DBRS Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Kingdom of Sweden’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA and Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). All ratings have a Stable trend.

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects DBRS’s view that the Swedish economy will remain resilient and that the challenges faced by the sovereign are manageable. Real GDP grew 2.4% in 2017, driven by private consumption, investment, and exports. Employment generation is also strong. Amid this favourable economic environment, public finances continue to strengthen. Sweden posted another budget surplus in 2017 at 1.1% of GDP and the debt ratio fell by 1.3 percentage points to 40.9% of GDP. After a prolonged period of house price increases, the housing market has cooled down. Housing prices dropped by 6.4% between last August’s peak and March 2018. Spill-overs from the housing market correction to the rest of the economy have been contained. However, high household debt and the vulnerabilities in the banking sector continue to be sources of concern.

RATING DRIVERS

The trend could be changed to Negative from Stable if Sweden’s public debt ratio trajectory were to experience a material reversal, although DBRS views this as unlikely. A materially higher public debt ratio could result from (1) a severe deterioration of medium-term growth coupled with a sharp weakening in public finances, or (2) a considerable materialisation of contingent liabilities. Furthermore, a worsening of financial conditions severe enough to significantly dampen the economic outlook, potentially because of a sharp drop in housing prices, could put downward pressure on the ratings.

RATING RATIONALE

A Low and Declining Public Debt Ratio and Solid Fiscal Framework Underpin Sweden’s Creditworthiness

Sweden’s sound fiscal performance over the last two decades has been underpinned by its prudent and credible fiscal policy framework. The revised budgetary rules, coming into place in 2019, underscore Sweden’s commitment to sound public finances. The new structural fiscal surplus target will be 0.33% of GDP, below the previous 1%. Furthermore, a new 35% of GDP debt anchor will act as an explicit multi-annual objective. For the last two years, the general government’s fiscal surplus averaged 1.2% of GDP, and the structural surplus averaged an estimated 0.9% of GDP. Fiscal overperformance relative to budgetary projections stems from positive revenue collection, amid stronger than expected economic activity and lower than expected spending associated with asylum seekers. The National Institute of Economic Research projects the robust fiscal results to continue, with an annual headline surplus of 0.9% of GDP for 2018-2022.

The long-term sustainability of public finances is well anchored. The public debt-to-GDP ratio has declined substantially over the past two decades, placing Sweden among the lowest indebted sovereigns in the EU. The public debt-to-GDP ratio stood at 40.9% of GDP in 2017 and is projected to drop below 35% of GDP by end-2019. The government’s net asset position was estimated at around 21.8% of GDP at end-2017, mainly reflecting the national pension funds.

There are nonetheless a few sources of vulnerability, including the short average debt maturity of five years; and a considerable proportion of public debt denominated in foreign currency. Contingent liabilities also remain high at 44% of GDP in 2017, although more than two-thirds are related to deposit insurance guarantees. Vulnerabilities are mitigated by the moderate debt ratio, good debt servicing capacity and favourable funding costs. Likewise, Nordea Group’s decision to move its headquarters to Finland from Sweden by the end of the year could reduce the sovereign’s contingent bank exposures.

Sweden’s Economic Dynamism is Set to Continue at a Healthy Pace, Although the Housing Market Raises Uncertainties

Sweden’s strong economic performance benefits from a competitive export sector and a productive labour force. Over the last two decades, Sweden’s 2.6% average output growth was higher than the 2.1% OECD average. More recently, the combination of accommodative monetary policy amid low inflation, a weak exchange rate, and the European cyclical recovery have boosted activity in Sweden. In this favourable environment, private consumption, investment, and exports have been key drivers of the expansion. GDP grew at a robust average of 2.8% in 2016-2017. With the highest employment rate in the EU at 81.8% in 2017 and unemployment at 6.2% in March 2018, the labour market continues to strengthen and support medium-term growth prospects. GDP is expected to grow around 2.1% in 2018-2023.

The key downside risk to the growth outlook stems from the property market. Triggered by a sharp increase in supply and tighter macroprudential policies, the extent and depth of the housing market correction are still unclear. A less supportive external environment or unexpected monetary policy tightening could exacerbate property price deceleration. The decline in prices could have a negative effect on consumption and construction, both of which have been key growth drivers in the last couple of years. However, a strong labour market and a high household savings rate helps safeguard against a shock to private consumption. DBRS also considers that the government’s strong public finances and the private sector buffers would help the country weather a severe shock.

Risks to Financial Stability are Manageable, But Key Vulnerabilities to the System Remain

Managing risks associated with elevated levels of household indebtedness, housing market pressures and banking sector vulnerabilities remain a key challenge. The Swedish central bank (Sveriges Riksbank) has been pursuing a highly expansionary monetary policy in an attempt to reach its inflation target. The confluence of low interest rates, a sluggish housing supply, and generous tax incentives to debt financing led to a rapid increase in household debt to disposable income, that reached 186.1% at end-2017 from 108.0% at end-2000. One third of indebted households had a debt ratio above 400%, at end-September 2017. There is also a very high share of mortgages at variable rates, around 67% of the total. This has enabled households to benefit from a lower interest burden, despite the rapid build-up of debt. High indebtedness and interest rate sensitivity expose households to an abrupt rise in interest rates, or an income shock.

Swedish banks have substantial exposure to the domestic property market. Therefore, a shock to the real economy, accompanied by declining house prices, could adversely affect banks’ profitability and asset quality. Especially from commercial real estate exposures. Problems in the housing market could also have an impact on banks’ funding, given that the banks have issued covered bonds with mortgages as collateral to fund their mortgage portfolios. Covered pool enhancements mitigate these risks. Market funding represents around half of bank’s funding, predominantly in foreign currency (about two-thirds), thereby increasing refinancing and foreign exchange rate risks. Retaining market confidence remains crucial for Swedish banks to ensure a stable source of funding. On the other hand, Swedish banks have improved their profitability despite the negative interest rate environment and have strengthened their capital buffers.

Recent regulatory changes, together with macro-prudential measures, have made the system more resilient to shocks. Several measures have been implemented, including tighter capital requirements, higher regulatory risk weightings on mortgage loans, and a loan-to-value (LTV) cap for new mortgage loans. March 2018 saw the introduction of additional amortisation requirements for highly indebted households, complementing those already introduced in June 2016. In DBRS’s view, these measures are positive, but additional effort may be needed to effectively slow the increase in the household debt.

Sweden’s External Position Remains Strong on the Back of a Competitive Export Sector

The combination of a high savings rate and strong competitiveness have underpinned sizable current account surpluses, which averaged 5.3% of GDP over the last 20 years. Although it remained high at 3.4% of GDP in 2017, the current account has experienced a gradual decline in the past decade, mirroring stronger domestic demand and a lower export market share. Over the same period, services exports and Sweden’s trade surplus have gained more relevance relative to goods, reflecting a more service-intensive Swedish economy. Sweden specialises in fast-growing service sectors, including - information technology, banking services, engineering, and design services. A weak effective exchange rate, strong external demand and solid merchanting flows will continue to support the external sector. Sweden’s net international investment position turned positive in 2016, and increased to 9.5% of GDP in 2017.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

Sweden’s political system is characterised by strong democratic institutions and predictable consensus-oriented policies. Like other Nordic countries, Sweden scores very strongly in terms of governance and institutional quality indicators. Sweden will hold its next general election on 9 September 2018. Opinion polls are showing a tight contest between the so-called red-green bloc (Social Democratic Party, Green Party, and the Left Party) and the Alliance for Sweden political grouping (Moderate Party, the Centre Party, the People's Party Liberals, and the Christian Democrats). Both blocs are polling close to 40%. The possibility that smaller parties in these political blocs fall short of the 4% threshold to enter the parliament make seat allocation predictions harder. The anti-immigration Sweden Democrats have lost momentum since last autumn but retain around a fifth of potential votes. In this context, the formation of another minority government or a hung parliament could ensue. However, DBRS does not expect these potential outcomes to jeopardize Sweden’s history of responsible macroeconomic policymaking.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. The main points discussed during the Rating Committee include Sweden’s economic performance, fiscal and debt metrics, banking system, financial stability, housing market, and macroprudential framework.

KEY INDICATORS

Fiscal Balance (% GDP): 1.1 (2017); 0.7 (2018F); 1.1 (2019F)
Gross Debt (% GDP): 40.9 (2017); 37.0 (2018F); 34.2 (2019F)
Nominal GDP (USD billions): 538.6 (2017); 603.4 (2018F); 630.8 (2019F)
GDP per Capita (USD): 53,220.1 (2017); 59,114.6 (2018F); 61,180.1 (2019F)
Real GDP growth (%): 2.4 (2017); 2.8 (2018F); 2.1 (2019F)
Consumer Price Inflation (%): 1.8 (2017); 1.7 (2018F); 2.0 (2019F)
Domestic Credit (% GDP): 264.6 (2016); 266.9 (2017)
Current Account (% GDP): 3.2 (2017); 4.1 (2018F); 4.2 (2019F)
International Investment Position (% GDP): 5.0 (2016); 9.6 (2017)
Gross External Debt (% GDP): 175.7 (2016); 178.1 (2017)
Governance Indicator (percentile rank): 94.7 (2016)
Human Development Index: 0.91 (2015)

Notes:

All figures are in Swedish kronor unless otherwise noted. Public finance statistics reported on a general government basis unless specified. 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 Ministry of Finance of the Kingdom of Sweden, Swedish National Debt Office, Sveriges Riksbank, Statistiska Centralbyran, Valueguard, National Institute of Economic Research, 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: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 17 April 2012
Last Rating Date: 10 November 2017

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