Switzerland's central bank took drastic action to hold down its currency on Tuesday, pledging to buy “unlimited quantities” of euros to stop it appreciating any further against the Swiss franc.
The Swiss National Bank’s move could be bad news for private equity firms operating in the Eurozone – both because it muddies the waters around currency risk, and because it will make life more difficult for portfolio companies that rely on exports.
Investors have been pouring money into Switzerland, which is seen as a safe haven given the problems in the US and the eurozone, sending the value of the franc soaring. In 2009, one euro was equivalent to 1.50 Swiss francs; early last month, the two almost reached parity. Now the SNB has promised not to let the euro fall below 1.20 francs, a move has been welcomed by Swiss exporters. Exports account for more than a third of Swiss GDP, but exporters have been hit hard by the appreciation of the currency, which has made their products and services less attractive to international buyers. The strategy should also be a boon to multinational firms with a large presence in the country, whose costs are likely to fall.
However, the move is also a risky one: analysts have suggested it will be expensive, inflationary and carries no guarantee of success.
There are also concerns that a unilateral move like this may hamper the European Central Bank's efforts to contain the crisis in the eurozone. Further weakening of the euro would help exporters in the region, potentially boosting growth prospects. So for managers and investors operating in the eurozone, any moves to cap other currencies will mitigate against that, making life more difficult for Eurozone exporters and adding to currency risk for investors in the region.
Research published Wednesday by Swiss bank UBS did, however, contain some good news for investors worried about a possible break-up of the eurozone. Although there has been speculation that German voters will ultimately refuse to foot the bailout bill for the more profligate Eurozone members, UBS argues that leaving the euro would actually be far more expensive for Germany than staying put. It estimates the cost would be somewhere between €486 billion and €648 billion in the first year alone – equivalent to €9,500-€11,500 for every man, woman and child in the country – thanks to currency appreciation (which would hammer exports) and the cost of recapitalising its banking sector.
By contrast, the bail-out bill for Greece, Ireland and Portugal is expected to equate to about €1,000 per capita.
The cost of leaving the euro would be even higher for the weaker Southern European countries, UBS believes – possibly as much as 40-50 percent of GDP. If these figures are accurate, all the eurozone countries will clearly have a strong financial incentive to stay the course.
You can read more about the potential impact of the eurozone sovereign debt crisis on the private equity industry in the September issue of Private Equity International, which is out now.