DBRS Confirms AAA Rating to Sweden, Trend Stable

DBRS Ratings Limited (DBRS) has today confirmed the long-term, foreign and local currency issuer rating of the Kingdom of Sweden at AAA, with Stable trends. DBRS has also confirmed the short-term, foreign and local currency ratings at R-1 (high), also with Stable trends. The ratings reflect Sweden’s strong fiscal position, resilient economy, strong external accounts and credible institutional framework. The confirmation of the Stable trend on all ratings is motivated by DBRS’s view that the challenges faced by the country are manageable and are being addressed proactively.

Over the past decade, Sweden has built a strong fiscal position which resulted in average annual fiscal surpluses equivalent to 1.2% of GDP between 2000 and 2008. Going forward, and consistent with the adoption of a countercyclical fiscal stance, the government has adopted expansionary fiscal policies that will likely generate small deficits of 1.6% and 1% of GDP in 2013 and 2014. The transparency and stability of the country’s fiscal framework contribute to preserve the credibility of the sovereign in the current adverse economic environment.

Sweden’s economic performance in the past decade was solid, with annual real GDP growth averaging 2.4% between 2000 and 2012, well above the EU average of 1.5% in the period. Balanced income growth, with wages and profits up more than 50% between 2000 and 2012, led the private sector to accumulate a stock of financial surpluses that was worth 10% of GDP in 2012. Further sustaining economic growth, the country’s external position improved markedly, with the current account surplus averaging 7% of GDP between 2000 and 2012. In the current adverse environment, Sweden is outperforming its peers, with GDP growing 0.8% in 2012 and expected to expand 1.5% in 2013.

Going forward, GDP growth in Sweden is likely to be driven primarily by domestic demand, which is expected to contribute roughly 90% to real growth in 2013 and 2014 in the wake of higher private and public consumption (expected to grow at annual rate of 1.8% and 1.1% in 2013, respectively) as well as rising investment (1.4% annual growth expected in 2013).The contribution of net exports to growth is expected to stabilise or fall moderately as domestic demand gains momentum and a stronger Swedish krona (SEK) puts pressure on exports. Further intensification of the Euro area sovereign crisis would, however, pose downside risks to the macroeconomic outlook for Sweden.

Despite these strengths, Sweden faces some important challenges. In particular, the country’s domestic banking sector is comparatively large at approximately 400% of GDP in 2012 and highly reliant on the wholesale market for funds, especially in foreign currency. Liquidity is the main weakness of the banking system, with estimated Net Stable Funding Ratios being still below the minimum 100% threshold recommended under Basel III. DBRS also notes that the high capitalisation of the major Swedish banks (approximately 16% Core Tier 1 ratio under Basel II) is affected by the comparatively benign risk weights applied on mortgages. In addition, DBRS believes that that the linkages between banks and the sovereign increased in 2012-13, as an additional SEK100 billion worth of foreign currency is being borrowed by the government to increase the Central Bank’s stock of foreign currency reserves. This process, known as on-lending, aims at setting aside emergency liquidity to cover potential foreign currency funding needs of domestic banks. DBRS identifies as mitigating factors the presence of a deep covered bond market which provides an alternative source of liquidity for the country’s banks’ as well as the resilience of the banking industry demonstrated through the financial crisis, together with continued underlying profitability and record-low loan losses.

Sweden’s moderate stock of government debt, at 38.2% of GDP in 2012, is expected to peak at 42.0% in 2013 as a result of deficit spending and the on-lending to the Central Bank. DBRS notes that the maturity structure gives rise to frontloaded refinancing needs, with 50% of the debt set to expire within the next three years, and 90% by 2023. The maturity of the debt stock is 5.4 years for local currency-denominated debt, and 2.3 years for foreign currency debt, which accounts for 20% of the total. While the Swedish krona is the world’s tenth most traded currency, the relatively short-term structure could make the government debt vulnerable to a deterioration in market sentiment.

A third underlying risk to the Swedish economy is the high level of debt overhang of the Swedish private sector (equivalent to 253% of GDP in 2012, vs. an EU average of approximately 160%). High private debt is partly the result of comparatively soft lending criteria in the mortgage market. This debt burden exposes the private sector to rising debt servicing costs, and the prolonged low-inflation and low-interest-rate environment could reduce borrowers’ incentives to deleverage. A high and rising unemployment rate, at 8.7% in April, could add pressure to the debt servicing capacity of certain segments of the population.

However, DBRS takes comfort in Sweden’s sound macroeconomic environment which has so far prevented the accumulation of major imbalances. In particular, and despite strong growth over the last 20 years, house prices appear to have moved broadly in line with fundamentals. Moreover, DBRS believes that strong public finances would enable the sovereign to intervene in a stress scenario, albeit at the price of a rising debt stock. In addition, DBRS acknowledges the considerable effort made by Swedish authorities in strengthening the country’s financial system, as well as their recognition that an effective macroprudential policy framework has to be quickly developed to prevent episodes of financial instability.

The Stable trend on the Kingdom of Sweden’s ratings reflects DBRS’s expectation that the ratings will be supported by the country’s track record of political stability, fiscal and monetary flexibility, competitive economy and solid external position. Downside pressure on the ratings could arise if severe episodes of market distress were to lead to a materially higher debt stock, sudden stops of capital inflows and rapidly rising borrowing costs.

Notes:
All figures are in Swedish Krona (SEK) unless otherwise noted.

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

The sources of information used for this rating include the Swedish Ministry of Finance, Sveriges Riksbank, the Swedish National Debt Office, Statistics Sweden, the European Commission, Eurostat, IMF 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 rating. This credit rating was not initiated at the request of the issuer.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 17 April 2012
Most Recent Rating Update: 16 November 2012

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