DBRS Confirms Kingdom of Norway at AAA, Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the Kingdom of Norway’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Kingdom of Norway’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

Norway’s AAA ratings are underpinned by its high public-sector wealth, prudent management of its oil-related windfalls, strong external position, and sound institutional framework. The economy continues to expand on the back of solid private consumption, improved cost competitiveness, and the recovery in oil-related investments. Mainland GDP growth, which excludes petroleum production and shipping, remains buoyant and is expected to rise further to 2.7% this year from 2.6% in 2018. Strong growth, rising house prices, and higher employment levels have prompted a gradual policy tightening. Norges Bank has been increasing its benchmark rate from 0.5% in August 2018 to 1.5% in September 2019 and the government has moved from an expansionary to mildly contractionary fiscal stance for 2020.

The Stable trend reflects DBRS Morningstar’s view that downside risks to the ratings are limited, though Norway faces several structural challenges. The country is highly reliant on the petroleum sector, the household sector has high levels of debt, and the population is aging. However, Norway is well-positioned to deal with these challenges and has substantial buffers to absorb shocks. In light of the elevated and growing level of household debt, stricter lending regulations have been put in place to mitigate the risks stemming from the housing market, and the banking system is well capitalized. The Government Pension Fund Global (GPFG), with a market value equivalent to 290% of mainland GDP in December 2018, is an important source of income and, if needed, could be used to cover future deficits for decades to come. The country’s flexible exchange rate provides another important tool to absorb shocks.

RATING DRIVERS

Norway is firmly placed in the AAA rating category. Potential downward rating drivers include one or a combination of the following: (1) a worsening of financial conditions and medium-term growth prospects that is severe enough to materially affect Norway’s financial stability and fiscal position; and (2) a significant loosening of the government’s commitment to prudent fiscal policy.

RATING RATIONALE

Norway Has A Solid Fiscal Framework and Prudently Manages Oil-Related Proceeds

Norway’s solid fiscal framework and its prudent management of oil-related proceeds is a key factor supporting the ratings. The public sector’s sizable net creditor position provide the government with significant fiscal space to implement counter-cyclical policies. A fiscal rule introduced in 2001 requires the State’s net cash inflow from the petroleum industry (receipts from the sale of oil reserves and oil taxes) be transferred to the sovereign wealth fund – the Government Pension Fund Global (GPFG or the Fund) – proceeds of which are invested entirely overseas. The fiscal rule specifies that over time only the expected real return of the Fund (estimated at 3%) can be allocated to finance the non-oil deficit. This aims to preserve the real value of the Fund for the benefit of future generations and to isolate the government’s budget from volatility in petroleum revenues. The Fund has grown from NOK 2.3 trillion in 2008 to NOK 9.7 trillion as of October 2019, or about 290% of mainland GDP. Consequently, the structural non-oil deficit has risen from 1.4% in 2001 to 7.2% in 2018 (measured as a share of mainland GDP), in line with the 3% return from the Fund. A financial market shock could have a negative impact on government finances, given the size of the fund and its 69.3% allocation in equities. Without a depreciation in the Norwegian krone, such a shock may become a larger source of volatility to the value of the fund than oil price fluctuations.

Following an expansionary fiscal policy during the years of declining oil prices (2014-2016), the government moved to a near-neutral fiscal stance during 2017-2019. This was reflected in the fiscal impulse (measured by the increase in the structural non-oil deficit as a share of the trend mainland GDP) declining from an average of 0.7% between 2014 and 2016 to an average of -0.2% during 2017 and 2018. With economic growth forecast to be above the long-term trend and unemployment rates declining further, the 2020 budget takes a slightly contractionary stance with the fiscal impulse at -0.2%. This translates into the government spending petroleum revenues amounting to only 2.6% of the Fund, below the 3% annual real rate of return of the GPFG. However, the ongoing tax reform is pro-growth as it shifts the burden from direct to indirect taxation through lowering personal and corporate tax rates as well as broadening the VAT base.

Although headline fiscal surpluses have averaged 6% of GDP over the last few years, fiscal space will likely become smaller over the medium- to long-term. The steady decline in net oil revenues (from over 20% of GDP in 2010 to less than 5% currently), lower expected returns from the Fund (as a share of mainland GDP), and an ageing population will close the available fiscal space in the future. The government expects a funding gap equivalent to 1.7% of mainland GDP per decade between 2030 and 2060 and is assessing potential measures to address this funding gap. The reform of the National Insurance System and the alignment of the public sector occupational pension scheme with that of the private scheme is an important step to incentivize civil servants to delay retirement.

A Strong Balance Sheet Underpins Norway’s Creditworthiness

The public sector’s solid balance sheet constitutes one of Norway’s key credit strengths, even relative to other AAA-rated countries. General government gross debt amounted to an estimated 36% of GDP in 2018 and is one of the lowest ratios among advanced economies. In most countries, the main purpose of government borrowing is to finance a budget deficit. In Norway, the non-oil budget deficit is covered by transfers from the GPFG and therefore does not trigger any borrowing requirement. However, the government borrows in NOK to fund government lending schemes, cover redemptions of existing debt and to ensure a well-functioning financial market in Norway. DBRS Morningstar expects a gross general government debt ratio of around 30% of GDP in coming years.

With financial assets far exceeding total debt, the government’s net asset position currently stands at 308.4% of GDP. This is largely accounted for by the sovereign wealth fund whose market value was equivalent to 290% of mainland GDP at the end of 2018. Thus, in the event of a negative shock, net rather than gross government debt is most likely to be affected. Fiscal stimulus, taking the form of a higher non-oil fiscal budget deficit, could be financed by higher transfers from the GPFG. Given the fiscal guidelines and the government’s asset position, gross government debt is generally insulated from negative shocks.

High Household Debt Raises Financial Stability Risks, But Banking Regulators Remain Proactive

One of the key challenges facing Norway is that financial imbalances continue to build up. This is due to rising housing prices and household debt outpacing growth in disposable incomes. Since 2000, housing prices have more than doubled due to a prolonged accommodative monetary policy, high immigration, and supply constraints. Following a temporary downward correction between November 2017 and April 2018, housing prices are once again on a rising trend, albeit at a moderate pace. According to Real Estate of Norway, housing prices have increased on average by 2.3% between May 2018 and September 2019, albeit lower than the 7.2% average pace recorded during 2015-2017. Household indebtedness in Norway is high on both a comparative and historical basis and household debt is mainly concentrated in mortgages. While the ratio is now stabilizing, new mortgages granted to households with high debt levels could make the banking sector more vulnerable.

Against this concerning background, Norway benefits from a credible and independent monetary policy authority and proactive regulators. Banks’ low loan losses and strong capital buffers mitigate the risks to financial stability. Asset quality remains very strong: the Norwegian banking sector has one of the lowest ratios of non-performing loans as a share of total gross loans at 0.8% in Q2 2019. In addition, financial vigilance has resulted in a series of banking regulatory measures and macro-prudential policies to contain risks. In September 2019, the Financial Supervisory Authority (FSA) proposed a further tightening of rules to reduce vulnerabilities in the housing market. These include: (1) limiting the debt-to-income ratio to 4.5 times borrowers’ annual income, down from 5 times; (2) reducing the flexibility ratio (a cap on the lender on approving loans to vulnerable households) to 5% from 10%; and (3) harmonizing the flexibility ratio between Oslo (at 8%) and the rest of the country (at 10%). These measures are currently being debated, and if approved by government, will likely be implemented from January 1, 2020.

While the household debt-to-disposable income ratio has stabilized at around 225% over the last year, the high ratio renders households vulnerable to various shocks. Given that a significant portion of mortgage loans have variable interest rates, households are particularly exposed to rising rates. According to studies by Norges Bank, a 1% increase in the mortgage interest rate could reduce general household consumption by around 0.4%. As regards rates, the stronger than expected upturn in the economy contributed to the Norges Bank’s decision to raise its policy rate from 0.75% in January 2019 to 1.50% in September. The latest Monetary Policy Report has lowered the projected rate path with the key policy rate peaking at 1.6% in Q4-2020.

Similar to its Nordic peers, Norwegian banks rely heavily on wholesale and short-term foreign funding. At the end of 2018, the wholesale funding ratio stood at 49.4%, with over half of wholesale funding denominated in foreign currency. However, banks remain liquid, profitable, and well-capitalized. Banks have built significant liquidity buffers in recent years which amply meet the liquidity coverage ratio requirement and the countercyclical capital buffers (to increase to 2.5% from December 2019). The banking sector’s average Common Equity Tier 1 (CET1) capital ratio at 16.0% on 3Q 2019, is almost double the rate during the financial crisis. A new anti-money laundering law gives the FSA greater sanctioning powers against breaches by supervised banks.

Economic Recovery Gains Momentum but Long-Term Challenges Remain

Norway’s wealthy and stable economy, with a balanced income distribution, underpins its AAA ratings. Thanks to counter-cyclical policies, the mainland economy (which excludes petroleum production and shipping) has proven resilient to a material downturn in oil prices, and growth has averaged 2.5% over the last two decades. Mainland GDP growth in 2019 is forecasted to be above the long-term trend at 2.7%, with consumption projected at 3.3%. Consumption has been supported by rising employment and wage growth. The weak krone has made exports more competitive globally. Additionally, the recovery in oil prices and cost-cutting efforts are providing support to petroleum sector investments. This had been a significant drag on mainland growth between 2014 and 2017 as the main transmission channel of the downturn in the petroleum sector to the mainland economy had been through the collapse in petroleum investments.

While near-term prospects remain relatively benign, external risks include global trade tensions and uncertainty about growth in Europe. On the domestic side, a downturn in the housing market could have a negative impact on the economy, particularly if households were to cut their consumption. Over the medium- to long-term, the main challenge for the Norwegian economy will be to successfully diversify the oil-dependent economy towards other tradable sectors.

Strong External Position Provides a Significant Buffer to Absorb Shocks

Norway benefits from a strong external position. The country’s large creditor position provides significant buffers for weathering external shocks. In addition, its flexible exchange rate regime facilitates adjustments, acting as an automatic stabilizer. On the back of the sizeable energy trade surplus, the current account surplus has averaged over 10% in the last two decades. The substantial accumulation of foreign assets through the GPFG makes the government the main contributor to the country’s net external position that is more than double GDP. Ownership of such a large stock of net financial assets reduces Norway’s dependence on foreign capital flows and provides a sizable source of income. On the other hand, the private sector is a net debtor to the rest of the world. The banking sector’s external debt reached 93.2% of GDP in Q2 2019, stemming from its reliance on foreign funding. Nonetheless, the overall economy has room to manoeuvre in the face of a temporary disruption in liquidity conditions.

A Predictable Policy Framework Supports the Ratings

Norway benefits from strong political institutions with a well-established track record of a consensus-based approach to macroeconomic policy. This is conducive to a stable and predictable policy framework. The center-right coalition of Prime Minister Solberg comprising the Conservatives, the Progress Party, and the Liberals, was re-elected for a second term in September 2017. Following two cabinet reshuffles due to issues surrounding immigration and climate change earlier this year, the prime minister struck a deal to form a center-right majority government by adding the Christian Democratic Party to the minority three-party coalition. This suggests continued stability and consensus-based policies aimed at preserving the dynamism of the Norwegian economy.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments:
https://www.dbrs.com/research/352090/.

Notes:

All figures are in Norwegian Krone (NOK) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS Morningstar 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 primary sources of information used for this rating include the Government of Norway, the Ministry of Finance of Norway, Norges Bank, Statistics Norway, the Financial Supervisory Authority of Norway, Norges Bank Investment Management, Norsk Forbund for Innkjop og Logistikk/Danske Bank, TNS Gallup, UN, IMF, BIS, Energy Information Administration, Real Estate Norway, and Haver Analytics. DBRS Morningstar 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 participate in the rating process for this rating action. DBRS Morningstar 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 rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on April 26, 2019.

Solely with respect to ESMA regulations in the European Union, this is an unsolicited credit 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 Morningstar had no access to relevant internal documents for the rated entity or a related third party

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar 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.

Lead Analyst: Rohini Malkani, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer – Global FIG and Sovereign Ratings
Initial Rating Date: 21 March 2012

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