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 DBRS Morningstar’s view that Denmark’s strong economic fundamentals and public finances limit the risks to the rating stemming from the Coronavirus Disease (COVID-19). Following a sharp output contraction triggered by the pandemic shock during the first half of the year, the relaxation of restrictions and the income support measures have permitted a strong recovery during the third quarter. More recently, the tightening of restrictions has intensified uncertainty over the growth outlook in the short term. Nevertheless, Denmark’s flexible economy, robust labour market, and productive specialisation bode well for the recovery. Given Denmark’s strong public finances, with one of the lowest public debt ratios in the European Union (EU) and very low funding costs, the government is able to support the economy and mitigate long-lasting effects from the pandemic without materially affecting public debt sustainability.

The ratings are supported by Denmark’s strong external position, its sound public finances, its credible policy framework, as well as 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 in this more difficult environment brought about by the pandemic.

RATING DRIVERS
Given Denmark’s credit strengths, downgrading the ratings appears unlikely. The ratings could be downgraded if one or a combination of the following occur: (1) a severe shock to the economy that materially impairs Denmark’s medium-term prospects; or (2) a substantial deterioration of the public debt ratio, which could potentially be triggered by a materialisation of contingent liabilities associated with its large and interconnected financial system.

RATING RATIONALE

The Pandemic Will Trigger a Deep But Transitory Contraction in GDP This Year

The pandemic and the measures to limit its spread prompted a 7.0% q-o-q contraction of Danish GDP during the second quarter. The restrictions heavily impacted private consumption and affected the hospitality, retail, and travel sectors. As a small and open economy, the recession and production disruption in the global economy weighed severely on exports and investment. The reopening of the economy has permitted a strong GDP rebound of 4.9% q-o-q in the third quarter of the year related to strong private consumption. Pent-up demand, the government’s wage subsidy scheme, and the improvement in the labour market have lifted consumption. Furthermore, the implementation of the new holiday scheme, with the holiday pay to be earned concurrently rather than one year ahead as per the previous scheme, has permitted wage earners to claim the disbursement of three weeks of frozen holiday pay from the Q3 2020 to Q2 2021, boosting household spending in coming quarters. Despite the pandemic, the housing market has been robust, with both transactions and prices recovering strongly, helped by the low interest rate environment and solid household income.

The European Commission (EC) forecasts Danish GDP to fall 3.9% in 2020, much less than the 7.4% forecast for the EU. An effective pandemic containment policy, lesser reliance on tourism-related activities, a relatively higher prevalence of remote working, and substantial fiscal support could help explain Denmark’s relatively less affected economic performance. The EC projects the recovery to continue with GDP growth of 3.5% in 2021 and 2.4% in 2022 benefiting from a domestic and external demand rebound. The recent tightening of restrictions to limit the spread of the pandemic in Denmark, and across other European nations, poses downside risks to growth in the short term. Nevertheless, Denmark’s wealthy, diversified, and flexible economy points to a strong recovery once the pandemic is under control. Aside from the pandemic-related risks, other sources of risk stem from Danish households’ high levels of debt, protectionism and the evolution of global trade, given Denmark’s large shipping sector, as well as still the risk of a no-deal Brexit, given Denmark’s trade links with the UK.

Denmark Is Well Prepared Given Its Solid Public Finances And Fiscal Institutions

Denmark entered the current crisis with sound public finances, providing the government with valuable fiscal headroom to mitigate the severe impact from the pandemic without compromising fiscal sustainability. The fiscal surplus averaged 1.6% of GDP annually between 2016 and 2019 benefiting from a favourable macroeconomic backdrop. The budgetary surplus reached 3.7% of GDP in 2019 driven by higher than expected pension-yield tax revenues. Denmark’s fiscal track-record is buttressed by a robust and credible fiscal framework. 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 response to the pandemic and the impact of the economic downturn is expected to result in a significant fiscal deficit this year. The discretionary measures worth 4.5% of GDP include direct support to firms to partially cover fixed costs and wage expenditures, along with specific support to sectors particularly affected by the restrictions. In addition, the government has provided substantial liquidity support to business in the form of tax deferrals and state loan guarantees that pose a risk of additional spending later. The government estimates losses on state guarantees of 0.5% of GDP in 2020.

The government projects a fiscal deficit of 3.9% of GDP in 2020, well below previous expectations of 8.0% of GDP, in part due to lower take-up of the fixed cost compensation scheme. The rebalancing is expected to be gradual with the deficit declining to 2.4% of GDP in 2021 as the economy rebounds and measures are phased out, although there is significant uncertainty linked to the pandemic. These projections are broadly in line with those of the EC. On a structural basis, the government foresees a deficit of 0.4% of GDP in 2020 and 0.5% of GDP in 2021, complying with medium term structural deficit targets. Over the longer term, demographic developments and declining revenues from oil and gas production will put pressure on public finances. The 2011 retirement reform, which increased the statutory retirement age and reduced voluntary early retirement, partially offsets these risks.

Despite The Shock, The Public Debt Ratio Will Remain Moderate and Financing Conditions Favourable

The government projects the sharp economic contraction and large fiscal deficit triggered by the pandemic to be reflected in a sharp increase in the public debt ratio to 46.3% of GDP in 2020 from 33.3% of GDP in 2019. The EC foresees a similar deterioration. This increase is also influenced by stock-flow adjustments created by the temporary tax deferrals and new lending related to the new holiday scheme. The EC projects the public debt ratio to stabilise around 41% during 2021-2022, driven by the rebound in output, fiscal rebalancing, and the cancellation of tax deferrals. In the current context, the main risks stem from the pandemic and its economic impact. On another note, the financing model for social housing is expected to increase the public debt ratio in coming years, although it will be neutral for net debt.

Despite this large increase, Denmark’s public debt ratio still is expected to be one of the lowest in Europe. Denmark’s low level of public debt and favourable debt profile support its resilience to shocks. Debt is mostly 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.

Financial Stability Risks Still Contained And Supported By the Policy Response

Denmark’s monetary policy is geared to keeping the Danish krone stable against the euro. Faced with the pandemic, the Danmarks Nationalbank (DN), Denmark’s central bank, acted rapidly to stabilise the peg and prevent credit flow disruptions. The DN raised its policy rate by 15 basis points to -0.6% to offset temporary weakening pressures on the exchange rate. Also, the DN launched extraordinary lending facilities and activated/reached swap agreements with the European Central Bank (ECB) and the Federal Reserve to support liquidity in various currencies. Similarly, the Danish authorities released the countercyclical capital buffers, cancelled planned increases, and eased Liquidity Coverage Ratio (LCR) requirements.

Denmark’s financial system is large, with assets over 630% of GDP, partly reflecting the strong links between financial institutions, households, and firms, according to the International Monetary Fund (IMF). The housing market and mortgage covered bond market —the largest in the world as a percentage of GDP— play a crucial role in Denmark connecting the balance sheets of mortgage banks, pension funds, insurers, foreign investors, and households. Similar to other Nordic countries, the Danish banking system has strong linkages and exposures concentrated within the Nordic-Baltic regions.

The high level of household indebtedness, at 260.9% of seasonally adjusted disposable income in 2019, remains an important source of vulnerability, rendering household consumption susceptible to adverse shocks. Offsetting these risks, households have been deleveraging significantly in recent years and the high debt ratios tend to be concentrated in high-income households. Households’ net financial assets are sizeable, albeit a large portion remain illiquid housing and pension savings. Stricter borrower-based measures to limit risky borrowers have resulted in an increasing share of mortgages with longer fixed interest rate periods and amortising loans in recent years. The impact thus far has been contained. A negative qualitative adjustment in the “Monetary Policy and Financial Stability” building block has been made to reflect the risks stemming from Denmark’s large and interconnected financial system and its highly indebted households.

The pandemic-induced recession is expected to hinder profitability by higher loan losses, compounding long-standing pressures from the ultra-low interest rate environment. However, credit institutions will face the current situation better capitalised and with higher excess liquidity. The DN’s latest stress test in May 2020 shows that the banking system can withstand a severe but temporary economic slump and absorb substantial losses. The housing market is showing signs of resiliency after coming to a halt during the lockdown. The combination of low interest rates and households’ income holding up, benefitting from the government support and a recovering labour market, are factors supporting the housing market. Lastly, the litigation and reputational risks surrounding the investigations into possible money laundering by Danske Bank A/S at its Estonian branch between 2007 and 2015 remain in the background.

Denmark’s Strong External Sector Will Help Weather The COVID-19 Shock

Denmark exhibits a strong external position both from a flow and a stock perspective. The current account surplus averaged 7.2% of GDP over the last ten years and the net international investment asset position (NIIP) amounted to 77.5% of GDP in 2019. The global downturn and supply disruption generated by the pandemic have weighed on Danish exports this year. The mobility restrictions have significantly impacted travel service exports and the slump in global trade impacted its sizable shipping service sector. On the other hand, goods exports were less affected, in part because of relatively good performance of the pharmaceutical and food export sector, which represent a large portion of goods exports and are less sensitive to the business cycle. The current account surplus is expected to continue to be large in 2020 given that the physical restrictions and lower domestic demand have led to lower imports.

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 and to prevent large external imbalances from building up. A strong external position, ample international reserves, sound public finances, and a strong political commitment underpin the high credibility of Denmark’s long-standing fixed exchange rate policy. This supports DBRS Morningstar’s positive qualitative assessment of the “Balance of Payments” building block.

Strong and Stable Political Framework Supports Economic Stability

Denmark’s political environment and institutions are very strong as reflected in the World Bank governance indicators. The introduction of key reforms tends to rely on broad support across the political spectrum, ensuring its durability. This predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades. After winning the general election in June 2019, the centre-left Social Democratic Party formed a single-party minority government with the support of three left-wing parties in parliament. DBRS Morningstar continues to expect the minority to continue to support green, welfare, and education initiatives during this legislature.

ESG CONSIDERATIONS
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/370827.

DBRS Morningstar notes that this Press Release was amended on 4 December 2020 to incorporate the link to the Scorecard Indicators and Building Block Assessments document.

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 https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020).

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 sources of information used for this rating include Danmarks Nationalbank (Financial Stability 1st Half 2020, 27 May 2020), Ministry for Economic Affairs and the Interior, Ministry of Finance (Economic Survey, August 2020; Finance Bill 2021, August 2020; DK2025, August 2020), Danmarks Statistik, European Central Bank, European Commission (European Economic Forecast Autumn 2020, November 2020), Eurostat, OECD, IMF (Financial System Stability Assessment for Denmark, August 2020; Policy tracker: Policy Response to COVID-19), 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.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

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 12-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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/370826.

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

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Financial Institutions and Sovereign Ratings
Initial Rating Date: September 20, 2012
Last Rating Date: June 5, 2020

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