The coronavirus makes 2020 an exceptional year for public finances. The debt brake remains appropriate.
In every possible way, 2020 is an exceptional year – and this should also apply to the debt brake. This is because the fiscal measures for fighting the coronavirus pandemic increase the national debt of Switzerland. However, this should be economically manageable in order to avoid a reduction that is too rapid.
Swiss fiscal measures were implemented in a timely manner
As part of the pandemic response, the Federal Council approved fiscal measures of over 70 billion Swiss francs between March and May 2020. The key to the success of the measures was their timely implementation: The infrastructure for the payment of COVID bridging credit facilities for companies was up and running within a week; the support for household incomes was also rapidly provided through existing structures such as short-time working.
The additional costs of the fiscal measures are causing a deficit
However, the actual additional expenditure of the federal government will likely be less than the nominal 70 billion Swiss francs of the announced measures package. This is because not all fiscal measures automatically involve spending. The bridging credit facilities, for instance, are obligations that will only generate inflow when they are actually due.
However, the financial results of the federal government are additionally burdened by the loss of income from direct federal, value added, and withholding taxes. According to Credit Suisse estimates, a deficit of 38 billion Swiss francs is likely for 2020; the Federal Council anticipates a shortfall between 30 and 50 billion.
As a result of the debt brake, this deficit should be offset in the immediate following years. However, the Federal Council announced that it would classify the majority of the fiscal measures as extraordinary spending. Under the law, this can be paid back more slowly – specifically, within six years. Additionally, with the escape clause, the Federal Assembly has the option of extending the repayment deadline even further in special cases.
National debt of Switzerland is less than deficits suggest
Concerns regarding the federal government's overly high debt levels are generally unfounded. The debt-to-GDP ratio of the federal government will increase in 2020, but much less than the deficit suggests at first glance. The federal government has high liquidity reserves and can also sell a portion of its unplaced equity tranche federal bonds.
Based on this, according to Credit Suisse estimates, the federal government would have to take on a maximum of 36 billion Swiss francs in new debt, even with a deficit of 50 billion. This would increase the total government debt-to-GDP ratio, the ratio of federal government, canton, and municipality to the GDP, by 6 to 8 percent by the end of 2020. With this figure, Switzerland would still be in a good position by international comparison.
"Passive reduction" alone can reduce Switzerland's debt-to-GDP ratio
From a strict cost perspective, higher government debt is not a problem for Switzerland, since the public sector can currently borrow at negative interest rates. Furthermore, the debt-to-GDP ratio decreases by itself with a balanced primary budget, provided the GDP growth is above the average interest rate, which will likely remain the case in the future.
With low or negative interest rates and a balanced budget starting in 2022, the new debt would thus decrease annually as part of this "passive reduction." A simulation with one-time new debt of 36 billion Swiss francs in 2020 at current market conditions also shows that the debt-to-GDP ratio of the federal government would drop back to its 2019 level within as little as 17 years.
The question remains as to whether the interest rates for future refinancing would remain low with a higher debt-to-equity ratio. This depends on the global interest rate environment, the creditworthiness of the debtor, and the resulting credit rating. In light of extremely low risk to the Swiss rating and no sign of an interest rate turnaround, continued low interest rates can be expected.
The debt brake is reasonable
In light of this, the question arises as to whether the debt brake and a certain budget discipline are even necessary "in good times." From both a political and economic perspective, the answer is yes: The debt brake specifies the conditions under which deficits are justifiable, bolsters the political consensus in favor of extraordinary measures in future crises, and ensures that Switzerland remains flexible for the special case of rising interest rates. In addition, a credible fiscal rule for the confidence of investors in the creditworthiness of a country is more important than its actual debt.
A rapid debt reduction in accordance with the debt brake would be economically damaging
Nonetheless, one thing is clear: If Switzerland had to repay the new debt by 2026, the necessary austerity measures would either delay the economic recovery by burdening households and companies or compromising the monetary independence of the SNB. For this reason, 2020 should be treated as an exceptional year in the context of government finances: It is advisable to make one-time use of the special rules of the debt brake and significantly extend the repayment deadline of the extraordinary deficit.