DBRS Confirms Switzerland at AAA, Stable Trend

DBRS, Inc. 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 is a reflection of the strong fundamentals of the Swiss economy and public finances. The Swiss economy continues to grow at a moderate pace in spite of a challenging external environment. 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. Fiscal policy remains highly disciplined, and general government debt continues to shrink relative to GDP. Switzerland has ample flexibility to respond to shocks, including the recent appreciation of the franc.

Switzerland’s ratings could nonetheless come under pressure if growth prospects weaken and deflationary pressures become entrenched. Swiss authorities are facing a challenging global environment, characterized by weak Eurozone growth, a strong franc, and deflationary pressures due in large part to the declining prices of imported goods and services. Should these conditions persist, the health of the public sector balance sheet could gradually deteriorate. In addition, external shocks and a significant decline in domestic real estate prices would pose risks to the financial sector and likely burden the public sector.

Swiss economic growth has been relatively strong, averaging 1.9% of GDP in 2010-2014, supported by a resilient labor market with unemployment close to 3% in spite of headwinds emanating from weak external demand. The Swiss franc has appreciated significantly in recent years, and the abandonment of the exchange rate floor against the euro on January 15, 2015 has pushed the franc over 15% higher. Wages are relatively high, yet Switzerland has seen continued growth in consumer goods exports to non-European economies (particularly the US and emerging markets). Resilient demand for Swiss goods, particularly luxury products and pharmaceuticals, has enabled the economy to grow in spite of weak economic conditions in major European trading partners.

Switzerland benefits from strong external finances. A positive net international investment position of 121% of GDP in 2014Q3 is a reflection of the substantial accumulated wealth of Swiss citizens. This net position can be volatile, given Switzerland’s role as a financial center, but has averaged over 100% of GDP for the past decade. This large stock of foreign assets contributes to a large and recurrent surplus in the income account, which has averaged more than 6% of GDP during the same period.

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 overall fiscal surplus deteriorated marginally to an estimated -0.2% of GDP in 2014. As a result of sustained primary surpluses, general government debt declined from 50.7% of GDP in 2003 to an estimated 33.5% of GDP in 2014, one of the lowest debt burdens among advanced economies.

However, Switzerland’s large net creditor position and safe haven capital inflows have led to continued appreciation pressures on the Swiss franc. After maintaining an exchange rate floor of CHF1.2 per euro for over three years (since September 2011) the Swiss National Bank (SNB) abandoned the floor on January 15, 2015 and lowered the already negative interest rates from -0.25 to -0.75 basis points. This appears to reflect the SNB’s judgment that the policy was unsustainable in the context of the anticipated adoption of quantitative easing by the European Central Bank and rising safe-haven capital inflows, driven in part by risks in Greece and Russia. DBRS expects that in the near term sustained franc strength is likely to have a negative effect on growth, investment and exports. On the positive side, the SNB’s actions may help increase household purchasing power in real terms. This will likely contribute to a rebalancing of growth toward consumption. Consequently, DBRS views deflationary pressures in Switzerland as likely to be temporary, though there are risks that deflation could become entrenched.

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. In addition, the exchange rate floor appears to have been contributing to housing price appreciation by increasing foreign demand for real estate assets. Stricter capital requirements for mortgage assets and the activation of counter-cyclical capital buffers on domestic banks appear to have helped slow mortgage credit growth. The appreciation of the franc may also help to alleviate upward pressures on property prices.

The large size and concentration of the banking sector, despite the significant deleveraging undertaken by the two largest banks since 2008, highlights the ongoing exposure 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 corporate and financial sector over the medium term. The Swiss banking system is expected to continue to shrink over coming years, while changes to corporate taxation 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 the potential failure of a large bank.

Switzerland faces some 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 aggravate 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.

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.

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.

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

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: Thomas R. Torgerson
Rating Committee Chair: Roger Lister
Initial Rating Date: 14 July 2011
Most Recent Rating Update: 10 January 2014

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