. transport and chemicals) as well as for consumers the cheap cost of energy is good news. Furthermore, the labor market situation remains very robust, and despite a slight slowdown in the service sector, here too a slip into recession seems very unlikely. We accordingly expect the US Fed to continue with the normalization of interest rates later on in the course of the year. The European Central Bank (ECB), on the other hand, is once again facing an increase in downward risks in terms of both inflation and growth. First of all, sentiment in corporate surveys has already deteriorated, and on top of this the renewed pressure on the banking sector poses the risk that following a brief phase of weak growth, lending in the Eurozone could already falter again. As the inflation expectations in the Eurozone have also fallen to new lows, the ECB will have to adopt further easing measures in the course of the year. The same applies to the Bank of Japan. The prospects for the larger emerging markets have stabilized somewhat in the past few months, although at very weak levels. The latest indicators in China continue to point toward a slowdown in growth due to the prevailing high oversupply in heavy industry. Furthermore, in view of the fraught financial situation, only a moderate increase in public spending is to be expected. Meanwhile, monetary policy remains on course for easing. The currency depreciation to be expected as a result will place the emerging markets under additional pressure. Both the Brazilian and Russian economies are continuing to suffer from the low oil price and are therefore also set to contract in 216. Only India's outlook remains positive. bjoern.eberhardt@credit-suisse.com Core inflation rising in the USA Inflation rate in % YoY change in % Credit growth in the Eurozone slowing down Loans to non-financial corporates Loans to households Loans to private sector Core inflation rate Source: Datastream, Credit Suisse Source: Datastream, Credit Suisse 5

6 Global Economy l Monitor Eurozone Falling PMIs at the start of the year PMI index > 5 = growth Fears recently arose that the economic recovery in the Eurozone could have started to falter, not least due to a significant decline in important leading indicators such as the purchasing managers' indices (PMIs) and consumer sentiment. Altogether, however, these indicators remain at relatively solid levels. While there are certainly some negative factors (including the weak emerging markets, financial market turbulence, the risk of a credit crunch), we do not think that these suffice to bring the recovery to a standstill Manufacturing sector Service sector philipp.waeber@credit-suisse.com USA Source: Bloomberg, Credit Suisse Rising trend for wages Year-on-year change in %; as % of workforce (r.h.s.): three-month average A low unemployment rate and solid employment growth underline the robust condition of the US labor market. Various indicators are pointing toward increasing bottlenecks on the labor market. For example, the voluntary resignation rate, a measure of confidence in the labor market and a leading indicator of wage growth, has been rising continuously since 29. The positive correlation between changing jobs and the growth of wage income should soon be reflected in rising inflation Hourly wage Voluntary resignation rate (r.h.s.) patrick.steiner.3@credit-suisse.com China The depreciation of the Chinese renminbi (CNY) over the past year has increasingly unsettled investors. However, compared with the average depreciation of other emerging market currencies of 17%, the fall in the CNY of 5% against the USD is modest. On a trade-weighted and inflation-adjusted basis, the CNY has even appreciated slightly and remains 6% above the level at the start of 2. In view of the weaker growth and massive capital outflows, a further depreciation seems justified. With the globally highest currency reserves (USD 3.2 trillion), China altogether remains well armed to counter an increase in CNY volatility. Source: Datastream, Credit Suisse Capital outflows putting pressure on CNY In USD bn per quarter, USD/CNY exchange rate Net capital outflows (excl. direct investments and currency reserves) USD/CNY (r.h.s.) nora.wassermann@credit-suisse.com Source: State Administration of Foreign Exchange (SAFE), Bloomberg, Credit Suisse 6

7 Swiss Economy GDP per capita shrinking again in Switzerland The Swiss economy is set to grow by 1% in 216. The export sector has bottomed out, but the rising unemployment rate is negatively impacting consumption. Economic output per capita decreased in 215 and is likely to fall further in 216. No recession but statistically exaggerated growth in 215 Job cuts and rationalization bring franc shock to domestic economy As we expected, Switzerland avoided a recession in 215. However, the economic growth of.9% published by the State Secretariat for Economic Affairs (SECO) makes the past year seem better than it actually was, as a large part of the growth took place before the appreciation shock. Technically there was a statistical overhang from the previous year of around.9 percentage points at the start of 215 (see chart). Thanks to the strong growth in the second half of 214, gross domestic product (GDP) at the beginning of 215 was therefore already.9% above the average of 214. However, since January 215 the economy has more or less been moving sideways. On top of this, the non-price-adjusted national accounts have deteriorated considerably: Nominal GDP shrank by.4% last year. It was obviously only possible to prevent a loss of sales volumes by means of price discounts and a significant decline in profit margins. Margin pressure and cost cuts will also dominate economic activity this year. Even if according to our forecast the franc does not appreciate any further, it will still remain considerably overvalued. It will therefore continue to be important for companies to restore their price competitiveness. This entails direct consequences for investment behavior and the labor market. We accordingly think that while investments will continue to be made, these will largely comprise replacement investments and rationalization measures, particularly as there will be less cashflow for financing due to falling corporate profits (see detailed discussion of demand components starting on page 9 -> Investments). Furthermore, the unemployment rate is set to rise further in 216 and reach 3.8% at the end of the year. Increases of this kind have not failed to leave their mark on consumption in the past as consumer sentiment is impaired by concerns about individual job security (-> Consumption). The key growth driver of private consumption therefore remains population growth and immigration. However, per capita consumption is likely to decline. In view of the further slowdown in immigration to be expected, the domestic economy is therefore set to lose further momentum (-> Immigration). Economic growth statistically exaggerated Sample calculation of statistical overhang Consumption has supported GDP growth so far YoY growth; growth contributions in percentage points GDP level 6.% 4.% Statistical overhang 2.%.% -2.% Year t Year t + 1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4-4.% -6.% -8.% -1.% Private consumption Government consumption Construction investments Investments in equipment Stocks & statistical deviation Balance of trade GDP, real Source: Credit Suisse Source: State Secretariat for Economic Affairs, Credit Suisse 7

8 Export sector remains susceptible to exchange rate fluctuations Better but not good enough Meanwhile, the export sector will have bottomed out. However, it would be premature to talk about a broad-based recovery in exports. First of all, demand is only rising slowly owing to the sluggish economic performance in the importing countries and the continued overvaluation of the franc. Secondly, the differences by sector, importing country and even company are enormous (-> Exports). Thirdly, it is noticeable that those export sectors providing a lot of jobs in Switzerland have still barely gained momentum (see chart). The growth impact on domestic demand of the weak recovery in exports will accordingly be limited. Furthermore, the export sector remains extremely susceptible to economic shocks. A renewed marked appreciation of the franc would be difficult to cope with. The Swiss National Bank (SNB) will therefore be obliged for some time to come to keep interest rates negative and intervene in the foreign exchange market. The export sector will only contribute little to growth this year, while the domestic economy continues to lose momentum. Economic growth is therefore likely also to be subdued this year. We forecast a GDP growth rate of 1%. Growth will therefore remain below potential growth again, and, in view of the rising population economic output, will even decrease on a per capita basis. However, non-price-adjusted value creation should increase again so that nominal GDP expands slightly in 216. On the other hand, inflation will remain negative, with the price level set to fall for the fifth year in succession (-> Inflation). We expect an average fall in prices of.5%. claude.maurer@credit-suisse.com Fewer than 2% of workforce in the pharmaceutical and Nominal GDP should rise again in 216 chemicals sector YoY export growth in Q4 215, in % YoY growth, in % Pharma & chemicals Textiles & clothing Food & tobacco Plastics Watches & data proc. MEM Vehicle construction -1% -8% -6% -4% -2% % 2% 4% 6% 8% Export growth Share of total workforce 5.% 4.% 3.% 2.% 1.%.% -1.% -2.% -3.% Nominal Real * Source: Swiss Customs Administration, Swiss Federal Statistical Office, Credit Suisse Source: OECD, Credit Suisse * 216 forecasts 8

9 Swiss Economy l Monitor Exports Pharmaceutical exports driving overall growth Export revenues, seasonally-adjusted, index (1997 = 1) The trend reversal appears to have been accomplished: The volume of exports rose by 3.6% compared with the previous quarter in the fourth quarter of 215. However, the sector differences are large. Above all pharmaceutical exports are increasing. We expect a continuation of this sluggish and imbalanced recovery in the next few months. Moreover, as of February the negative impact of the franc appreciation on the year-on-year comparison is no longer reflected in the statistics, which should also place export revenues in a more favorable light again Total exports Pharma/chemicals Machines/electronics Watches bettina.rutschi@credit-suisse.com Consumption Consumer sentiment remained below the long-term average at the start of the year, among other things because confidence in the labor market was subdued. In view of the rising unemployment rate, no noticeable upturn in sentiment is to be expected by the end of the year. Concerns about job security are exerting a negative impact on consumption: At times of high unemployment such as after the bursting of the dotcom bubble or at the end of the 199s consumption growth has always been extremely weak or even negative. Consumption growth in 216 (forecast: 1%) is also set to be lower than population growth. Source: Swiss Customs Administration, Credit Suisse Consumer sentiment correlating with consumption Consumption growth (moving two-quarter average), YoY, in % Consumer sentiment Private consumption (r.h.s.) claude.maurer@credit-suisse.com Investments While employee compensation and hence that part of economic output paid out as salaries has been gradually rising since 28, income from manufacturing capital stagnated or fell. This trend intensified during the recession in 29 and after the abandonment of the minimum exchange rate in January 215. There is therefore less cashflow available for financing investments. There is no sign of any improvement: Economic output is only increasing at a subdued rate and a decrease in total employee compensation would only be possible by making heavy job cuts which we hope are not to be expected. Source: State Secretariat for Economic Affairs, Credit Suisse Corporate profits falling QoQ rates of change, in % 1% 5% % -5% -1% Employee compensation Depreciation Net operating surplus Duties -15% claude.maurer@credit-suisse.com Source: Swiss Federal Statistical Office, Credit Suisse 9

10 Inflation Cheaper fuel In CHF per liter Consumer prices are this year set to be.5% lower on average than in 215. The main reason for this is the renewed fall in the price of oil at the start of 216 that is reflected among other things in lower fuel prices. However, the other components of the consumer price index are also not displaying any inflationary pressure. The sharp expansion in the supply of rental apartments is having a curbing impact on the growth in rents that is expected to be only marginally positive, while the only moderate level of wage growth is limiting price increases in the domestically-oriented service sector Unleaded 95 Diesel maxime.botteron@credit-suisse.com Immigration Source: Swiss Federal Statistical Office, Credit Suisse Decrease in economic migration continuing Net immigration (Swiss and foreigners) Immigration to Switzerland declined further in 215 in accordance with our forecast. Fewer new arrivals were registered in particular from Portugal, Spain and the eight new EU member states. Economic migration from the EU has generally decreased. However, this downturn is partly being offset by immigration with the purpose of seeking asylum. Altogether we expect net immigration of 7, persons for 216, down from 73, persons last year and 81, in , 9, 8, 7, 6, 5, Net immigration Forecast 4, 3, sara.carnazzi@credit-suisse.com Labor Market While economic momentum stagnated and unemployment rose, employment continued to increase throughout 215. Measured in terms of the number of jobs, the total workforce on average grew by.2% in each quarter. At.1 percentage points per quarter, healthcare made the greatest contribution to employment growth. By contrast, jobs were cut in industry and construction. We expect a slowdown in employment growth from.8% to.3% in 216. Source: State Secretariat for Migration, Credit Suisse Employment growth in the service sector QoQ change, in %.5%.3%.% -.3% Sector II Sector III others Management consulting Architects and engineers IT Healthcare Social services Public administration & education -.5% Total lukas.gehrig@credit-suisse.com Source: Swiss Federal Statistical Office, Credit Suisse 1

11 Labor Market Debate Is unemployment set to fall again soon? A large number of jobs that were lost due to the strength of the franc are likely to be replaced again. However, at least in industry, more long-term processes such as outsourcing and automation have been accelerated by the franc shock. Permanent rise in unemployment due to structural change? Anatomy of the labor market in 215 compared to that of crisis years No imbalance across occupations At the start of the current year, there were 13, more registered unemployed than at the beginning of 215. This increase will primarily be attributable to the economic performance that was stifled by the appreciation of the Swiss franc. Moreover, the strong franc could have accelerated structural change and in particular the cost-related offshoring of jobs abroad. Automation is also likely to cost further jobs in the medium term. Do we therefore need to adapt to a permanently higher level of unemployment? In terms of the sector structure, the rise in unemployment during 215 was essentially no different from a typical cyclical increase (see chart). However, it was significantly less rapid than in the previous two downturns. At the end of the recession from 22 to 23, there were around 8, more unemployed recorded than at the start of the recession; in 29 there were about 5, more within the course of the year. As in the two preceding downturns, industry and trade laid off the most employees during 215. The sector picture therefore points more toward a temporary or cyclically-related rise in unemployment. The ratio between the number of vacancies and the number of unemployed a variable for measuring the degree of imbalance within a labor market provides a further indication that the labor market has not fundamentally gone off the rails. If, for example, unemployment among retailers rises while there is a disproportionately large number of vacancies in the catering industry, the imbalance increases. At %, unemployed and vacancies are evenly distributed across all groups, while at 1% this is totally imbalanced. The imbalance with respect to occupational groups actually decreased in the course of 215 (see chart). In order to achieve a balanced ratio between registered unemployed and unfilled vacancies, 18% of the workforce would have to change occupation. In 211 this amounted to over 35%, although this was due to an unprecedented construction boom and a large number of vacancies in construction. The reduction in the imbalance across occupations in 215 therefore suggests just a temporary rise in unemployment. Crises have had similar impacts on the labor market Absolute change over periods specified; l.h.s. by education category, r.h.s. by sector Imbalance across occupations has decreased Unemployment rate in %; imbalance as % of number of employees Unemployment rate Imbalance indicator (r.h.s.) 4% 35% 3.4 3% % % % Source: State Secretariat for Economic Affairs (SECO), Credit Suisse Source: State Secretariat for Economic Affairs (SECO), Credit Suisse 11

12 Low-qualified workers in industry more strongly affected by unemployment Job cuts rather than shorttime work in industry Offshoring increasingly also taking hold in the service sector Increasing fragmentation of production in all three economic sectors over time The recent rise in unemployment at first sight also appears to be of a cyclical nature in terms of qualifications. The bulk of the newly unemployed is formed by employees without postcompulsory education or with no more than an apprenticeship as was also the case with previous cyclical increases in unemployment. However, a closer examination reveals that within industry employees with lower qualifications are more strongly affected than in a normal crisis, while hardly any of those with higher qualifications are losing their jobs. Furthermore, the number of short-time employment contracts in industry only rose marginally in relation to unemployment in 215 (see chart) and even remained below the level of 212. The latter is an indication that employers in industry no longer expect to have any more work for many employees even if the economy picks up. Particularly at export-oriented industrial enterprises this could be a result of the closure of less productive business units or their transfer abroad. At least part of the rise in unemployment could therefore be attributable to the structural trend toward the increased transfer of production abroad (offshoring). However, offshoring has long ceased only to be an industry-specific phenomenon. Thanks to the often lower advance delivery costs abroad, companies from the service sector can also cut production costs through offshoring and in doing so enhance their competitiveness. Clues facilitating a quantitative assessment of the offshoring activities of companies in Switzerland are provided by the development of the gross value creation rate, defined as the ratio between value creation and gross production value. As value creation is derived from the difference between gross production value and advance deliveries, a decreasing gross value creation rate over time points toward an increase in advance deliveries and therefore a greater division of labor that among other things is accompanied by the offshoring of activities. The gross value creation rate has for a long time been displaying a downward trend in all three economic sectors in Switzerland, thereby suggesting a greater division of labor. This key figure does not permit any statements to be made regarding the origin of the advance deliveries; however, as production is strongly shaped by processes of globalization, at least part of the decline in the gross value creation rate is likely to be attributable to offshoring activities. While the gross value creation rate in industry has already been at a low level since the 199s, a clearer downward trend is emerging in the service sector (see chart). According to estimates of the State Secretariat for Economic Affairs, only 1.8% of service advance deliveries were imported from abroad in 21; this had already risen to 5.3% in 28. Following the globalization of the goods markets, the fragmentation of the value creation chains has therefore now also set in in the service sector. Unemployment rather than short-time work in industry Absolute figures, short-time work until October 215 Annual gross value creation rate in % Greater division of labor in the value creation chains 35, 3, 25, 2, 15, Short-time employees traditional industry Short-time employees high-tech industry Unemployed traditional industry Unemployed high-tech industry 48.% 46.% 44.% 42.% 4.% Industry, construction Services incl. trade (r.h.s.) 58.% 57.5% 57.% 56.5% 1, 5, 38.% 36.% 56.% % % Source: State Secretariat for Economic Affairs (SECO), Credit Suisse Source: Swiss Federal Statistical Office, Credit Suisse 12

13 Short-term residents: The new cyclical shock absorber? Foreign labor is known previously to have acted as a strong cushion for the Swiss economy and unemployment in Switzerland. However, the underlying conditions on the Swiss labor market have changed significantly for foreign labor in recent decades. The greatest turning point lies in the free movement of persons with the countries of the European Union (EU) and the European Free Trade Association (EFTA). Short-term residents (L permits with a right of residence of up to 12 months) who have replaced the seasonal workers of the past still appear to respond sensitively to cyclical developments today. Over the past 15 years the number of short-term residents always declined ahead of an increase in the nationwide unemployment rate (see chart). However, the number of short-term residents rises rapidly during times of economic upturn. Nevertheless, it is possible to identify some factors that have weakened the economic cushioning function of foreign labor. First of all, foreigners are receiving more annual and permanent residence permits. While the ratio of seasonal workers', short-term and cross-border permits to annual and permanent residence permits averaged 4% in the 197s, this has today fallen to 32%. Secondly, foreign labor is today more strongly integrated into the unemployment and social welfare system, not least also shortterm residents. Switzerland is therefore assuming greater responsibility for the problem of unemployment among foreign labor and no longer "exporting" it through the return migration of workers who have become unemployed to their individual countries of origin as was the case in the past. Wage benefits in offshoring countries gradually getting smaller Large service companies have already been gaining experience with offshoring for years. For example, many Swiss financial services providers operate major centers of competence in Eastern Europe and India and wish to expand these further in the future. As well as more straightforward administrative and support activities, employees there are increasingly also taking on more complex tasks such as accounting and analytical services. In the medium term, however, offshoring activities are giving rise to a certain amount of wage pressure in the target countries. This can be observed in terms of the average hourly wages in Eastern Europe, for instance. While average Swiss hourly wages in the financial sector were six times higher than in Poland in 22, this ratio had already fallen to around 4:1 by 21. The wage benefits as the most important driver of offshoring activities are therefore tending to recede over time. Short-term residents as leading indicator Number of short-term residents* and foreigners in employment, YoY in %; unemployment rate, seasonally adjusted in % Offshoring creates wage pressure in target countries Annual gross value creation rate in %, ratio of average hourly wage Switzerland/abroad (in CHF) in the financial and insurance sector 3% 2% 1% Foreigners in employment Short-term residents in employment Unemployment rate (r.h.s.) 6% 5% 4% % 66% 64% % 3% 4. 62% -1% 2% 3. 6% -2% -3% % % 2. Hungary 1. Czech Republic Poland Gross value creation rate of financial services (r.h.s.) % 56% Source: Swiss Federal Statistical Office, Credit Suisse *L permits, seasonal workers and residents subject to registration Source: Swiss Federal Statistical Office, Credit Suisse 13

14 Automation will change the labor market in the medium term Franc shock has not caused the labor market to derail mediumterm challenges remain On the other hand, automation, another factor set to shape the structure of the Swiss labor market in the medium term, is gaining momentum. According to a study for the USA, 47% of all jobs could theoretically be automated in the future. While it may not be possible to transfer this 1:1 to Switzerland, the key findings are also relevant for Switzerland: as well as production steps in industry, many service activities can also potentially be automated. Occupational groups such as trade and the hotel industry as well as commercial and administrative activities which have already seen large numbers of unemployed in recent years will remain under pressure among other things due to automation. Automation is difficult in occupations requiring social intelligence, creativity or manual skills. Occupations in healthcare and education that entail the ability to empathize will also remain unlikely in the future to become automated. The medium-term effects of these developments on the labor market will ultimately depend on the extent and speed at which structurally-related job losses can be offset with additional jobs in areas with a more promising future. Cyclical job losses are made good when the economy picks up again. However, the pressure on the labor market triggered by the franc shock is set to hold up over the next year or two and unemployment is also likely to remain high due to cyclical reasons. sara.carnazzi@credit-suisse.com julia.dumanskaya@credit-suisse.com lukas.gehrig@credit-suiss.com jan.riss@credit-suisse.com These occupational groups contained the largest number of unemployed Historic share of each occupational group ( average) in the total number of unemployed, in % Service occupations can also potentially be automated Likelihood of automation by occupational group 16% 14% 12% 1% 8% 6% 4% 2% Hotel industry Trade and sales Commerce and Administration Construction Cleaning, hygiene Entrepreneurs Healthcare Transport Education Metal processing and mechanical engineering IT Advertising, marketing very high high medium low Commercial and administrative occupations Construction Cleaning, hygiene Hotel industry Trade, sales Transport Advertising, marketing Education Metal processing and mechanical engineering Entrepreneurs Healthcare IT Source: State Secretariat for Economic Affairs (SECO), Credit Suisse Source: Frey, C. B., & Osborne, M. A. (213). The future of employment: how susceptible are jobs to computerisation, University of Oxford, US radio broadcaster association NPR, Credit Suisse 14

15 Sectors Economy 4. The digitalization level of the Swiss economy is set to increase strongly in the future. The growth potential of the IT sector is therefore well above average. Far-reaching changes imminent Upheaval due to increased performance capability, lower prices and miniaturization of electronic devices Opportunities above all for IT service providers; risks among other things in trade and at printing houses The Swiss economy is about to undergo structural upheaval from which the "Economy 4." is increasingly likely to emerge. This links devices, employees and companies via digital, selflearning and self-organizing systems. For example, real estate is in future set to be planned, constructed and managed largely by means of computers based on input from architects, workmen, interior designers and authorities. This development is being made possible by the rapid pace of technological progress. For instance, the performance capability of processors (chips) has risen exponentially in the past 5 years (Moore's Law, see chart). At the same time, processors and electronic devices have shrunk to a minimum size and become more and more affordable. The transmission rates of networks have also risen sharply in recent years ( average download speed in Switzerland: +321%). All this already makes it possible today to make use of programs that are not installed on the local workplace computer (cloud computing), equip devices with sensors and communicating chips (e.g. RFID for fully automated logistics) or collect and evaluate huge quantities of data (big data). Among the Swiss industries, above all IT service providers are benefiting from the increasing utilization of this potential. According to the Swiss Software Industry Survey (SSIS), Swiss software companies expected average sales growth of 12% for 215. And the positive development is set to continue thanks to the digital transformation of the economy. The Swiss IT sector therefore receives the best assessment out of all sectors in our medium-term opportunities/risks analysis as we attest to it well above-average growth potential (see chart). However, the anticipated far-reaching changes also entail some risks. The digital transformation calls for major investments particularly in industry, although these are likely to result in significant efficiency gains in the longer term. Furthermore, competition and price pressure in areas such as the retail trade are set to increase due to the expansion of e-commerce. We also expect printing houses to record significantly below-average growth in the years to come owing to the increasing distribution of online contents. patricia.feubli@credit-suisse.com Chips: exponential increase in performance capability Number of transistors on Intel processors; the more transistors there are on a processor, the greater its performance capability 1,,, 1,,, 1,, 1,, 1,, 1, 1, 1, Source: Intel, Credit Suisse Best opportunities/risks analysis for IT service providers 216 medium-term opportunities/risks analysis, synthetic indicator, overall economy = Above average Average Below average Information technology Pharmaceuticals Healthcare services Corporate services Medical technology Social services Education Watchmaking Real estate Wholesale trade Insurance Architects/engineers Construction Telecommunications Food Automotive trade Transport/logistics Electrical engineering Electronics Retail trade Wood products Banks Hotels/catering Chemicals Mechanical Engineering Energy supply Metals industry Printing/publishing Source: Credit Suisse 15

16 Sectors I Monitor Industry Sharp rise in unemployment in industry Number of registered unemployed There were around 23, registered unemployed in industry in January 216, 3,7 more than in the previous year (+18.6%). Almost three fifths of the increase in unemployment is attributable to the engineering, electrical and metal industry (MEM) as well as the watch industry. Further job cuts in industry are to be expected in the next few quarters. For 216 as a whole we forecast an overall decline in employment in this sector of 1.2%, which is equivalent to around 7,8 FTEs. 25, 2, 15, 1, Electrical/watches/optics Food Chemicals/pharmaceuticals Metal Mechanical engineering Other industry 5, 1/213 1/214 1/215 1/216 emilie.gachet@credit-suisse.com Retail Trade Nominal retail sales and prices in 215 were 1.5% lower than in 214. The situation eased somewhat in the fourth quarter of 215, which was above all thanks to a slight increase in sales in the food/near-food segment (+.3% year-on-year). However, sales in the clothing segment once again fell sharply (- 4.2%) as sales of the winter collection proved sluggish due to the warm weather. Assuming a EUR/CHF exchange rate of around 1.1, we expect a stabilization of nominal retail sales in 216 despite the anticipated slight increase in the unemployment rate and the difficult start to the year. The expected rise in sales in the food/near-food segment is likely to be offset by a decrease in sales in the non-food segment. Source: State Secretariat for Economic Affairs, Credit Suisse Brief easing at the end of 215 thanks to Food/Near-Food Moving three-month average, YoY change in % 4% 3% 2% 1% % -1% -2% -3% Retail prices Nominal retail sales (adj. for calendar days) Real retail sales (adj. for calendar days) -4% 1/214 5/214 9/214 1/215 5/215 9/215 1/216 patricia.feubli@credit-suisse.com Source: GfK, Swiss Federal Statistical Office, Credit Suisse Hotel Industry.8% fewer overnight stays in the hotel industry in 215 Overnight stays at hotels and health resorts The Swiss hotel industry recorded.8% fewer overnight stays in 215 than in the previous year. The decrease in overnight stays by European guests due to the franc shock proved particularly painful (Netherlands: -14.3%; Germany: -12.3%). However, the increase in overnight stays by Chinese and Indian guests (+29.7%) was able to offset a significant portion of this decline. The start to the 215/16 winter season proved partially sluggish for the Alpine regions owing to the mild winter. Assuming a EUR/CHF exchange rate of around 1.1 and a continued economic recovery in Europe, the decrease in overnight stays should slow down in % 6% 4% 2% % -2% -4% Year-on-year change (3-month moving average) 12-month moving average (in thousands; right axis) 3,1 3,6 3,2 2,98 2,94 2,9 2,86-6% 2,82 12/212 6/213 12/213 6/214 12/214 6/215 12/215 patricia.feubli@credit-suisse.com Source: Swiss Federal Statistical Office, Credit Suisse 16

17 Economic Policy Debate Is Switzerland still being invested in? Despite the strength of the franc and political uncertainty, there has so far been no collapse in investment in Switzerland. However, the momentum of foreign direct investments has declined. Declining momentum of foreign direct investments Fall in settlements supported by cantonal economic development agencies Investments in Switzerland increasing Switzerland remains popular as a target country for foreign direct investments (FDI). Globally it ranks tenth, with FDI stocks of CHF 756 billion. According to the Swiss National Bank (SNB), at total of 455, persons (11% of the total workforce) in Switzerland were employed at foreign companies at the end of 214. However, employment growth at companies under foreign ownership has lost momentum recently: Between 24 and 213 it averaged at 4.2% per year, while between 211 and 213 it was just 1.4% (no comparable data is available for 214). By way of comparison, the total workforce grew by an average of 1.4% between 24 and 213 and by 1.6% per year between 211 and 213. Meanwhile, according to the United Nations Conference on Trade and Development (UNCTAD), the growth of FDI stocks in Switzerland fell from an average of 15.7% between 24 and 213 to 3.1% p.a. between 211 and 213. Globally there was only a marginal slowdown in the growth of FDI stocks over the same period from 1.2% to 9.4% per year. The development of settlements supported by the economic development agencies of the cantons confirms the impression that Switzerland is currently having less success in attracting foreign investments. According to data of the Swiss Conference of Cantonal Directors of the Economy, the number of new settlements has been falling since 212, while the number of newly created jobs decreased from 2,59 in 211 to just 78 in 214. On the other hand, overall investment activity in Switzerland does not at first glance appear to have declined. According to the State Secretariat for Economic Affairs (SECO), gross capital formation rose by 1.6% in real terms between 2 and 214. Between 211 and 214 there was even a slight acceleration in investment growth to 2.1% p.a., and gross capital formation was also up 1.5% year on year in the first three quarters of 215. Crisis situations look different: Year-on-year investments slumped by 7.5% in 29. According to data of the Organization for Economic Co-operation and Development (OECD), above-average volumes are also invested in Switzerland when compared internationally. On average, 1.1% more was invested in the OECD countries than in the previous year between 2 and 214 and 1.7% more between 211 and 214. Slowdown in job growth at foreign companies Switzerland: Higher investments than OECD average Number of employees, indexed (24 = 1) Annual growth of real gross capital formation, in % Employment at foreign companies Total workforce 6% 4% OECD Switzerland % % -2% -4% -6% -8% 15-1% % Source: Swiss National Bank, Swiss Federal Statistical Office, Credit Suisse Source: OECD, Credit Suisse 17

18 but only in a few areas Investments in industry subdued Companies remaining loyal to Switzerland at least for the time being However, a detailed analysis by the SECO uncovers a less positive picture of investment activity. It is above all investments in "IT and IT services" (software and databases), "Research and development" and since early 215 "Vehicles" that are currently making a positive contribution to the growth of investments in equipment. By contrast, investments in "Other and military equipment", which also includes investments in machinery, have been moving sideways since the collapse in 29. Hence while the research and development-oriented high-tech industry continues to invest, wider industry appears no longer to be making any headway. This picture is also confirmed by corporate surveys and there is no sign of a trend reversal for the time being: According to a survey carried out by Credit Suisse and the professional association for procurement and supply management procure.ch under the latter's members, only around 25% of companies intend to invest more this year than in 215, another 25% less and around 5% the same amount, with replacement investments prevailing (7% of all specifications). There are still no decisive indications to suggest that companies are instead investing at a faster rate abroad. According to SNB data, both job growth at Swiss companies abroad and the growth of Swiss FDI stocks abroad have slowed down in recent years more sharply than was to be expected based on the global trend toward lower growth. Swiss FDI stocks abroad increased by an average of 13.7% annually between 2 and 213 but by just 5.6% between 211 and 213. Imports of telecommunications, information technology and business services amounting to around CHF 44 billion per year that largely reflect the offshoring of such services abroad also do not suggest any massive offshoring activities even if the trend is not clear due to the inherent volatility. A survey carried out in December 215 by Credit Suisse and Switzerland Global Enterprise among export-oriented small and medium-sized enterprises (SMEs) suggests that the latter are currently not turning their backs on Switzerland. Around 56% of companies responding are planning investments this year in Switzerland and just 22% are planning them abroad. However, a significant 45% of companies claimed that investments in the European Union (EU), by far the most important foreign investment location, had become more attractive in recent years (despite all crisis reports), and 6% even expect their volume of investments in the EU to increase in the next few years. Sounding the all-clear is therefore not appropriate, as here too a creeping trend toward decreasing enthusiasm for the Swiss location appears observable. bettina.rutschi@credit-suisse.com Sideways trend among machinery investments Calculation of real level values in CHF mn by SECO, based on data of the Swiss Federal Statistical Office Swiss foreign investments declining FDI stocks abroad, in USD, indexed (2 = 1) 45' 4' 35' Vehicles Other and military equipment Software and databases Electricity Research and development 6 5 Global Switzerland 3' 4 25' 2' 3 15' 2 1' 5' Source: State Secretariat for Economic Affairs (SECO), Credit Suisse Source: UNCTAD, Credit Suisse 18

19 Regions Domestic competition keeps cantons fit Countries influence prosperity and value creation with their underlying conditions for business. Swiss federalism is a success model in this respect. However, financial equalization and tax reform are reducing the role of the cantons in fiscal policy. Fiscal policy: Balancing act between federalism and equalization Swiss locations have competition in their DNA Move toward substantive harmonization The underlying conditions for business are decisive for the long-term success of locations. In order to illustrate the differences in locational quality in the Swiss cantons and regions, we have developed our Locational Quality Indicator (LQI) (see chart). Individual criteria of locational quality, such as topography, are naturally derived and therefore difficult to change. However, Switzerland's federal structure provides the municipalities and in particular the cantons with a large amount of leeway for location-relevant decisions. Remote mountain valleys are also involved in shaping fiscal policy and infrastructure investments. Intra- and intercantonal financial equalization systems simultaneously ensure a certain degree of equalization of resources and burdens. Thanks to this creative leeway, the parts of the country therefore to a certain extent share responsibility for ensuring prosperity and value creation. They compete with their neighbors and endeavor to position themselves optimally in accordance with their political objectives. Unlike subnational units in the European environment, they are unable to rely on the national government to create attractive underlying conditions. Despite rising deficits, the nationwide debt situation still remains relatively unproblematic on a European comparison. At the same time, tax payers bear a very low tax burden from an international perspective. Financial federalism has therefore proven to be a success model also for global competition. The role of the cantons in determining their fiscal policy is subject to influence by national fiscal equalization (NFE) and Corporate Tax Reform III (CTR III): Although a harmonization of cantonal tax rates is not envisaged by law, rising contributions could force the NFE net contributors to raise taxes as was recently the case in the Canton of Schwyz. CTR III is likely to prompt many cantons to cut taxes. Furthermore, the cantons are to receive a larger share of direct federal tax. The ranking of the cantons in the LQI is set to shift (see chart). For example, Geneva jumps from mid-table to third position. NFE and CTR III represent a move toward substantive harmonization, thereby reducing the cantonal leeway in fiscal policy. At its core, however, the "financial federalism" success model is not at risk. thomas.ruehl@credit-suisse.com Locational quality of Swiss cantons in 215 and following planned fiscal adjustments due to CTR III Locational Quality Indicator (LQI), synthetic index, CH =, 215 and following recalculation of partial indicator for tax burden of legal entities ZG ZH LQI ZG ZH LQI following planned fiscal adjustments Swiss average Source: Credit Suisse BS SZ AG NW LU OW AR SH TG BL AI SG SO GE GL BE VD UR NE TI FR GR VS JU Swiss average GE BS SZ AG NW BL LU SH TG OW VD AR BE AI SO SG FR NE GL UR TI GR VS JU 19

20 Regions Monitor Tax rates on profits after tax reform Special status companies with significantly lower tax rates Effective tax rates on profit including Federal Government, , selected cantons The privileged taxation of special status companies is set to disappear with Corporate Tax Reform III. Although individual cantons have already announced a reduction of their standard tax rates, most holdings and mixed companies will still be confronted with higher rates after the reform. In conjunction with further tax benefits (such as the former Lex Bonny) they were even able in some cases to reduce their tax burden below the 8.5% federal tax between 29 and 211. While the differences today may be lower, there are no corresponding figures available. 3% 25% 2% 15% 1% 5% % Taxed at standard rate Planned standard rate after CTR III All legal entities Taxed at standard rate LU ZH BE BL CH FR SH GE NE ZG BS VD thomas.ruehl@credit-suisse.com Start-up rate and locational quality By launching a new start-up, entrepreneurs express optimism. They invest time and money in order to gain success in a given market and at a given location. Particularly attractive locations such as the Zug regions, March/Höfe (SZ), Nyon (VD) and the City of Zurich are therefore benefiting from lively start-up activity. The rates are generally lower in outlying and mountainous regions. New start-ups are often associated with product and process innovations welcome new blood for the regional sector portfolios. 2% 4% 4% 6% 6% 8% >8% Share of profits accrued by special-status companies Source: Swiss Federal Tax Administration, cantons, Credit Suisse More business start-ups in attractive regions start-up rate, 215 locational quality Locational quality 4. Zürich-Stadt Basel-Stadt Luzern Lorzenebene/ Ennetsee Zuger Berggemeinden Sursee/ Bern March/Höfe 1. Seetal Nyon Oberaargau CH Genève Lugano -1. Lausanne Thun Mesolcina -2. La Gruyère Oberes Jura -3. Emmental Goms % 2% 4% 6% 8% Start-up rate thomas.ruehl@credit-suisse.com Financial equalization: 216 payments Source: Swiss Federal Statistical Office, Credit Suisse Jura now largest net recipient 216 NFE equalization payments, CHF per capita. Negative figures: net recipients Since the reform of the national fiscal equalization (NFE) in 28, Uri has received the highest annual equalization payments per capita. The Canton of Jura has recently displayed lower resource potential and overtaken Uri in terms of per capita payments. Neuchâtel and Fribourg continue to receive the highest payments from the hardship subsidy intended to cushion the effect of the change of system. The contributor cantons are being relieved by CHF 67 million for the current equalization period. However, the hardship subsidy will be continued up until 228 at the latest. 3, 2, 1, -1, -2, -3, ZG SZ Equalization of resources Equalization of burdens Hardship subsidy NW BS ZH BLVD TI AG LU AR SO AI GR GLVS GE SH OW Net contributors SG TG NE Net recipients BE FR UR JU thomas.ruehl@credit-suisse.com Source: Swiss Federal Tax Administration, Credit Suisse 2

21 Monetary Policy Who pays negative rates? The burden of negative interest rates varies considerably between banks, depending on each bank's specific business model. According to our estimates, banks with a stronger focus on retail customers pay proportionately less. The negative interest rate is mainly charged to domestic banks Deposits at the SNB are partly exempted from the negative interest rate Foreign banks and wealth managers pay proportionately more As part of its strategy to weaken the Swiss franc, the Swiss National Bank (SNB) has introduced a negative interest rate. The negative rate is charged on franc deposits kept at the SNB. These deposits are mainly owned by domestic banks, but also by insurance companies, the Confederation and a few foreign banks. Importantly, private and institutional investors such as pension funds cannot open a deposit at the SNB. Hence, the SNB does not directly impose a negative interest rate on pension funds, nor can the central bank exempt them from it. At the end of December 215, CHF 47 billion were held on deposits at the SNB. However, the negative interest rate is not imposed on the entire amount. Firstly, the Confederation is exempted entirely. Secondly, an exemption threshold has been defined for domestic banks, which has been set at 2 times the minimum required reserves. Foreign banks and other institutions have individual exemption thresholds which have not been communicated. However, based on our estimates and comments by SNB officials, we assume that these individual thresholds are proportionately lower than those of domestic banks. The level of minimum required reserves, which defines each bank's exemption threshold, depends on selected liabilities of the bank, notably customer deposits. Typically, a bank with a large retail customer business will be required to hold more minimum reserves and will therefore have a higher exemption threshold on its own deposit at the SNB. Currently, banks hold reserves which by far exceed the minimum required. These "excess reserves" stem from "money creation" by the SNB which has financed the central bank's foreign exchange interventions. The chart on the right shows the ratio between domestic bank deposits at the SNB and the minimum reserve requirement for different bank groups. These estimates indicate clearly that banks with a stronger focus on the retail business are currently just below or just above the exemption threshold, suggesting they have relatively low negative interest rate expenses. On the other hand, branches of foreign banks in Switzerland as well as other banks such as pure wealth managers or brokers have excess reserves at the SNB that are substantially above the exemption threshold, implying proportionately larger negative interest rate expenses. maxime.botteron@credit-suisse.com Sight deposits at the SNB mainly owned by domestic banks In CHF bn Other deposits (e.g. domestic insurance companies) Banks and other institutions abroad Confederation Domestic banks Not all bank groups are affected the same Ratio of banks' deposits and minimum required reserves Foreign-controlled banks Big banks Raiffeisen banks Exemption threshold Other banks Cantonal banks Regional and saving banks Source: SNB, Credit Suisse Source: SNB, Credit Suisse; Estimates are based on our own calculation of minimum required reserves and particularly uncertain for selected bank groups. 21

22 Money, credit and markets I Monitor Asset allocation of pension funds The drop of nominal interest rates into negative territory has had a visible impact on Swiss pension funds' asset allocation. Pension funds have reduced their liquidity allocation from 7% of their assets in Q3 214 (i.e. before the SNB introduced the negative interest rate) to less than 5% in Q4 215, as banks are generally charging a negative rate on their deposits. However, they have not shifted their allocation toward foreign currency assets as the SNB would probably have wished, but instead increased their real estate holdings. More than 22% of pension funds' assets are currently invested in real estate, typically in Switzerland. Cash is no longer king for pension funds In % of pension funds' assets Liquidity Real estate Introduction of the negative interest rate by the SNB maxime.botteron@credit-suisse.com Foreign exchange reserves Source: Credit Suisse Pension Fund Index The SNB has increased its USD allocation In CHF bn The foreign currency reserves of the SNB increased continuously over the course of 215, reflecting regular interventions by the central bank in the foreign exchange market. Reserves now stand at around CHF 6 bn, which is approximately equivalent to the annual economic output of the Swiss economy. While in 211 around 55% of the assets were invested in EUR, this share has dropped to 42%. On the other hand, the share of USD assets rose from 25% to 32% over the same period. More recently the SNB has also added a small share of Chinese renminbi (CNY) to its foreign currency reserves USD EUR JPY GBP CAD Others maxime.botteron@credit-suisse.com Negative interest rates globally Source: Swiss National Bank, Credit Suisse Exempted deposits are relatively large in Switzerland Deposits of domestic banks with the central bank The SNB is not the only central bank to impose a negative interest rate on commercial bank deposits. The central banks of the Eurozone (ECB), Sweden, Denmark and Japan have also introduced a similar measure. However, the specific schemes differ. While in Denmark, the Eurozone and Sweden most commercial bank deposits at the central bank are charged a negative interest rate, only a small share of domestic banks' deposits at the Bank of Japan and SNB are subject to the negative rate. The Swiss and Japanese experiences suggest that the transmission of negative rates to market interest rates also works with relatively generous exemptions. 12% 1% 8% 6% 4% 2% % Subject to the negative rate Exempted from the negative rate Japan Switzerland Denmark Eurozone Sweden maxime.botteron@credit-suisse.com Source: Central banks, Credit Suisse 22

23 Bonds Yields on corporate bonds increasingly attractive Interest rate premiums of corporate bonds (investment grade) vs. US government bonds in percentage points Interest rates are remaining low on the key markets for the foreseeable future. This low interest rate level is the result of the subdued economy and expansive central bank policy that could even be intensified in the next few months. Even American yields are only tending to rise very slowly as the US Fed is pursuing just a gradual tightening of monetary conditions. For corporate bonds we see the recent correction as an opportunity to expand long-term positions. However, owing to the uncertain outlook, we would only increase the share in stages and start with investment grade issuers AAA AA A BBB karsten.linowsky@credit-suisse.com Currencies Source: Bloomberg, Credit Suisse Consolidation of USD/CHF should be over Exchange rate; interest margin in percentage points As pointed out previously, the USD lost ground against the major currencies following the initial Fed interest rate hike in December. However, we see some recovery potential for the greenback again in the next few months. The interest rate market has now priced out all interest rate hikes in the USA for this year. The downward potential for the USD is therefore limited. Furthermore, the US currency should benefit from the clearing out of short positions. Among the major currencies, the JPY should hold up best and appreciate against the CHF USD/CHF exchange rate 2-year interest rate swap margin USD minus CHF (r.h.s.) marcus.hettinger@credit-suisse.com Equities Source: Datastream, Credit Suisse European banks under pressure since the start of the year Index ( = 1) The decline in equity prices continued at the start of February, with the European banking sector in particular coming under further pressure. Although high-risk investments temporarily stabilized, market sentiment remains nervous. We think that alongside the ongoing expansive central bank monetary policy a series of positive economic surprises will be necessary in order to bring about a more significant upturn in sentiment. As we consider this unlikely for the time being, we are retaining a neutral stance for equities. At the regional level we continue to favor Eurozone equities over US securities MSCI AC World MSCI Europe Banks 7 31/12/15 14/1/16 28/1/16 11/2/16 25/2/16 jin.wiederkehr@credit-suisse.com Source: Datastream, Credit Suisse 23

24 Real Estate Inexpensive rental apartments very popular The investment crisis caused by low interest rates continues to drive forward the construction of rental apartments. While the resulting supply is still being met by high demand, the latter is shaped by a considerably lower willingness to pay. Decrease in immigration from the EU offset by refugees Demand shifting to lower price segments In recent years, immigration has ensured a high level of housing absorption particularly in the urban centers and their environs. However, a marked decline ( 16.2%) was recorded in 215 above all in the influx of migrants from the countries of the European Union (EU). A slowdown is currently being observed in particular among Portuguese, Spaniards and citizens of the eight new EU member states. The main reasons for this development are the slight economic upturn in most of the countries of origin that is being accompanied by a fall in unemployment there and the simultaneous downturn in the Swiss economy. As we expect a stagnation of employment (+.3%) in 216, we anticipate a further decrease in economic migration. On the other hand, an increase can be observed in net immigration from America, Africa and above all Asia (215: +16.5%). A new development here is the sharp rise in immigration with the purpose of seeking asylum. Altogether, 3.7% of immigrants in 215 comprised recognized refugees ( average: 1.7%). This figure is set to record a further significant increase in the current year as the number of asylum applications rose enormously in 215 due to the European refugee crisis (+66% year on year). Asylum seekers are only recorded in the statistics for foreigners after a delay and incompletely as these only include recognized refugees. However, temporary refugees often also remain in Switzerland on a long-term basis and generate a demand for housing that is only covered in the initial months by federal accommodation and provisional municipal infrastructure (e.g. civil defense accommodation). The change in the demand structure that is emerging is set increasingly to penetrate through to the rental accommodation market. While immigrants from the EU and the European Free Trade Association (EFTA) pay an average net rent of around CHF 1,5, at CHF 1,, the figure for immigrants from the current crisis hotspots lies significantly below this (see chart). From an investor perspective, this changed demand structure is opening up new opportunities in the low-cost housing segment in which demand is today already exceeding supply in the urban centers. fabian.waltert@credit-suisse.com Marked change in immigration structure Net immigration of usual foreign resident population by origin and number of asylum applications, moving 12-month average 9' 8' 7' 6' 5' 4' 3' 2' 1' EU/EFTA Rest of Europe Africa America Asia/Oceania Asylum applications Source: State Secretariat for Migration, Credit Suisse Paid apartment rent associated with origin Average net rent of immigrant households, by number of rooms and nationality, , in CHF/month 3, 2,5 2, 1,5 1, 5 All Switzerland 1 room 2 rooms 3 rooms 4 rooms 5 rooms TOTAL EU/EFTA Rest of Europe *Top six countries of asylum seekers in 215: Eritrea, Afghanistan, Syria, Iraq, Somalia, Sri Lanka Source: Swiss Federal Statistical Office, Credit Suisse Africa North America Latin America Asia/Oceania Crisis states* 24

25 Real Estate I Monitor Price growth of residential property Price growth slowed down further to 1.3% in 215. However, there are major differences between the price segments and individual regions. The high-price segment is creaking under the strain of tightened regulatory requirements for lending. In the case of condominiums prices actually fell by 1.5%. Starting from Lake Geneva, prices are now decreasing almost universally in Western Switzerland. While this is reducing the overvaluation in the Lake Geneva region, the rest of Switzerland is heading more towards overvaluation. Slowdown in price growth continuing Annual growth of transaction prices, condominiums and single-family dwellings in % Annual growth >6% 4 6% 2 4% 2% -2 % -4-2% <-4 thomas.rieder@credit-suissse.com Source: Wüest & Partner, Geostat, Credit Suisse Compared with p.a. Well above average Slightly above average Average Slightly below average Well below average Office property Owing to locational uncertainties arising due to the reform of corporate tax, the outsourcing of jobs and structural changes in the financial sector, employment is only set to rise marginally in the typical office-based sectors in 216. We expect marginal additional demand for office space of around 1, m². Planned expansion is too high in relation to this. The imbalances between supply and demand are therefore likely to increase again, resulting in continuously rising vacancy rates and ongoing pressure on rents. 216: Stagnating demand for office space Estimated additional demand in 1, m²; 215 and 216: forecasts 1,6 1, Construction, trade, catering, transportation -8 Manufacturing Public and social services -1,2 Banking and insurance, real estate and service sector Total -1, denise.fries@credit-suisse.com Real Estate Crowdfunding Source: Swiss Federal Statistical Office, Credit Suisse Alternative form of investment on the rise Estimated number of crowdfunding platforms for real estate in selected countries While in the US real estate crowdfunding has been a topic on everyone's lips since 213, this alternative form of investment and financing only gained a foothold in Switzerland at the end of last year. The low search costs compared with a direct investment, coupled with the freedom of being able to select the property individually, make crowdfunding attractive for both institutional and small investors. However, due to their lack of knowledge and experience with real estate, the latter face some quite considerable risks and crowdfunding investments therefore need to be well thought out US UK NL FR GE SWE CH monika.luethi@credit-suisse.com Source: timesrealtynews.com, Credit Suisse 25

26 Economic Policy Agenda The Federal Government wants to tighten its belt The collapse in corporate profits due to the appreciation of the franc will exert a negative impact on tax revenues. In combination with deferred legacies, this creates a much greater need to save with a view to the Federal Government budget in the years to come. Structural deficits from 217 even with full implementation of the savings package Debt cap will entail further savings packages Debt level should stabilize in the next few years The Federal Government forecasts a deficit of CHF 6 million for 216. This already takes account of a package of savings measures intended to relieve pressure on the budget by CHF 1.2 billion. The lion's share of these savings measures is attributable to the correction of overstated inflation adjustments. In the event of full implementation of the savings measures, the debt cap requirements would be fulfilled for 216 despite the deficit. However, a fiscal thunderstorm is brewing for the years 217 to 219. According to estimates by the Federal Finance Administration, the correction of overestimated future tax revenues and the negative effects of weak economic performance and political decisions such as the increase in the cantonal share of federal tax or the decision by the First Chamber to place a greater burden of the 22 reform of the pensions system on the federal budget will altogether result in structural deficits of up to CHF 1 billion by 219 despite a further expenditure stabilization program recently presented to the parliament that has already been taken into account. These structural deficits would prevent compliance with the debt cap and therefore call for adjustments to the draft budgets. This is nothing new: In the crisis year of 29 the Federal Government presented a financial plan with an even greater need for adjustment. However, at that time the strength of the economy was greatly underestimated (real growth of gross domestic product of -.4% was estimated for 211 while +3.% was ultimately realized). We do not expect a similar surprise to occur in the next few years. Although 215 closed with an unexpected surplus of CHF 2.8 billion, we think that with growth rates of 1.5% in 216, 2.% in 217 and 1.7% in the years thereafter, the real economic growth underlying the budget has been overestimated. The appeal to the parliament by the Federal Government to tighten its belt in budgetary matters and to refrain from expensive undertakings for the Federal Government such as the relief in the financing of the old-age and survivors' insurance scheme (AHV) that has been rejected by the Council of States should therefore be taken seriously despite the surplus in 215. We expect the absolute debt of the Federal Government to stabilize in the next few years. However, a fall in the debt level (following a revision-based increase in 217) as forecast by the Federal Government appears to us to be unrealistic, although so too does willful violation of the debt cap. Nevertheless, the Federal Government is capable of sustaining one or two budgetary "lapses" without any problem as the adjustment account on which structural deficits of the federal account balance are recorded should offer a comfortable cushion of over CHF 22 billion at the end of 215. Only when this account displays a shortfall will it be necessary to generate structural surpluses to offset the deficit. lukas.gehrig@credit-suisse.com Economic Policy Outlook Motion Date Economic Policy Significance Popular Initiative for an Unreserved Basic Income Regardless of their occupation, every adult should be paid a monthly 6 May 216 income that enables them to lead a "dignified existence" (proposal of the initiators: CHF 2,5 for adults). Referendum on Corporate Taxes in the Canton of Vaud The Canton of Vaud intends to cut its ordinary tax rate on profit from around 23% at present to 13.79%. Source: Credit Suisse 2 March 216 This draft bill contradicts the fundamental concept of individual responsibility that only offers welfare assistance to those in need, and reduces the incentive to participate in the labor market. Despite savings in the social security system, tax rises would probably be inevitable, which would weaken the appeal of Switzerland as a location. There is also no answer to the question of what happens if someone has spent their basic income and then becomes a burden on the state again. The vote can be considered an initial indicator of the acceptance of Corporate Tax Reform III which is intended to bring corporate taxation into line with international standards. 26

27 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 27

28 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 28

29 Forecasts and Indicators Forecasts for the Swiss Economy 216P 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 , , US , Euro zone , Germany , France , Italy , UK , Japan , China ,36.7 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 29

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32 Other Credit Suisse Economic Research Publications Sector Monitor Q1 216 The Sector Monitor provides a quarterly description of the current situation and economic outlook of Switzerland's key sectors. March 31, 216 Global Monitor Q1 216 The Global Economic Monitor provides an overview of our expectations for the key economies and discusses topical macroeconomic themes. April 12, 216 Global Real Estate Monitor Q2 216 The Global Real Estate Monitor is a quarterly overview of the key real estate markets and trends around the world. We analyze both direct and indirect real estate investments. April 15, 216 Southern Foot of the Jura Region Structure and Prospects The southern foot of the Jura region faces challenges resulting from its geographical situation and economic structure. The study focuses on the region's economic prospects. May 3, 216 Real Estate Monitor Q2 216 The Real Estate Monitor provides an update on all market developments related to the real estate sector three times a year, thereby supplementing the fundamental analyses and special topics addressed in the annual Credit Suisse Real Estate Study. Company Succession in Practice In the new edition of the study of corporate succession dating from 213, we investigate how Swiss SMEs handle succession planning. The study is based on an extensive survey in which over 1,2 SMEs took part. June 22, 216 June 2, 216 The next Monitor Switzerland will be published on 14 June 216 Subscribe to our publications directly from your relationship manager. 32