DBRS Confirms Switzerland at AAA

On January 27, DBRS confirmed the long-term foreign and local currency issuer ratings of the Swiss Confederation at AAA with a Stable trend. The short-term foreign and local currency issuer ratings have been confirmed at R-1 (high) with a Stable trend.

Switzerland’s ratings are a reflection of the strong fundamentals of the Swiss economy and soundly managed public finances. 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 – already at low levels – continues to shrink relative to GDP. Although the planned corporate tax reform and expected tax rate reductions by the Cantons are likely to have a material impact on tax revenue, Switzerland has ample flexibility to finance deficits and has demonstrated a strong commitment to maintaining fiscal discipline through the economic cycle.

Swiss economic growth has resumed, albeit below the average growth rate from 2010-14. After slowing considerably in 2015 due to the impact of a stronger franc, domestic demand has largely recovered. Exports have continued to grow, particularly luxury products and pharmaceuticals, even while the strong franc has diminished profit margins and the pace of growth in investment. DBRS expects the gradual strengthening of EU growth to ease pressures on the franc and help support continued growth in Switzerland, though significant economic policy changes in G-7 economies could have unanticipated effects on Swiss growth prospects.

Switzerland benefits from strong external finances. A positive net international investment position of 123% of GDP in Q3 2016 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 balance is expected remain in modest surplus, potentially exceeding the government’s projection of 0.1% of GDP in 2016. As a result of sustained primary surpluses, general government debt declined from 60.3% of GDP in 2004 to an estimated 45.4% of GDP in 2016, one of the lowest debt burdens among advanced economies.

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. Restrictions on loan-to-value ratios have already dampened valuations in the higher-priced end of the residential real estate market.

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 its foreign assets 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 to have strengthened the financial sector’s resilience and are hence likely to reduce the risk of systemic bank failures.

Switzerland faces some challenges with regard to macroeconomic management and would be adversely affected by renewed economic and financial stresses in Europe. 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 over the long-term.

RATING DRIVERS
The Stable trend reflects DBRS’s view that Switzerland is in a strong position to respond to potential shocks, and that the rating is not likely to be affected by any foreseeable near term risks. Switzerland’s ratings could nonetheless come under pressure if external shocks undermine the country’s growth prospects or if deflationary pressures begin to undermine public and private sector balance sheets. The global environment remains challenging in spite of gradually accelerating growth, and continued upward pressure on the Swiss franc could pose a challenge. In addition, external shocks or a significant decline in domestic real estate prices could pose risks to the financial sector, which could ultimately burden the public sector.

Notes:
All figures are in Swiss franc (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. These can be found at http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include Swiss Federal Finance Administration, Swiss National Bank, Swiss Federal Statistical Office, Swiss Customs Administration, IMF, OECD, Eurostat, World Bank, UN. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

This is an unsolicited credit rating.

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, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer – Global FIG and Sovereign Ratings
Initial Rating Date: 14 July 2011
Last Rating Date: 29 January 2016

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