DBRS Confirms Norway at AAA, Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Kingdom of Norway’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA and Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings remains Stable.

KEY RATING CONSIDERATIONS

Norway’s AAA ratings are underpinned by its high public-sector wealth, prudent management of its oil-related windfalls, strong external position and sound institutional framework. Norway faces some challenges, such as the accumulation of household debt, the country’s high reliance on the petroleum sector, and an ageing population. Nonetheless, the country is well equipped to deal with these challenges, and shocks could be absorbed by substantial buffers. The size of the Government Pension Fund Global (GPFG or the Fund), whose market value was equivalent to 293% of mainland GDP in June 2018, is a significant backstop. The country’s flexible exchange rate provides another important tool to absorb negative shocks.

The Stable trend reflects DBRS’s view that downward risks to the ratings are limited. Since 2017 economic activity has been buoyant following years of subdued performance. Real GDP growth in the mainland is expected to accelerate to 2.3% in 2018 compared with 2.0% recorded last year. Solid private consumption, higher exports and the recovery in oil-related investment are expected to support the overall GDP performance. House inflation, following a temporary drop in 2017, has resumed its growth at a more moderate rate. This to some extent reduces the risk of a sharp correction that could weigh on economic growth. Moreover, the banking system is well capitalized and the extension of the mortgage regulation in June this year bodes well for a continuation of stricter lending practices for high-risk mortgages.

RATING DRIVERS

Norway is firmly placed in the AAA rating category. Potential downward rating drivers include one or a combination of the following: (1) a worsening of financial conditions and medium-term growth prospects that is severe enough to materially affect Norway’s financial stability and fiscal position; and (2) a significant loosening of the government’s commitment to prudent fiscal policy.

RATING RATIONALE

Ratings Benefit from a Prudent Fiscal Management of Oil-Related Proceeds and a Strong Government Balance

Public finances benefit from a conservative management of oil sector revenues. Following the introduction of a fiscal rule in 2001, the government is responsible for transferring the State’s net cash inflow from the petroleum industry to the GPFG, and over time only the expected real return of the Fund can be allocated to finance the non-oil deficit. This aims to preserve the real value of the Fund for the benefit of future generations and to isolate the government’s budget from volatility in petroleum revenues. However, given the size of the Fund, fluctuation in its value may become a larger source of volatility. This also because of the the asset allocation which is predominantly in equity and it is expected to increase to 70% from 68% as of end September 2018. Last year, the government revised the expected annual real rate of return of the Fund to 3% from 4%, driven by expected lower international interest rates. This is expected to result into less room for expenditure from the Fund going forward.

With the economy recovering since 2017, the government has opted for a more conservative fiscal stance over the last few years. The fiscal impulse, measured by the increase in the structural non-oil deficit as a share of the trend mainland GDP, has declined from 0.7 percentage points registered on average from 2014 to 2016 to around -0.1 percentage points estimated for 2018. A broadly neutral stance is also expected in 2019, when the government will spend petroleum revenues amounting to only 2.7% of the Fund, below the 3% annual real rate of return of GPFG.

Norway’s ratings benefit from a strong fiscal position which including net surpluses from oil activities and from the GPFG is very sizeable (6% of GDP on average over the last four years). However, in the medium- to long-term, an ageing population will start to put pressure on public finances. A sharp rise in age-related spending is expected to begin in ten to fifteen years. This will occur at the same time as the returns from the Fund measured as a share of mainland GDP are expected to drop. In this context, Norway would benefit from rebalancing its economic growth model in order to be less reliant on the oil sector as well as continuing to implement structural reforms to increase the labour participation rate, while maintaining conservative fiscal management. The government aims to make the public sector more efficient and the recent agreement on public sector occupational pension reform is an important step to incentivize civil servants to stay longer at work before retiring.

The government’s robust balance sheet is a key strength for DBRS’s ratings. The government’s net asset position reached 308.4% of whole economy GDP in 2017, which is very strong compared with other AAA-rated sovereigns and is largely explained by the sovereign wealth fund. DBRS expects the gross general government debt ratio to hover around 36% of GDP in coming years. In the event of a negative shock, net rather than gross government debt is most likely to be affected. This is related to the fact that fiscal stimulus, taking the form of a higher non-oil fiscal budget deficit, could be financed by higher transfers from the GPFG, as debt issuance is destined to finance capital transactions. Thereby, given the fiscal guidelines and the government’s asset position, gross government debt is generally insulated from negative shocks.

Economic Recovery Gains Momentum but Household Debt Makes the Country Vulnerable to Shocks

This year, economic growth for the mainland is projected to accelerate to around 2.3% compared with 2.0% in 2017. The main driver will be consumption which should more than compensate for the negative contribution of housing investment. While the former is supported by an improvement in the labour market, the latter is correcting following previous record growth levels, in combination with a high supply of new dwellings and a slowdown in population growth because of lower immigration. At the same time, petroleum investments, which have been a significant drag on mainland growth between 2014 and 2017, is projected to contribute positively to the growth in 2018. This is because of the recovery in oil prices from 2016 lows and significant cost-cutting efforts. Despite a brighter outlook for economic growth, which is projected to remain at around 2.4% for the mainland in the period 2019-2020, a severe contraction in the housing market could have a negative impact on the economy. Moreover, intensifying geopolitical risks and inward trade policies might result in a slowdown of global growth, containing Norway’s economic performance.

Financial imbalances have built up in the context of overvalued house prices and increasing household debt. Since 2000 house prices have increased substantially fueled by a prolonged accommodative monetary policy, high immigration and supply constraints. Recent developments have showed a moderation reflecting a temporary correction between Spring 2017 to April 2018, and a slow recovery over the past few months. According to Real Estate of Norway, home prices are now growing at around 2.7% year-on-year as of September 2018, below the average pace recorded in the period 2015-2017 (7.2%).

Against this background, according to Statistics of Norway, the household debt-to-disposable income ratio continues to grow and at 242.6% as of Q2 2018 renders the households vulnerable to shocks. Given that a significant portion of mortgage loans have variable interest rates, households are particularly exposed to rising rates. The Norges Bank raised its policy rate from 0.5% to 0.75% in September 2018. Going forward, although the national bank is expected to gradual increase further its policy rate achieving a level close to 2% by 2021, a faster tightening may materially reduce household consumption. According to studies by Norges Bank, for a 1% increase in the mortgage interest rate the reduction in consumption could be around 0.4%. In this context, financial vigilance has resulted in a series of banking regulatory measures and macro-prudential policies to contain risks, including a debt-to-income ratio ceiling at 500% of borrowers’ income. However, more measures may be needed in the future, including the reduction in tax incentives for home ownership to continue to reduce vulnerabilities in the housing market.

Against this background, banks’ low loan losses and strong capital buffers mitigate the risks to financial stability. Asset quality remains very strong, with non-performing loans (NPLs) as a share of total gross loans at 1.3% in Q2 2018, one of the lowest in Europe. Moreover, the average Common Equity Tier 1 (CET1) capital ratio at around 15.5% at end-June this year among large Norwegian banks is double the rate it was during the financial crisis.

Strong External Position Provides a Significant Buffer to Absorb External Shocks

Norway’s strong external position provides significant buffers to weather external shocks. The country’s net international investment asset position stood at 209.6% of GDP as of Q2 2018. The public sector, through the GPFG, is the main contributor to Norway’s net creditor position. On the other hand, the private sector is a net debtor to the rest of the world. The banking sector’s external debt stood at 89.9% of GDP as of Q2 2018, stemming from its reliance on foreign funding. Nonetheless, the overall economy has ample room to maneuver in the case of a temporary disruption in liquidity conditions. Moreover, Norway continues to record robust current account surpluses averaging 7.7% of GDP a year over the last five years.

A Predictable Policy Framework Supports the Ratings

Norway benefits from strong political institutions with a well-established track record of a consensus-based approach to macroeconomic policy. This is conducive to a stable and predictable policy framework. DBRS expects a continuation of policy making despite the current coalition government, comprising the Conservatives, the Progress Party and the Liberals, is 5 seats short of the majority in the parliament. This means that it has to rely on the external support of the Christian Democrats, which to some extent could delay implementation of the reforms. In this context, in DBRS’s view, high tensions between and within parties, especially on immigration as demonstrated by the resignation of the Justice Minister in March, are likely to persist. Nonetheless, DBRS does not expect these tensions to have a significant impact on the fiscal stance.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. The main points discussed during the Rating Committee include: Household debt, macro prudential policies, fiscal space, and the Government Pension Fund Global.

KEY INDICATORS

Fiscal Balance (% GDP): 4.4 (2017); 5.7 (2018F); 5.7 (2019F)
Gross Debt (% GDP): 36.5 (2017); 36.4 (2018F); 36.4 (2019F)
Nominal GDP (USD billions): 398.8 (2017); 441.4 (2018F); 448.5 (2019F)
GDP per Capita (USD): 75,643 (2017); 79,156 (2018F); 79,729 (2019F)
Real GDP growth (%): 1.9 (2017); 2.1 (2018F); 2.1 (2019F)
Consumer Price Inflation (%): 1.8 (2017); 2.8 (2018F); 1.7 (2019F)
Domestic Credit (% GDP): 107.0 (2016); 106.1 (2017); 106.6 (Jun-2018)
Current Account (% GDP): 5.6 (2017); 8.7 (2018E); 9.1 (2019F)
International Investment Position (% GDP): 203.8 (2016); 220.3 (2017); 209.6 (Jun-2018)
Gross External Debt (% GDP): 169.8 (2016); 162.1 (2017); 153.4 (Jun-2018)
Governance Indicator (percentile rank): 98.6 (2016); 99.0 (2017)
Human Development Index: 0.95 (2015); 95.1 (2016); 95.3 (2017)

Notes:

All figures are in Norwegian krone (NOK) 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 the Ministry of Finance of Norway, Norges Bank, Statistics Norway, the Financial Supervisory Authority of Norway, Real Estate Norway, Norges Bank Investment Management, 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: Carlo Capuano, Assistant Vice President – Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Senior Vice President, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 21 March 2012
Last Rating Date: 27 April 2018

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