DBRS Confirms Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings GmbH (DBRS) confirmed the Kingdom of Denmark’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS confirmed the Kingdom of Denmark’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects Denmark’s strong fundamentals and DBRS’s view that the challenges Denmark faces are contained. After nine years of consecutive expansion, the economy continues to grow at a healthy pace and the labour market continues to perform robustly. The pressures in the housing market eased in 2018, as reflected in the marked deceleration in house price growth, especially for owner-occupied flats, likely affected by strong investment in dwellings and a number of measures aimed at the housing market and limiting risky mortgages. This helps mitigate the vulnerabilities stemming from the private sector, mainly related to high household debt.

The ratings are supported by Denmark’s strong external position, its sound public finances, its credible policy framework, and its wealthy and diversified economy. The predictable macroeconomic policy framework has underpinned the country’s economic stability for decades. Denmark’s strengths offset the credit challenges associated with an interconnected financial system, high levels of household debt, and potential pressures on the housing market. The interconnectedness between banks and the insurance sector and pension funds mainly results from mortgage banks’ financing of lending through mortgage covered bonds, in which insurance companies and pension funds invest. A shock to the financial system, including to the large covered bond market, could have an impact on the whole economy.

RATING DRIVERS

Given Denmark’s credit strengths, downward pressure on the ratings appears unlikely. Nevertheless, a severe shock to the economy, most likely generated by turmoil in financial markets, or a shock to Denmark’s mortgage covered bond market, which is pivotal for the Danish financial system, could pose a risk to the ratings. Either of these scenarios could weaken private sector balance sheets and have an adverse impact on the financial system and the overall economy.

RATING RATIONALE

Financial Stability Risks Remain Contained and Price Stability Maintained

Denmark’s financial sector is concentrated and interconnected, which could amplify shocks to the financial system and the economy. Seven systemically important financial institutions (SIFIs), including mortgage banks, account for close to 84% of total assets of the sector. Mortgage banks fully finance lending through mortgage covered bonds, in which the Danish insurance sector and pension funds invest. An important participant in financial markets, the Danish pension sector manages a large portion of households’ wealth, which is sizeable. Thus, a shock to the financial system, including to the mortgage covered bond market – the third largest in Europe – could have a significant impact on Denmark’s financially complex economy. Stress tests carried out by both the European Banking Authority and Danmarks Nationalbank (DNB), Denmark’s central bank, indicate that the country’s systemic banks have sufficient capital to withstand a severe recession.

The money laundering case in the Estonian branch of Denmark’s largest bank, Danske Bank, has raised concerns about financial supervision and the bank’s governance. Adverse market reaction has been limited so far, but the size of the potential fines that could result from the various ongoing investigations is uncertain. The Danish anti-money laundering (AML) rules are founded on the European AML directives and have been strengthened in recent years. Moreover, in response to the Danske case, the government has tightened the AML legislation further.

In the household sector, rising incomes have contributed to a lower household debt ratio in recent years. Still, household debt remains at the highest level among OECD countries, at 269% of disposable income (OECD) at end-2018. Moreover, around 55% of residential mortgages are at variable rates, exposing some households to increases in interest rates. Nevertheless, the share of fixed-rate mortgages is rising. Limits on deferred amortisation mortgages have been adopted, and mortgage interest deductibility, which acts as a tax incentive to accumulate debt, is being reduced. High debt ratios are concentrated in high-income households, and households’ net financial assets are sizeable, amounting to 328.7% of disposable income (OECD) at end-2018.

Since 2012, house prices have steadily recovered from the burst of the housing boom. The recovery has helped rebuild households’ net wealth. In particular, price growth for owner-occupied flats was strong in recent years, especially in the Copenhagen area. Last year, price growth decelerated significantly, in particular for owner-occupied flats, even contracting 2.1% yoy in March 2019. The deceleration appears to be partly driven by increased construction and new measures tightening lending conditions, especially for borrowers in growth areas. A new housing taxation system, which removes the 2001 tax freeze, is set to be implemented from 2021 and expected to have a stabilising effect on house prices.

Monetary policy in Denmark aims to ensure price stability through the Danish krone peg to the euro. The krone is allowed to fluctuate within a band around a central rate, with the DNB responding to changes. Policy interest rates are used to maintain the peg and normally track the European Central Bank (ECB) rates. As a result, the DNB lending rate and the certificates of deposit rate remain at very low levels. The annual inflation rate is expected to pick up gradually but to remain below 2% in coming years.

Denmark’s Economic Performance Remains Strong and Its External Sector Robust

The Danish economy, which is entering its tenth year of economic expansion this year, is expected to continue growing steadily in coming years. An improving labour market, with solid employment growth, has bolstered domestic demand in recent years, especially private consumption and investment. Following three years of strong growth at an annual average of 2.3%, GDP decelerated to 1.7% in 2018, mainly as a result of temporary factors affecting exports and agricultural production growth. In 2019, GDP growth is projected at 1.7%, driven by strong private consumption, supported by strong job creation and rising disposable incomes, and investment. The government projects annual average growth of 1.4% between 2020 and 2025, largely driven by domestic demand. The main risks to the downside could stem from weaker world trade, given Denmark’s large shipping sector, and tightness in the labour market that could constrain growth.

Denmark’s long-term prospects benefit from a diversified, competitive, and wealthy economy. Reforms of unemployment benefits and the pension system are increasing the structural level of labour supply and are expected to improve potential GDP growth. Denmark also remains an attractive destination for investment, ranking third in the 2018 World Bank’s Ease of Doing Business Index. Moreover, the resilience of its economy is underpinned by a high GNI per capita and high private sector savings. Denmark’s diversified and wealthy economy counterbalances its vulnerability to external shocks, given its small size and openness.

Denmark’s current account surplus and net external asset position remain large. The current account has averaged 6.9% of GDP over the past ten years, with the goods, services and primary income accounts remaining in surplus. The net international investment position, at 63.2% of GDP on average over the same period, is accounted for by the non-bank private sector. External trade competitiveness is expected to continue to support Danish export performance. Income from foreign direct investment and external financial assets is also expected to remain substantial.

Public Finances Remain Sound and the Political Environment Stable

Denmark’s sound fiscal position supports its fiscal flexibility. A prudent fiscal policy, supported by a robust framework, has ensured sufficient fiscal space to support the economy during downturns without leading to large imbalances. As the headline budget balance tends to be affected by one-off factors, fiscal targets are set based on the structural balance. According to Denmark’s Convergence Programme 2019, the structural balance (adjusted for volatile revenues from oil and gas and pension-yield taxes) is projected at -0.1% of GDP in 2019, within the statutory limit of -0.5%. The government projects the structural balance to average +0.2% between 2020 and 2025, under the no policy change assumption. Moreover, the long-term fiscal sustainability is supported by the 2011 retirement reform, which increased the statutory retirement age and reduced voluntary early retirement.

Denmark’s government debt ratio is also modest and one of the lowest in the European Union. The debt ratio, which stood at 33.8% of GDP at end-2018, is expected to remain flat until 2020. Afterwards, the government projects the debt ratio to increase to close to 38% of GDP by 2025, largely driven by the new financing model for social housing, where the government buys government-guaranteed bonds to fund social housing. Although this change will result in an increase in the EMU debt ratio towards 2025, the impact on the net debt ratio will remain unchanged because of the increase in the central government assets from the acquisition of a portfolio of government guaranteed bonds backed by real estate.

Denmark´s low levels of public debt and favourable debt profile support its resilience to shocks. Debt is entirely denominated in local currency, and about half of government bonds are held by the Danish insurance and pension sector. Danish government bond yields remain low, reflecting low policy interest rates and investor confidence in the Danish economic policy framework.

Denmark’s political environment and institutions are stable. General elections were held on June 5, 2019. The Social Democratic Party won the elections, obtaining 25.9% of the votes, closely followed by the Liberal Party of Denmark (Venstre), which obtained 23.4% of the votes. Independently of the electoral result, DBRS expects the next government to continue to implement prudent economic policies. Sound public finances, together with a strong external position, helps Denmark to maintain its long-standing fixed exchange rate policy. The predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades.

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 new financing model for social housing, monetary policy, financial stability risks, and the banking sector.

KEY INDICATORS

Fiscal Balance (% GDP): 0.5 (2018); -0.1 (2019F); -0.1 (2020F)
Gross Debt (% GDP): 34.1 (2018); 33.4 (2019F); 33.4 (2020F)
Nominal GDP (EUR billions): 297.6 (2018); 307.1 (2019F); 317.7 (2020F)
GDP per Capita (EUR): 51,369.5 (2018); 52,683.5 (2019F); 54,219.3 (2020F)
Real GDP growth (%): 1.4 (2018); 1.7 (2019F); 1.6 (2020F)
Consumer Price Inflation (%): 0.8 (2018); 1.5 (2019F); 1.8 (2020F)
Domestic Credit (% GDP): 227.3 (2017); 225.8 (2018)
Current Account (% GDP): 5.8 (2018); 5.6 (2019F); 5.1 (2020F)
International Investment Position (% GDP): 55.5 (2017); 63.2 (2018)
Gross External Debt (% GDP): 150.3 (2017); 138.9 (2018)
Governance Indicator (percentile rank): 95.7 (2017)
Human Development Index: 0.93 (2017)

Notes:

All figures are in Danish kroner (DKK) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. General Government Gross Debt is calculated on a Maastricht basis. Fiscal Balance (DSt/MoE), Gross Debt (DSt, Eurostat/MoE), Nominal GDP (EC), GDP per Capita (EC), Real GDP growth (DSt/MoE), Consumer Price Inflation (DSt/MoE), Domestic Credit (DNB/DSt), Current Account (DSt/MoE), International Investment Position (DSt), Gross External Debt (DNB/DSt). 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 Danmarks Nationalbank (DNB), Ministry for Economic Affairs and the Interior (MoE), Ministry of Finance of the Kingdom of Denmark, Danmarks Statistik (DSt), European Central Bank, 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 GmbH are subject to EU and US regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: September 20, 2012
Last Rating Date: December 14, 2018

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