Updated: Jun 22
Switzerland has a stable, prosperous and high-tech economy and enjoys great wealth, being ranked as the wealthiest country in the world per capita in multiple rankings. The country has been ranked as one the least corrupt countries in the world, while its banking sector has been rated as "one of the most corrupt in the world”. It is the world's twentieth largest economy by nominal GDP.
Banking is seen as emblematic of Switzerland, along with the Swiss Alps, Swiss chocolate and watchmaking. Switzerland has a long, kindred history of banking secrecy and client confidentiality reaching back to the early 1700s. Switzerland has been one of the largest offshore financial centers and tax havens in the world since the mid-20th century. The Swiss Bankers Association (SBA) estimated in 2018 that Swiss banks held 6.5 trillion US$ in assets or 25% of all global cross-border assets.
The Swiss franc is known to appreciate strongly during financial market turmoil, demonstrating its status as a typical safe haven currency. Between 2009:Q2 and 2010:Q2 and between 2011:Q3 and 2014:Q4, the SNB (Swiss National Bank) heavily intervened in foreign exchange markets with the aim of halting and reversing the appreciation of the CHF amid the European sovereign debt crises. At the end of both episodes, however, the exchange rate was allowed to float freely and appreciated significantly.
Switzerland finds itself at the 9th place in the NIIP classification with a NIIP of +819.015 US$MM (2020 Q2). The Swiss GDP was 707.868 US$MM in 2020. Switzerland has negative -0.75% interest rates. The main factors (a large positive NIIP and low interest rates in advanced countries) determining a currency’s safe haven status are met also by Switzerland.
Numerous papers have shown that the Swiss franc (CHF) exhibits safe haven characteristics. For example, RANALDO and SoDERLIND (2010) found that etween January 2000 and July 2015, the CHF tended to appreciate in real trade-weighted terms during periods of increased uncertainty in European financial markets (shaded columns in the figure) demonstrating its safe haven currency status.
During these periods, the volatility index of EURO STOXX 50 (VSTOXX) exhibited a steep and sudden increase owing to a rise in risk perception in Europe. Figure 1 confirms that the CHF has strongly appreciated during risk-off periods: especially from 2008 to 2012 during the global financial crisis and the following European debt crisis, reflecting its safe haven status during risk-off periods.
International financial institutions and the financial press usually mention two possible mechanisms through which safe haven currencies appreciate during turmoil in financial markets: first, global unwinding of carry trade positions in low-yielding currencies; second, increased capital flows to safer political and economic environments. Both mechanisms are believed to create an increased demand for safe haven currencies, which results in appreciation pressure. Indeed, the strong appreciation of the CHF during the global financial and European sovereign debt crises was mainly attributed to higher capital inflows to Switzerland according to international financial institutions. The IMF (International Monetary Fund) in 2012 stated that "safe-haven capital inflows from the euro zone turmoil pushed the exchange rate to new heights last summer, just as slower global economic activity was curtailing export growth." Similarly, the OECD (Organization for Economic Co-operation and Development) in 2011 asserted that "the trade-weighted real exchange rate appreciated to record levels as the Swiss franc benefited from capital inflows in the context of turbulence in some euro area debt markets."
Although international financial institutions and the financial press have maintained the view that capital inflows were driving the exchange rate of safe haven currencies during the global turmoil, the academic literature on this topic has been rather sparse.
The analysis developed by Pinar Yesin reveals that capital flow variables are not necessarily coincident with the movements of the Swiss franc. Interest rate differentials, a traditional determinant of exchange rates, co-move only weakly with Swiss franc movements. However, a robust and stronger link between variables that capture global or regional market uncertainty and movements of the Swiss franc is observed.
The empirical analysis shows that the explanatory power of capital flow variables for the movements of the CHF is not always statistically significant or is economically rather small. This finding indicates that no strong statistical relationship exists between the CHF and contemporaneous capital flows. By contrast, variables that capture market uncertainty are persistently coincident with exchange rate movements. In other words, movements in the exchange rate co-move with global risk perception, but not necessarily with cross-border investment and capital flows.
BROOKS et al. (2004) studied the impact of different types of capital flows on the exchange rate of the US dollar. The motivation for their study is as follows: different types of capital flows are invested for different purposes and in different sectors of the economy, and therefore, the impact of different types of capital flows on the exchange rate may differ. The study found that net portfolio investment flows lead to real exchange rate appreciation but that net FDI flows have no effect on the real exchange rate.
Using data for 52 currencies for 25 years, HABIB AND STRACCA (2012) found that the safe haven status of a currency is not determined by the interest rate spread, as claimed in the carry trade literature. By contrast, the net foreign asset position, and, to some extent, the stock market size can explain exchange rate behavior during financial stress. Because the net foreign asset position is determined to a large extent by capital in- and outflows, a link may exist between exchange rate movements and capital flows for safe haven currencies.
Net derivatives flows show the economically largest co-movement with the CHF. While all positions in this asset/liability class are normally registered in a country's net foreign assets, only a part of the outstanding derivatives will ultimately appear in net capital flows because only some of these positions will require upfront charges and/or will be executed at maturity to initiate a capital flow. Furthermore, transactions involving financial derivatives may arise at inception, on secondary markets, with ongoing servicing (such as for margin payments), and at settlement. Thus, a positive net flow of derivatives is difficult to interpret economically.
Capital flows and CHF movements (in nominal or real terms) do not co-move strongly, whereas variables that capture market uncertainty continue to have statistically significant and economically larger coefficients.
The VIX (CBOE (Chicago Board Options Exchange) Volatility Index) volatility and VSTOXX (Euro Stoxx 50) volatility do have some explanatory power in explaining CHF movements. For example, a one-percentage-point increase in the VIX is coincident with a 0.07 percent appreciation of the CHF.
Interest rate differentials do not appear to be statistically significant in explaining the movements of the CHF capital inflows to Switzerland do not appear to be coincident with CHF appreciation.
The main finding of the study by Pinar Yesin is that capital flows have little explanatory power in tracking the movements of the real effective exchange rate of the CHF. Statistical evidence that capital flows drive the movements of the CHF remains lacking. This result challenges the presumption that capital flows are the main mechanism behind the appreciation of the CHF as a safe haven currency during the recent global turmoil. This finding should not be surprising considering earlier findings in the financial economics literature, where asset prices can change drastically without major shifts in portfolios.
There is empirical evidence that factors other than capital flows were coincident with the appreciation ofthe CHF during the euro area sovereign debt crisis. In particular, financial market uncertainty variables have been found to persistently co-move with CHF movements. The appreciation of the CHF may have been due to a mechanism other than higher capital inflows during the recent global turmoil, like the general investors preference for this currency during risk-off episodes.
The sustained appreciation of the Swiss franc during the global financial crisis seems to reflect, to a large extent, its perceived role as a safe-haven currency, amid an environment of elevated risk aversion, the unwinding of carry trade positions and net derivatives flows. Moreover, the positive NIIP, the relative resilience of the Swiss economy during the crisis, a comparatively benign growth outlook and sound public finances constitute additional factors potentially accounting for the increased capital inflows observed and the strengthening of the franc. These developments were further intensified through the narrowing interest rate differential with respect to other major economies as well as expectations of continued currency appreciation.
i) ECB Working Paper, No. 1288: Getting beyond carry trade: what makes a safe haven currency? By Maurizio Michael Habib and Livio Stracca;
ii) IMF Working Paper: The Curious Case of the Yen as a Safe Haven Currency: A Forensic Analysis by Dennis Botman, Irineu de Carvalho Filho and W. Raphael Lam;
iii) Swiss National Bank: Capital Flows and the Swiss Franc by Pinar Yesin.