DBRS Confirms Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings Limited (DBRS) 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.

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects Denmark’s strong fundamentals and DBRS’s view that the challenges Denmark faces are contained. The economy continues to grow at a solid pace, with forecasts pointing to an above-trend growth rate of close to 2% in 2018, which is set to lead to even higher incomes. Danish authorities have introduced additional macro-prudential measures, including limits on risky mortgages, to address the build-up of risks to financial stability. These factors limit the vulnerabilities stemming from the private sector, mainly related to high household debt.

RATING DRIVERS

Given Denmark’s credit 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, which is pivotal for the Danish financial system, could pose a risk to the ratings. Either of these scenarios could weaken private sector balance sheets and have an adverse impact on the financial system and the overall economy.

RATING RATIONALE

Denmark’s Economic Performance Remains Strong and Its External Sector Robust

The Danish economy has performed strongly in recent years and its prospects are favourable. Growth is being driven by private consumption, private investment, and exports. The significant rise in job creation has led to low levels of unemployment, and a lower tax rate has helped boost household disposable incomes. Additional employment gains are expected to continue to support private consumption. After growing by a strong 2.3% in 2017, real GDP growth is forecast to moderate to 1.9% in 2018 and 1.7% in 2017. Upside risks to the outlook could derive from higher disposable incomes and corporate savings, and stronger external demand. Downside risks could stem from a weaker world trade, given Denmark’s large shipping sector, and tightness in the labour market that would constrain growth.

Denmark’s long-term prospects benefit from a diversified, competitive, and wealthy economy, which provides support to its ratings. Structural reforms have helped improve external competitiveness, while reforms on unemployment benefits and the pension system are expected to increase structural employment further and improve growth potential. Denmark also remains an attractive destination for investment, ranking 3rd in the world in the 2017 World Bank’s Ease of Doing Business Index. Moreover, the resilience of its economy is underpinned by a high GDP per capita, at USD 49,883 in PPP terms in 2017, and high private sector savings. Denmark’s diversified and wealthy economy counterbalances its vulnerability to external shocks, given by its small size and openness.

Reflecting the competitiveness of its external sector and underpinning Denmark’s ratings, its current account surplus and net external asset position remain large. The current account has averaged 6.6% of GDP over the past ten years, with the goods, services and primary income accounts remaining in surplus. The net international investment position, at 29.2% of GDP on average over the same period, is accounted for by the non-bank private sector. External trade competitiveness, 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.

Household Debt Remains Elevated but Financial Stability Risks Are Contained

Denmark’s rating challenges are mainly associated with high household debt, potential pressures on the housing market, and interlinkages in the financial system. Higher incomes have allowed households to deleverage, with mortgage debt now at 2005 levels. Still, household debt remains the highest among OECD countries, at 264% of disposable income and 134% of GDP in Q3 2017. Debt reflects in part tax incentives to accumulate debt. Also, more than half of mortgages are at variable rates. Nevertheless, deferred amortisation mortgages have decreased and the share of fixed-rate mortgages is rising, reducing the risks to households from higher interest rates. Moreover, high debt ratios are concentrated in high-income households, and households’ net financial assets are sizable, amounting to 168% of GDP in 2016.

House prices have been recovering from the burst of the housing boom, helping to rebuild households’ net wealth. After rising strongly in 2015 and for most of 2016, price growth for owner-occupied flats eased to 6.8% in 2017. The house price-to-income ratio remains almost 25 percentage points below its 2007 peak. 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).

Denmark’s financial sector is concentrated and interconnected, with mortgage banks fully financing lending through mortgage covered bonds, in which the Danish insurance and pension funds invest. Six systemically important financial institutions (SIFIs), including mortgage banks, account for close to 90% of total bank lending. The Danish pension sector manages a sizeable portion of households’ wealth and is an important participant in financial markets. Thus, a shock to the financial system, particularly to the covered bond market, could have a significant impact on the economy.

Nevertheless, the overall regulatory and supervisory framework has been enhanced and macro-prudential measures have been adopted. Moreover, the Systemic Risk Council’s recommendation to limit mortgages at variable rates or with deferred amortisation in the Copenhagen area was adopted in January 2018. Following the Council’s recommendation last December, the government also decided in March 2018 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 buffer rate has been set at 0.5% of credit institutions’ total risk exposures from 31st March 2019.

The condition of the financial institutions is also sound. Banks are well-capitalised and profitable, despite the squeeze on net interest income from still very low interest rates. Policy interest rates in Denmark are used to maintain the Danish krone peg to the euro and normally track the European Central Bank (ECB) rates.

Public Finances Remain Sound and the Political Environment is Stable

Denmark’s sound fiscal position is another factor supporting its ratings. A prudent fiscal policy, supported by a robust fiscal framework, has ensured sufficient fiscal space to support the economy during downturns without leading to large imbalances. Currently, the policy stance is being gradually tightened to help dampen capacity pressures in the economy. As the headline budget position tends to be affected by one-off factors, fiscal targets are set based on the structural balance. The 2018 target for the structural balance (adjusted for volatile revenues from oil and gas and pension-yield taxes) is -0.2% of GDP, within the statutory limit of -0.5%. Moreover, the long-term fiscal sustainability is supported by the 2011 retirement reform, which increased the statutory retirement age and reduced voluntary early retirement.

Denmark’s government debt ratio is also modest and one of the lowest in the EU. At 36.4% of GDP in 2017, the debt ratio is expected to continue to decline gradually in the coming years. The debt profile is favourable and interest costs are low, supporting its resilience to shocks. Debt is entirely denominated in local currency, and about half of government bonds are held by the Danish insurance and pension sector, while about 40% of bonds are held by overseas investors. The average maturity of government bonds is also relatively long at 8.3 years. Moreover, Danish government bond yields remain low, reflecting low policy interest rates and investor confidence in the Danish economic policy framework.

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, has a minority position in Parliament and needs additional support to pass legislation. Nevertheless, DBRS expects the government to continue to implement prudent economic policies. Sound public finances, together with a strong external position, helps Denmark to sustain its fixed exchange rate policy. The predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades.

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 Denmark’s economic performance, monetary policy, financial stability risks, households’ balance sheets and vulnerabilities, housing market, banking sector, and risks to the outlook.

KEY INDICATORS

Fiscal Balance (% GDP): 1.0 (2017); -0.5 (2018F); -0.5 (2019F)
Gross Debt (% GDP): 36.4 (2017); 35.4 (2018F); 34.9 (2019F)
Nominal GDP (EUR billions): 288.4 (2017); 297.2 (2018F); 308.6 (2019F)
GDP per Capita (EUR): 50,004 (2017); 51,250 (2018F); 52,953 (2019F)
Real GDP growth (%): 2.3 (2017); 1.9 (2018F); 1.7 (2019F)
Consumer Price Inflation (%): 1.1 (2017); 1.5 (2018F); 1.7 (2019F)
Domestic Credit (% GDP): 221.2 (2017)
Current Account (% GDP): 7.8 (2017); 7.3 (2018F); 7.0 (2019F)
International Investment Position (% GDP): 54.5 (2017)
Gross External Debt (% GDP): 152.8 (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. Forecasts based on the Ministry for Economic Affairs and the Interior’s forecasts. 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 for Economic Affairs and the Interior, Ministry of Finance of the Kingdom of Denmark, 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: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: 20 September 2012
Last Rating Date: 12 January 2018

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