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 has experienced slower growth in 2015 as appreciation pressures on the franc have resulted in slower export and investment growth. Nonetheless, 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. The federal government’s fiscal policy framework remains conservative, and federal government debt continues to shrink relative to GDP. Switzerland has ample flexibility to respond to shocks and to successfully weather a period of real exchange rate appreciation.

Switzerland’s ratings could nonetheless come under pressure if growth prospects weaken significantly and deflationary pressures become entrenched. Swiss authorities are facing a challenging global environment, characterized by weak Eurozone growth, a strong franc, and declining prices for imported goods and services. Should these conditions persist and weaken prospects for growth in domestic demand, 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 potentially burden the public sector.

Swiss economic growth has been relatively strong, averaging 1.9% of GDP in 2010-2014. The economy has slowed in 2015 due to the impact of a stronger franc, but private consumption growth has accelerated due to rising real disposable incomes. Exports have continued to grow, particularly luxury products and pharmaceuticals, even while the strong franc has affected profit margins and investment. DBRS nonetheless expects a gradual strengthening of EU growth to ease pressures on the franc and help support continued growth in Switzerland.

Switzerland benefits from strong external finances. A positive net international investment position of 101% of GDP in Q3 2015 is a reflection of the substantial accumulated wealth of Swiss residents. 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. Switzerland consequently enjoys recurrent surpluses in its income account, and has also been successful in increasing net exports, particularly of consumer goods.

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 improved marginally to an estimated 0.1% of GDP in 2015. As a result of sustained primary surpluses, general government debt declined from 50.7% of GDP in 2003 to an estimated 34.6% of GDP in 2015, 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 abandoning the exchange rate floor of CHF1.2 per euro in January 2015, the Swiss National Bank (SNB) lowered interest rates from -0.25 to -0.75 basis points. Although the SNB has continued to accumulate foreign exchange reserves to lean against further appreciation of the franc, the currency is up roughly 5% in real effective terms since mid-2014. This has exacerbated negative price pressures on imported goods, and made domestic producers reluctant to raise prices as well. In spite of a decline in inflation expectations, real disposable household incomes continue to rise, and DBRS views deflationary pressures in Switzerland as likely to be temporary.

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, albeit at a slower pace. 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, the fiscal implications of an aging population will likely require further reforms to the social security system.

Notes:

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, 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.

DBRS does not typically accept editorial changes other than to correct for factual, accuracy and/or to remove confidential, material non-public, or sensitive information that might otherwise be inadvertently disclosed.

Lead Analyst: Thomas R. Torgerson
Rating Committee Chair: Roger Lister
Initial Rating Date: 14 July 2011
Most Recent Rating Update: 23 January 2015

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