DBRS Confirms Kingdom of Norway at AAA, Stable Trend

DBRS, Inc. (DBRS) confirmed the Kingdom of Norway’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS confirmed the Kingdom of Norway’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is 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. Despite these strengths, Norway faces structural challenges, such as the country’s high reliance on the petroleum sector, an ageing population and high levels of household debt. However, Norway has substantial buffers to absorb shocks and is well positioned to deal with these challenges. A significant backstop is the Government Pension Fund Global (GPFG), that had a market value equivalent to 290% of mainland GDP in December 2018. 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. Mainland GDP growth, which excludes petroleum production and shipping, remains buoyant and is expected to rise further to 2.7% this year from 2.5% in 2018. This is on the back of solid private consumption, higher exports, and the recovery in oil-related investments. Following a temporary correction between November 2017 and April 2018, house prices are rising, albeit moderately. Despite the elevated and growing level of household debt, stricter lending practices and a well-capitalized banking system mitigate the risks stemming from the vulnerabilities of the housing market. Nonetheless, strong growth, rising house prices, and higher employment levels have prompted a gradual tightening in economic policy: Norges Bank increased its benchmark policy rate to 1% in March 2019 and the government adopted a neutral fiscal policy stance for 2019.

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

Prudent Management of Oil-Related Proceeds and a Solid Fiscal Framework

Norway’s ratings benefit from a prudent management of oil-related proceeds. In addition, its solid fiscal framework and the public sector’s sizable net creditor position provide the government with significant fiscal space to implement counter-cyclical policies and support the ratings. 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 (receipts from the sale of oil reserves and oil taxes) to the sovereign wealth fund, the Government Pension Fund Global (GPFG or the Fund), which are invested abroad. The fiscal rule stipulates that transfers back from the fund to finance the non-oil deficit shall over time equal the expected real return of the Fund, estimated at 3%. 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. The Fund has grown from NOK 2.275 trillion in 2008 to NOK 8.256 trillion in 2018, or about 290% of mainland GDP. However, a financial market shock, if unaccompanied by a depreciation in the Norwegian krone, may become a larger source of volatility than oil prices, given the size of the fund and its 70% allocation in equities.

Following an expansionary fiscal policy during the years of declining oil prices (2014 -2016), the government moved to a near-neutral fiscal stance in 2017 and 2018. This was reflected in the fiscal impulse (measured by the increase in the structural non-oil deficit as a share of the trend mainland GDP) declining from an average of 0.7% between 2014 and 2016 to 0.2% in 2017 and -0.1% in 2018. With economic growth forecast to be above the long-term trend and unemployment rates declining further, the 2019 budget has proposed a neutral stance. This implies that the government will spend petroleum revenues amounting to only 2.7% of the Fund, below the 3% annual real rate of return of GPFG.

While fiscal surpluses have averaged 6% of GDP over the last few years, fiscal room for maneuvering will likely become smaller over the medium- to long-term. The steady decline in the importance of the oil sector, lower expected returns from the Fund (as a share of mainland GDP), and an ageing population will reduce the available fiscal space compared with the present. The government expects a funding gap equivalent to 1.7% of mainland GDP per decade between 2030 and 2060 and is assessing potential measures that could be implemented to address this funding gap. The reform of the National Insurance System and the alignment of the public sector occupational pension scheme with that of the private scheme is an important step to incentivize civil servants to delay retirement.

Strong Balance Sheet Underpins Norway’s Creditworthiness

The government’s robust balance sheet is a key strength for DBRS’s ratings with its financial assets far exceeding total debt. The government’s net asset position reached 308.4% of whole economy GDP in 2018, which is very strong compared with other AAA-rated sovereigns. This is largely explained by the sovereign wealth fund whose market value was equivalent to 290% of mainland GDP at the end of 2018.

In most countries, the main purpose of government borrowing is to finance a budget deficit. In Norway, the non-oil budget deficit is covered by transfers from the GPFG and therefore does not trigger any borrowing requirement. However, the government borrows in NOK to fund government lending schemes, cover redemptions of existing debt and to ensure a well-functioning financial market in Norway. DBRS expects the gross general government debt ratio to hover around 30% 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. Thus, given the fiscal guidelines and the government’s asset position, gross government debt is generally insulated from negative shocks.

Economic Recovery Gains Momentum but Long-Term Challenges Remain

Norway’s wealthy, stable economy and balanced income distribution support its AAA ratings. Thanks to counter-cyclical policies, the mainland economy (excluding petroleum production and shipping) has proven resilient to a material downturn in oil prices with growth averaging 2.6% during the last two decades. Mainland GDP growth in 2019 is forecast to be above the long-term trend at 2.7%. Consumption is the main driver supported by an improvement in labor market in the form of higher employment and higher wage growth. This should more than compensate for the negative contribution of housing investment, following previous periods of record growth levels. At the same time, due to the recovery in oil prices and cost-cutting efforts, petroleum investments, which had been a significant drag on mainland growth between 2014 and 2017, is likely to continue to contribute to growth. However, a more severe downturn in the housing market could have a negative impact on the economy in particular if households were to cut their consumption. In addition, geopolitical risks and inward-looking trade policies might result in a slowdown of global growth, containing Norway’s economic performance. Over the medium- to long-term, the main challenge for the Norwegian economy will be to successfully shift resources from an oil-dependent economy towards other tradable sectors or exports of oil-related goods and services.

High Household Debt Raises Financial Stability Risks, But the Banking Sector Continues to Strengthen Buffers

One of the key challenges facing Norway are the financial imbalances that have built up as housing prices and household debt have outpaced disposable income growth. Since 2000, house prices have more than doubled fueled by a prolonged accommodative monetary policy, high immigration, and supply constraints. Following a temporary correction between November 2017 and April 2018, house prices are once again on a rising trend, albeit moderately. According to Real Estate of Norway, home prices have increased on average by 2.4% since May 2018 to March 2019, lower than the 7.2% average pace recorded during 2015-2017. Household indebtedness in Norway is high on a comparative and historical basis and continues to increase. Statistics Norway estimates the household debt-to-disposable income ratio at 230% in Q4 2018, predominantly concentrated in mortgages.

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 five times borrowers’ annual 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: the Norwegian banking sector has one of the lowest ratios of non-performing loans (NPLs) as a share of total gross loans at 1.5% in Q4 2018.

While the household debt to disposable income ratio has stabilized at around 230% over the last year, the high ratio renders households vulnerable to various shocks (i.e., income, interest or house prices). Given that a significant portion of mortgage loans have variable interest rates, households are particularly exposed to rising rates. The stronger than expected upturn in the economy, resulted in Norges Bank raising its policy rate from 0.75% to 1.00% in March 2019. Going forward, although the central bank is expected to gradually increase its policy rate to 1.75% by 2022, a faster tightening may materially reduce household consumption. According to studies by Norges Bank, a 1% increase in the mortgage interest rate could reduce consumption by around 0.4%.

Similar to its Nordic peers, Norwegian banks rely heavily on wholesale and short-term foreign funding. At the end of 2018, the wholesale funding ratio stood at 49.1%, with over half denominated in foreign currency. However, the banks have built significant liquidity buffers in recent years which amply meet the liquidity coverage ratio requirement and strengthen their ability to cope with liquidity and exchange rate risks. The banking sector’s Tier 1 capital ratio stood at 17.6% and average Common Equity Tier 1 (CET1) capital ratio at 16.1% on December 2018, almost double the rate during the financial crisis.

Strong External Position Provides a Significant Buffer to Absorb Shocks

Norway’s strong external position provides significant buffers to weather external shocks. Largely explained by public-sector savings that have been invested overseas through the GPFG, the country accumulated 199.2% of GDP in net financial assets at YE2018. Ownership of such a large stock of net financial assets reduces Norway’s dependence on foreign capital flows and provides a sizable source of income. 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 88.8% of GDP as of Q3 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 7.2% 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. The center-right coalition of PM Solberg comprising the Conservatives, the Progress Party and the Liberals which has been in power since 2013 was reelected for another four years in September 2017. Following two cabinet reshuffles due to contentious issues – immigration and climate change, earlier this year, PM Solberg struck a deal to form a center-right majority government by adding the Christian Democratic Party to the minority three-party coalition. This could provide further stability and continue with policies aimed at Norway remaining a dynamic economy.

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 and the fiscal space in context with the Government Pension Fund.

KEY INDICATORS

Fiscal Balance (% GDP): 7.5 (2018); 7.5 (2019F); 7.2 (2020F)
Gross Debt (% GDP): 36.7 (2018); 36.7 (2019F); 36.7 (2020F)
Nominal GDP (USD billions): 434.9 (2018); 427.0 (2019F); 438.6 (2020F)
GDP per Capita (USD): 81,767 (2018); 79,733 (2019F); 81,407 (2020F)
Real GDP growth (%): 1.7 (2018); 1.9 (2019F); 1.9 (2020F)
Mainland GDP growth (%): 2.5 (2018); 2.7 (2019F); 1.8 (2020F)
Consumer Price Inflation (%): 2.7 (2018); 2.3 (2019F); 2.0 (2020F)
Domestic Credit (% GDP): 151.0 (2017); 146.7 (2018)
Current Account (% GDP): 5.6 (2017); 8.0 (2018); 7.4 (2019F)
International Investment Position (% GDP): 219.6 (2017); 198.5 (2018)
Gross External Debt (% GDP): 162.0 (2017); 150.0 (2018)
Governance Indicator (percentile rank): 98.6 (2016); 99.0 (2017)
Human Development Index: 0.951 (2016); 0.953 (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 primary 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, Norges Bank Investment Management, Norsk Forbund for Innkjop og Logistikk/Danske Bank, TNS Gallup, UN, IMF, BIS, Energy Information Administration, Real Estate Norway, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was 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 rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on 26 October 2018.

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 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

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: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 21 March 2012

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