Recession unavoidable

In the latest issue of the quarterly publication “Monitor Switzerland”, published today, the economists of Credit Suisse put forward – in full awareness of the many imponderables – an initial assessment of the repercussions of the coronavirus pandemic for the Swiss economy. Even if the rate of infection is slowed by the measures taken by the Federal Council and their disciplined implementation by both people and businesses, the economists believe a recession in Switzerland is unavoidable. However, the magnitude of the downturn should be limited to 2–3 months thanks to the resolute support measures taken by monetary and fiscal authorities both in Switzerland and abroad, before the economy then moves into a gradual recovery phase. In this moderately positive scenario, the decline in Swiss GDP should be limited to around -0.5% for the year as a whole. In particular, the economists of Credit Suisse are not expecting a serious slump in either corporate investment or the real estate market, while pharma exports in particular should continue to contribute to Switzerland’s balance of trade with the outside world. However, in the event of the pandemic not being brought under control sufficiently quickly, more serious repercussions can be expected.

Development of pandemic the key
The decisive factor when it comes to the repercussions not just for human health, but also for economic development, is the progress of the pandemic itself. With a few exceptions, the measures taken to contain the virus in the various countries will trigger a sharp slump in economic activity. This is also true of Switzerland’s key trade partners. However, if the progress of the pandemic can be slowed, the health policy measures taken so far – which have in many cases been quite drastic – can be gradually loosened, which will then feed through into a gradual pickup in economic activity. In order for the lockdown phase to trigger only minimal medium-to long-term consequences, it is crucial that the guardians of fiscal policy respond rapidly, unbureaucratically, and extremely forcefully. Fortunately this would appear to be the case both in Switzerland and in its key trade partner countries. In Germany, for example, we can expect to see fiscal stimulus of more than 10% of GDP, with the equivalent figures for the US and Switzerland (based on the most recent announcements) coming in at around 6% in each case. Most important of all is to avoid this crisis triggering a wave of defaults on the part of otherwise healthy companies, and to support the incomes of workers who are laid off due to the collapse in orders. The system of short-time working, a familiar instrument in both Switzerland and Germany, is ideally suited to this situation.

Stabilization of the financial system essential
In order for these measures to have any beneficial effect, however, the global financial system must first be stabilized. In recent weeks, the stress evident in financial markets has at times taken on dimensions similar to those seen in the financial crisis of 2008/09, despite the much stronger capital situations of the banks; the driver of this development has primarily been the dramatic flight of various types of investor to the preferred haven of liquidity, which has even put the market for longer-dated government bonds under pressure. In the meantime, however, the emergency measures taken – above all by the US central bank (Fed) – have restored a degree of calm that will hopefully persist. The measures taken by the European Central Bank (ECB) and the Swiss National Bank (SNB) itself are likewise helping to alleviate the liquidity bottlenecks being experienced by companies. Guarantees for corporate loans are another very appropriate tool for preserving the flow of credit.

Recession on horizon for many of Switzerland’s trade partners
Despite all these measures, a recession will be unavoidable for all of Switzerland’s key trade partners. For the next three months or so, the economists are anticipating a decline in economic output of between 10% and 20% for most European countries. The slump is unlikely to be significantly less painful in the US. By contrast, China and a number of other Asian countries such as South Korea have already reached the nadir of their recessions, and tentative signs of recovery are apparent. This is having some mitigating effect on the global downturn. On the other hand, the downturn has only just begun in other emerging markets such as India and Brazil. Overall, Credit Suisse is anticipating slightly negative growth for the global economy in 2020; as recently as February of this year the corresponding forecast stood at 2.6%.

Switzerland also most unlikely to avoid recession
As a consequence of economic developments both domestically and in its key trade partner countries, Swiss economic growth in 2020 is likewise set to be much weaker than was expected until recently. In the short term in particular, a significant slump would appear unavoidable. For the year as a whole, however, the economists of Credit Suisse are anticipating a more limited decline in gross domestic product (GDP) of 0.5%. Underlying this forecast is the assumption that the current exceptional situation will only last until mid-May, before the situation then gradually normalizes. In the event of the pandemic lasting longer, by contrast, a more extended period of economic weakness should be expected.

Exports set to slump
The next few months will see the consequences of the crisis directly affect Switzerland’s export industry. The expected recession in Europe will have a particularly pronounced effect on demand for Swiss goods. Viewed overall, however, the exports of Swiss companies should decline by a smaller margin this year than in the global recession of 2009. Among other things, this is because pharma exports now account for a much larger share of total goods exports. As exports from this sector barely react to short-term economic fluctuations abroad, they exert a certain stabilizing influence. Nonetheless, the anticipated slowdown in the global economy will inevitably reduce Swiss GDP growth considerably.

MEM and watchmaking industries particularly sensitive to economic weakness abroad
The feature section (Focus) of the latest issue of Monitor Switzerland shows that the country’s export success over the last 20 years is attributable in particular to strong growth in China and the US, as well as to the increase in global demand for pharma products. The findings of these analyses are particularly valuable in the current environment, as they show which export sectors are more or less vulnerable to economic growth slowdown abroad or to the latest appreciation of the franc. For the engineering, electrical and metal industry (MEM industry), the current growth slump in Europe and the US is likely to prove particularly painful. The calculations of Credit Suisse economists indicate that MEM exports respond very sensitively to both economic developments and exchange rate fluctuations. Swiss watches, which are generally viewed as luxury goods, can likewise be expected to suffer from the fall in consumer spending, as they too exhibit great sensitivity to changes in GDP growth abroad. However, according to the analysis of Credit Suisse, they should be less affected by the latest appreciation of the Swiss franc. Similarly, the analyses of Credit Suisse reveal that pharma exports are largely immune to both short-term declines in economic growth and the negative effects of an appreciation of the franc. This sector, which accounts for almost 40% of all Swiss goods exports, is commensurately important in these turbulent times.

Consumer spending to decline temporarily before certain catch-up effects become apparent
Consumer spending in Switzerland is likely to take even more of a hit over the next few months. Around a third of average consumer expenditure is estimated to revolve around goods and services that are either in less demand or indeed not even consumable in the current environment. In addition, in view of the closure of borders and lower recruitment levels, net immigration can be expected to slow sharply. Credit Suisse is anticipating net immigration of just 35,000–40,000 persons for 2020 as a whole (from 53,000 last year). However, consumer spending could at least partly normalize once the lockdown restrictions are lifted: On the one hand the negative level of inflation (forecast: -0.3%) will increase purchasing power, while on the other the labor market situation – traditionally so important to consumer sentiment – should prove relatively stable. Thanks to the instrument of short-time working in particular, the unemployment rate should rise only modestly. The economists of Credit Suisse are expecting only a gradual rise, from 2.3% at the moment to 2.9% by the end of the year.

Support for the large number of self-employed also crucial
The recourse to short-time working in response to the effects of the pandemic will dwarf that of 2009: According to Credit Suisse forecasts, more than half a million people – or 10% of all workers in Switzerland – are employed purely in the sectors directly affected by the Federal Council’s coronavirus lockdown measures. As a compounding factor, an above-average number of self-employed people work in these sectors: According to Credit Suisse estimates, this brings in another 100,000 affected people. However, the expected outlay triggered by short-time working, which is estimated at around CHF 3 bn per month, is certainly tolerable for the national unemployment fund and the Confederation. Despite all the measures taken, consumer spending (when viewed as an annual average) can be expected to fall for the first time since 1993. This will remove a key driver of Swiss economic growth, at least temporarily.

Corporate investment to be temporarily reined in
In view of weaker global demand, great uncertainties, and the specific difficulties connected to the coronavirus outbreak, companies will put the brakes on investment activity for at least a while. Viewed over the year as a whole, however, the economists of Credit Suisse are not expecting a genuine slump in investment activity in Switzerland, particularly if an end to the current exceptional situation appears on the horizon. There is now a consensus among the political establishment that disruptions to supply chains and company bankruptcies must be avoided wherever possible. However, a more severe recession will only be averted if the coronavirus outbreak can be rapidly brought under control and the negative repercussions of the associated state-decreed lockdowns cushioned.

Corona will not bring real estate market to its knees
In the wake of the turbulence in equity markets and the rapid proliferation of the crisis across the entire globe, fears are being expressed that the coronavirus crisis could derail the Swiss property market and plunge Switzerland into a real estate crisis. Across-the-board value losses in double-digit percentage territory have already been flagged up as a probable scenario. According to Credit Suisse economists, however, predictions of this kind do not stand up to close scrutiny. While it is true that the Swiss real estate market will inevitably feel the repercussions of the current crisis, it will not be brought to its knees.

Residential segment remains backbone of real estate market
The residential real estate market is the backbone and anchor of Switzerland’s real estate market. And in the residential property market, there is absolutely no likelihood of any selling wave materializing. Why not? Because in a direct comparison with the rental apartment market, residential property remains the more cost-effective option. Due to the low burden of mortgage interest rates, the billions of francs that residential property owners have saved in interest payments in recent years, and the multiple tightenings of regulation to the point where only the affluent echelons of society have been able to access residential property, Credit Suisse is not expecting any major rise in payment defaults in the mortgage area. In addition to very low interest rates, the slow tempo of newbuild production in the residential segment (currently 40% below its long-term average) provides a further degree of support.

Residential investment properties: Buyers likely to outnumber sellers
Where the residential investment property segment is concerned, the greater security of rental income compared to other cash flows means that investors are extremely unlikely to turn their backs on the real estate market. Quite the opposite: Once the most dramatic shockwaves have been absorbed by the capital markets, we are more likely to see an increase in investor demand, particularly as an end to the era of negative interest rates has now been pushed back even further into the future. While it is true that a combination of lower immigration (forecast correction of 10,000-15,000 net immigrants for 2020) and lower domestic demand is likely to see the number of vacant rental apartments rise by between 7,000 and 8,000 units (+3,000 compared to 2019), net cash flow yields are likely to decline by only tiny percentage fractions. Problems in the residential property market will be largely restricted to the luxury segment, to serviced apartments heavily used for business tourism purposes, and – in the event of a prolonged crisis – to promoters of residential property.

Commercial property market facing setback
By contrast, commercial office space looks set to face greater problems. Particularly in the traditional “bricks-and-mortar” retail trade and the hotel market, Credit Suisse economists are expecting a slew of insolvencies, business closures, and downsizings. Both sectors are perceived to be struggling in the face of structural change (online shopping and the strong franc respectively). The loss in income suffered by tenants can therefore be expected to trigger declines in income for the owners of retail premises and hotels, particularly as landlords face a slump in revenues in any case due to the widespread use of sales-based rental agreements in this sector. That said, the retail sector and hotel industry together account for only around 5-6% of the overall Swiss real estate market, which is why the reversal for the real estate sector as a whole is likely to be kept within clear limits. Where the office space market is concerned, demand for additional space is likely to collapse due to the enormous uncertainty of market participants. As a consequence, the trend of declining vacancies is likely to reverse, and rental price growth can be expected to grind to a screeching halt. Despite the economic recovery expected for the second half of the year, the office property market is likely to require more than a year to recover from this setback.

The publication “Monitor Switzerland” is published on a quarterly basis, and can be found on the internet in German, French, Italian and English at: www.credit-suisse.com/monitorswitzerland

The next issue will appear on June18, 2020.

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