SWISS PAY HEAVY PRICE FOR CURRENCY STRENGH / THE FINANCIAL TIMES ( HIGHLY RECOMMENDED READING )

Swiss pay heavy price for currency strength

By Haig Simonian

Published: January 9 2011 23:10

Traditionally discreet, even for a central bank, the Swiss National Bank is having to contend with unaccumstomed publicity.

Its decision to stop accepting Irish and Portuguese paper as collateral for repurchase (“repo”) agreements with commercial banks has put it at the heart of an international storm about the prospects of the eurozone, and particularly the recovery chances of two of the most exposed members.


Meanwhile, at home, the bank – which is fully independent – is at the centre of a heated debate about intervention to curb the spiralling value of the Swiss franc.


Making difficult decisions to brake a rising currency is nothing new for Switzerland’s central bank. The franc is one of the world’s havens, and is invariably bought by investors and speculators when alternatives such as the dollar, euro and pound are under pressure.


But current circumstances are presenting unusual challenges. The Swiss economy has performed relatively robustly compared with the US, Britain and many eurozone neighbours. Growth remains respectable, inflation is negligible and public sector finances are impeccable. Last year, Switzerland even managed a surplus.


However, the rising franc has become a big concern for exporters. Last year it rose almost 10 per cent against the dollar, more than 15 per cent against the euro – Switzerland’s main trading partner – and surged against the pound.


The trend has continued into 2011, with the dollar and the euro last week hitting nominal historic lows. Economists calculate the real value of the franc is on a par with its historic highs of 1978 and 1994 and warn further rises are possible.


Intervention, the initial response, has come at a price. Last June, the banks said they would stop dealing in the currency markets after building up vast foreign currency reserves. It had holdings of SFr200bn at the end of last year.


The reserves increase the risk profile of the central bank’s balance sheet and have led to big losses. Last November, it reported a SFr8.5bn ($8.8bn, €6.8bn, £5.6bn) loss for the first nine months of 2010. Losses on foreign exchange alone amounted to SFr21bn, mitigated by windfall gains on gold and other earnings.


The bank has recently reduced its exposure by diversifying out of dollars and euros into a broader basket of currencies. But top officials acknowledge that foreign currency holdings remain at record levels and do not deny higher losses seem inevitable.


The issue has thrust the institution into political controversy, as its earnings are an important source of funds for the federal government – and vital for many of the 26 cantons.


Under an established formula – guaranteed by the bank’s current accumulated profits reserve of about SFr19bn – the bank diverts SFr2.5bn of its annual profits to the cantons and to Bern. But last month, Thomas Jordan, the bank’s deputy chairman, warned that that arrangement – due to last until 2017 – had probably become unsustainable because of the recent losses. “Seen from the current perspective, it would come as no surprise if the annual distribution had to be reduced somewhat,” he said.

The threat has prompted many politicians to attack the extent and timing of the bank’s costly interventions. But others, echoing industrialists and trade union leaders, have by contrast demanded further measures to stem the franc’s surge.


“We must look seriously at linking the Swiss franc to the euro,” says Paul Rechtsteiner, head of the trade union federation, who argues 90,000 jobs are at risk this year. Nick Hayek, Swatch Group chief executive, has been as vocal.

Some proposed remedies – such as an ill-defined dual exchange rate guaranteeing a lower parity for exporters – are fantasy. Reviving a 1976 “gentleman’s agreement” with leading Swiss banks, which at the time promised not to speculate against the franc, might help cosmetically, but be ineffective given globalisation of currency markets.


So the crisis has prompted calls for more imaginative solutions. Daniel Lampert, the trade unions’ chief economist, and a member of the bank’s supervisory council, suggested on Sunday the bank should take a leaf out of South America’s book. Pointing to recent capital controls, he said: “The SNB can learn a lot from Brazil.”


Copyright The Financial Times Limited 2011.