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 confirmation of the Stable trend reflects DBRS Morningstar’s view that Sweden’s strong credit fundamentals can withstand the expected deterioration in economic and fiscal metrics without affecting its rating. The spread of the Coronavirus Disease (COVID-19) and the restrictive measures to limit contagion are expected to result in a sharp contraction in Sweden’s GDP this year, although it will likely be a milder contraction than that experienced by other European countries. Data so far suggests that the economic slump bottomed out in the second quarter of the year and that a stronger-than-expected recovery is underway. This should be reinforced by the fiscal stimulus planned for 2021. The recent increase in infection rates in Europe, and to a lesser extent in Sweden, that could potentially force the re-imposition of some restrictions, remains the main downside risk to growth. The government’s fiscal response to mitigate the impact of the pandemic has resulted in a substantial deterioration in public finances. However, DBRS Morningstar notes that even after the expected increase in the public debt ratio this year, the ratio is expected to remain comparatively low and the fiscal headroom substantial.

Sweden’s AAA ratings are underpinned by strong public finances, healthy external accounts and a robust economic performance. The country’s solid track-record and sound fiscal framework are expect to continue supporting its fiscal performance. Sweden’s flexible and competitive economy is well placed to recover, however, external risks to its small and open economy remain high. In addition to a challenging external backdrop, 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

Rating 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 Public Debt Ratio and Solid Fiscal Framework Underpin Sweden’s Creditworthiness

Sweden’s strong fiscal performance, underpinned by its fiscal framework, and low public debt levels have provided the country with ample fiscal room to respond to the COVID-19 shock. Sweden’s public debt-to-GDP ratio at 35.1% in 2019 was amongst the lowest in the European Union (EU). The authorities estimate the fiscal aid package could amount to between 11.3% and 17.0% of 2019 GDP depending on the uptake. Of this, the deficit impact this year is currently expected to amount to SEK 200 billion (4% of 2019 GDP). Most of the fiscal measures are temporary and are not expected to impact 2021 to any significant extent. In parallel, the government has supported business liquidity through state credit guarantees (e.g., for airlines and SMEs), credit lines, and temporary tax deferrals. Following four consecutive years of fiscal surpluses, the Ministry of Finance projected in September the fiscal deficit to reach 5.5% of GDP in 2020, well below the 7.8% of GDP estimated in June, due to better-than-expected economic performance and lower-than-expected usage of the short-term work scheme and the re-orientation support scheme for businesses.

The 2021 Budget Bill submitted to parliament proposes fiscal stimulus amounting to SEK 105 billion (2.1% of 2019 GDP) in 2021 and SEK 85 billion (1.7% of 2019 GDP) in 2022. DBRS Morningstar considers the stimulus warranted given the cyclical downturn and the still lingering uncertainties. The proposals include tax cuts for households and firms, green investments, grants for regions and municipalities, and extra resources for welfare. The Ministry of Finance estimates that the fiscal deficit will decline to 3.5% of GDP in 2021 and gradually converge towards the surplus target of 0.33% of GDP by 2023. DBRS Morningstar notes that this could be delayed if the economic recovery is weaker than expected or if the government implements additional stimulus measures.

In this context, the public debt ratio is expected to increase from 35.1% in 2019 to 42.6% of GDP in 2020. The public debt ratio is expected to decline to 39.5% of GDP by 2023, below the debt anchor’s upper band of 40% of GDP. The materialisation of contingent liabilities, potentially stemming from Sweden’s large public sector, the exposure to financial sector-related entities, or the most recent extension of state guarantees, could lead to a higher but still manageable debt ratio. DBRS Morningstar considers that the associated risks to Sweden’s short average debt maturity and high share of foreign currency-denominated debt are small given the comparatively low level of debt, steady demand for Swedish government bonds, and the Swedish National Debt Office`s on-lending operations. Furthermore, the government borrowing rate, the average market rate on government bonds that have a residual maturity of at least five years, remains in negative territory at -0.08% as of 25 September 2020.

The Economic Recovery Has Started After An Unprecedent Contraction In the Second Quarter

The spread of the pandemic and the restrictive measures to limit contagion, both in Sweden and abroad, have massively disrupted economic activity. Sweden’s GDP contracted by 8.3% QoQ in Q2, the sharpest decline in a single quarter since 1980, but still milder than the 11.7% slump for the EU during the same period. Sweden’s lighter restrictions, smaller reliance on the tourism-related sector, relatively favourable starting point in terms of distance working and digital skills, and sizable fiscal room to react, could have contributed to this overperformance.

The GDP contraction is expected to be substantial, with both the Ministry of Finance (-4.6%) and the Riksbank (-3.9%) expecting an annual contraction in output this year commensurate to the one seen in 2009 (-4.3%). As a small and open economy, with significant external trade and financial linkages, and well-integrated into the global value chain, Sweden’s economy is sensitive to cyclical developments abroad and to trade disturbances. Indeed, the supply chain and demand disruptions triggered by the pandemic have sharply impacted Swedish exporters and the manufacturing sector during the first half of the year, especially in the automotive sector. The construction and service sector have experienced output falls to a lesser extent. Within the service sector, the hospitality, transport and cultural services groups have been most adversely affected by the restrictions, physical distancing, and concerns of infection.

Indicators suggest that the economy has bottomed out in Q2 and that the recovery is underway in Sweden. The labour market is showing early signs of stabilisation after the unemployment rate increased from 6.8% in March to 9.1% in August 2020. However, the improvement in employment is expected to lag the economic rebound. Going forward, Sweden’s strong economic track-record, underpinned by its flexible and competitive economy, bodes well for the growth outlook. The main downside risk remains linked to the evolution of the pandemic both locally and externally, as well as to negative developments on the trade front that could hinder Sweden’s export performance. Domestically, the main challenges are linked to the housing market and to improving the employability of foreign and low skilled workers.

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

In response to the COVID-19 shock, the Riksbank has announced a sizable package of measures to support the economy and to prevent a tightening of financial conditions from exacerbating the adverse economic impact of the pandemic. Since March, the Riksbank has kept the repo rate unchanged at zero per cent, committed up to SEK 500 billion for its asset purchase programme until June 2021, committed up to SEK 500 billion for a corporate lending programme via monetary policy counterparties, and offered loans in US dollars up to USD 60 billion, among other measures. Until mid-September, a significant portion of these programmes remained untapped. Given the subdued inflationary pressures and lingering economic uncertainties, DBRS Morningstar expects monetary policy to remain extraordinarily accommodative in coming years. From a macro-prudential standpoint, the Swedish authorities have reduced the countercyclical capital buffer for banks from 2.5% to 0%, and eased temporarily liquidity and amortisation requirements, among other measures.

The Swedish banks entered the current crisis from a strong position, displaying good capital levels, profitability, and asset quality. DBRS Morningstar considers this will help banks weather the potential deterioration in asset quality and profitability from the pandemic shock. However, if the economic downturn becomes protracted this could increase financial stability risks, that currently remain contained. The main risks are linked to the high level of household indebtedness and banks’ exposure to the housing and commercial property markets. On the latter, commercial property companies tend to be highly leveraged and vulnerable to income and interest shocks. However, repayment capacity seems adequate, although DBRS Morningstar will continue to monitor the situation in this pandemic environment.

The large size of the Swedish banking system relative to the economy, its interconnectedness (e.g., banks own each other’s debt), high exposure to the housing markets, and heavy reliance on wholesale funding of which an important share is in foreign currency, could amplify confidence shocks through the banking system and the economy. However, policy support remains a key mitigating factor. For example, Riksbank purchases of banks’ covered bonds and offering of US dollar loans have supported the Swedish banks’ good financing conditions during the most turbulent times.

High and rising household indebtedness, at 201% of disposable income in Q2 2020, continues to pose an important risk to financial and macroeconomic stability in Sweden. Swedish households’ high level of indebtedness could amplify the potential impact from lower income or higher interest rates, risking a material reduction in private consumption and potential second round effects to the overall economy. Households could be especially sensitive to increases in interest rates, given the predominance of variable interest rate mortgages in Sweden. However, interest rates are expected to remain very low in coming years, enhancing debt affordability. Households’ high savings rate and large financial assets also alleviate these risks.

Since the mid-1990s, the increase in household debt has been driven by steeply rising housing prices, influenced by declining real interest rates and a favourable macroeconomic environment. Structural features, such as debt-friendly taxation, a weak amortisation requirement in the past, and constraining rental regulation, have also been factors contributing to imbalances between supply and demand for housing. While the housing market has stabilised in recent years, following the price correction during late 2017 that was triggered by tighter macroprudential measures and higher supply, house prices have been gathering pace lately even as the economy and the labour market weakened substantially. DBRS Morningstar expects the underlying housing market pressures to continue as the structural problems in the functioning of the housing market and the tax incentives for debt financing remain broadly present.

Sweden’s External Position Remains Strong Related to a Competitive Export Sector

Sweden enjoys a solid external position and its competitive exporting sector is expected to recover from the slump brought about by the pandemic. Sweden’s floating currency, a potential shock absorber, has appreciated on a trade-weighted basis (KIX) since April, although after several years of relative weakness. On the back of the high savings rate and firms’ competitiveness, the current account surplus 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. 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 relied thus far on parliamentary support from the Centre Party and the Liberals to pass legislation. The government is using the flexibility built into the fiscal framework to respond to the pandemic shock and to stabilise the economy. In line with Sweden’s prudent fiscal track record, DBRS Morningstar expects the government to remain committed to achieving the fiscal surplus target once the effects of the pandemic wane. Deeper and politically contentious reforms of the labour market and of rental regulations, or a comprehensive tax reform, remain unlikely in the near term.

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/367774.

DBRS Morningstar notes that this Press Release was amended on 5 October 2020 to incorporate the link to the Scorecard Indicators and Building Block Assessments document.

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 (July 27, 2020):
https://www.dbrsmorningstar.com/research/364527.

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 (Key Indicators Forecast 21 September 2020; Reform table, September 2020), Swedish National Debt Office (SNDO), Sveriges Riksbank (Monetary Policy Report, September 2020; Economic Commentaries NO.5 2020, June 2020), Statistiska Centralbyran (SCB), European Commission, Eurostat, Organisation for Economic Co-operation and Development (OECD), Bank for International Settlements (BIS), International Monetary Fund (IMF), World Bank (WB), 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: https://www.dbrsmorningstar.com/research/367773.

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: April 3, 2020

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