(Bloomberg) -- For Swiss policymakers confronting the franc’s strongest levels in almost a decade, there’s comfort to be had: its squeeze on the economy isn’t quite what it used to be.
A country whose signature exports include chocolate, cheese and watches is benefiting from the rising proportion that pharmaceuticals play in its overall growth mix — offering the Swiss National Bank some limited breathing space to respond to currency shocks. That’s because their overseas sales, often of patent-protected medicines, are more insulated to such swings.
“If I need a drug because I’m in pain, then I don’t care about the price,” said David Marmet, Swiss chief economist at Zuercher Kantonalbank. “The bigger pharma’s contribution to Switzerland’s economy becomes, the less dependent we are on the franc.”
The industry may now may rival the country’s iconic financial services in significance. Classed together with chemicals, it makes up some 6.3% of gross domestic product in Switzerland — double what it was three decades ago, and more than a third of the gradually shrinking contribution of overall manufacturing.
Such insights may have helped embolden the SNB to tolerate strength in a currency whose haven status keeps it in demand amid heightened geopolitical turbulence. Within the past year, the franc touched the highest since early 2015 against both the dollar and the euro.
While the central bank has already cut its interest rate to 1% — and is likely to ease again in December — it has done so in gradual quarterly increments of 25 basis points, unlike the more drastic half-point moves in recent months seen from the US to New Zealand. It has also stopped short of much intervention in foreign-exchange markets.
The shifting contours of Switzerland’s economy tell a tale not only about the drugmakers themselves, but also about the competitive struggles of manufacturing shared throughout advanced economies such as neighboring Germany.
“The strength of pharma masks the weakness of other industries that are more cyclical and sensitive to the exchange rate,” said Alexander Koch, an economist at Raiffeisen in Zurich. “There’s an accelerated structural change away from industrial production in Switzerland.”
At the center of its pharma sector are Roche Holding AG and Novartis AG, whose roots lie in the 19th century innovations of Basel’s dye industry adapting to drug production. Their headquarters there eye each other from opposing banks of the river Rhine, which offered a supply of fresh water, an outlet for waste, and easy transport links.
The market capitalizations of Roche and Novartis now put them among the top 10 members by weighting of the Stoxx Europe 600 Index, and account for about 30% of the Swiss Market Index.
Peers Lonza Group AG and Novartis spinoff Sandoz Group AG are also based in Basel, though the industry has spread to locations such as Zurich, Zug and the Lake Geneva region. Research is a focus as well as production, since much of that also takes place abroad.
Switzerland isn’t the only economy with an out-sized pharma sector, with Denmark’s increasing reliance on Novo Nordisk A/S a striking example.
Even so, Swiss drugmakers have themselves become significant enough to drive growth. Last year, Economy Minister Guy Parmelin cited the industry as a key reason for the economy contracting less than peers after the crises of 2008 and Covid.
Pharma’s relative economic contribution got a notable boost in 2015, when the SNB’s decision to abandon its franc cap knocked other exporters whose overseas sales fluctuate more according to price.
Since then, the central bank has still taken a muscular approach to stemming money inflows, having subsequently cut rates further below zero than any other peer until inflation took hold.
National lobbies have taken note. Swiss watchmaking groups were among those calling for action before officials last cut borrowing costs in September.
Jean-Philippe Kohl, head of economic policy at technology manufacturing lobby Swissmem, observes that companies he represents have adapted to currency strength and can weather a 1% annual appreciation in the franc, but greater volatility can be a real challenge.
“The franc cuts into margins and competitiveness,” he said. “Sudden spikes like we’ve seen recently put manufacturers under significant stress.”
SNB officials acknowledge the challenges, but President Martin Schlegel has also said that policymakers can’t focus on “specific industry concerns,” and last month he even cited an example of how the franc is a spur for businesses to improve.
What Bloomberg Economics Says...
“The strength of the Swiss franc remains a clear challenge for the SNB, as lower prices on imported goods drags down Swiss inflation toward the lower end of the central bank’s 0% to 2% target. Still, a strong dollar and rising exports to the US of products like pharmaceuticals, that tend to be less price sensitive, mean that the SNB’s concerns over FX impacts on the export sectors may be less pronounced than in the past.”
—Maeva Cousin, senior economist
Pharma’s rising significance brings its own risks. With America by far the world’s most important drug market, regulatory decisions there could deliver a meaningful impact.
“If drug prices were capped in the US, this would hit us hard,” said Marmet at Zuercher Kantonalbank. “The effect could be similar like the one Germany experiences right now from the car industry suddenly struggling.”
There’s a risk in becoming over reliant on Roche or Novartis too. Both have struggled to win over investors and chart a convincing path toward growth in recent years.
Pharma also has a limited role in the real economy. It has disproportionately fewer jobs, with 53,000 compared to the 639,000 working in overall Swiss manufacturing.
All companies there can take heart that lower borrowing costs are almost certainly on the way, offering relief both with financing costs, and as a disincentive for investors to buy francs.
A majority of economists predicts the SNB will cut rates twice more from the current 1% level to reach 0.5%, while some even say a drop to zero in due course can’t be ruled out. Out of 19 surveyed by Bloomberg, three forecast a 50 basis-point move in December.
While policymakers know there’s a limit to what they can do, the currency is still likely to remain a primary focus.
“What matters to the SNB is that it doesn’t appreciate suddenly and too quickly,” said Zuercher Kantonalbank’s Marmet. “Officials know that they can’t keep it low.”
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