DBRS Confirms Norway’s Rating at AAA, Stable Trend

DBRS, Inc. (DBRS) has confirmed the long-term foreign and local currency ratings of the Kingdom of Norway at AAA, and the short-term foreign and local currency ratings at R-1 (high). The trend on all rating is Stable.

The Stable trend reflects DBRS’s assessment that the challenges faced by Norway are manageable and are being addressed proactively. As a result, DBRS does not anticipate downward pressures on the ratings. The AAA ratings on Norway are underpinned by its elevated public sector wealth, solid public finances, and strong external position. These strengths have resulted from significant oil-related windfalls and prudent fiscal management. Though the recent oil shock is likely to negatively impact near-term economic growth, DBRS does not expect any material change in the country’s debt dynamics. Norway’s challenges are long-term in nature and the government has been active in promoting and implementing policies designed to address them.

The trend could be changed to Negative if severe external or financial sector shocks impair Norway’s ability to deliver sustained growth over the medium term and causes a structural modification to the stable outlook for public finances. The ratings could also face downward pressure if fiscal rules were to weaken significantly or if the commitment to a credible macro-prudential framework that preserves financial stability were to wane.

Underpinning Norway’s AAA rating are its sound institutional framework and prudently managed oil revenues. The country consistently scores top marks on governance indicators and strong political institutions have an established track record for a consensus-based approach to macroeconomic policy. Since the early 2000s, the government transfers the receipts from the sale of oil reserves and oil taxes to the sovereign wealth fund, the Government Pension Fund Global (GPFG or the Fund). By gradually phasing in oil receipts into the economy, the fiscal rule is designed to insulate the mainland economy from the volatility in oil prices. Over time, 4% of the value of the Fund can be allocated to finance the structural non-oil deficit. Given the size and growth of the Fund, directing 4% of GPFG investments to the budget could result in a large and unwarranted fiscal expansion. As such, a government commission has been established to consider the need to adjust the fiscal framework.

As a result of judicious management of oil revenues, public finances in Norway are solid. Between 2003 and 2013, annual government surpluses averaged 13.4% of GDP and gross debt declined from 43.4% of GDP to 29.5%, according to the IMF. The reduction in gross debt was mostly due to reduced repurchase agreements used to administer the Fund. Public borrowing in Norway is done to finance capital transactions, not to finance budget deficits. Based on the technical assumption that public debt grows in line with GDP, gross government debt is expected to remain flat at 30% of GDP through 2019. Perhaps more importantly, net debt is expected to reach roughly -215% of GDP once reserves from the Fund are included. The recent drop in oil prices is likely to adversely affect the headline fiscal balance, yet sound macroeconomic management is expected. DBRS expects the Fund’s returns to offset any short-term increases in the non-oil fiscal deficit.

Creditworthiness is also supported by the country’s strong external position. Persistent double digit current account surpluses over the last decade have led to considerable GPFG financial investments abroad. Thus, Norway has a high net international investment position of 92.8% of GDP. Ownership of such a significant amount of net financial assets abroad reduces Norway’s dependence on foreign capital flows and provides a stable source of income. Despite its strengths, Norway faces several medium- and long-term challenges.

Rising household debt and house prices could pose risks to growth and financial stability. Over the last decade, strong employment, high wage growth, and low interest rates increased household wealth and provided a basis for growth in consumption and property investment. Despite annual real housing price inflation falling from above 10% (2004-2007) to average 5% (2010-2013), indebtedness since 2010 has risen at a faster pace than the 3.5% growth in real disposable income. The debt to disposable income ratio among households increased from 144% in 2003 to 209% in 2013. A sudden turnaround in the housing market would likely have adverse wealth effects on consumption, weaken households’ net asset position, and increase financial sector vulnerabilities. Nevertheless, financial sector risks in the short-term remain manageable. Stress tests performed by Norges Bank indicate that the share of high risk borrowers remains low, even in a stressed scenario where house prices decline significantly. The financial system is further safeguarded by increasing bank capital requirements, including an additional countercyclical capital buffer equivalent to 1% of risk-weighted assets that will become effective in July 2015.

The impact to the mainland economy from the rapid decline in the headline price of oil underscores the slow deterioration of the Norwegian oil sector and presses for greater economic diversification. Extraction of crude petroleum declined 63% from 2000 to 3Q14. Though still accounting for 21% of GDP, off-shore output is down from the 37% of GDP recorded in the early 2000s. Likewise, the nearly 50% decline in the price of oil from June to December 2014 undercuts growth through several channels. Energy related capital formation is expected to peak in 2014 or 2015. Furthermore, a decline in confidence and negative income effects are expected to create a drag on economic growth. Statistics Norway forecasts mainland growth will slow to 1% in 2015. As oil production declines and if low oil prices persist, improving the external competitiveness of the non-oil tradable sector is integral for the economy to shift towards less commodity dependence. Norway’s external competitiveness has thus far been held back by low productivity growth and rising labor costs.

Long-term age-related spending will increasingly pressure the public balance. Under current projections, GPFG transfers will no longer exceed old-age related expenditures, which already account for 10% of GDP, by 2030. Preserving the current welfare level would result in a fiscal shortfall of about 6% by 2060, according to government estimates. Against this background, Norway passed pension reform in 2011 meant to improve incentives to work longer in old age and link working age with life expectancy. Nevertheless, these are long-term predictions that are likely to adjust with any forthcoming changes to the fiscal framework.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under 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 under Rating Scales. These can be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include the Government of Norway, the Ministry of Finance of Norway, Norges Bank, Statistics Norway, the Financial Supervisory Authority of Norway, European Commission, Statistical Office of the European Communities, IMF, OECD, BIS, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Jason Graffam
Rating Committee Chair: Roger Lister
Initial Rating Date: 21 March 2012
Most Recent Rating Update: 4 July 2014

For additional information on this rating, please refer to the linking document under Related Research.