DBRS Confirms Switzerland at AAA, Stable Trend

DBRS, Inc. (DBRS) confirmed the Swiss Confederation’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA and its 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 the strong fundamentals of the Swiss economy, its soundly-managed public finances, and its institutional strength. The Swiss economy continues to grow at a moderate pace despite a challenging outlook. Fiscal policy remains highly disciplined and general government debt continues to shrink relative to GDP. While the implementation of the tax reforms will result in the Swiss Confederation incurring a short-term reduction in receipts, these reforms will ensure that Switzerland’s international competitiveness is maintained. The recent appreciation of the euro has eased some of the pressure on the Swiss franc, though inflation remains low. Housing price pressures remain a concern, but financial risks appear well contained.

In DBRS’s assessment, Switzerland’s strong credit fundamentals are underpinned by its economic resilience, high levels of productivity, and wealth. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Sound fiscal management remains another key credit strength. The federal government’s fiscal policy framework remains conservative with the general government posting a surplus of 0.6% of GDP and the debt ratio declining to 28.1% of GDP in 2018. Despite these strengths, Switzerland faces some medium-term challenges. These include uncertainties surrounding the outcome of negotiations with the EU to establish an institutional agreement, aimed at ensuring a more uniform and efficient application of existing and future market access agreements. U.S. tax reform and potential changes to tax policy in Europe may have an impact on multinational corporations domiciling in Switzerland. Financial risks could increase in the event of a shock to domestic housing prices. Similar to other advanced economics, demographics could hold back potential growth and affect fiscal dynamics in the medium term.

RATING DRIVERS

DBRS considers the likelihood of downward pressure on Switzerland’s ratings to be low. Nonetheless, a sustained deterioration in growth prospects combined with a serious erosion in fiscal discipline could put downward pressure on the ratings. Alternatively, external shocks or a significant decline in domestic real estate prices could potentially expose the sovereign balance sheet to increased contingent liability risks.

RATING RATIONALE

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

Switzerland’s strong fiscal position is reflected in consistent modest surpluses and a declining debt-GDP ratio. The country benefits from a robust and transparent federal fiscal framework and has demonstrated a commitment to structurally balanced budgets. The debt brake, introduced in 2003, ties spending to cyclically-adjusted revenues and saves any surplus, helping to ensure that fiscal policy is balanced over the business cycle. While much of government spending is executed at the sub-sovereign level (federal spending accounts for only 32% of general government expenditure), cantons also have a demonstrated track record of prudence. At present, a modest fiscal surplus (0.3% of GDP) is expected to persist through the government’s budget forecast horizon.

The federal government debt to GDP ratio is one of the lowest among advanced economies and well below the euro area average. General government gross debt has steadily declined over the past decade from 45.9% of GDP in 2008 to 40.2% in 2018 according to the IMF (33.5% to 28.1%, per the Maastricht definition), while federal government debt fell from 19.2% in 2007 to 14.5% in 2017. The government’s debt maturity structure is favorable, with debt issued in local currency. Nominal yields on government debt are negative out to 13 years, enabling the government to enjoy projected negative real yields on its entire debt stock. Interest expenditures for the general government, as estimated by the IMF, were less than 0.2% of GDP in 2017 and at very low fixed interest rates. Because of this modest debt burden and the strong commitment to fiscal discipline, the downward trend in Switzerland’s general government debt ratio is resilient to a variety of negative shocks.

Strong Economic Fundamentals; Tax Reforms to Preserve Switzerland as an Investment Destination

Switzerland’s ratings are underpinned by its wealthy and diversified economy, its strong public institutions, and the country’s financing flexibility. The economy consistently ranks highly in international comparisons; GDP per capita currently stands at US$83,583 and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland’s high levels of educational attainment and the almost 80% labor force participation rate. Swiss economic growth has historically outperformed the euro area and did so again in 2018, following a few years of subpar growth in the wake of the SNB’s January 2015 decision to allow the franc to appreciate. The forecasts for 2019 and beyond are in line with the EA average, underpinned by low unemployment (2.6%) and rising net wealth.

Following the rejection of an earlier proposal of corporate tax reforms by a referendum in 2017, on September 28, 2018 the Swiss parliament passed the Federal Act on Tax Reform and AHV Financing (TRAF). The new law largely eliminates preferential income tax rules benefiting multinational corporations at the canton level, seeking to satisfy EU and OECD concerns, while preserving Switzerland’s attractiveness as an investment destination. TRAF also incorporates pension reforms which accounts for supplementary AHV financing through a 0.3% increase in social security contributions. To ensure that the reform burden will be distributed equally between the levels of government, TRAF proposes to raise the cantons' share of direct federal tax revenue to 21.2% from 17%. Assuming voters approve the May 19, 2019 referendum on corporate tax reforms, overall fiscal balances could deteriorate marginally as the law is to enter into force on January 1, 2020. However, the reform would likely be supportive of medium-term growth prospects, and DBRS believes the compensating revenue and expenditure adjustments will be manageable for the confederation.

Effective Monetary Policy; Mortgage Lending Stresses Well Contained

Switzerland’s highly open economy and historical status as a financial center are important sources of growth and prosperity for the country. Monetary policy is focused on price stability, (defined as a rise in the price index of less than 2% per year), a medium-term inflation forecast, and a target range for interest rates. Following the financial market turmoil, the SNB introduced its exchange-rate ceiling at 1.2 vis-à-vis the Euro in 2011. However, to avoid further reserve accumulation and take advantage of the strengthening dollar, it abandoned the ceiling in January 2015 and lowered deposit rates into negative territory, to -0.75%, and reduced the target range for the three-month Libor to -1.25% and -0.25%. In its December 2018 policy assessment, the SNB remained concerned on low inflation (lowering its inflation forecast to 0.5% in 2019 and 1% in 2020), and the appreciation pressure on the franc thereby maintaining its highly accommodative stance. While Switzerland has experienced three bouts of deflation in 2009, 2012/13 and 2015/16 in the last decade due to weak global growth, volatile oil prices and the steady upward pressures on the franc, deflationary pressures have been mild and have not extended to domestic asset prices.

The Swiss financial sector could be a potential source of vulnerability due to its size and level of concentration, though DBRS believes this to be unlikely. Property prices and mortgage lending stabilized following the introduction of macro-prudential measures during 2012-2014, but have risen again due to moderating interest rates. As of end-2017, household debt stood at 129.3% of GDP, with mortgage debt representing 93.4% of total household financial liabilities. However, while newer vintage mortgages have high loan-to-value ratios, with nearly half exceeding affordability thresholds, population growth has been strong and standard housing-price metrics do not indicate significant misalignment. In addition, the increase in capital and liquidity buffers (particularly the increase in the countercyclical capital buffer to 2%) have helped to reduce risks in the housing market. Consequently, DBRS views risks stemming from potential housing market stresses as well contained and the sovereign ratings are unlikely to come under pressure.

Persistent Current Account Surpluses and Net Creditor Position Reflect Strong External Accounts
Switzerland’s external accounts remain a key source of strength, characterized by a structural current account surplus and a positive net creditor position. The persistent current account surpluses averaging 10% of GDP over the last two decades are a reflection of its role as a financial center, an attractive location for corporations and Switzerland’s high per-capita prime saver population. Over the last decade, the Swiss National Bank accumulated over CHF784 billion (US$803 billion) in foreign exchange reserves, which have reached approximately 116% of GDP as of end-2018. Accumulation of net savings and official foreign exchange reserves have resulted in a positive net creditor position of 135.1% of GDP as of June 2018.

Strong Institutions and Stable Politics

Switzerland’s political environment is characterized by its federal democratic system, high institutional capacity and low level of corruption. Stable politics combined with neutrality in international conflicts have long made Switzerland a safe haven for investors. The Federal Council, Switzerland’s executive body, is a collective presidency comprised of seven members. Combined with a bicameral legislature and multiparty system, political decisions require a broad degree of consensus. The system is highly deliberative and allows for frequent popular referenda on important issues. Thus far, however, Swiss voters have displayed pragmatism by rejecting some of the most radical policy proposals. Furthermore, Switzerland has found ways to implement the results of some potentially problematic popular initiatives while preserving sound policies and meeting key international commitments.

Switzerland is not a member of the European Economic Area. Relations with the EU are based on a network of agreements made up of 20 main agreements and more than 100 other agreements ensuring, among other things, access to the EU’s single market. In the recent past, relations with the EU have been affected by concerns over Switzerland’s corporate tax regimes, banking secrecy laws, and immigration quotas. Consequently, Switzerland and the EU are in the process of negotiating an agreement on institutional matters, aimed at ensuring a more uniform and efficient application of existing and future market access agreements. This is important, as 53% of Switzerland’s exports go the EU and about 71% of all its imports come from the EU. Noting the outcome of the negotiations, the Federal Council on 7 January, 2019 instructed the Federal Department of Foreign Affairs together with the Federal Department of Economic Affairs, Education and Research and the President of the Swiss Confederation to conduct a series of consultations on the draft agreement with the main stakeholders, including all political parties and the social partners. The results of the consultation will be presented to the Federal Council in the spring of 2019, after which it will then decide on the next steps.

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 the economic outlook; inflation; housing prices; financial risks; potential implications of tax policy changes.

KEY INDICATORS

Fiscal Balance (% GDP): 1.3 (2017); 0.3 (2018E); 0.2 (2019F)
Gross Debt (% GDP): 29.5 (2017); 28.1 (2018E); 27.2 (2019F)
Nominal GDP (CHF billions): 668.6 (2017); 692.4 (2018E); 712.1 (2019F)
GDP per Capita (CHF): 78,957(2017); 80,838 (2018E); 82,199 (2019F)
Real GDP growth (%): 1.7 (2017); 3.0 (2018E); 2.3 (2019F)
Consumer Price Inflation (%): 0.5 (2017); 1.1 (2018); 1.4 (2019F)
Domestic Credit (% GDP): 258.5 (2017)
Current Account (% GDP): 6.7 (2017); 10.2 (2018F); 9.8 (2019F)
International Investment Position (% GDP): 126.8 (2017); 135.1 (Jun-2018)
Gross External Debt (% GDP): 280.1 (2017); 268.5 (Sept-2018)
Governance Indicator (percentile rank): 99.5 (2017)
Human Development Index: 0.94 (2017)

Notes:
All figures are in Swiss Franc (CHF) 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 primary sources of information used for this rating include Federal Department of Finance, Swiss National Bank, Swiss Federal Statistical Office, State Secretariat for Economic Affairs, OECD, IMF, European Commission, UNDP, World Bank and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

Solely with respect to ESMA regulations in the European Union, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

This rating includes 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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS’s outlooks and ratings are monitored.

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.

Lead Analyst: Rohini Malkani, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: July 14, 2011
Last Rating Date: January 31, 2018

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