DBRS Confirms Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings Limited has today confirmed the long-term foreign and local currency ratings of the Kingdom of Denmark at AAA, and the short-term foreign and local currency ratings at R-1 (high). All ratings have a Stable trend.

The Stable trend reflects DBRS’s baseline scenario in which the country’s credit metrics remain strong. Downward pressure on the ratings could occur if the challenges faced by Denmark prove to be structural. The ratings could also come under downward pressure if a migration of liabilities from the financial sector onto the sovereign balance sheet substantially increases the debt stock, thereby undermining the credibility of the current resolution framework for banks.

The AAA ratings of Denmark are underpinned by sound public finances, which are characterised by low structural deficits and a moderate debt burden. In addition, the ratings benefit from Denmark’s net creditor position vis-à-vis the rest of the world and by a wealthy and resilient economy. The main challenges facing the Danish economy relate to (i) the high levels of domestic private sector debt, (ii) a domestic financial sector that remains in recovery mode and (iii) the slow recovery in employment and productivity. Indicative of concern, is the upward pressure on the Danish kroner as a result of the adoption of quantitative easing by the European Central Bank (ECB). The Danish central bank cut its deposit rate on the 19 January by 15 bps to minus 0.2% and by a further 15 bps to -0.35% on 22 January, after the ECB’s QE announcement. In DBRS’s view although the pressure on the Kroner has been intensifying, the DNB has considerable options to cope with the situation.

DBRS believes that whilst there is a risk that the policy actions of the central bank could become ultimately insufficient or politically undesirable, it is our base case scenario that with still ample scope to boost the size of the DNB’s balance sheet and the comparatively small size of the country’s currency in the international money markets, both the demand for the DKK and the policy response to stem its excessive appreciations, should support the peg.

Denmark’s ratings benefit from the country’s sound fiscal framework based on a countercyclical fiscal stance and a moderate public debt burden. The government exited the excessive deficit procedure in June 2014, as Denmark fulfilled the requirement to bring the public deficit sustainably below 3% of GDPIn 2014 a general government of 1¾ per cent of GDP in 2014 (DKK 34.2bn) is estimated. It is the first surplus since 2008. The general government deficit is projected to 2.5% of GDP in 2015 (DKK -49.7bn) and 2.7% of GDP in 2016 (DKK -52.7bn), thus within the limit of 3% of GDP according to the Stability and Growth Pact. Over the medium-term, government finances are expected to remain in deficit until 2020, largely as a result of a strategy aimed at supporting the economy. However, DBRS judges this strategy to be sustainable, against a backdrop of moderate public debt of 45% of GDP in 2013 and borrowing costs which are expected to remain low, at 2.8% of total government revenues in 2014.

Denmark’s external finances are a key rating strength. The country’s external position is characterized by persistent current account surpluses, which averaged 4.3% of GDP between 2005 and 2013. Since end 2013, Denmark’s current account performance has improved further, averaging 6.2% of GDP between 2014Q1 and 2014Q3. This reflects the improvement in the trade balance as a result of modest domestic demand and of the positive income flows. The net international asset position, at 38.5% of GDP in 2013, contributed to these inflows, which have averaged 1.7% of GDP since 2005.

Denmark’s diversified economic structure, resilient net exports, and a countercyclical fiscal stance are likely to support economic activity. GDP is estimated to have expanded by 0.7% in 2014 and is expected to grow by 1.4% and 2.0% in 2015 and 2016 respectively, driven by exports. The contribution from net trade is expected to remain positive, but become less significant over time as higher investment activity translates into stronger imports of machinery and other equipment, of which Denmark is a net importer. As a net energy importer, Denmark’s current account should further benefit from the sharp decline in oil prices and from the pick-up in growth in its main trading partners.

These strengths are balanced by some challenges which DBRS sees as material but abating. High private sector debt, estimated at 255% of GDP in 2014Q1, constitutes a rating weakness as it could hamper growth. While early signs of deleveraging observed at the beginning of 2013 have persisted through 2014, the highly leveraged structure of the Danish economy is unlikely to change substantially over the medium term, primarily as a consequence of limited incentives to reduce private sector debt. However, DBRS recognises that high private sector debt is mirrored by a healthy asset position. Moreover, the concentration of household debt amongst high-income households also provides some reassurance that such high levels of debt will not necessarily pose a threat to financial stability.

The Danish financial sector also faces some challenges, although these are being addressed pro-actively. The country’s banks are now materially better capitalised than during the crisis. However, while it returned to profitability in 2013, the industry remains large and exposed to an increasingly more demanding regulatory environment. Counterbalancing these challenges, the decision by the EU Commission, as part of the new banking sector liquidity rules for credit institutions, that Danish mortgage bonds can continue to benefit from the highest possible qualification and be treated in the same way as government bonds, limits the liquidity risks faced by the sector. Finally, although DBRS recognises that Denmark’s employment rate is high by international standards, further raising the country’s employment rate will be crucial to achieve the long-term economic growth rate of 1.7% per annum, 24% of which is expected to come from growth in the labour supply. DBRS believes however, that this is a medium-term challenge which should not put immediate pressure on the rating.

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.

These can be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Ministry of Finance of the Kingdom of Denmark, the Ministry of Business and Growth of the Kingdom of Denmark, Danmarks Nationalbank, Danmarks Statistik, European Commission, European Central Bank, Statistical Office of the European Communities, IMF, OECD, 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.

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 outlooks and ratings are under regular surveillance.

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

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.

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

Lead Analyst: Carla Clifton
Initial Rating Date: 20 September 2012
Rating Committee Chair: Roger Lister
Last Rating Date: 25 July 2014

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