DBRS Morningstar Confirms the Kingdom of Denmark at AAA, Stable Trend

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

KEY RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar's view that risks to the ratings remain limited. DBRS Morningstar takes the view that Denmark is well positioned to withstand the fallout from the Russian invasion of Ukraine, thanks to very strong public finances and a rapid economic recovery from the Coronavirus Disease (COVID-19) shock. Both output and employment, which already surpassed pre-pandemic levels, are estimated to be operating above capacity. That said, the rapid increase in inflation, both in Denmark and abroad, is denting real disposable income and resulting in tighter financial conditions, posing significant near-term headwinds to economic activity and the housing market. A tight, albeit expected to weaken, labour market; extraordinary household savings levels; and a healthy business sector mitigate the risks. Denmark's strong public finances, with one of the lowest public debt ratios in the European Union (EU), continue to provide ample room to support the economy against severe shocks. In line with its strong commitment to, and track record of fiscal prudence, the government debt ratio is expected to drop below pre-pandemic levels as early as next year.

The ratings are supported by Denmark’s sound public finances, strong external position, credible policy framework, and wealthy and diversified economy. The country’s predictable macroeconomic policy framework has underpinned its economic stability for decades. Denmark’s strengths offset the credit challenges associated with an interconnected financial system, high levels of household debt, and risks building up in the property market, especially in a context of rising interest rates and falling real income.

RATING DRIVERS
Given Denmark’s credit strengths, a downgrade to the ratings appears unlikely. The ratings could be downgraded if one or a combination of the following occur: (1) a severe shock to the economy that materially impairs Denmark’s medium-term prospects; or (2) a substantial deterioration of the public debt ratio, which could potentially be triggered by a materialisation of contingent liabilities associated with its large and interconnected financial system.

RATING RATIONALE
Higher Inflation and Weaker External Demand to Temper Denmark’s Economic Boom

Denmark benefits from a productive, diversified, wealthy, and flexible economy, which is reflected in its high GDP per capita and its resilience to shocks, despite its small size and high degree of trade and financial openness. Before the pandemic, the country experienced a prolonged period of economic upswing, with annual growth averaging 1.8% during the 2010–19 period, mainly driven by domestic demand and strong job creation. The pandemic triggered a comparatively mild contraction in output of 2.1% in 2020 from an international perspective, followed by a strong recovery of 4.9% in 2021, mostly propelled by domestic demand. Private consumption rebounded strongly in 2021 as pandemic restrictions were lifted, boosted by excess savings and government measures, not least of which included the release of frozen holiday allowances and the salary compensation scheme.

The fallout from Russia’s invasion of Ukraine has dampened growth momentum in 2022, mainly through higher energy and inflation pressures, tighter monetary policy, and weaker external demand. Against this context, the government projects Denmark’s GDP to expand by 2.8% in 2022 on the back of a strong carryover effect from 2021 and robust activity in Q2, with the slowdown becoming more evident in the second half of this year. Growth is forecast to decelerate to 0.8% in 2023; however, several uncertainties are clouding the growth outlook in the near-term, including the risks of energy supply shortages in Europe, more permanent inflationary dynamics, and new supply-chain bottlenecks created by pandemic containment restrictions abroad. The risks of inflation becoming more entrenched than expected, potentially due to stronger wage-price dynamics, could require further policy tightening that could ultimately hurt both activity and the housing market. However, accumulated household savings during the pandemic and considerable net wealth, as well as a still tight labour market, should mitigate the impact.

Denmark’s Public Finances Remain Very Strong Despite the COVID-19 and Energy Shocks

DBRS Morningstar views Denmark's very strong public finance metrics and its fiscal-track record as key credit strengths, providing the country with valuable fiscal space to stabilise the economy against severe shocks. Denmark posted annual fiscal surpluses of 1.7% of GDP between 2016 and 2019, supported by a sound fiscal framework and a favourable macroeconomic environment. The fiscal targets are set in structural terms due to the volatility of some of Denmark’s revenue sources, especially regarding pension-yield taxes and oil and gas extraction in the North Sea. Fiscal performance during the pandemic was very strong, particularly compared with other sovereigns, despite the implementation of considerable coronavirus support measures for households and companies, including a temporary wage compensation scheme. Denmark posted a fiscal deficit of 0.2% of GDP in 2020 before returning to a surplus of 2.3% of GDP in 2021, both outperforming EU averages of -6.8% and -4.7%, respectively. Higher-than-anticipated tax revenues on the back of a booming economy, considerably higher-than-expected pension-yield tax revenues, and one-off tax revenues from the payment of frozen holiday allowances have largely explained this outperformance.

Despite the expected economic slowdown, the government has revised its projected fiscal surpluses upward to 1.2% of GDP in 2022 (from 0.6% in May 2022) and to 0.8% of GDP in 2023 (from 0.2%), mostly due to an upward revision to revenue growth projections. Similarly, the structural balance is now estimated at 0.3% of GDP in 2022 and 0.4% of GDP in 2023, an improvement of around 0.5% each year, compared with previous estimates. Considering that employment and activity are still operating above capacity and inflation is running high, the government is pursuing a relatively tight fiscal policy. Denmark has introduced a series of measures to counter the effects of the rapid cost-of-living increase with a relatively small fiscal impact of around 0.2% of GDP per year in 2022 and 2023, are almost fully funded. This included one-off targeted ‘cheques’ to households with natural gas heating and to vulnerable pensioners, as well as a temporary reduction in the electricity tax. In addition to this, parliament approved a loan scheme to energy companies that will allow households and companies to spread the costs of higher energy over the following four years expected to reach DKK 45 billion (1.8% of GDP) and a guarantee programme available for energy companies up to DKK 100 billion (4.0% of GDP). DBRS Morningstar expects the next administration to continue implementing a prudent fiscal policy, given the strength of the economy and inflationary pressures. Over the medium term, DBRS Morningstar considers that Denmark is well placed to accommodate higher spending related to its green transition and defence pledges, potentially implementing offsetting measures if needed. Parliament has increased the structural fiscal deficit limit to 1% of GDP from 0.5% of GDP, and aims for a headline deficit of 0.5% of GDP in the medium term.

Denmark’s public debt ratio (EMU debt definition), at 36.6% of GDP by the end of 2021, was one of the lowest in Europe and well below the limit of 60% set out in the EU’s Stability and Growth Pact. After a brief deterioration triggered by the pandemic in 2020, the debt ratio resumed its pre-pandemic downward trend in 2021, helped by a favourable economic and fiscal performance. According to the government’s latest projections, the public debt ratio could fall to 32.2% by the end of 2022 and 31.4% by the end of 2023, levels not seen since 2008. These projections include the debt-increasing effect from the social housing financing model, which nevertheless is neutral on a net-debt basis. In addition to its low levels, a favourable debt profile supports the country’s resilience to shocks. Debt is mostly denominated in local currency, and about half of government bonds are held by Danish insurance companies and pension funds. While bond yields have increased significantly this year, Denmark’s interest burden is expected to remain low in coming years.

Financial Stability Risks Appear Contained but High Household Debt Still a Source of Vulnerability Amid Higher Interest Rates and Housing Market Downturn

Given Denmark’s fixed exchange-rate regime, the Danmarks Nationalbank (DN) conducts monetary policy to keep the Danish krone stable against the euro. This, together with Denmark’s sound fiscal and economic policy, has provided an environment of low and stable inflation for several decades. In light of the rapid rise in inflation both in the euro area and Denmark, the DN has raised its benchmark rate by 1.85 percentage points since June 2022, exiting the negative interest rate policy territory after entering in 2014, broadly following the European Central Bank (ECB) albeit widening its policy spread to counter the appreciation pressures in favour of the Danish krone. The DN is expected to continue tightening in coming months, in tandem with the ECB, given the still-strong underlying inflationary pressures. More recently, the rise has been more substantial for mortgage rates: the average rate for long mortgage bonds denominated in DKK increased to 4.74%, a rise of 2.82 percentage points year to date, according to Finance Denmark.

As of Q2 2022, household indebtedness stood at 203.4% of seasonally adjusted gross disposable income, the highest among OECD nations. This level of debt exposes households to and could amplify shocks, not least with regard to a sharp surge in interest rates. In this sense, higher mortgage rates, a slowing economy, and sharply falling real household incomes pose headwinds to the housing market. The housing market has cooled down over the summer and the DN now forecasts house prices to decline by 5.6% in 2023 and by 1.8% in 2024. Nonetheless, the risk of a hard landing in the housing market spreading to the broader economy remains limited. The strength of the labour market, the net financial assets of the Danish household sector, sluggish housing supply, and the concentration of debt among the most wealthy households mitigate these risks. Furthermore, Danish households have been deleveraging and, according to the DN, homeowners' sensitivity to interest rates decreased in the 2009–19 period and remains limited, although households have increasingly taken variable-rate and non-amortising mortgages this year.

The Danish banking system remains strong, characterised by healthy capitalisation, liquidity, and profitability metrics. While pandemic effects and the fallout from the Russian invasion of Ukraine could cause asset quality to deteriorate over time, the Danish banking system is well equipped to absorb substantial losses. Furthermore, the Danish authorities decided to rise the countercyclical capital buffer for banks to 2.5% from March 2023. On the other hand, the large and highly interconnected Danish financial system, with the housing market and covered bond market—the world's largest as a percentage of GDP—strongly linked, could act as an amplifier of shocks. DBRS Morningstar made a negative qualitative adjustment in the “Monetary Policy and Financial Stability” building block to reflect the risks stemming from Denmark’s large and interconnected financial system and its highly indebted households.

Denmark External Accounts and Competitiveness Levels Remain Strong, Despite the Intensifying Global Headwinds

Denmark exhibits a strong external position from both a flow and a stock perspective. The current account surplus averaged 7.7% of GDP over the past 10 years and the net international investment asset position (NIIP) amounted to 77.0% of GDP in 2021. Despite the intensification of external headwinds, Denmark is expected to continue to post sizeable current account surpluses. The relatively low sensitivity to the global business cycle of its pharmaceuticals, wind turbines, and food exports as well as the strong performance of its shipping sector bodes well for Danish exports. In addition to this, the country's high net asset position generates recurrent primary income surpluses, which more than offset transfer outflows. While Denmark’s terms of trade have been affected by the rise in energy prices due to its net importer condition, this has been compensated by a massive increase in freight rates albeit now normalising. The planned restart of production in the Tyra gas field during the 2023–24 winter season is expected to give an additional lift to exports in coming years. In terms of competitiveness, Danish firms are well placed to absorb the prospect of higher wages in coming years.

While Denmark's peg to the euro reduces its external adjustment capacity, the country has successfully relied on sound economic and fiscal policies to stabilise the economy and prevent large external imbalances from building up. A strong external position, ample international reserves, sound public finances, and a strong political commitment underpin the high credibility of Denmark's long-standing fixed exchange rate policy. This supports DBRS Morningstar’s positive qualitative adjustment of the “Balance of Payments” building block.

Strong and Stable Political Framework Supports Economic Stability and the Incoming Administration to Remain Fiscally Prudent

Denmark's political environment and institutions are very strong, as reflected in the World Bank's governance indicators. The introduction of key reforms tends to depend on broad-based support across the political spectrum, ensuring their durability. This predictable macroeconomic policy framework has underpinned the country's price and economic stability for decades. Acting Prime Minister Mette Frederiksen called snap elections for November 1, 2022, seven months ahead of the due date, after one of the parties supporting the minority government of the centre-left Social Democratic Party threated to withdraw its backing. The Social Democratic Party won the elections garnering 27.5% of the votes and is expected to lead a minority government with the support of parties from the so-called ‘red bloc’ or to form a broader coalition. Irrespective of the final form of the next administration, DBRS Morningstar foresees the authorities continuing to exercise fiscal prudence, and avoiding stimulating an economy operating above capacity.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, and Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://www.dbrsmorningstar.com/research/405458.

Notes:
All figures are in Danish kroner (DKK) 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, https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments (August 29, 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings. (May 17, 2022) in its consideration of ESG factors.

The sources of information used for this rating include Ministry of Finance (Economic Survey, August 2022; The Finance Bill 2022, August 2022), Danmarks Nationalbank (Outlook for the Danish Economy, September 2022; Financial Stability 1st Half 2022, June 2022), Danmarks Statistik, Systemic Risk Council (Recommendation March 2022), Ministry of Trade and Industry, Danish Energy Agency, Finance Denmark, The Danish Parliament, European Central Bank, European Commission (Autumn 2022 Economic Forecast, November 2022), The Social Progress Imperative (2022 Social Progress Index), Eurostat, OECD, IMF, World Bank, BIS, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit 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: YES
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.

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 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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/405459.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James; Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: September 20, 2012
Last Rating Date: May 20, 2022

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