Record-high FX reserves prompt new questions for SNB

Switzerland’s foreign currency reserves have climbed again, reaching a new record high of SFr714.3 billion ($734 billion), in July, the Swiss National Bank (SNB) announced on August 7. Swiss forex reserves now represent 108% of national GDP.

The latest increase is the result of the appreciation of its euro-denominated assets – some 40% of the total, an SNB spokesman said.

“The danger of a large exposure to the euro is that if the currency falls the SNB would see its reserves dwindle, and that is an issue because it distributes annual dividends to the Swiss confederation and the cantons,” says Alvin Tan, a foreign exchange analyst at Societe Generale. “That is likely one of the reasons they unpegged (from the euro) in January 2015, following an alarming growth of the reserves between 2011 and 2015.”

The growth in reserves is the result of the SNB’s effort to prevent the franc from appreciating against the euro. In the aftermath of the financial crisis, investors flocked to the franc seeking safety, which pushed up its value. To reverse the trend, the SNB introduced an exchange-rate peg to the euro in 2011 and started to create new francs to buy euro-denominated assets, ensuring the euro reached SFr1.2.

But the central bank abandoned the strategy in January 2015. Its reserves had reached the equivalent of more than $400 billion, and it faced criticism from some Swiss politicians for having expanded its exposure to sovereign default risk in some euro area countries.

Additionally, the European Central Bank (ECB) was about to start its quantitative easing (QE) programme, which would have forced the SNB to buy ever-larger amounts of euros. The franc sharply appreciated after the floor policy was dropped, and approached parity with the euro, which forced the SNB to resume its intervention to stabilise the franc at SFr1.09.

Since late June this year, the euro has progressively appreciated to reach SFr1.15. This has given the SNB room to halt its market interventions, as relatively stable domestic sight deposits in recent months indicate.

The SNB is seeing its policy goals achieved, but this outcome is largely not a result of its own actions, because what has finally weakened the franc is a combination of stronger growth in the eurozone, mounting expectations that the ECB will tighten its monetary policy and the appreciation of the euro, Tan argues. “All of these are contributing to franc depreciation, yet none of them is of course under the SNB’s control,” he says.

Any setback to the global economy might reverse the euro’s rise and boost the franc again. The currency rose against the euro from SFr1.14 to SFr1.12 on 9 August, a move possibly due in part to market tensions over North Korea. There is a possibility that the SNB will have to carry out further  purchases of foreign currency.

“There is not a recognised specific threshold indicating reserves are too high in relation to GDP,” says Gary Smith, member of the strategic relationship management team at Barings. Hong Kong and Singapore also have reserves over 100% of GDP. “The main question would be, in terms of their intervention, are they achieving their objectives?”

Significant impact

But the sheer size of the reserves makes any SNB decision a market-sensitive move. “Too much concentration of exposure can distort markets, and central banks do not want to be perceived to be influencing asset prices,” says Tan.

One analyst says that any unwinding of the SNB’s eurozone sovereign-debt positions might reverse the Swiss franc’s depreciation against the euro.

The same analyst says that SNB holdings of the sovereign debt of members of the eurozone’s periphery are sufficiently large that if the Swiss central bank unwinds its position, it could have a significant impact – potentially increasing the spreads between Germany’s 10-year bond yields and yields on bonds of peripheral eurozone members.

Baring’s Smith also argues that if the SNB reversed its holdings of eurozone sovereign debt, it could have an impact on eurozone debt, and might lead to a depreciation of the euro. A fall in the euro’s currency would not be in the SNB’s interest.  

“They (the SNB) do not have to engage in selling their assets. What they should consider is diversifying,” Smith says. “The bigger the pile of reserves, the less likely is the future need for liquidity and safety, and the more opportunities it opens for investments in higher yielding assets,” he adds.

“As the reserves of any given country grow, the central bank may consider widening the criteria of asset classes it can acquire,” says Elliot Hentov, vice-president and head of policy and research at Official Institutions Group. “Could they, for instance, buy real estate? What needs to happen for them to do that? It requires some institutional changes, establishing new rules and regulations.”

The SNB already has 20% of equities in its portfolio, but reorienting some of the reserves to emerging markets could be an alternative. Smith points out that a number of central banks, including the SNB, have increased their holdings of renminbi, reflecting growing trade with China. But the percentage of forex portfolios accounted for by renminbi remains small, he says. Swiss exports to China reached 7.3% of its total exports in 2015, according to the OECD, but the SNB’s renminbi reserves are below 3% of its total, and below the Canadian dollar.

 “A main risk for the SNB would be to play too safe and forgo the opportunity to enhance yield,” Smith says.