DBRS Morningstar Confirms Swiss Confederation at AAA, Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the Swiss Confederation’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

Switzerland’s ratings are underpinned by its wealthy and diversified economy, sound public finances, consistent external surpluses, and institutional strength. Switzerland benefits from a highly productive workforce, high levels of educational attainment and labor force participation. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Switzerland’s low levels of indebtedness combined with substantial financial flexibility, helps the country to stand out among other highly-rated sovereigns.

The Stable trend reflects DBRS Morningstar’s view that despite a marked deceleration in GDP growth to 0.9% in 2019 from 2.8% in 2018 caused by weaker global trade and one-off factors, the economy continues to demonstrate its resilience by achieving steady growth in private consumption and gross fixed investment. Fiscal policy remains highly disciplined, with the general government posting a surplus of 0.9% in 2019 and the public debt ratio declining to 26.7% of GDP in 2019. While the implementation of corporate tax reforms will likely result in the Swiss Confederation incurring a short-term reduction in receipts, these reforms should ensure that Switzerland’s international competitiveness is maintained.

Looking ahead, Switzerland faces some medium-term challenges. Low interest rates and the consequent search for yield are fueling increased borrowing by domestic investors in the real estate market, thereby moderately increasing risks to financial stability. The outcome of negotiations with the EU to establish an institutional agreement, aimed at ensuring a more uniform and efficient application of existing and future market access agreements, remains surrounded by uncertainty. In the near term, an intensification of international trade tensions and an overhaul of the EU-UK trade relationship could also adversely affect the open Swiss economy. That said, Switzerland is expected to provide appropriate responses to these challenges, and is firmly placed in the AAA category.

RATING DRIVERS

DBRS Morningstar considers the likelihood of downward pressure on Switzerland’s ratings to be low. Nonetheless, a significant decline in domestic real estate prices could potentially expose the sovereign balance sheet to increased contingent liability risks. Alternatively, external shocks or a sustained deterioration in growth prospects, combined with a substantial and long-lasting weakening of the country’s fiscal performance, could put downward pressure on the ratings.

RATING RATIONALE

A Low Public Debt Ratio and a Solid Fiscal Framework Underpin Switzerland’s Creditworthiness

Sound fiscal management remains a key credit strength for the Swiss Confederation. The Swiss authorities have maintained pragmatic and disciplined fiscal policies for more than a decade, which is reflected in modest structural surpluses since 2006 and a declining debt-to-GDP ratio. The ratio amounted to 26.7% at end-2019. The introduction of the debt break in 2003 also helps ensure that fiscal policy is balanced over the business cycle by linking spending to cyclically-adjusted revenues and saving any surplus. With highly transparent public finances and consistent efforts to analyze and address medium- and long-term fiscal challenges, DBRS Morningstar views Swiss fiscal management and policy to be very strong.

The corporate tax reforms and AHV financing (TRAF) legislation entered into force on January 1, 2020 and eliminated preferential income tax rules that had benefited multinational corporations at the canton level, satisfying European Union (EU) and OECD concerns while preserving Switzerland’s attractiveness as an investment destination. Despite the implementation of the tax reforms and AHV financing, the Confederation is likely to run a modest fiscal surplus through 2020-2021. The 2020 budget expects a modest fiscal surplus of CHF 0.6 billion with revenues from direct federal taxes and withholding taxes likely to largely offset the impact of TRAF reforms.

Switzerland’s low level of public indebtedness, combined with substantial financial flexibility, helps the country to stand out among other highly-rated sovereigns. General government gross debt has steadily declined over the past decade from 45.9% of GDP in 2008 to 39.6% in 2019 according to the IMF and the Ministry of Finance (33.5% to 26.7%, per the Maastricht definition, which excludes pensions and healthcare), while federal government debt fell from 19.2% in 2007 to 14.5% in 2018. The government’s debt maturity structure is favorable, with average maturity at 10.7 years and all debt issued in local currency. Nominal yields on government debt are negative over all outstanding bonds (up to 45 years). Interest expenditures for the general government, as estimated by the IMF, were less than 0.2% of GDP in 2019 and at very low fixed interest rates. Moreover, as Swiss fiscal management is characterized by a prudent countercyclical approach, Swiss authorities have ample space to enact a gradual fiscal adjustment without affecting the downward trajectory of debt. Consequently, macroeconomic and fiscal shocks are unlikely to exert downward pressure on the ratings.

Strong Economic Fundamentals Underpin The Ratings

Switzerland’s ratings are underpinned by its wealthy and diversified economy. The Swiss economy repeatedly ranks highly in international comparisons; GDP per capita currently stands at USD 86,670 and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland’s highly productive workforce, high levels of educational attainment, and high levels of labor force participation. Swiss economic growth has historically outperformed the euro area average due to sustained consumption and investments growth Nevertheless, in 2019 the Swiss economy was affected by the growth slowdown in Switzerland’s main trading partners and by weaker global trade outturns, resulting in 2019 GDP growth coming in at 0.9%. Growth is expected to accelerate in 2020 with private consumption remaining resilient, supported by low unemployment of 2.3% of the workforce. In addition, sporting events, such as the Olympics and the football championships at biennial frequency (alternately the European Championship and the World Cup) provide a modest boost to growth of around 0.4 percentage points from licensing fees and broadcast rights, as their parent associations – IOC, FIFA, UEFA – are based in Switzerland.

DBRS Morningstar views Switzerland’s near-term economic outlook as strong, underpinned by solid real income growth and continued rising net wealth. However, risks to external and domestic demand are tilted to the downside. On the external front, intensification of international trade tensions and an overhaul of the EU-UK trade relationship could adversely affect the open Swiss economy. Moreover, as a safe haven currency, the Swiss franc remains vulnerable to appreciation pressures arising from risk aversion. On the domestic front, the search for yield could moderately increase financial stability risks while uncertainty on the EU-Switzerland institutional framework could lead to stalled investment decisions.

Switzerland’s External Accounts Remain a Key Credit Strength

Swiss external accounts are characterized by a structural current account surplus and a positive net creditor position. The persistent current account surpluses averaging 10% of GDP over the last two decades reflect its role as a financial center, an attractive location for corporations, Switzerland’s high per-capita income levels, and high savings rate. Over the last decade, the Swiss National Bank (SNB) accumulated over CHF 833 billion (USD 836 billion) in foreign exchange reserves, which have reached approximately 116% of GDP as of end-2019. Accumulation of net savings and official foreign exchange reserves have resulted in a positive net creditor position of 130.5% of GDP as of September 2019.

Monetary Policy Remains Accommodative

Switzerland’s historical position as a financial center is an important source of growth and prosperity for the country but can also leave Switzerland exposed to external shocks. Swiss National Bank’s monetary policy is focused on price stability, defined as a rise in the price index of less than 2% per year; a medium-term inflation forecast; and the SNB policy rate. Since the removal of the exchange rate ceiling at 1.20 vis-à-vis the euro in early 2015, the SNB has maintained an accommodative stance using negative interest rates and unsterilized FX intervention. Negative interest rates and the SNB’s willingness to intervene both serve to counteract the attractiveness of Swiss franc investments and thus ease pressure on the currency. In this way, the SNB stabilizes price developments and supports economic activity.

The Swiss policy rate, or the interest rate on sight deposits held by banks, currently stands at -0.75%. This rate is the lowest in the world and has been unchanged since 2015. Following the November 1, 2019 decision by the European Central Bank to restart its quantitative easing program and lower its deposit rate to -0.5%, the SNB, in its latest policy assessment in December 2019, reiterated concerns on low inflation and appreciation pressures on the franc. As a result, the SNB maintained its highly accommodative stance in its policy. The SNB’s reserves have risen from USD 340 billion in 2011 to USD 836 billion currently due to its foreign exchange intervention, and its balance sheet now stands at 120% of GDP. In comparison, the U.S. Federal Reserve is at 20% of GDP, the European Central Bank is at 40%, and the Bank of Japan at 100%. Unlike the G3 central banks, the increase in SNB assets was primarily due to purchases of foreign rather than domestic assets.

Financial Vulnerabilities Continue to Rise, But Risks are Contained

The search for yield in a low growth and low inflation environment have intensified financial stability risks. Several years of strong growth in both bank credit and real estate prices have resulted in the build-up of imbalances on the mortgage and residential real estate markets. With mortgage growth outpacing income growth, Switzerland’s mortgage-to-GDP ratio has risen to 128.7% of GDP – the highest among the OECD countries.

Property prices and mortgage lending, which had stabilized following the introduction of macro-prudential measures during 2012-2014, have risen since 2017. While transaction prices for owner occupied apartments have risen broadly in line with rents, GDP, and population growth, imbalances appear to be rising in the residential investment space. This is reflected not only in prices rising faster than rents but also due to the brisk construction, that is leading to higher vacancy rates outside of the largest metropolitan areas. In addition, the share of mortgages with loan to value ratios (LTVs) between 75% and 80% has increased from 16% in 2012 to 25% in 2019. The household sector is especially vulnerable to a correction in the real estate market. The IMF notes that with yields on residential investment above those on government bonds, pension and insurance funds have invested more than 25% of their resources in the real estate sector. Consequently, between property ownership, pension and insurance savings, and real estate-related equity holdings, Swiss households are highly exposed to real estate market developments through both direct and indirect channels.

The Swiss financial sector is a potential source of vulnerability due to its size and level of concentration, with the two global systemically important banks (G-SIBs) each having total assets exceeding domestic GDP. However, DBRS Morningstar believes risks stemming from the financial sector are contained with both the G-SIBs meeting the resilience and resolution requirements – the two pillars of the ‘too big to fail’ regulations. Domestically-focused banks remain the greater concern as they could come under greater strain in the event of a significant reversal in real estate prices or a shock to household incomes. However, strong population growth, continued monitoring of real estate developments by the SNB, and the increase in capital and liquidity buffers (particularly the increase in the countercyclical capital buffer to 2%) have helped to reduce risks related to the housing market. In addition, new self-regulation measures, such as decreasing the amortization from 15 years to 10 years and a minimum down payment of 25% for new mortgages financing income producing real estate, have entered into force in 2020. Consequently, DBRS Morningstar views risks stemming from potential housing market stresses as contained.

Strong Institutions and Stable Politics Mitigate Uncertainty Around Swiss-EU Relations

Switzerland’s political environment is characterized by its federal democratic system, high institutional capacity, and low level of corruption. Stable politics, along with neutrality in international conflicts, have long made Switzerland a financial safe haven for investors. The Federal Council, Switzerland’s executive body, is a collective presidency comprised of seven members. Combined with a bicameral legislature and multiparty system, political decisions require a broad degree of consensus. The system is highly deliberative and allows for frequent popular referenda on important issues. Thus far, Swiss voters have displayed pragmatism by rejecting some of the more radical policy proposals. Furthermore, Switzerland has found ways to implement the results of some potentially problematic popular initiatives while preserving sound policies and meeting key international commitments.

Switzerland currently enjoys a unique relationship with the EU. Switzerland is not part of the EU and unlike Norway, it is not a member of the European Economic Area. Relations with the EU are based on a network of agreements made up of 20 main agreements and more than 100 other agreements ensuring, among other things, access to the EU’s single market for several sectors. Unlike the other members of the EEA, it enjoys partial access to the EU’s single market while being under no legal obligation to adopt new EU legislation. In the past, Switzerland’s relations with the EU were complicated by concerns over its corporate tax regime and a popular vote in 2014 requiring a change in the free movement of people.

Since 2014, Switzerland and the EU have been negotiating an agreement on institutional matters, aimed at ensuring a more uniform and efficient application of existing and future market access agreements. The draft institutional agreement unveiled in December 2018 is going through consultations with the main stake holders including cantonal governments, trade unions and the business community. The EU is waiting for the Swiss authorities to approve the new framework. This is important as latest estimates indicate that 52% of Switzerland’s exports are sent to the EU and about 70% of all its imports come from the EU. Furthermore, DBRS Morningstar will pay particular attention to the results of a popular referendum scheduled for May 17, 2020. This referendum could potentially change the Swiss Constitution and prevent the free movement of EU citizens in Switzerland, effective a year after the vote. The vote could negatively affect the relationship between Switzerland and the EU. DBRS Morningstar will also closely monitor the progress in the discussions concerning the upcoming EU-UK trade deal, expected to conclude by the end of 2020, as the stance taken by the EU could affect the future relationship between Switzerland and the EU.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
http://www.dbrs.com/research/355877

Notes:
All figures are in Swiss Franc (CHF) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The primary sources of information used for this rating include Federal Department of Finance, Swiss National Bank, Swiss Federal Statistical Office, State Secretariat for Economic Affairs, OECD, IMF, European Commission, UNDP, World Bank and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on July 26, 2019.

Solely with respect to ESMA regulations in the European Union, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Rohini Malkani, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Co-Head of Global Sovereign Ratings
Initial Rating Date: July 14, 2011

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