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 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 Norway’s credit fundamentals remain solid despite the severe economic shock caused by the new Coronavirus Disease (COVID-19). The Norwegian economy saw a sharp contraction in the first half of the year due to the restrictions to contain the spread of the outbreak. Mainland GDP fell by over 11% between February and April, with the decline amplified by a fall in oil prices and a contraction among Norway’s trading partners. Registered unemployment rose from 2.3% in February to 10.7% in March. However, the economy hit bottom in April and a strong recovery supported by extraordinary levels of fiscal and monetary stimulus is now underway. While high-frequency indicators, along with both GDP and employment data, point to a robust rebound in the third quarter, the outlook is still highly uncertain and will likely depend on the evolution of the epidemic. Norges Bank expects GDP to decline by 3.6% in 2020 and expand by 3.6% in 2021, whereas the Ministry of Finance is slightly more optimistic at 3.1% contraction in 2020 and 4.4% growth in 2021. The IMF in its latest WEO sharply revised up its earlier estimates and expects growth to decline by 2.8% in 2020 and expand by 3.6% in 2021.
Notwithstanding the uncertainties, Norway has substantial capacity to absorb shocks and to cope with pending challenges without putting downward pressure on the ratings. Even accounting for a significant downturn and deterioration in the fiscal stance, our building block assessments for Norway remain broadly unchanged. The credit profile is underpinned by Norway’s ample public-sector wealth, prudent management of its oil-related windfalls, strong external position, and sound institutional framework. One significant backstop is the sovereign wealth fund, the Government Pension Fund Global (GPFG), that had a market value equivalent to nearly three times GDP as of June 2020. Despite net transfers from the fund to the national budget to offset the impact of the pandemic, the market value of the Fund still increased to NOK 10,398 billion as of June 2020 from NOK 10,084 billion on December 2019, due to depreciation of the Norwegian krone.
Norway is firmly placed in the AAA rating category but could be downgraded by one or a combination of the following factors: (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.
Norway’s Economy Rebounds Quickly From the Twin Shocks of COVID-19 and Oil, But Uncertainties Remain
Norway has been effective in containing the spread of the coronavirus pandemic, recording 15,953 confirmed infections and 277 deaths related to the outbreak as of October 15, 2020. That said, the spread of COVID-19 and measures to contain it contributed to a marked decline in the Norwegian economy in March and April, with the decline amplified by a fall in oil prices and a contraction among Norway’s trading partners. Mainland GDP contracted 11.0% during March and April with the registered unemployment rate rising from 2.3% in February to 10.7% in March, of which 90% reflected furloughs. While Norway’s Q2 GDP contracted -5.1% QoQ, the sharpest fall since the series started in 1978, the decline was significantly less than the 11.7% drop seen in the EU during the same period. This is primarily due to Norway’s economic structure: lesser reliance on the tourism-related sector, relatively favorable starting point in terms of distance working and digital skills, sizable fiscal room to react, and lighter touch approach to control the pandemic. Furthermore, Norway did not shut down factories or construction sites and the country was among the first to open kindergartens.
As the pandemic restrictions eased over the summer, activity has picked up with the high frequency data recording a strong rebound. The full-time jobless rate has declined to 3.7% in September as more employees are returning to work. However, there has been a clear shift away from service consumption towards goods. As the impulse from service consumption to the wider economy are far stronger than the impulse from goods consumption, it will take time for the economy to return to its pre-pandemic level. Government officials expect GDP to decline between 3.1% and 3.6% in 2020, and GDP growth from 3.6 to 4.4% in 2021. Nonetheless, the main downside risks remain linked to the evolution of the pandemic both domestically and abroad, to the scale of new containment measures, and to the broad availability of a vaccine. Additionally, uncertainty surrounding external developments such as the EU-UK trade agreement and the U.S.-China relationship could be a drag on growth.
Once the shocks dissipate, the Norwegian economy is expected to expand at a moderate pace over the medium term. Prior to the shocks, the IMF and Norges Bank had projected annual growth over the medium-term at 1.6%, in line with the structural slowdown experienced across most advanced economies. This is lower than Norway’s historical growth performance, which saw growth averaging 2.6% during the last two decades. Growth was led by consumption, supported by higher employment and wages, oil related investments, and the flexible currency helping exports. As a result of the pandemic shock, Norges Bank has lowered its projections for both productivity (due to business closures and lower investment) and labor force participation and now pins potential growth at 1.2%. Over the medium- to long-term, the main challenge for the Norwegian economy will be to successfully re-tool the oil-dependent economy towards other tradable sectors.
Norway’s Ratings Benefit From Its Strong Public Sector Balance Sheet and Prudent Fiscal Framework
Norway’s solid fiscal framework and the public sector’s sizable net creditor position, due to its sovereign wealth fund, the Government Pension Fund Global (GPFG), provide the government with significant fiscal space to implement counter-cyclical policies without jeopardizing its ratings. The GPFG forms an integral part of the budget and fiscal policy framework. Government petroleum revenues are transferred to the GPFG in their entirety. The fiscal policy guidelines require petroleum revenue spending over time to be limited to the expected real rate of return on the fund, estimated at 3%. The guidelines further stipulate that petroleum revenue spending in any given year shall be adapted to the economic situation, as determined by the parliament.
Norway’s recovery has been helped by its unprecedented fiscal response. The government introduced several measures amounting to NOK 126 billion (4.5% of mainland GDP) to secure jobs, help businesses, and strengthen health services. To cushion the economic shock, the government is taking advantage of the flexibility offered by the fiscal policy rule, with petroleum revenue spending likely above the 3% limit of the GPFG. Including the announced stimulus of NOK 126 billion, Norway’s structural non-oil deficit is expected to rise to NOK 395.0 billion in 2020 (12.3% of mainland GDP), equivalent to 3.9% of the value of GPFG, from NOK 242.6 billion in 2019 (7.9% of mainland GDP). As the stimulus measures are largely temporary, the non-oil deficit in 2021 is expected to be lower at NOK 313.4 billion (9.4% of mainland GDP), equivalent to 3% of the GPFG. While the headline numbers indicates a -2.4% fiscal impulse, adjusted for COVID-19, the fiscal impulse is still expected to be expansionary at 1% of GDP.
Norway’s public sector balance sheet constitutes one of its key credit strengths relative to other AAA-rated countries. General government gross debt, at an estimated 40.6% of GDP in 2019, is one of the lowest debt 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 local currency to fund government lending schemes, to cover redemptions of existing debt, and to ensure a well-functioning financial market in Norway. DBRS Morningstar expects the general government gross debt ratio to stabilize around 40% of GDP in the coming years.
With financial assets far exceeding total debt, the government’s net asset position currently stands at 266.9% of GDP as of Q2 2020. This is largely explained by the sovereign wealth fund whose market value was equivalent to 289.1% of mainland GDP at the end of June 2020. The current negative shock would impact net rather than gross government debt. This is because the fiscal stimulus, taking the form of a higher non-oil fiscal budget deficit, will likely be financed by higher transfers from the GPFG. Given the fiscal guidelines and the government’s asset position, Norway’s gross government debt is generally insulated from negative shocks. This accounts for the one category uplift in the “Debt and Liquidity” building block assessment.
Norges Bank Acts Proactively, But Vulnerabilities Remain in the System
Norges Bank took a number of actions to alleviate the impact of COVID-19. The bank cut its policy rate first from 1.5% in February to 0.25% in March, and then to 0% in May, while expanding liquidity facilities. It introduced a large number of emergency lending programs in both Norwegian krone and U.S. dollar and intervened in the foreign exchange markets to strengthen liquidity and improve the functioning of financial markets. The monetary policy stance is expected to remain highly expansionary during 2020-21 as central bank authorities plan to keep rates low until the recovery is well underway. These stabilization measures have been effective so far. Following the shock to markets in late March, financial conditions improved, with credit spreads and premiums narrowing across a variety of markets and equity prices rebounding. While COVID-19 has led to significant revenue losses among many businesses in 2020, the number of bankruptcies has been moderate, largely due to the authorities’ proactive measures such as principal payment deferrals and liquidity loans from banks.
While banks remain liquid, profitable, and well-capitalized, the overall system has some structural vulnerabilities. Similar to its Nordic peers, Norwegian banks rely heavily on wholesale and short-term foreign funding. At the end of 2019, the wholesale funding ratio stood at 49.4%, half of which is denominated in foreign currency. Against this 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 (NPLs) as a share of total gross loans at 0.7% in Q2 2020. Banks have built significant liquidity buffers in recent years which amply meet the liquidity coverage ratio requirement. The banking sector’s average Common Equity Tier 1 (CET1) capital ratio, at 17.9% during Q2 2020, is almost double the rate during the financial crisis. The countercyclical capital buffer requirement was set at 2.5% reflecting the build-up of financial imbalances, primarily in credit and real estate markets, but has since been reduced to 1% in March.
Norwegian banks also have a large exposure to the real estate market. One of Norway’s main challenges are the financial imbalances that have built up as housing prices and household debt outpaced disposable income growth. Real house prices have more than doubled since the year 2000, fueled by lower residential mortgage rates, growth in household income, high immigration, and supply constraints. As a result, the household debt-to-disposable income ratio rose from 127% in 2001 to 227% in 2018 before stabilizing. Since then, house price inflation has been moderate and lower than income growth, reflecting the rise in interest rates between 2018 and 2019 and the introduction of a number of measures to restrain borrowing. However, the system could see a further build up in financial imbalances due to COVID-19 related measures. House prices fell in March and April, but have subsequently picked up as lower interest rates and temporary easing of the residential mortgage regulation have stimulated housing demand. Bank’s exposure to commercial real estate (CRE) is another vulnerability in the financial system. Due to COVID-19, rents in prime office spaces in Oslo have fallen nearly 10 %, while the fall in sales prices have been somewhat higher due to a small increase in the yield.
Government measures to reduce vulnerabilities in the housing market reflect increased financial vigilance by authorities. Current regulations include limiting the debt-to-income ratio to five times the borrower’s annual income and the loan to value ratio at 60% for secondary housing in Oslo. The flexibility ratio, the mortgage regulation which allows a certain amount of a lender’s approved loans to deviate from the requirements in the regulation, was set at 10% for loans outside Oslo and 8% in Oslo. During the peak of the crisis, the ratio was temporarily increased to 20% for loans both in and outside of Oslo. From Q4 2020, the flexibility quota has been brought down to 10 per cent of the lender’s approved loans outside Oslo, and 8 per cent for mortgages in Oslo.
Norway’s Strong External Position Provides a Significant Buffer to Absorb Shocks
Norway’s external accounts are characterized by a structural current account surplus and a positive net creditor position. The persistent current account surpluses, averaging 10% of GDP over the last two decades, reflect Norway’s sizeable energy surplus, high per-capita income levels, and high savings rate. Its large positive net international investment position of 266.9% of GDP, more than double Norway’s GDP, is due to the substantial accumulation of foreign assets through the GPFG. In addition to the backstop from the sovereign wealth fund, Norway’s floating currency acts as shock absorbers in the face of the global economic consequences from coronavirus. The krone tends to depreciate when a pronounced negative shock occurs, as observed during the financial crisis in 2008, the fall in oil prices in 2014, and in March 2020 when the pandemic broke out. The Norwegian krone, as measured by the import-weighted index I-44, has appreciated since reaching record lows in March. Reduced uncertainty in global financial markets and a rise in oil prices likely contributed to the krone appreciation.
A Predictable Policy Framework Supports Norway’s Ratings
Norway benefits from strong political institutions with an established track record of a consensus-based approach to macroeconomic policy. The country is characterized by strong rule of law, a robust regulatory environment, and low levels of corruption. According to the World Bank’s Worldwide Governance Indicators, Norway ranks highly compared to other advanced economies in all areas of measured governance. This is conducive to a stable and predictable policy framework. The minority center-right coalition government of Prime Minister Solberg, composed of the Conservatives and the Liberals, has relied thus far on the parliamentary support from the Christian Democratic Party to pass legislation. The coalition has seen several cabinet reshuffles due to issues surrounding immigration and climate change. The government is using the flexibility built in the fiscal framework to respond to the pandemic shock and to stabilize the economy.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/368393.
All figures are in Norwegian Krone (NOK) 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 (July 27, 2020): https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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, World Bank 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 (DBRS Morningstar) 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 17, 2020.
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.
With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
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: Thomas R. Torgerson; Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: 21 March 2012
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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