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

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

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar's view that risks to the credit ratings remain limited. Denmark is well positioned to withstand the near-term economic slowdown reflecting mainly high, although declining inflation, and the tightening in financing conditions. The performance of the pharmaceutical sector is expected to continue to support the economy without intensifying pressures on the labour market. This bodes well for a decline in inflation, which, by remaining moderate going forward will sustain the recovery in households’ purchasing power. DBRS Morningstar views Denmark's strong public finances, benefitting from fiscal surpluses and one of the lowest public debt ratios in the European Union (EU), will continue to provide ample room to support the economy against severe shocks. Moreover, higher defense, healthcare and green-related spendings are not expected to undermine the government’s robust fiscal position in coming years. A rapid post-pandemic growth and higher-than-expected fiscal revenues contributed to the drop of the public debt ratio below the 2019 level. The ratio is projected to slightly increase above 30% of GDP over the medium term.

The credit ratings are underpinned by Denmark’s sound public finances, strong external position, credible policy framework, and wealthy and diversified economy. Moreover, 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 and high levels of household debt along with a high share of variable rate mortgages in a context of elevated interest rates.

CREDIT RATING DRIVERS
Given Denmark’s credit strengths, a downgrade to the credit ratings appears unlikely. The credit 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 be triggered by a materialisation of contingent liabilities associated with its large and interconnected financial system.

CREDIT RATING RATIONALE

The Pharmaceutical Sector’s Performance Counteracts Weak Domestic Demand

Denmark benefits from a productive, diversified, wealthy, and flexible economy, which is reflected in its high GDP per capita level and its resilience to shocks, despite its small size and high degree of trade and financial openness. The economy has experienced a strong economic performance post-pandemic, with GDP expanding by 6.8% in 2021 and by 2.7% in 2022, driven by solid investment, an improving labour market, and robust net exports.

The strong performance of the pharmaceutical sector is mitigating the negative impact stemming from the tightening in monetary policy and the decline in real purchasing power of households. Domestic demand will be weak this year, and consumption will recover gradually next year when wage growth supports real incomes. Latest projections from the government point to a GDP growth of 1.2% this year and 1.4% in 2024 with the pharmaceutical sector boosting net exports, particularly this year. GDP growth would have been significantly weaker in 2023 in the absence of the pharmaceutical industry’s positive performance. In DBRS Morningstar’s view, medical companies which are sustaining the performance of this sector could benefit from their leadership position also in coming years, supporting the country’s economic performance.

The labour market is expected to remain resilient, but employment growth is slowing. Since 2021, Denmark has seen a strong job creation, which has attracted foreign workers that have led the employment ratio to peak at 77.2% in Q3 2022 before slightly decreasing to 76.4% as of Q2 2023. Nevertheless, the economic slowdown is weighing on the labour market and the unemployment rate is gradually increasing, although from a very low level, achieving 2.9% as of September 2023 from 2.5% in March 2022.

Denmark’s Public Finances Underpin the Credit Ratings

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. After the pandemic, Denmark has posted sizeable surpluses amounting to 4.1% of GDP in 2021 and to 3.4% in 2022 as a result of high economy activity, the strong labour market, pension yield taxes, and frozen holiday allowance payments.

The near-term economic deterioration is unlikely to derail the very conservative fiscal stance of the government. The fiscal surplus, although declining, will remain sound particularly this year. The government projects the surplus to fall to 2.0% of GDP in 2023 and 1.0% next year, reflecting mainly lower economic activity and the increase in general defense spending including a rise in the Ukraine Fund aimed to provide support to Ukraine. The rise in income transfers and public wage indexation are likely to put pressure on public finances going forward, even though it won’t materially affect the government’s budgetary positions. Moreover, over the medium term, DBRS Morningstar considers that Denmark is well placed to accommodate higher spending related to its green transition and defence pledges, thanks to a sizeable fiscal space. In early November, the government presented the 2030 political agenda that expands the framework in the defense settlement to DKK 154.8 billion until 2033 with the aim to reach the target of 2.0% of GDP of military spending by 2025 onwards.

Denmark’s public debt ratio (European Economic and Monetary Union debt definition) at 29.5% of GDP in 2022 remains one of the lowest in Europe, and its profile bolters the country’s resilience. The public debt trajectory is not expected to be materially affected by the current economic slowdown or by the government’s fiscal stance in the medium term. According to the latest Finance Act, the debt-to-GDP ratio will remain slightly below 30% of GDP in 2024. In addition to the low debt level, 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 by pension funds. While bond yields have increased significantly since mid-2022, Denmark’s interest burden is expected to remain low in the coming years. Moreover, a sizeable liquidity buffer, estimated to be around DKK 183 billion (6.5% of GDP) by the end of 2023, provides the government with a significant buffer.

Financial Stability Risks Appear Contained, but High Households Debt at Variable Rate Remains a Source of Vulnerability Amid High Interest Rates

The fall in inflation including in the euro area should have reduced the likelihood of further interest rate hikes in the near term. This should mitigate the worsening financial burden for indebted households, particularly on those who have a variable interest mortgages with a short refixing period. To counteract elevated inflation and to maintain the fixed exchange rate with the euro, Danmarks Nationalbank (DN) has raised its benchmark interest rate by 4.2 percentage points cumulatively since June 2022. The DN’s monetary policy has broadly followed the European Central Bank (ECB), although its policy spread has widened to counter the appreciation pressures in favour of the Danish krone. Inflation has declined significantly to 0.1% as of October 2023 from the peak of 10.1% in October 2022 but wage pressure as a result of the spring collective wage negotiations, however, is likely to push consumer price growth again in the coming quarters above 2%.

The deleveraging in household debt over the past few years has been significant and mitigates financial imbalances, but the increase in interest rate sensitivity makes households more vulnerable to elevated interest rates. Household debt as a share of adjusted disposable income declined by more than 50 percentage points since the end of 2021 to around 185% in Q2 2023, but it remains one of the highest among Organisation for Economic Cooperation and Development (OECD) countries. The decline was mainly due to a large share of borrowers converting their fixed interest rate mortgages into variable ones but with a low level of debt along with the mark-to-market impact on mortgages valuations. On the other hand, the growing share of borrowers with a variable rate makes them vulnerable to elevated interest rates. Nevertheless, 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. The fall in house prices has slowed down over the past months, and this bodes well for financial stability. According to the DN, the introduction of the housing tax reform in 2024 could reduce house price fluctuations. This would make the housing market more stable.

Danish banks are strong, well capitalised and liquid, and the surge in the net interest income is also bolstering profitability. The system is well equipped to absorb the likely deterioration in credit quality because of the economic slowdown, high interest rates, and the unfolding economic consequences of the pandemic and the war in Ukraine. But the banking sector’s exposure to the real estate market is large and represents a point of attention, which led the Systemic Risk Council to recommend a sector-specific systemic risk buffer for exposures to real estate companies starting in April 2024. In DBRS Morningstar’s view, 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. This underpins the negative adjustment in the Monetary Policy and Financial Stability Building Block assessment, which reflects the risks stemming from Denmark’s large and interconnected financial system and its highly indebted households.

Denmark’s 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. A weaker external environment in the near term should not undermine its very strong external position. The external strength is driven mainly by exports. While the normalisation of freights and shipping rates will result in a decline in the current account surplus this year, going forward, Denmark’s external performance will benefit from the relatively low sensitivity to the global and business cycle of its pharmaceuticals, wind turbines, and food exports. The current account balance will moderate after the surplus of 13.5% of GDP in 2022. But it is expected to remain large at around 9.0% of GDP on average over the next two years, supported also by the planned restart of production in the Tyra gas field during the 2023–24 winter season. Denmark benefits also from a high net international investment asset position (NIIP) amounting to 56.6% of GDP in Q1 2023.

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 to 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 assessment.

Strong and Stable Political Framework Supports Economic Stability and Credit Ratings

Denmark's political environment and quality institutions are very strong, as reflected in the high scores of the World Bank's Worldwide Governance Indicators. Moreover, the introduction of key reforms tends to depend on broad-based support across the political spectrum, limiting the risk of reversal. This predictable macroeconomic policy framework has underpinned the country's price and economic stability for decades. The new coalition government, formed after the elections in November 2022, and including the Social Democrats, the Liberals, and the Moderates, is expected to continue to exercise fiscal prudence, and to avoid stimulating an economy operating above capacity.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or 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 (4 July 2023) https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://www.dbrsmorningstar.com/research/423537.

Notes:
All figures are in Danish krone 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 (6 October 2023) https://www.dbrsmorningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. 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/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for these credit ratings include Ministry of Finance (DK 2030, Denmark prepared for the future, November 2023), Ministry of Economy (Economic Survey, August 2023), DN (Outlook for the Danish Economy, September 2023; Financial Stability 1st Half 2023, June 2023, Central government borrowing strategy 2nd half of 2023 – June 2023), Danmarks Statistik, Danish Energy Agency, European Central Bank, European Commission, The Social Progress Imperative (2022 Social Progress Index), Eurostat, OECD, International Monetary Fund (World Economic Outlook, October 2023, IFS), Statistics Denmark, World Bank, Bank for International Settlements, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were 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 credit 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 credit 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://registers.esma.europa.eu/cerep-publication. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/423538.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Senior Vice President, Credit Ratings, Global Sovereign Ratings.
Rating Committee Chair: Nichola James, Managing Director, Credit Ratings, Global Sovereign Ratings.
Initial Rating Date: 20 September 2012
Last Rating Date: 19 May 2023

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