DBRS Morningstar Confirms Kingdom of Sweden at AAA, Stable Trend

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

KEY RATING CONSIDERATIONS

The rapidly evolving Coronavirus Disease (COVID-19) poses a considerable downside risk to Sweden’s near-term growth outlook The restrictive measures to contain the spread of the virus, both in Sweden and abroad, have halted activity in several sectors. Sweden has so far imposed less restrictive measures than most European peers, refraining from a total lockdown of the country and focusing on protecting those at risk from the pandemic. Nevertheless, DBRS Morningstar expects coronavirus to severely affect economic activity in Sweden in the near term, as firms struggle with supply disruptions, lower demand, and financial difficulties. DBRS Morningstar assumes that the impact will be deep but transitory, for one or two quarters. The latest projections from the Ministry of Finance point in this direction, forecasting a contraction of 4.0% in 2020 followed by three years of growth above 3%. However, a more protracted impact is possible.

The Swedish authorities have responded to the shock with an unprecedented monetary and fiscal stimulus to mitigate the economic impact and support credit supply. The fiscal package announced so far could be worth over 8% of GDP, although the bulk is related to tax deferrals and state guarantees. The measures range from partially financing temporary lay-offs and sick leave, reinforcing unemployment benefits, tax deferrals for firms, credit guarantees, and credit lines, among other measures. In parallel, to support the well-functioning of credit markets and support the economy, the Swedish central bank, the Riksbank, announced an increase up to SEK 300 billion (6% of GDP) in its asset purchase programme this year and offered commercial banks up to SEK 500 billion (10% of GDP) to lend to corporates, among other measures. More measures could ensue in the coming days or weeks.

The confirmation of the Stable trend reflects DBRS Morningstar’s view that Sweden’s strong credit fundamentals can withstand a deterioration in economic and fiscal metrics without affecting its rating. DBRS Morningstar considers that Sweden’s strong public finances, flexible exchange rate, and wealthy households will help cushion the fallout from coronavirus. Sweden’s low public debt ratio and healthy budgetary position provide significant headroom to implement counter-cyclical fiscal policy. The Ministry of Finance now projects a fiscal deficit of 3.8% of GDP and the debt ratio to increase to 39.9% of GDP in 2020 from 35.1% of GDP in 2019. Output has remained above potential for several years, although it experienced a cyclical downturn last year.

Sweden’s AAA ratings are underpinned by strong public finances, healthy external accounts and robust economic performance. On the other hand, managing the risks stemming from the combination of high household leverage, banks’ large exposure to the property market, and housing prices remains a challenge for Sweden. The high level of household debt could amplify shocks, potentially triggering a deleveraging process and hampering domestic demand, with knock-on effects to the broader economy. Wealthy households and debt affordability mitigate the risks.

RATING DRIVERS

Downgrades could occur if Sweden’s public debt ratio trajectory were to experience a material reversal, although DBRS Morningstar views this as unlikely. A materially higher public debt ratio could result from a severe deterioration of the medium-term growth outlook or a substantial materialisation of contingent liabilities.

RATING RATIONALE

A Low and Declining Public Debt Ratio and Solid Fiscal Framework Underpin Sweden’s Creditworthiness

Given its strong public finances and credible fiscal framework, Sweden is well equipped to respond to adverse developments without jeopardising debt sustainability. The general government fiscal balance averaged a surplus of 0.7% of GDP between 2015 and 2019, propelled by higher tax collection amid a favourable macroeconomic environment and contained public spending. Driven mostly by these fiscal surpluses and GDP growth, the government debt ratio is estimated to have fallen to 35.1% of GDP in 2019 from its most recent peak of 45.2% of GDP in 2014. In fact, the public debt-to-GDP ratio has declined substantially over the past two decades, placing Sweden among the lowest indebted sovereigns in the European Union (EU).

After four years of consecutive surpluses, DBRS Morningstar expects the fiscal balance to turn negative in 2020 as the automatic stabilisers are triggered by the economic slowdown and discretionary measures are implemented to support the economy and shield the most vulnerable sectors. The final cost of the crisis package is still unclear and will hinge on the depth and severity of the crisis and potential additional measures being implemented. Nevertheless, DBRS Morningstar considers this most likely temporary setback will remain manageable, especially given Sweden’s strong starting point. The Ministry of Finance now projects the budgetary balance to pass from a surplus of 0.4% of GDP in 2019 to a deficit of 3.8% and 1.4% of GDP in 2020 and 2021.

The main fiscal measures unveiled thus far affecting the fiscal deficit include: (1) additional support for the healthcare system via subnational governments, (2) temporarily and partially costing/subsidising short-term lay-offs and sick leave, (3) temporary and targeted measures for small and medium-size enterprises (SMEs), such as reductions in social contributions, rent discounts, and tax cuts, and (4) support for the culture and sports sector. In parallel, the government has announced measures to provide liquidity and facilitate credit to businesses, such as state credit guarantees (e.g., for airlines and SMEs) and credit lines. Similarly, temporary tax deferrals, potentially providing cash flow relief up to SEK 300 billion, should affect only the cash-based fiscal accounts but not net lending.

The public debt ratio and contingent liabilities of the public sector will increase as a consequence of these measures and the expected contraction in activity this year. However, DBRS Morningstar expects this deterioration to prove temporary and debt should fall over time as the situation normalises. Similarly, the Ministry of Finance anticipates that the debt ratio will peak at 39.9% of GDP in 2020 and to drop to 32.4% of GDP by 2023. The materialisation of contingent liabilities, stemming from Sweden’s large public sector and exposure to financial sector-related entities, could lead to a higher but still manageable debt-ratio.

DBRS Morningstar considers that the associated risks to Sweden’s short average residual maturity and high share of foreign currency-denominated debt are small given the low levels of debt, steady demand for Swedish government bonds, and the Swedish National Debt Office`s on-lending operations. Furthermore, the yield on the Swedish ten-year bond remains in negative territory, at -0.05% as of 27 March.

Sweden’s Economic Outlook Remains Solid Despite Substantial Near-Term Risks

The rapidly evolving coronavirus pandemic poses a considerable threat to Sweden’s economic activity and employment this year. As a small and open economy, with significant external trade and financial linkages, Sweden is exposed to external developments. DBRS Morningstar considers that the supply disruptions and demand shock at a global scale, coupled with weaker domestic demand, will most likely send Sweden into a recession in 2020. If the restrictive measures only last for a few months, the economic fallout could prove transitory (i.e., one or two quarters), and a gradual normalisation of activity levels could ensue as the restrictions are lifted. However, if the shock extends in time, having a more lasting impact on consumption, investment, and external demand, a more permanent loss of output could take place.

The Ministry of Finance latest projections point to a sharp GDP contraction of 4.0% in 2020, with marked declines in investment and exports, albeit a high level of uncertainty is attached to this forecast. In line with this, the projections include a worsening of the labour market with the unemployment rate increasing from 6.8% in 2019 to 9% in 2020. The new projections assume the recovery phase will last for several years, with average growth of 3.3% between 2021 and 2023.

While the contraction in activity will be severe in the near term, DBRS Morningstar notes that Swedish GDP has been above potential for the last five years. Sweden’s economic performance has been strong, with average GDP growth of 2.4% per annum for the last two decades, underpinned by its knowledge-based, competitive economy that is well integrated in global value chains. Sweden’s high GDP per capita estimated at USD 51,243 in 2019 reflects a productive labour force and one of the highest employment rates in the EU.

Risks to Financial Stability are Manageable, But Key Systemic Vulnerabilities Remain

The Riksbank has announced a sizable package of measures to support the economy and to prevent a tightening of financial conditions from exacerbating the economic fallout from the pandemic. Two key measures to support liquidity in the capital markets and facilitate credit supply are: (1) an increase of up to SEK 300 billion (6% of GDP) in its asset purchase programme this year, enlarging the pool of eligible assets to include municipal bonds, mortgage bonds, corporate bonds, and commercial paper if necessary, (2) offering commercial banks up to SEK 500 billion (10% of GDP) against collateral to lend to businesses, among other measures. The Riksbank kept the repo rate at 0% after exiting negative territory in December 2019. In parallel, the Swedish financial supervisory authority lowered the countercyclical capital buffer for banks from 2.5% to 0% to safeguard a well-functioning credit supply. Inflationary pressures will remain subdued in the near term, given the collapse of oil prices and the weak economic outlook.

The deterioration of the macroeconomic background will put pressure on banks. While the Swedish banks are in good health, exhibiting good capital, profitability and asset quality, the overall system has some potential structural vulnerabilities. The Swedish financial system is large relative to the size of the economy, with high exposures to the housing market, being interconnected, and heavily reliant on wholesale funding. About two-thirds of market funding is in foreign currency, implying considerable refinancing and foreign exchange rate risks. Given the limited domestic and retail deposit source, retaining market confidence remains crucial for Swedish banks to ensure a stable source of funding. The liquidity measures announced by the Riksbank, including offering loans in US dollars against collateral, go in this direction.

Managing risks associated with high levels of household indebtedness, housing market pressures and banking sector vulnerabilities remains a key challenge. Swedish households’ high indebtedness, at 182.1% of GDP in 2019, could amplify potential interest rate, housing price, or income shocks. Despite the high leverage, households’ interest-to-income ratio at 2.5% remains very low. Although unlikely in the near to medium term, higher interest rates could put increasing pressure on households, given the predominance of mortgages at variable rates. Households’ high savings rate and large financial assets alleviate these risks. Tighter macroprudential measures, coupled with higher supply, triggered a correction in the housing market during late 2017. While housing prices are now growing closer to incomes, structural measures might be needed to improve the functioning of the housing market and reduce tax incentives for debt financing.

Swedbank and SEB have been under investigation for insufficient procedures against money laundering for their activities in the Baltic region. While this could affect confidence in the Swedish banking system, there is no significant evidence to date. Sweden has strengthened its anti-money-laundering framework in recent years.
Sweden’s External Position Remains Strong on the Back of a Competitive Export Sector

DBRS Morningstar considers that Sweden’s solid external position and a floating currency will act as shock absorbers in the face of the global economic consequences from coronavirus. On the back of the high savings rate and firms’ competitiveness, the current account has averaged 5.2% of GDP over the last two decades, resulting in a net international investment position of 20.9% of GDP at the end of 2019. Although, the global slowdown and deteriorating global investment climate will most likely dampen Swedish export growth, the current account surplus is expected to continue in coming years. Finally, Sweden´s liquid currency and its international reserves, at 10.3% of GDP in 2019, enhance the ability to weather significant shifts in investor confidence.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

Sweden’s political system is characterised by strong democratic institutions and predictable consensus-oriented policies. The minority coalition government, composed of the Social Democratic Party and the Green Party, has been passing legislation with the parliamentary support from the Centre Party and the Liberals. The “January Agreement”, which should guide policymaking during the current legislature, includes initiatives that will most likely be implemented on an incremental basis each year. A temporal deviation from the fiscal targets/debt anchor is likely to happen as the government attempts to stabilise the economy amid a challenging global and domestic environment. Nevertheless, DBRS Morningstar expects the government to remain committed to achieving the targets once the situation normalises, in line with Sweden’s prudent fiscal track record.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
https://www.dbrsmorningstar.com/research/359254

Notes:
All figures are in Swedish kronor (SEK) 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 (September 17, 2019):
https://www.dbrsmorningstar.com/research/350410/.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include the Ministry of Finance (including, Key Indicators Forecast 31 March 2020), Swedish National Debt Office (SNDO), Sveriges Riksbank, Statistiska Centralbyran (SCB), European Commission, Eurostat, Organisation for Economic Co-operation and Development (OECD), International Monetary Fund (including, World Economic Outlook October 2019), World Bank, United Nations Development Programme (UNDP), and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

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

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.

The sensitivity analysis of the relevant key rating assumptions can be found at: http://www.dbrsmorningstar.com/research/359255

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: April 17, 2012
Last Rating Date: October 25, 2019

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