DBRS Confirms Switzerland at AAA, Trend Remains Stable

DBRS, Inc. (DBRS) has today confirmed the long-term foreign and local currency debt of the Swiss Confederation at AAA. The trend on both ratings is Stable. The ratings are underpinned by Switzerland’s highly competitive and broad-based economy, macroeconomic stability with low public debt and high savings. The Stable trend reflects Switzerland’s healthy fiscal position, strong external balances and moderate medium term growth outlook.

The Swiss economy has performed remarkably well despite headwinds posed by weak external demand and a strong Swiss franc. Exports have slowed markedly since mid-2011, but consumption and investment have shown resilience. Domestic demand expanded 2.5% in the first half of 2012, supported by low unemployment, healthy public and private sector balance sheets and expansionary monetary policy. The Swiss KOF Consensus Forecast points to GDP growth of 0.9% in 2012 and 1.3% in 2013.

Safe haven inflows as the Euro area crisis deepened in the summer of the 2011 led to a sharp appreciation of the Swiss franc. According to the Bank of International Settlements, the real effective exchange rate appreciated 19% in August 2011 from one year earlier, generating downside risks to growth and inflation. The Swiss National Bank responded by reducing interest rates to “as close to zero as possible”, increasing liquidity and, in September 2011, introducing an exchange rate floor of CHF 1.20 per euro. These measures have helped reduce recessionary and deflationary risks.

Switzerland’s ratings are underpinned by its open, highly competitive and prosperous economy. Exports of goods and services, which amounted to 50% of GDP in 2011, have become an increasingly important contributor to growth. Notwithstanding recent appreciation concerns, Switzerland has largely maintained its share of global trade over the last decade. Output per worker is on par with other advanced economies, although lower than the top performers, and the labor utilization rate is one of the highest in the world. As a result, Switzerland’s GDP per capita is only surpassed by Norway among OECD economies.

Switzerland’s public finances exited the global downturn in good financial health. The fiscal surplus widened modestly from 0.2% of GDP in 2010 to 0.4% in 2011, and the government estimates a surplus of 0.7% of GDP this year. The rules-based fiscal policy framework at the federal and cantonal level reinforces budgetary discipline while allowing automatic stabilizers to support the economy over the business cycle. As a result of sustained budgetary surpluses and moderate economic growth, general government debt declined from 53% of GDP in 2003 to 35% of GDP in 2011, one of the lowest debt burdens among the advanced economies.

With an efficient and flexible labor market, Switzerland has benefited from low unemployment and strong job creation. In July 2012 the unemployment rate was 2.9%, well below the Euro area rate of 11.3%. In addition, the effect of the 2009 recession on the labour market was relatively mild given the severity of the shock. Employment contracted 0.5% in 2009 but quickly recovered, expanding 1.9% in 2010 and 2.5% in 2011.

However, as a highly open economy with strong trade links to Europe and a very large financial sector, Switzerland is exposed to a further escalation of the euro area debt crisis. Nearly 60% of Swiss goods exports are destined for European markets, and although Swiss banks have modest exposure to Greece, Portugal, Ireland, Spain and Italy, spillover effects from renewed turbulence in international markets could lead to significant losses.

The prolonged period of accommodative monetary policy could also be facilitating the creation of domestic imbalances. Low interest rates and a competitive lending market have led to concerns of overheating in the mortgage and real estate markets. Housing prices have increased markedly in some regions and mortgage lending continues to expand at a strong pace. DBRS believes that the recent introduction of stricter capital requirements for mortgage assets and the potential activation of counter-cyclical capital buffers could help reduce risks associated with strong credit growth.

In addition, the capital leverage ratios of Switzerland’s big banks remain low compared to international peers. In September 2011, the Swiss parliament passed “too big to fail” legislation, which aims to address the systemic risks posed by UBS AG and Credit Suisse Group. The legislation requires that these institutions hold substantially more high quality capital in order to increase the loss-absorption capacity and reduce the likelihood of a potential failure. Since the onset of the global financial crisis, Swiss banks have strengthened their capital positions and improved their funding profiles. Specifically, UBS and Credit Suisse have reduced risk-weighted assets and increased common equity through retained earnings and equity offerings.

The expected increase in public spending stemming from an ageing population is a common concern among many advanced economies. Switzerland is in a comparatively good starting position, given its low public debt burden. However, pension, health, long-term care and education costs in Switzerland are expected to increase by approximately 3% of GDP by 2030. These projections are subject to considerable uncertainties but suggest that further parametric reforms could be needed to temper the rise in age-related expenditures, particularly if healthcare costs rise faster than anticipated or growth underperforms.

The financial and sovereign debt crisis in the euro area presents significant downside risks to the Swiss economy through trade and financial channels. Nevertheless, DBRS believes that Switzerland’s low public debt, healthy fiscal position, sound external balances and resilient labor market put the economy in a relatively strong position to weather future market volatility.

Note:
All figures are in Swiss francs (CHF) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the Swiss National Bank, FINMA, Federal Department of Finance, Federal Department of Economic Affairs, Swiss Statistics, Eurostat, IMF, OECD, AMECO, BIS and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 14 July 2011
Most Recent Rating Update: 14 July 2011

For additional information on this rating, please refer to the linking document under Related Research.