DBRS Morningstar Confirms the Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Denmark’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Kingdom of Denmark’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 Denmark’s strong fundamentals and DBRS Morningstar’s view that the challenges Denmark faces are contained. Following a pronounced contraction in 2009, the Danish economy experienced a prolonged period of economic upswing mainly driven by domestic demand, showing limited evidence of imbalances building up. Despite a weaker external backdrop, Danish GDP growth held up in 2019 benefiting from the good performance of the pharmaceutical and wind turbine industries. The pressures in the housing market have eased, likely affected by strong investment in dwellings in recent years and several measures aimed at the housing market and limiting risky mortgages. This helps mitigate the vulnerabilities stemming from the private sector, mainly related to high household debt.

The ratings are supported by Denmark’s strong external position, its sound public finances, its credible policy framework, and its wealthy and diversified economy. The predictable macroeconomic policy framework has underpinned the country’s economic stability for decades. Denmark’s strengths offset the credit challenges associated with an interconnected financial system, high levels of household debt, and potential pressures on the housing market.

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 plays a pivotal role in 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 overall economy.

RATING RATIONALE

Financial Stability Risks Still Contained, Price Stability Remains

The Danish banking system is sound, with adequate capital, robust liquidity and good profitability levels. However, the overall financial sector is concentrated and interconnected, which could amplify shocks to the financial system and economy. The housing market plays a crucial role in Denmark connecting the balance sheets of mortgage banks, pension funds, insurers, foreign investors, and households. Mortgage banks fund mortgage loans issuing covered bonds, which are largely purchased by Danish pension funds, the insurance sector, and foreign investors. Households have a significant portion of their wealth in housing and pension assets. Thus, a shock to the financial system, including to the mortgage covered bond market —the largest in the world as a per cent of GDP— could have a significant impact on Denmark’s financially complex economy. A recent stress test carried out by Danmarks Nationalbank (DNB), Denmark’s central bank, shows that a few systemic banks would fall short of their buffer requirements under a severe stress scenario even if the countercyclical buffer were to be released. As such, DNB has urged banks to reconsider their capital targets to ensure sufficient capital adequacy versus minimum requirements.

High household indebtedness and high house valuations remain a key source of macro-financial vulnerability, according to the International Monetary Fund (IMF). Although household debt, which is 273.1% of seasonally adjusted disposable income as of Q2 2019, remains the highest among Organization for Economic Cooperation and Development (OECD) countries, households have been deleveraging significantly in recent years. Variable interest rate and deferred amortising mortgage loans still account for a significant portion of mortgage lending, around 54% and 45% respectively. However, households have increasingly chosen longer fixed interest rate periods and amortising loans in recent years. Limits on deferred amortisation mortgages have been adopted, and mortgage interest deductibility, which acts as a tax incentive to debt financing, is being reduced. High debt ratios are concentrated in high-income households, and households’ net financial assets are sizeable, amounting to 372.9% of seasonally adjusted disposable income as of Q2 2019.

On the back of income growth and lower mortgage rates, housing prices have steadily increased since 2012, although they have started to soften. Moreover, Denmark’s urban areas have been facing increasing pressure from population growth, the complex rental market, and some supply constraints, especially in the Copenhagen area. However, the apparent soft-landing in the housing market seems to partly be driven by increased construction and new measures tightening lending conditions, especially for borrowers in growth areas. A new housing taxation system, which removes the 2001 tax freeze, is set to be implemented from 2024 and is expected to have a stabilising effect on house prices.

The ongoing investigations over possible money laundering in the Estonian branch of Denmark’s largest bank, Danske Bank A/S (Danske Bank; rated “A” with a Negative trend by DBRS Morningstar), along with the serious shortcomings identified in Danske’s operational risk management framework have raised reputational and confidence risks in the Danish financial system. Adverse market reaction has been limited so far, but the size of the potential fines that could result from the various ongoing investigations is uncertain. In response to the Danske Bank case, the government has further tightened its anti-money-laundering legislation. A negative adjustment in the “Monetary Policy and Financial Stability” building block has been done to reflect the financial risks stemming from the banking system.

Monetary policy is aimed at keeping the Danish krone peg to the euro, which anchors inflation and inflation expectations at low and stable levels. Policy interest rates are used to maintain the peg and normally track European Central Bank (ECB) rates. As a result, the DNB lending rate and the certificates of deposit rate remain at very low levels.

Denmark’s Economic Performance Remains Strong, Risk Mostly External

Denmark is characterised by a wealthy, diversified, and flexible economy. Denmark is an attractive destination for investment, ranking third in the 2018 World Bank’s Ease of Doing Business Index. Following a pronounced contraction in 2009, the Danish economy experienced a prolonged period of economic upswing mainly driven by domestic demand, showing limited evidence of imbalances building up. A strong labour market, with significant job creation since 2013, has underpinned the dynamism of domestic demand, especially private consumption and investment. An enlarged labour supply —thanks to the raised retirement age and increased foreign supply— has supported employment growth and eased pressures in the labour market.

Despite weaker global activity and lingering external uncertainties, the European Commission (EC) expects growth to stand at 2.0% for the full year in 2019. The specialisation of the Danish manufacturing sector in less cyclically sensitive products, such as pharmaceutical products and wind turbines, has supported exports and industrial production. However, an economy operating above potential capacity and a weaker external backdrop both point to a gradual deceleration of activity in coming years.

The EC projects annual average growth of 1.6% for the next two years largely driven by domestic demand. The main risks to the downside could stem from protectionism and weaker world trade, given Denmark’s large shipping sector; a hard Brexit, given Denmark’s trade links with the UK; and the risk of a sharper downturn in Germany and Sweden, key export markets to the country. On the domestic front, growth could be inhibited by capacity constraints.

Strong Fiscal Institutions Buttress Solid Public Finances

Denmark’s sound public finances provide valuable fiscal headroom to respond during economic downturns without compromising fiscal sustainability. Denmark’s robust and credible fiscal framework includes an annual budget balance limit of 0.5% of GDP and a balanced budget target by 2025, both in structural terms, and multiannual expenditure limits. Given the volatility of some of its revenue sources, especially from the pension-yield taxes and oil and gas extraction in the North Sea, fiscal targets are set in structural terms.

The 2020 budget plan projects the structural balance to be -0.1% of GDP both in 2019 and 2020. The actual budget balance has benefitted from the economic upswing, which boosts revenues and reduces expenses for income transfers. The EC forecasts the actual budget balance to reach 2.2% of GDP in 2019, well above earlier projections, mostly due to an upward revision to the revenues from the pension-yield tax. For 2020, the headline deficit is expected to decline to 0.5% of GDP, principally due to a one-time tax refund to homeowners who overpaid property taxes in the past and additional spending on welfare and education. Over the long term, the demographic development and declining revenues from oil and gas production will pressure public finances. On the other hand, long-term fiscal sustainability is supported by the 2011 retirement reform, which increased the statutory retirement age and reduced voluntary early retirement.

Moderate Public Debt Ratio and Favourable Financing Conditions

Denmark’s government debt ratio at 33.8% of GDP is modest and one of the lowest in the European Union. While it should drop further next year, the IMF sees a gradual increase in the debt ratio towards 38% of GDP by 2025, largely driven by the impact of the new financing model for social housing. The new model is expected to increase both the general government’s EMU debt ratio and assets by around 7% of GDP in the next five or six years, as the government will be issuing new debt to finance the purchase of government-guaranteed bonds backed by real estate. Therefore, the net debt ratio of the general government will by unaffected by the new model.

Denmark’s low levels of public debt and favourable debt profile support 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. Danish government bond yields remain low, reflecting low policy interest rates and investor confidence in the Danish economic policy framework.

Denmark Benefits from a Strong External Sector, Posting Substantial and Persistent Current Account Surpluses

Denmark’s current account surplus and net external asset position remain large. The current account has averaged 7.0% of GDP over the past 10 years. According to the IMF’s estimates, the surplus continues to be driven by the exports of goods, including by offshore activities of Danish multinational companies (merchanting and processing activities) as well as investment income from its sizeable net creditor external position. The net international investment position stood at 60.0% of GDP in 2018.

While Denmark’s peg to the euro reduces its capacity for external adjustment via exchange rate movements, the country has successfully relied on sound economic and fiscal policies to stabilise the economy. In addition, strong political commitment and ample international reserves lend further credibility to the peg. Sound public finances, together with a strong external position, help Denmark to maintain its long-standing fixed-exchange-rate policy.

Strong and Stable Political Framework Supports Economic Stability

Denmark’s political environment and institutions are stable. The introduction of key reforms tends to rely on broad support across the political spectrum. This predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades. After winning the general elections in June 2019, the Social Democratic Party formed a single-party minority government with the support of three left-wing parties in parliament. DBRS Morningstar expects the new government to use the available fiscal space within the fiscal framework to pursue its green, welfare, and education initiatives during this legislature.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.

Notes:
All figures are in Danish kroner (DKK) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal 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 (DNB), Ministry for Economic Affairs and the Interior, Ministry of Finance, Danmarks Statistik, European Central Bank, European Commission, Eurostat, OECD, IMF, World Bank, BIS, UNDP, and 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: September 20, 2012
Last Rating Date: June 7, 2019

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