DBRS Confirms Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings Limited (DBRS) has confirmed the Kingdom of Denmark’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings remains Stable.

The Stable trend reflects Denmark’s strong fundamentals and DBRS’s view that the challenges Denmark faces are manageable. The economy continues to grow at a steady pace and growth forecasts have been revised upwards recently. Denmark’s economic policy framework is also solid and credible, and authorities are considering additional measures to address the build-up of risks in the financial system. These factors limit the vulnerabilities stemming from the private sector.

The ratings reflect Denmark’s strong external position, its sound public finances, its credible policy framework, and its wealthy and diversified economy. Denmark has recorded current account surpluses for decades and is a large net external creditor. Denmark also has fiscal flexibility and its government debt ratio is modest. A responsible fiscal policy supporting sound public finances, together with a strong external position, has helped maintain Denmark’s fixed exchange rate policy. The predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades. Moreover, Denmark benefits from a wealthy and diversified economy, which counterbalances the vulnerability to external shocks, given by its small size and openness.

There are also some credit challenges, which include high levels of household debt, an interconnected financial system, and potential pressures on the housing market. Indebtedness in the household sector creates a potential vulnerability to shocks, but the robust asset position of households and the fact that high debt burdens are largely concentrated in high-income households help mitigate this risk. The concentration and interconnectedness of Denmark’s financial sector also poses another challenge, with mortgage banks fully financing lending through mortgage covered bonds, in which the Danish insurance and pension funds invest. Thus, a shock to the financial system, particularly to the covered bond market, could have a large impact on the economy. Moreover, house prices rises have been particularly strong in the Copenhagen area, and a sustained spread of this trend to the rest of the country would raise concerns.

Denmark’s economic performance has been strong recently and its long-term prospects are favourable. Driven by solid household spending, equipment and residential investment, and the recovery in sea freight and world trade, real GDP growth for 2017 is estimated at 2.0%. Growth is forecast to moderate only slightly to 1.9% and 1.7% in 2018 and 2019, respectively, supported by domestic demand. Additional employment gains are expected to support private consumption, while some reimbursements of both voluntary early retirement contributions and property tax payments are set to provide an additional boost to household incomes. Downside risks to the outlook could stem from a weaker external environment, and further tightness in the labour market that would constrain growth, while upside risks could derive from higher disposable incomes and corporate savings, and stronger world trade.

In the long term, Denmark’s prospects benefit from a diversified, competitive, and wealthy economy. Recent structural reforms have helped improve external competitiveness, while reforms on unemployment benefits and the pension system are expected to increase structural employment and improve growth potential. Denmark remains an attractive destination for investment, ranking 3rd in the world in the 2016 World Bank’s Ease of Doing Business Index. The resilience of the economy is also underpinned by a high income per capita, at USD 48,230 in PPP terms in 2016, and high private sector savings.

DBRS also views risks to financial stability as contained, although high household debt, potential pressures on the housing market, and interlinkages in the financial system could be sources of vulnerability. Households have deleveraged, but household debt remains the highest among OECD countries. At 267% of disposable income and 135% of GDP in Q3 2017, debt is expected to remain high, partly reflecting tax incentives to accumulate debt. Nevertheless, deferred amortisation debt has decreased and a portion of variable-rate mortgages has been converted into fixed-rate ones, reducing the risks to households from rising interest rates. Households’ net financial assets are also sizable, amounting to 168% of GDP in 2016, and high debt ratios are concentrated in high-income households.

At the same time, house prices have been recovering from the burst of the housing boom, and have helped rebuild households’ net wealth and improved the performance of banks. After rising strongly by over 10% Y-o-Y from Q2 2015 to Q1 2016, price growth for owner-occupied flats eased in the second half of 2016 and was 6.7% on average in the first three quarters of 2017. Price rises, however, have been particularly strong in the Copenhagen area, and a sustained country-wide spread of this trend could lead to concerns over financial stability. A new housing taxation system, which removes the 2001 tax freeze, is set to be implemented from 2021 and expected to have a stabilising effect on house prices (for further details, please see DBRS commentary entitled “The Evolving Dynamics of the Danish Housing Market”, available at www.dbrs.com).

Concerns over the Danish banking sector are related to its exposure to the housing market and its concentration and interlinkages. Six systemically important financial institutions (SIFIs), including mortgage banks, account for close to 90% of total bank lending. Nevertheless, the condition of financial institutions is sound, the overall regulatory and supervisory framework has been enhanced, and the Systemic Risk Council’s recommendation to limit mortgages at variable rates or with deferred amortisation in the Copenhagen area has been adopted. The Council also recommended in December 2017 to activate the countercyclical capital buffer to strengthen the resilience of the banking system in view of increased risk appetite, rising asset prices, and easing of credit standards. The recommendation is to initially set the buffer rate at 0.5% of credit institutions’ total risk exposures from 31st March 2019.

On the public finances front, Denmark’s fiscal management is sound, with a robust policy framework founded in the Danish Budget Law and EU fiscal rules. A prudent fiscal policy has also ensured sufficient fiscal space to support the economy during downturns without leading to large imbalances. The overall budget position remains in deficit, but this is modest, averaging 0.4% of GDP in the past five years. As the headline budget position tends to be affected by one-off factors, fiscal targets are set on the basis of the structural balance. The Ministry of Finance’s estimate for the structural balance (adjusted for volatile revenues from oil and gas and pension-yield taxes) for 2017 is -0.2% of GDP, within the statutory limit of -0.5%. A gradual fiscal tightening is expected in the coming years. Moreover, long-term fiscal sustainability is supported by the 2011 retirement reform, which increased the statutory retirement age and reduced voluntary early retirement.

Denmark has also reduced its government debt ratio significantly over the past two decades to one of the lowest in the EU. Estimated at 36.0% of GDP in 2017, the debt ratio is expected to continue to decline gradually in the coming years. The debt profile is very favourable and interest costs are low, supporting its resilience to shocks. Debt is entirely denominated in local currency. About half of government bonds are held by the Danish insurance and pension sector, while about 40% of bonds are held by overseas investors. Moreover, Danish 10-year government bond yields have fallen since 2011, remaining below 1.0% since end-2014, largely reflecting investor confidence in the Danish economic policy framework and low policy interest rates. The average maturity of government bonds is also relatively long at over eight years, meaning that any rises in interest rates will be filtered through gradually to interest costs.

As regards the external sector, Denmark’s current account surplus and net external asset position remain large. The current account has averaged 6.0% of GDP over the past ten years, with the goods, services and primary income accounts remaining in surplus. The net international investment position, at 23.6% of GDP on average over the same period, reached 54.8% in 2016. The asset position is accounted for by the net external assets of the non-bank private sector. External trade competiveness, supported by a favourable trade-weighted Danish krone and moderate wage growth in recent years, together with solid demand from Germany – Denmark’s main trading partner – is expected to continue to support Danish exports. Income from foreign direct investment and external financial assets is also expected to remain substantial.

Denmark’s political environment and institutions are stable. The three-party coalition government of the Liberal Party, Liberal Alliance and Conservatives, formed in November 2016, reduced the risk of early elections. The coalition government, nevertheless, has a minority position in Parliament and needs additional support to pass legislation. The government will most likely continue to implement responsible economic and fiscal policies. According to the Budget Law, fiscal policy is subject to a precautionary principle, under which medium-term projections can only incorporate the reforms and initiatives that have been agreed by a majority in the Danish Parliament. DBRS does not expect major shifts in fiscal policy.

RATING DRIVERS

Given Denmark’s strengths, downward pressure on the ratings appears unlikely. Nevertheless, a severe shock to the economy, most likely generated by turmoil in financial markets or a shock to Denmark’s mortgage covered bond market, could pose a risk to the ratings. Either of these scenarios could potentially weaken private sector balance sheets and have an adverse impact on the financial system and the overall economy.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. The main points discussed at the Rating Committee include: Denmark’s economic performance and resilience, financial risks, household balance sheets, and risks to the outlook.

KEY INDICATORS
Fiscal Balance (% GDP): -0.4 (2016); 0.0 (2017E); -0.8 (2018F)
Gross Debt (% GDP): 37.7 (2016); 36.0 (2017E); 35.4 (2018F)
Nominal GDP (EUR billions): 277.3 (2016); 288.6 (2017E); 299.2 (2018F)
GDP per capita (EUR thousands): 48.4 (2016); 50.0 (2017E); 51.4 (2018F)
Real GDP growth (%): 2.0 (2016); 2.0 (2017E); 1.9 (2018F)
Consumer Price Inflation (%): 0.3 (2016); 1.2 (2017E); 1.5 (2018F)
Domestic credit (% GDP): 210.9 (2016); 206.5 (Sep-2017)
Current Account (% GDP): 7.3 (2016); 8.1 (2017E); 7.6 (2018F)
International Investment Position (% GDP): 54.8 (2016); 52.5 (Sep-2017)
Gross External Debt (% GDP): 155 (2016); 151 (Sep-2017)
Governance Indicator (percentile rank): 99.0 (2016)
Human Development Index: 0.93 (2015)

Notes:

All figures are in Danish Kroner (DKK) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. General Government Gross Debt is calculated on a Maastricht basis. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Danmarks Nationalbank, Ministry of Finance of the Kingdom of Denmark, Ministry for Economic Affairs and the Interior, Danmarks Statistik, European Central Bank, European Commission, Eurostat, OECD, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“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 and US regulations only.

Lead Analyst: Adriana Alvarado, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 20 September 2012
Last Rating Date: 14 July 2017

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