DBRS Confirms Switzerland at AAA, Trend Remains Stable

DBRS, Inc. (DBRS) has confirmed the ratings on the Swiss Confederation’s long-term foreign and local currency debt at AAA, with Stable trends. DBRS has also confirmed the short-term foreign and local currency ratings at R-1 (high) with Stable trends.

The Stable trend on Switzerland’s AAA rating is a reflection of the strong fundamentals of the Swiss economy and public sector. Switzerland’s economy is expected to grow 1.7% in 2013 and 1.9% in 2014, well above average Euro area growth. Switzerland has an open and highly productive economy that benefits from a large pool of domestic savings and the safe-haven status of the Swiss franc. At a general government level, Switzerland’s fiscal position is sound, having achieved seven consecutive years of fiscal surpluses. General government debt has declined to 35% of GDP, relatively low compared to other advanced economies. Switzerland has ample flexibility to respond to shocks without jeopardizing its AAA credit rating.

Switzerland’s ratings could nonetheless come under pressure if banking system vulnerabilities were to increase significantly, due to a combination of external shocks and a significant decline in domestic real estate prices, and place a substantial burden on the public sector. In addition, if deflationary pressures become entrenched, this could damage growth and investment prospects and gradually undermine the health of the public sector balance sheet. In the context of regional financial and economic stresses, a sustained deterioration in the Euro area could also affect Switzerland’s credit ratings, given Switzerland’s strong economic and financial linkages to the Euro area.

Over the past decade, the rules-based fiscal policy framework at the federal and cantonal level has reinforced budgetary discipline while allowing automatic stabilizers to support the economy over the business cycle. The fiscal surplus shrunk modestly to 0.1% in 2012 from 0.3% of GDP in 2011, and a surplus of 0.2% of GDP is expected this year. As a result of these surpluses combined with economic growth, general government debt declined from 53.4% of GDP in 2003 to a projected 34.7% of GDP in 2013, one of the lowest debt burdens among the advanced economies.

Growth has been relatively strong, averaging 1.9% of GDP in 2010-2013, supported by a resilient labor market with unemployment close to 3% in spite of headwinds emanating from weak external demand. While capital inflows have caused a substantial appreciation of the Swiss franc, the policy response has thus far enabled the country to largely avoid the negative consequences for growth and price stability. In spite of several quarters of deflation due to the declining prices of foreign products and services, medium-term inflation expectations remain in positive territory, close to the Swiss National Bank’s definition of price stability.

Nonetheless, the prolonged period of accommodative monetary policy could 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 with household indebtedness exceeding 120% of GDP. DBRS believes that the recent introduction of stricter capital requirements for mortgage assets and the activation of counter-cyclical capital buffers on domestic banks are likely to help reduce risks associated with strong credit growth.

The large size and concentration of the banking sector, despite the significant deleveraging undertaken by the two largest banks since 2008, continue to amplify the vulnerability of the Swiss economy to external financial shocks. New regulatory initiatives applying to systemically important financial institutions, the resolution of cross border tax disputes and other regulatory initiatives could have significant effects on the scope and scale of Switzerland’s corporate and financial sector over the medium term. The Swiss banking system, in particular, is expected to continue to shrink over coming years, while changes to corporate taxation currently under consideration could lead to a structural shift in foreign assets and liabilities, if firms choose to relocate operations as a result. However, DBRS believes that Switzerland will retain its fundamental attractiveness as a financial center and that this process will play out gradually. As a consequence, any macroeconomic impact is likely to be muted. Moreover, recent changes implemented by Swiss authorities appear likely to reduce the systemic risks associated with large bank failures.

Switzerland faces some near-term challenges with regard to macroeconomic management and would be adversely affected by an intensification of the Euro area crisis. Due to its currency safe-haven status, such an event would likely result in weakening external demand alongside large financial inflows, which could lead to distortions and asset price bubbles within Switzerland’s highly open economy and financial system. In addition, particularly if immigration declines in the coming years, the fiscal implications of an aging population will require further reforms to the social security system.

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 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 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.

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. Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer and did not include participation by the issuer or any related third party.

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.

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.

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

Lead Analyst: Thomas Torgerson
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 14 July 2011
Most Recent Rating Update: 16 November 2012

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