IMD International

Massive avalanche in the Swiss market

IMD Professor Nuno Fernandes says the Swiss National Bank pursued its misguided exchange rate policy for too long

January 16, 2015

Despite the lack of snow in many ski resorts in Switzerland, today a major avalanche began in Zurich. The Swiss National Bank (SNB) ended the pegging of the Swiss franc to the Euro that it started back in 2011.

Unexpected move

This move was highly unexpected and has caused panic on the Swiss stock exchange. Less than a month ago, the SNB chairman, Thomas Jordan, said that Switzerland's exchange rate control measures keeping the Swiss franc at CHF 1.20 against the euro were "absolutely necessary". At the time Jordan said he would enforce the policy with "utmost determination".

As I predicted in the Financial Times when the SNB began the policy in 2011, the cap has been extremely costly for the Alpine country.

The SNB pursued its policy of pegging the Swiss franc to the euro for too long and has lost credibility in doing so. The bank removed the cap too late. The policy was unsustainable and the longer it lasted, the higher the costs were for the Swiss economy. The SNB only reacted once quantitative easing in the Eurozone became extremely likely and imminent. It should have seen sooner that its policy was unsustainable.

Huge exposure

The SNB's balance sheet is now overexposed due to the massive increase of foreign currency that it bought to keep the Swiss franc at CHF 1.20. The SNB balance sheet has doubled in the three years since the cap was introduced to reach an amazing CHF 500 billion, which is equal to 100% of Switzerland's GDP. As a percentage of GDP, this is three times more than the average of other central banks such as the Bank of England, the European Central Bank, the US Federal Reserve and the Bank of Japan. This means the SNB is vulnerable, and hugely exposed.

At the current 1:1 Swiss franc to euro exchange rate, the SNB would be officially bankrupt if it were a normal bank. Today, with the 20% revaluation of the franc, the bank has lost close to CHF 100 billion. Its equity has fallen from close to CHF 70 billion to a negative value of about CHF 20 billion, mark-to-market. Of course, the printing press can be turned on, but what would the consequences be for inflation?

Avalanche for corporate Switzerland

This is also a massive avalanche for corporate Switzerland. For companies with international operations their earnings will be lower. Companies that make products in Switzerland, and rely on exports, will have a hard time avoiding losses.

The SNB cap had one important implication for Swiss firms. Managers forgot to think about exchange rate risk. It seemed to be gone, and Switzerland seemed to be in the European Union, with a CHF 1.20:€1 exchange rate.

This created a false sense of security, and companies stopped hedging and trying to improve their international supply chain to reduce risk. The exchange rate was supposed to be here forever, according to the SNB's recent statements.But the risk was always there, and Swiss companies were fooled by the safety blanket. Now they are facing massive losses and even bankruptcies.

Negative interest rate

The negative interest rate that the SNB also announced today is irrelevant in my view. Given these massive fluctuations, the negative rate will not help at all.

I predicted in the Financial Times in 2011 that: "the Swiss Central Bank will potentially double or triple the amount of foreign currency on its balance sheet and will likely suffer massive losses there".

Unfortunately, I was right.

Nuno Fernandes is Professor of Finance at IMD, where he directs the Strategic Finance program. He is the author of Finance for Executives: A Practical Guide for Managers.




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