DBRS Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Kingdom of Sweden’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA and Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). All ratings have a Stable trend.

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects DBRS’s view that the risks to the ratings are limited. Solid domestic demand is underpinning economic growth, with a weaker krona helping mitigate the impact of increased risks to external demand. Steady employment creation, high capacity utilisation and favourable financing conditions bode well for private consumption and business investment. Housing investment has decelerated sharply in 2018, but spillovers to the rest of the economy have been contained and housing prices have stabilised. Amid this favourable economic environment, public finances continue to strengthen. In 2018, DBRS expects a fiscal surplus of 1% of GDP and the public debt ratio to drop to 37.9% of GDP. However, high household debt, housing market dynamics and potential vulnerabilities in the banking sector continue to be sources of concern, which could be exacerbated if interest rates increase quickly.

RATING DRIVERS

The trend could be changed to Negative from Stable if Sweden’s public debt ratio trajectory were to experience a material reversal, although DBRS views this as unlikely. A materially higher public debt ratio could result from a severe deterioration of the medium-term growth outlook or the future materialisation of substantial contingent liabilities related to the banking system, most likely triggered by a collapse in the housing market and sharp worsening of financial conditions.

RATING RATIONALE

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

Sweden’s sound fiscal performance over the last two decades has been underpinned by its prudent and credible fiscal policy framework. The revised fiscal framework, which will start to apply in 2019, sets a fiscal surplus target at 0.33% of GDP over an economic cycle, below the previous 1%, supplemented with a debt anchor at 35% of GDP. This debt anchor for general government consolidated debt will act as an explicit multi-annual objective. An expenditure ceiling, extending for the third year ahead in the budget bill, is an overarching restriction for the budgetary process.

Sweden’s public finances remain strong and well equipped to respond to adverse developments. The general government’s fiscal surplus averaged 1.3% of GDP in 2016-2017, and the structural surplus averaged an estimated 1% of GDP, both well above Sweden’s target and its medium-term objective. Benefiting from stronger than expected revenue collection, fuelled by economic dynamism and lower than expected spending on asylum seekers, Sweden has overperformed its budgetary targets. Despite the fiscal stimulus measures in 2018 amounting to 0.6% of GDP, the fiscal surplus is expected to drop only slightly to 1% of GDP. Under a no policy change assumption, the government projects the fiscal surplus to increase to 1.9% by 2021. However, DBRS expects the next government to implement new measures that will probably bring the surplus gradually closer to the 0.33% target in coming years.

The long-term sustainability of public finances is well anchored. The public debt-to-GDP ratio has declined substantially over the past two decades, placing Sweden among the lowest indebted sovereigns in the EU. The public debt-to-GDP ratio, which stood at 40.8% in 2017, is projected to decline to 27.3% by 2023, according to the IMF’s October 2018 estimates. The government’s net financial asset position reached 26.6% of GDP at end-2017, mainly reflecting the social security funds.

There are, nonetheless, a few sources of vulnerability, including the short average debt maturity of five years; and a considerable proportion of public debt denominated in foreign currency. These vulnerabilities are mitigated by the moderate debt ratio, good debt servicing capacity and favourable funding costs. More than half of the foreign-currency denominated debt was raised on behalf of the central bank (on-lending operations) to help build a precautionary foreign currency liquidity buffer for the banking sector. As of end-2017, central government guarantees were high at 44.7% of GDP, although around 83% of these are related to state-provided deposit insurance guarantees. Nordea Group’s decision to move its headquarters to Finland from Sweden this year should reduce Sweden’s contingent bank exposures, though other potential risks to financial stability could emerge should there be a change in the effectiveness of supervision and macroprudential controls.

Sweden’s Economic Dynamism is Set to Continue, Although the Housing Market Raises Uncertainties

Sweden’s strong economic performance, with average growth of 2.5% per annum for the last two decades, has been underpinned by a competitive export sector. Sweden’s high GDP per capita at EUR 53,170 reflects a productive labour force and the highest employment rate in the EU at 81.8% in 2017. Extraordinarily accommodative monetary policy in Sweden and abroad stimulating aggregate demand and a relatively synchronised recovery in Europe have provided tailwinds to growth in recent years. In this favourable environment, private consumption and investment have been key drivers of the expansion. Similarly, on the back of strong employment creation, the unemployment rate fell to 6.1% in Q3 2018. On the other hand, the unemployment rate for the foreign-born population is very high at 15% in Q3 2018, and matching skill sets with jobs demand in Sweden is becoming more difficult. Wage growth has remained contained, but should pick up in coming years, in line with peer countries.

House prices have largely stabilised this year after a sharp increase in supply and tighter macroprudential policies triggered a 9.2% decline in the Valeguard housing index between the months of August and December 2017. In this context, housing investment, which grew on average 14% per annum in 2014-2017, has decelerated sharply in 2018 and is expected to contract by 5.5% in 2019, according to the National Institute for Economic Research (NIER). In contrast, business investment is expected to accelerate in 2018, in response to higher than normal capacity utilisation and healthy exporting dynamics but is expected to decelerate in 2019.

The International Monetary Fund (IMF) projects Sweden’s average annual economic growth at 2% between 2019 and 2023. As a small and open economy, with significant external trade and financial linkages, Sweden is exposed to economic and political uncertainty from the rest of the world. On the domestic front, the main uncertainty is related to the impact on consumption and investment from sharper-than-expected increases in interest rates or/and a collapse in the housing market.

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

Managing risks associated with high levels of household indebtedness, housing market pressures and banking sector vulnerabilities remain a key challenge. Swedish banking system assets will drop to around 300% of GDP from around 400% following Nordea’s relocation to Finland. Nevertheless, the Swedish financial system will remain large, concentrated and interconnected.

A highly accommodative monetary policy, sluggish housing supply for a prolonged period of time, and generous tax incentives for debt financing led to a rapid increase in household debt-to-disposable income that increased from 108.0% at end-2000 to 186.1% at end-2017. Swedish households’ high indebtedness could act as amplifier of potential interest rate, housing price, or income shocks. The predominance of mortgages at variable rates, 69% of the total, exacerbates households’ sensitivity to rising interest rates. However, the Riksbank’s forecast that the repo rate will only gradually increase by about 1.5 percentage points over the coming three years if the economy develops as expected. In addition, the household sector’s interest-to-income ratio is very low at 2.5%. This, combined with the high savings rate and large size of household financial assets could help them to absorb potential shocks.

Swedish banks’ profitability is good, even amid a negative interest rate environment, and asset quality is solid. Banks’ loss absorption capacity is strong, with regulatory tier 1 capital to risk-weighted assets at 23% in Q2 2018, providing a buffer against a potential adverse impact that could arise in the event of a sharp increase of interest rates, housing market collapse, or an economic downturn. In recent years, the Swedish authorities have introduced several measures to strengthen the banks’ loss absorption ability and increase households’ resiliency to shocks. Loan-to-value (LTV) ceiling and amortisation requirements linked to LTV and debt-to-income levels for new mortgages could reduce future exposures to the most vulnerable households. However, additional effort may be needed to effectively curb the increase in household debt and lift non-risk weighted capital buffers.

A collapse of the housing market that affects investor confidence could also have an impact on banks’ funding, given that the banks have issued covered bonds with mortgages as collateral to fund their mortgage portfolios. Cover pool substantial enhancements mitigate these risks. Market funding represents around half of banks’ funding, predominantly in foreign currency (about two-thirds), 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.

Sweden’s External Position Remains Strong on the Back of a Competitive Export Sector

The combination of a high savings rate and strong competitiveness have underpinned sizable current account surpluses, which averaged 5.4% of GDP over the last 20 years. Although it remained high at 3.3% of GDP in 2017, the current account has experienced a gradual decline in the past decade, mirroring stronger domestic demand and a lower export market share. Over the same period, services exports and Sweden’s trade surplus have gained more relevance relative to goods, reflecting a more service-intensive economy. Sweden specialises in the fast-growing service sectors, including information technology, banking services, engineering and design services. A competitive effective exchange rate, strong external demand and solid merchanting flows will continue to support the external sector. Sweden’s net international investment position, which turned positive in 2016, stood at 18.4% of GDP in Q2 2018.

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 general elections in September were inconclusive. The so-called red-green bloc (Social Democratic Party, Green Party, and the Left Party) and the Alliance for Sweden political grouping (Moderate Party, the Centre Party, the People's Party Liberals, and the Christian Democrats) won 144 and 143 out of 349 seats, respectively. The anti-immigration Sweden Democrats obtained 62 seats and will most likely hold the balance of power.

The former minority government led by the Social Democratic Party will remain caretaker after losing a vote of no-confidence backed by the Alliance and the Sweden Democrats. Another minority government will most likely be formed requiring ad-hoc parliamentary support from external parties to legislate, although snap elections cannot be ruled out. Passing meaningful reforms could prove challenging for the next government. However, given the track record of consensual and predictable policies, DBRS does not expect the new government agenda to deviate substantially from a conservative fiscal policy.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. The main points discussed during the Rating Committee included Sweden’s economic performance, fiscal and debt metrics, banking system, housing market, macroprudential framework, and political environment.

KEY INDICATORS

Fiscal Balance (% GDP): 1.3 (2017); 1.0 (2018F); 0.8 (2019F)
Gross Debt (% GDP): 40.8 (2017); 37.9 (2018F); 34.5 (2019F)
Nominal GDP (EUR billions): 535.6 (2017); 554.7 (2018F); 563.2 (2019F)
GDP per Capita (EUR): 52,926 (2017); 53,866 (2018F); 54,137 (2019F)
Real GDP growth (%): 2.1 (2017); 2.4 (2018F); 2.2 (2019F)
Consumer Price Inflation (%): 1.9 (2017); 1.9 (2018F); 1.7 (2019F)
Domestic Credit (% GDP): 267.9 (2016); 271.7 (2017); 278.3 (Jun-2018)
Current Account (% GDP): 3.3 (2017); 2.6 (2018F); 2.8 (2019F)
International Investment Position (% GDP): 5.0 (2016); 11 (2017); 18.4 (Jun-2018)
Gross External Debt (% GDP): 176.5 (2016); 179.1 (2017); 189.4 (Jun-2018)
Governance Indicator (percentile rank): 96.2 (2017)
Human Development Index: 0.93 (2017)

Notes:

All figures are in Swedish kronor unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Ministry of Finance of the Kingdom of Sweden, Swedish National Debt Office, Sveriges Riksbank, Statistiska Centralbyran, Valueguard-KTH, National Institute of Economic Research, European Commission, Eurostat, OECD, IMF, World Bank, UNDP, Haver Analytics. DBRS 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.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS 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 twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS 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.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 17 April 2012
Last Rating Date: 4 May 2018

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