DBRS Confirms the Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings Limited (DBRS) has today confirmed the long-term foreign and local currency ratings on the Kingdom of Denmark (Denmark or the country) at AAA. DBRS also confirmed the short-term foreign and local currency rating at R-1 (high). The trend on all ratings is Stable, reflecting DBRS’s baseline scenario in which the country’s credit metrics remain comparatively strong.

The ratings reflect the structurally sound condition of Denmark’s public finances, characterised by contained deficits, moderate debt burden and by a track record of commitment to prudent administration of public finances based on strong political consensus. Other key factors underpinning the ratings are the country’s persistent current account surplus, a wealthy and resilient economy as well as transparent and credible institutions. The main challenges faced by the country relate to its financial sector that remains in recovery mode and vulnerable to shocks. Secondly, tight links between Denmark and the euro area have the potential to negatively affect the country via the trade and policy channel. Finally, domestic demand is still weak and it remains unclear to what extent the private sector will deleverage from its considerable debt burden.

The Stable trend reflects DBRS’s expectation that the ratings will be supported by the country’s track record of political stability, fiscal flexibility, competitive economy and solid external position. The ratings could come under pressure if the economic recovery fails to materialise, leading to weaker fiscal outturns and a less stable debt trajectory. Also, a migration of contingent liabilities from the financial sector onto the sovereign balance sheet that materially increases the debt stock would undermine the credibility of the current resolution framework for banks, thus putting downward pressures on the ratings.

Denmark has a reliable framework of prudent macroeconomic and fiscal policies. Public finances came under pressure in 2009, when the government surplus of 3.3% of GDP in 2008 turned into a deficit of 2.8%, partly as a result of large automatic stabilisers and partly due to the government’s countercyclical fiscal measures to respond to the deteriorating economic outlook. Several active measures to safeguard the financial sector, together with an increase in public consumption and income transfers as well as tax reductions have contributed to avoid a more severe fall in GDP, in DBRS’s view. The government plans to gradually bring public finances in balance by 2020 and, throughout the period, the government deficit (4.2% in 2012) will remain below the 3% threshold, at 1.7% of GDP in 2013 and 2% in 2014. Deficit figures for 2013 and 2014 will be positively impacted by one-off revenues from the reallocation of capital pension schemes worth approximately DKK40bn over the two years, without which the deficit would be 1.2 percentage points higher in each year. The primary balance is expected to be -1.3% of GDP in 2013 and -1.6% in 2014. In structural terms, government finances were in deficit of 1.1% of GDP in 2012, and are expected at -0.2% of GDP in 2013, within the Medium-Term Objective of an annual deficit of 0.5% of GDP.

While DBRS excludes further fiscal easing in the coming years, the scenarios for public debt suggest that a modest fiscal expansion in the coming years would not prevent the debt ratio to stabilise over the medium term. In 2012, gross government debt stood at 45.5% of GDP, set to decline to 44.9% in 2013. Government net debt remains moderate at 35% of GDP in 2012, as a result of the government’s large cash deposits with the central bank.

The Danish economy remains resilient, in DBRS’s view. Before the crisis, Denmark’s GDP expanded at an annual rate of 1.9%, mainly driven by fixed investment as land and property became more expensive. Between 2007 and 2012, public consumption (up 4%) and net exports (up 61%) provided an important countercyclical buffer to the Danish economy and contributed to prevent a more severe downturn. Going forward, DBRS expects the mild recovery to be driven by private consumption, expected in 2014 to be 20% higher than in 2000, with more investment activity making up for a narrowing current account surplus, and with balanced risks to the current forecast of an average 1% growth rate of GDP over 2013-2014.

DBRS notes that several key uncertainties weigh on the ratings. In particular, the country’s comparatively large financial sector (329% of GDP) is going through a major restructuring phase that involves systemic as well as non-systemic credit institutions. This process is aimed at: (i) ring-fencing the financial system from bank-specific problems, (ii) preventing contingent liabilities from migrating onto the sovereign balance sheet, and (iii) reducing domestic credit institutions’ structural dependence on external funding. DBRS notes that this process has made the financial system more resilient (domestic banks’ Tier 1 ratio was 17.3% in 2012, vs. 10.4% in 2008) and streamlined (95 banks were in business in 2012, versus 149 in 2008). However, the process is on-going and systemic banks still lack a credible resolution mechanism. Moreover, uncertainties remain with regards to the adequacy of banks’ liquidity buffers following the adoption of Basel III rules and the stability of funding sources as households’ deposits (which rose 21% since 2008) are likely to decline as the economy recovers. As of end-2012, Danish banks were still heavily dependent on foreign funds (MFI’s external debt at 119% of GDP, overall stable since 2007), although their maturity profile has been extended. Finally, the heavily indebted private sector (at 238% of GDP in 2012) could represent a major source of risks for banks in the medium-term if the economic recovery fails to materialise.

Denmark is also particularly exposed to economic and policy developments in Europe. Danish trade with the European Union accounts for 66% of the country’s total, with the major euro-area countries responsible for 30% of total trade. A prolonged slowdown in the region could affect Danish exports. Moreover, DBRS notes that, notwithstanding early signs of recovery, domestic demand in Denmark remains subdued, with real GDP in 2012 still 4.2% below its pre-crisis peak. This is mainly the result of the collapse in investment (-24% compared to pre-crisis peak), although private consumption also contracted, and remains 2% below the pre-crisis peak.

On the policy side, a stalemate in the implementation of the major institutional pillars of post-crisis Europe, such as the banking union, the bank resolution framework and the single-supervisory mechanism, could lead to weakened confidence in the country’s financial system, with negative repercussions on its stability.

Notes:
All figures are in Danish kroner (DKK) 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 IMF, OECD, BIS, European Commission, European Central Bank, Statistical Office of the European Communities, Ministry of Finance of the Kingdom of Denmark, Danmarks Nationalbank, Danmarks Statistik, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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

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

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 20 September 2012
Most Recent Rating Update: 16 November 2012

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