DBRS Morningstar Confirms Kingdom of Sweden at AAA, Stable Trend

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

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects DBRS Morningstar’s view that the risks to the ratings are limited. After five years of strong GDP growth at an annual average rate of 2.9%, the Swedish economy is experiencing a cyclical slowdown with growth expected to remain slightly above 1% in 2019/2020 amid a challenging external environment and a sharp contraction in housing investment this year. So far, a weak krona has helped cushion the impact of the global slowdown on the economy and there is no evidence of significant spillovers from the slump in housing construction to the rest of the economy.

The high level of household indebtedness, which could amplify the macroeconomic impact of shocks, remains a source of concern. Moreover, Swedish banks’ exposure to the housing market as well as its large, concentrated and interconnected nature could also reinforce potential shocks. On the other hand, Sweden’s strong public finances, as evidenced by its low and falling debt ratio and fiscal surplus, provide valuable fiscal room to respond to potential shocks. Furthermore, households’ high level of savings could also help them smooth consumption patterns if faced with a shock.

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 Morningstar views this as unlikely. A materially higher public debt ratio could result from a severe deterioration of the medium-term growth outlook or if substantial contingent liabilities related to the banking system materialise, most likely triggered by a collapse in the housing market and a sharp worsening of financial conditions.

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. As of 2019, the revised fiscal framework lowered the level of the general government surplus target to 0.33% of GDP from 1% of GDP on average over an economic cycle and introduced a debt anchor for the general government consolidated debt at 35% of GDP (+/-5% GDP). In the event of deviations from these targets, the government has to communicate how it intends to deal with the deviation. An expenditure ceiling, extending for the third year ahead in the budget bill, is an overarching restriction for the budgetary process.

Sweden’s public finances remain strong and well equipped to respond to adverse developments. The general government fiscal balance averaged a surplus of 0.8% of GDP between 2015 and 2018, driven by higher tax collection benefitting from the economic upswing as well as by public expenditure growing less than nominal GDP. The government projects the fiscal surplus to hover around 0.3%-0.4% of GDP between 2019 and 2021 before jumping to 1.2% of GDP in 2022. However, these projections include the measures in the 2020 budget bill and assume no policy changes after 2020, which under the current macroeconomic environment creates an automatic fiscal tightening through a declining central government spending-to-GDP ratio in coming years. However, DBRS Morningstar expects the central government to utilise the available fiscal space to be generated on an annual basis, leaving the structural surplus close to 0.33%.

The long-term sustainability of public finances is well anchored. The general government debt-to-GDP ratio has declined substantially over the past two decades, placing Sweden among the lowest indebted sovereigns in the European Union (EU). The government projects the debt ratio to drop to 34.8% in 2019 from 38.8% in 2018, driven by the fiscal surplus, nominal growth, and the Swedish central bank’s (Riksbank) decision not to refinance three foreign currency loans from the Swedish National Debt Office (SNDO) maturing in 2019 amounting to USD 8 billion.

Going forward, the International Monetary Fund (IMF) projects the debt ratio to decline further to 29.5% by 2024. However, the government´s ability to use the fiscal space within the fiscal targets or the impact of automatic stabilisers could render these projections somewhat optimistic. The National Institute for Economic Research’s (NIER) projections of a debt ratio at 33.3% by 2023 appear more realistic. The materialisation of contingent liabilities, stemming from Sweden’s large public sector and exposure to financial sector-related entities, could lead to a higher but still manageable debt-ratio.

Sweden’s outstanding debt stock has the second-shortest average residual maturity in the EU at 4.5 years and a considerable portion denominated in foreign currency. Nevertheless, DBRS Morningstar considers the associated risks are small given the low levels of debt, steady demand for Swedish government bonds, and the SNDO on-lending operations that account for two-thirds of the foreign currency exposure.

Sweden’s Economic Outlook Remains Solid Despite Cyclical and External Pressures

Sweden’s strong economic performance, with average GDP growth of 2.4% per annum for the last two decades, has been underpinned by its knowledge-based, competitive economy that is well integrated in global value chains. Sweden’s high GDP per capita at USD 54,357 reflects a productive labour force and the highest employment rate in the EU at 82.6% in 2018. As a small and open economy, with significant external trade and financial linkages, Sweden is exposed to external developments.

After this prolonged period of expansion, there is increasing evidence of a cyclical deceleration taking place in Sweden. The growth outlook for 2019-2020 is slightly above 1% per annum. Investment, which has been a key growth driver in recent years, is now expected to contract for the biennium. Housing investment could shrink further by 8.8% in 2019 and by 2.2% in 2020. This has followed a period of extraordinary high housing investment during 2014-2017, that combined with a tightening on new mortgage rules, led to a house price correction in Autumn 2017. So far, spillovers to the rest of the economy have been contained and housing prices are rising again albeit at a lower pace. Private consumption is expected to decelerate transitorily in 2019, as households increase slightly their precautionary savings and the labour market weakens. Export growth is set to decelerate gradually as the weak krona is cushioning the impact of the global economic and trade slowdown, although external risks are high. Against this environment, business investment is now expected to contract in 2020.

Despite this mostly cyclical deceleration, the latest IMF projections project a gradual convergence to growth rates close to 2% in coming years. The external front continues to pose significant downside risks to the outlook, with an escalation of global trade tensions, a disorderly Brexit, and deeper economic problems in the eurozone as the most prominent ones. On the domestic front, the main risks stem from the potential negative impact on consumption and investment decisions from a collapse in the housing market and/or an unexpected increase in interest rates.

Risks to Financial Stability are Manageable, But Key Systemic Vulnerabilities Remain

The Riksbank continues to pursue an accommodative monetary policy to steer core CPIF inflation towards its 2% target. The repo rate (-0.25%) is still in negative territory and the Riksbank will continue to purchase government bonds at least until 2020 to retain the level of holdings after the conclusion of its net purchases in December 2017. DBRS Morningstar considers that the recent softness in the labour market and inflation expectations, coupled with significant global uncertainties and monetary policy relaxation abroad, could delay the Riksbank’s envisioned normalisation path under more challenging conditions in the future.

Managing risks associated with high levels of household indebtedness, housing market pressures and banking sector vulnerabilities remain a key challenge. Housing prices and household debt have increased rapidly in recent decades on the back of growing disposable income, cheap credit, a sluggish housing supply for a prolonged period, and generous tax incentives for debt financing. This has led to a sharp increase in the household debt-to-disposable income ratio, which increased to 185.7% in 2018 from 90.8% in 1996 and has resulted in the price-to-income and price-to-rent ratios well above their long-term averages. Although monetary policy should normalise over time, DBRS Morningstar considers it will remain supportive for a prolonged period.

Swedish households’ high indebtedness could amplify potential interest rate, housing price, or income shocks. The predominance of mortgages at variable rates, about 70% of the total, exacerbates households’ sensitivity to rising interest rates. Some aspects mitigate these risks: (1) DBRS Morningstar believes that that monetary policy will normalise only gradually, (2) households’ very low interest-to-income ratio at 2.5%, and (3) households’ high savings rate and large financial assets. The Swedish authorities have adopted several macroprudential measures, including tightening the amortisation requirements and raising the countercyclical capital buffer to 2.5%, the highest in Europe. Although this is helping to strengthen the resiliency of households and banks and curb risky lending, structural measures might be needed to improve the functioning of the housing market and reduce tax incentives to debt-financing.

The Swedish financial system is large relative to the size of the economy, with high exposures to the housing market, interconnected, and heavily reliant on wholesale funding. The Swedish banking system’s total assets amount to just under 300% of GDP. Market funding represents around half of banks’ funding, predominantly in foreign currency (about two-thirds), implying considerable refinancing and foreign exchange rate risks. Given the limited domestic and retail deposit source, retaining market confidence remains crucial for Swedish banks to ensure a stable source of funding. On the other hand, banks’ loss absorption capacity is above requirements, profitability is good, and asset quality is solid.

Swedbank and SEB are currently being investigated for insufficient routines against money laundering for their activities in the Baltic region, which could weaken confidence in the Swedish banking system. Sweden has strengthened its anti-money-laundering framework in recent years; however, close international collaboration is needed.

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 have averaged 5.2% of GDP over the last two decades. At end-2018, Sweden’s net international investment position stood at 6.8% of GDP. On the back of stronger domestic demand, an ageing population, and a lower export market share, the current account has been declining from its 2006 peak of 8.2% of GDP and stood at 1.7% of GDP in 2018. In 2019, Swedish exports are holding up relatively well, benefiting from a weak krona. Although, the global slowdown and deteriorating global investment climate will most likely dampen Swedish export growth, the current account surplus is expected to continue in coming years. Finally, Sweden´s liquid currency and its international reserves, at 11.1% of GDP in 2018, enhances the ability to weather significant shifts in investor confidence.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

Sweden’s political system is characterised by strong democratic institutions and predictable consensus-oriented policies. The new minority coalition government, comprising the Social Democratic Party and the Green Party, came into power in January after reaching a comprehensive agreement with two centre-right parties, the Centre Party and the Liberals, to obtain their parliamentary support. The so-called “January Agreement”, which should guide policymaking during the current legislature, includes initiatives that will most likely be implemented on an incremental basis each year. In the agreement, the parties have agreed to initiate a broad tax reform. The implementation of the agreement could become challenging given the different political motivations of the parties supporting the current government. Importantly, DBRS Morningstar expects that future measures will be designed to comply with the fiscal framework targets, which enjoy broad political support.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments
http://www.dbrs.com/research/352112

Notes:

All figures are in Swedish kronor (SEK) 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 sources of information used for this rating include Ministry of Finance of the Kingdom of Sweden (MoF), Swedish National Debt Office (SNDO), Sveriges Riksbank, Statistiska Centralbyran (SCB), National Institute of Economic Research (NIER), European Commission, Eurostat, Organisation for Economic Co-operation and Development (OECD), International Monetary Fund (IMF), World Bank, United Nations Development Programme (UNDP), Haver Analytics. DBRS Morningstar 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 Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar 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 Morningstar’s outlooks and ratings are under regular surveillance.

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.

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: April 17, 2012
Last Rating Date: April 26, 2019

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