DBRS Confirms Swiss Confederation at AAA

DBRS, Inc. has confirmed the Swiss Confederation’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. The Short-term Foreign and Local Currency – Issuer Ratings have been confirmed at R-1 (high). The trend on all ratings is Stable.

The Stable trend reflects DBRS’s view that Switzerland retains ample policy space to confront potential shocks. The economy continues to demonstrate its resilience, achieving steady growth in private consumption and gross fixed investment. Fiscal policy remains highly disciplined, with the general government posting a modest surplus of 0.3% in 2017. The recent appreciation of the euro has eased some of the pressure on the Swiss franc, though inflation remains low. A strengthening recovery in the euro area is expected to provide support to the Swiss National Bank’s efforts to bring inflation closer to its target. Housing price pressures remain a concern but financial risks appear well contained.

Switzerland’s ratings are underpinned by an exceptionally high level of productivity and wealth. The economy is resilient and flexible, providing a stable tax base for the Confederation. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Sound fiscal management remains another key credit strength. Switzerland has posted modest fiscal surpluses in all but two of the last ten years and general government debt is below 30% of GDP.

Switzerland nonetheless faces some medium-term challenges. US tax reform and other potential changes to tax policy in Europe may have an impact on the use of Switzerland by multinational corporations, particularly given difficulties in achieving passage of Switzerland’s own corporate tax reform. Financial risks could increase in the event of a shock to domestic housing prices or as a result of industry-specific developments. Long-term growth prospects and fiscal dynamics may be affected by demographics, though immigration may offset some of the effects of population decline.

PRUDENT FISCAL POLICIES AND HEALTHY PUBLIC FINANCES ARE KEY CREDIT STRENGTHS

Swiss fiscal management is characterized by a prudent countercyclical approach that limits government deficits through the cycle. Switzerland’s debt brake, introduced in 2003, ties spending to cyclically adjusted revenues and saves any surplus. While much of government spending is executed at the sub-sovereign level (Federal spending accounts for only 32% of general government expenditure), Cantons also have a demonstrated track record of prudence. At present, a modest fiscal surplus (0.3% of GDP) is expected to persist through the government’s budget forecast horizon.

The Confederation continues to debate corporate tax reform, seeking to satisfy EU concerns regarding preferential tax treatment of foreign corporations while preserving Switzerland’s attractiveness as a destination for investment. Voters rejected an earlier version of the proposed reform in a referendum held in February 2017, but additional work is underway to prepare a legislative package that would take effect in 2019 and 2020. Opponents of the reform may nonetheless seek an additional referendum on the revised legislation. DBRS does not expect the ultimate outcome of the tax reform legislation to have any impact on the Confederation’s ratings, but the reform may have a material impact on fiscal balances over the long term. A rejection of the tax reform, meanwhile, could have implications for Switzerland’s competitiveness.

Federal government debt is low, spread out across a long maturity spectrum, and in high demand as a store of value. Nominal yields on government debt are negative out to ten years, enabling the government to enjoy projected negative real yields on its entire debt stock. Net interest expenditures for the general government, as estimated by the IMF, were less than 0.2% of GDP in 2017. DBRS analysis suggests that Switzerland’s overall position is sufficiently strong to withstand most adverse shocks. In the event of a severe recession (in 2018-19) followed by sub-par growth and very low inflation, DBRS anticipates a potential rise in public debt of around 8-10% percentage points of GDP. However, Swiss authorities would have ample space to enact a gradual fiscal adjustment and the downward trajectory of debt would likely be sustained over the medium-term. Consequently, foreseeable macroeconomic and fiscal shocks are unlikely to exert downward pressure on the ratings.

STRONG ECONOMIC FUNDAMENTALS AND EFFECTIVE MONETARY POLICY

Switzerland benefits from a highly productive workforce, high levels of educational attainment, and high levels
of labor force participation. The Swiss economy slowed in the wake of the Swiss National Bank’s
January 2015 decision to abandon the exchange rate ceiling against the euro, and the economy has generally underperformed relative to the euro area since that time. However, this reflects in part the weaker cyclical position of the euro area, and Swiss economic fundamentals remain robust. Growth has averaged 1.2% in the past three years and unemployment remains low at 3.0%. DBRS believes the near term economic outlook is strong, underpinned by solid real income growth and rising net wealth. However, developments in trade and tax policy in the UK, United States, and Europe could potentially have implications for the medium-term outlook, particularly if domestic tax policy fails to adapt to the changing international environment.

Swiss monetary policy has been highly effective in achieving low and stable inflation, establishing a high degree of confidence in the Swiss franc. In recent years, weak growth in the euro area combined with upward pressures on the franc have resulted in mild deflation. Though this has made monetary policy somewhat less effective in returning inflation toward its 2% target, deflationary pressures have not extended to domestic asset prices and balance sheets within Switzerland have not been adversely affected. Consequently, growth prospects remain strong and DBRS does not expect low inflation to persist indefinitely. Credit growth remains sluggish, relative to 2014 levels, but this is due in part to macroprudential measures designed to curb growth in mortgage credit (particularly the countercyclical capital buffer, increased to 2% in 2014).

CHALLENGE IN RISING HOUSE PRICES

Swiss housing prices have reached high levels and affordability risks are rising. Prices for single family homes continue to rise, though average prices for rental apartments have eased slightly. High loan to value (LTV) mortgages have not increased dramatically, but the share of mortgages with LTVs between 75 and 80% has increased from 16% in 2012 to 19% in 2016. High loan-to-income mortgage loans are also rising significantly. Domestically-focused banks remain the primary source of growth in mortgage lending, and could come under greater strain in the event of a reversal in real estate prices or a shock to household incomes. While DBRS considers this a growing source of macroeconomic risk for the Confederation, systemic financial risks are likely to be contained and the sovereign ratings are unlikely to come under pressure.

LARGE SURPLUSES IN EXTERNAL ACCOUNTS AND RECORD RESERVE LEVELS

Switzerland’s external accounts remain a key source of strength, characterized by a structural current account surplus and net creditor position of 118% of GDP as of end-2016. Due to its strong external position and the prolonged period of weak demand in Europe, upward pressures on the Swiss franc (CHF) have been a key concern. Over the last decade, the Swiss National Bank accumulated over CHF700 billion in foreign exchange reserves, which have reached approximately 117% of GDP as of end-2017. Worries over external competitiveness persist, though the recent appreciation of the euro may provide some relief. While net export growth has been weak, Swiss companies appear to have adjusted to the external pressures and there is little evidence of a significant loss of export competitiveness.

STRONG INSTITUTIONS AND STABLE POLITICS

Stable and predictable consensus-based politics combined with neutrality in international conflicts have long made Switzerland a safe haven for investors. The Swiss political system is characterized by federalism, a high level of civic participation in local matters, and a high degree of social cohesion. The Swiss Federal Government is headed by the Federal Council, with seven members elected by the governing parties and a rotating council presidency. Combined with a bicameral legislature and multiparty system, political decisions require a broad degree of consensus.

Popular referendums have at times generated tail risks, as they allow sponsors to put forward specific initiatives with potentially serious implications for reserve management, taxation, or other key economic and fiscal policies. In March 2018, for example, a vote is required to renew the Federal Government’s authority to tax Swiss citizens beyond 2020. Thus far, however, Swiss voters have displayed pragmatism by rejecting some of the most radical policy proposals. Furthermore, governments have found ways to implement the results of some potentially problematic voter initiatives while preserving sound policies and meeting key international commitments.

RATING DRIVERS

DBRS considers the likelihood of downward pressure on Switzerland’s ratings to be low. A sustained deterioration in growth prospects combined with a serious erosion in fiscal discipline could put downward pressure on the ratings. Alternatively, rising financial risks associated with property-based lending in the Swiss housing market could potentially expose the sovereign balance sheet to increased contingent liability risks.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. Main topics discussed in the rating committee include: the economic outlook; inflation; housing prices; financial risks; potential implications of tax policy changes.

KEY INDICATORS

Fiscal Balance (% GDP): 0.3 (2016); 0.3 (2017F); 0.4 (2018F)
Gross Debt (% GDP): 29.2 (2016); 29.6 (2017F); 28.8 (2018F)
Nominal GDP (USD billions): 669.0 (2016); 680.6 (2017F); 708.8 (2018F)
GDP per capita (USD thousands): 80.3 (2016); 80.8 (2017F); 83.2 (2018F)
Real GDP growth (%): 1.4 (2016); 1.0 (2017F); 1.3 (2018F)
Consumer Price Inflation (%, eop): 0.0 (2016); 0.6 (2017F); 0.8 (2018F)
Domestic credit (% GDP): 166.6 (2016); 167.8 (Nov-2017)
Current Account (% GDP): 10.5 (2016); 9.9 (2017F); 9.4 (2018F)
International Investment Position (% GDP): 118.8 (2016); 123.5 (Sep-2017)
Gross External Debt (% GDP): 262.4 (2016); 261.7 (mmm-2017)
Governance Indicator (percentile rank): 98.0 (2016)
Human Development Index: 0.94 (2015)

Notes:
All figures are in Swiss Franc (CHF) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Public finances compiled on GFS 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 Federal Department of Finance, Swiss National Bank, Swiss Federal Statistical Office, State Secretariat for Economic Affairs, OECD, IMF, European Commission, UNDP, World Bank, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be 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 for this rating action. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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, Co-Head of Sovereign Ratings
Rating Committee Chair: Roger Lister, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: July 14, 2011
Last Rating Date: January 27, 2017

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.