DBRS, Inc. (DBRS Morningstar) confirmed the Swiss Confederation’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 Switzerland’s credit fundamentals remain solid, despite the severe economic shock and the impact on its fiscal position from the Coronavirus Disease (COVID-19). The pandemic and the measures implemented to contain it resulted in the Swiss economy contracting 3.3% YoY in the first three quarters of 2020. While the recent rise in infections and consequent tightening of restrictions have somewhat increased the uncertainty over the growth outlook in the near term, authorities expect gross domestic product (GDP) growth to shrink -3.3% in 2020, before recovering to 3.2% in 2021. This performance, if confirmed, would be significantly stronger than most of Switzerland’s European peers. The fiscal costs of fighting the pandemic and its economic implications will result in a substantial, but temporary increase in the deficit, which will still be felt in 2021. However, Switzerland’s strong public finances, which include one of the lowest debt ratios among sovereigns in the AAA category (45.7% of GDP in 2020) and exceptionally low funding costs, provide the government ample fiscal headroom to mitigate long-lasting effects from the pandemic without compromising fiscal sustainability.
Switzerland’s AAA ratings are underpinned by its wealthy and diversified economy, sound public finances, and solid external position. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Switzerland’s low levels of indebtedness combined with substantial financial flexibility, help the country to stand out among other highly-rated sovereigns. These credit strengths counterbalance the challenges associated with the uncertainty related to COVID-19, the Swiss-EU relations on the institutional agreement with the EU as well as the moderately increasing risks to financial stability arising from the search for yield and increasing borrowing by domestic investors in the real estate market.
DBRS Morningstar considers the likelihood of a downgrade of Switzerland’s ratings to be low. Nonetheless, external shocks or a sustained deterioration in growth prospects that are severe enough to materially affect Switzerland’s financial stability and fiscal position could put downward pressure on the ratings.
Strong Swiss Fundamentals And Expansionary Policies Support Post Pandemic Recovery
The Swiss economy recovered markedly from the first wave of the pandemic in the spring. Following the -7.0% QoQ contraction in GDP in Q2 2020, growth rebounded 7.2% QoQ in the third quarter. However, the second wave of infections since October has resulted in a renewed, although substantially softer, deterioration in the economic outlook. Moreover, despite the containment measures introduced in December, with case numbers stagnating at high levels and risks of new infectious variants of the virus rising, the Federal Council decided at its meeting on 13 January to introduce further measures to contain the spread of the coronavirus. In addition to extending the measures introduced in December by a further five weeks: restaurants, cultural venues, and sports and leisure facilities are to remain closed until the end of February, the council tightened rules to contain the spread of the virus. Effective January 18, in addition to work from home, shops selling non-essential goods will be closed and stricter rules are being applied to private events and gatherings.
To deal with the economic fallout, the Federal Council announced a series of federal-level support packages amounting to CHF 73 billion (10.4% of 2019 GDP) to support affected businesses and households, while the Swiss National Bank (SNB) launched extraordinary lending facilities and activated swap agreements with the Federal Reserve. The strong rebound in Q3 2020 especially in the manufacturing sector led by pharmaceuticals and chemicals, coupled with expansionary monetary and fiscal policies, have resulted in Swiss authorities revising expectations for economic contraction in 2020 from -6.2% YoY at the beginning of the summer to -3.3% YoY at the end of Q4. They now expect the recovery to be 3.2% YoY in 2021, bringing the Swiss GDP back to its 2019 level at the beginning of 2022. This does not take into account revenues from sporting events, such as the Olympics and the football championships that were deferred due to the pandemic. These events provide a modest boost to growth of around 0.4 percentage points from licensing fees and broadcast rights, as their parent associations – IOC, FIFA, UEFA – are based in Switzerland.
While the near-term outlook remains clouded by uncertainty due to the evolution of the virus and the distribution of the vaccine, Switzerland’s ratings are underpinned by its wealthy and diversified economy and its medium-term economic outlook remains strong. The Swiss economy repeatedly ranks highly in international comparisons; GDP per capita currently stands at USD 82,341 and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland’s highly productive workforce, high levels of educational attainment, and the almost 80% labor force participation. While Swiss economic growth has historically outperformed the euro area average due to sustained consumption and investment growth, as a safe haven currency, the Swiss franc remains vulnerable to appreciation pressures arising from risk aversion. Additional downside risks include the uncertainty on the EU-Switzerland institutional agreement and the search for yield, which could increase financial stability risks.
Switzerland’s Strong Public Finances Provides Sufficient Space For Stimulus Measures to Support the Economy
Switzerland’s strong public finances have allowed it to adopt a comprehensive and substantial package of measures to mitigate the severe impact from the pandemic without compromising fiscal sustainability. In addition to the short-time unemployment scheme (Kurzarbeit) which limited the rise in unemployment to 3.5% in December 2020 from 2.5% in January 2020, the Federal Council announced a series of discretionary measures which include direct support for affected sectors, liquidity assistance for businesses, loan guarantees, tax deferrals, and automatic stabilizer’s. The measures amount to CHF 73 billion (10.4% of 2019 GDP), of which CHF 41 billion is accounted for by state guarantees and loans. As of September 30, authorities have utilized CHF 16.9 billion of the guarantee amount of CHF 41 billion and CHF 18.1 billion of the supplementary credits of CHF 31 billion are expected to be effectively used.
The policy measures to support the economy through the COVID-19 shock will result in a marked deterioration in fiscal performance. Latest estimates by the Ministry of Finance project the general government’s fiscal deficit at -3.7% of GDP in 2020 and -1.2% of GDP in 2021. To finance the package, the Federal Council has passed various supplementary credits for the 2020 budget and late registrations for the 2021 budget for the attention of the Parliament. However, the Swiss authorities have maintained pragmatic and disciplined fiscal policies for more than a decade, resulting in modest structural surpluses since 2006, and thus, the COVID-19 related increase in deficits is likely to remain cyclical and short lived.
Although a significant proportion of the deficit is likely to be financed from the government’s liquidity reserves, the deficit and contraction in growth will lead to a deterioration in Switzerland’s debt ratio. The debt break rule helps ensure that fiscal policy is balanced over the business cycle as the rule links spending to cyclically-adjusted revenues and saving of the surpluses. Moreover, the debt brake is flexible and contains an exception for non-controllable contingencies such as severe recessions, natural disasters, and other shocks. Therefore, the requirements of the debt brake rule can be respected even in the current crisis. The government expects the general government gross debt ratio to rise from 40.6% in 2019 to 45.7% of GDP in 2020 and the Maastricht debt ratio (which excludes pensions and healthcare) to rise from 25.8% in 2019 to 29.1% of GDP in 2020, where it is expected to stabilize at marginally lower levels.
Despite the increase in public debt in 2020, Switzerland’s low level of public indebtedness, combined with substantial financial flexibility, helps the country to stand out among other highly-rated sovereigns. The government’s debt maturity structure is favorable, with average maturity of marketable debt (bonds and T-bills) at 9.8 years and all debt has been issued in Swiss francs. Since July 2019, all marketable debt of the Swiss government has a negative yield to maturity (YTM). The longest maturity is in 2064 that currently is trading at a YTM of -0.375%, while the bond which matures in 2042 offers the highest yield of -0.276%. Interest expenditures for the general government, as estimated by the IMF, were less than 0.2% of GDP in 2020. Consequently, DBRS Morningstar does not expect the current macroeconomic and fiscal shocks to exert downward pressure on the country’s ratings.
The Swiss National Bank (SNB) Remains Highly Accommodative; Limited Impact of Currency Manipulator Label
The coronavirus pandemic and the measures implemented to contain it have led to a downturn in economic activity in Switzerland, resulting in 2020 inflation coming in at -0.7% and the SNB marginally lowering its inflation projections to, 0.0% in 2021 and 0.2% in 2022. In response to the pandemic, the SNB said that it would maintain its accommodative stance with a view to stabilizing economic activity and price developments, keeping its policy rate and interest on sight deposits at the SNB at -0.75% and continue with unsterilized FX intervention. The SNB also eased financing conditions for Swiss businesses and the public sector via low interest rates, and made additional liquidity available through its COVID-19 refinancing facility (CRF) for banks. The federal guarantees for the COVID-19 loans and the liquidity provided at favorable conditions by the SNB averted a substantial increase in credit risk over the past few months. SNB’s proactive measures have resulted in an upward adjustment in the “Monetary Policy and Financial Stability” Building Block.
As a safe haven currency, the Swiss franc tends to attract inflows during global risk-off periods or when financial volatility increases. Consequently in light of the appreciation pressure on the Swiss franc and with FX intervention a key policy tool, the SNB intervened to the tune of CHF 100 billion in the first three quarters of 2020 and said it would be willing to intervene more strongly in the foreign exchange market. This is despite the US Treasury designating Switzerland as a currency manipulator, declaring that Switzerland met all three criteria under the 2015 Trade Facilitation and Trade Enforcement Act. The SNB has stated that its policy of forex intervention is only to limit the appreciation of the currency and to combat deflationary risks, rather than to attempt to gain competitive advantage in trade. (see DBRS Morningstar’s commentary Currency Manipulator Label: No Immediate Impact For Switzerland at: https://www.dbrsmorningstar.com/research/371543/currency-manipulator-label-no-immediate-impact-for-switzerland)
Banks are Well Positioned to Meet Financial Stability Risks
Switzerland’s historical position as a financial center is an important source of growth and prosperity for the country but can also leave Switzerland exposed to external shocks. The two domestically domiciled, global systemically important banks (G-SIBs), each hold total assets which exceed domestic GDP. The COVID-19 pandemic has led to a marked deterioration in financial market conditions around the world. In addition, the search for yield in a low growth and low inflation environment have intensified financial stability risks for the domestically-focused banking sector. Several years of strong growth in both bank credit and real estate prices have resulted in the build-up of imbalances on the mortgage and residential real estate markets. With mortgage growth outpacing income growth, Switzerland’s mortgage-to-GDP ratio has been gradually rising from 135% of GDP in 2015 to 150% of GDP in 2020.
However, Swiss banks are well positioned to deal with these challenges. They have a solid capital base for managing the heightened risks caused by the pandemic-triggered economic downturn. DBRS Morningstar considers risks stemming from the financial sector to be contained with both the G-SIBs – Credit Suisse and UBS – having sound buffers over minimum capital requirements and being able to cope with significantly worse developments in the economic environment. In December, the SNB stated in its press conference that while provisions for credit risk increased, they were lower than their international peers. Moreover, the trading and wealth management businesses at both the G-SIBs benefited from the rapid recovery in the financial markets resulting in both banks seeing a slight improvements in their capital situation.
In addition to declining profitability due to declining interest margins, the domestically-focused banks could come under greater strain due to existing imbalances on the mortgage and real estate markets and/or a potential increase in provisions and write-downs on outstanding loans to Swiss corporations. However, SNB’s scenario analysis indicates that domestically focused banks’ resilience is adequate and that the available capital buffers ensure that the lending and loss-absorbing capacity of the banking sector are sufficient even if the economic impact of the COVID-19 pandemic should turn out to be worse than currently expected.
Switzerland’s External Accounts Remain a Key Credit Strength; Reserves Exceed USD 1 trillion
Swiss 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 its role as a financial center, an attractive location for corporations, Switzerland’s high per-capita income levels, and high savings rate. Over the last decade, the SNB reserves have risen from USD 340 billion in 2011 to USD 1 trillion currently. Accumulation of net savings and official foreign exchange reserves have resulted in a positive net creditor position of 143% of GDP as of September 2020.
Due to its foreign exchange intervention, the SNB’s balance sheet stands at 140% of GDP as on 3Q 2020. To put things in perspective, as on 3Q 2020, the U.S. Federal Reserve is at 33% of GDP, the European Central Bank is at 57%, and the Bank of Japan at 128% of GDP. However, unlike the G3 central banks, the increase in SNB assets was primarily due to purchases of foreign rather than domestic assets. The SNB is responsible for managing the currency reserves that are currently allocated in an 80:20 ratio between bonds and equities. The bond portfolios in the foreign exchange reserves largely contain government and quasi-government bonds including issued by supranational organizations, local authorities, financial institutions (mainly covered bonds and comparable securities) and other companies. The equity portfolios in the foreign exchange reserves include shares of mid-cap and large-cap companies in advanced economies and, to a lesser extent, shares of small-cap companies, as well as shares of companies in emerging economies. Existing rules indicate that the SNB annually transfers CHF 4 billion of its profits to the federal government and cantons.
Strong Institutions and Stable Politics But Uncertainty Around Swiss-EU Relations Remains Elevated
The Swiss political system is characterized by federalism, a high level of civic participation in local matters, and a high degree of social cohesion. Stable politics combined with neutrality in international conflicts have long made Switzerland a safe haven for investors. The Swiss Federal Government is headed by the Federal Council, a collective presidency comprised of seven members. Combined with a bicameral legislature and a multi-party system, political decisions require a broad degree of consensus. The system is highly deliberative and allows for frequent popular referenda on important issues.
Thus far, however, Swiss voters have displayed pragmatism by rejecting some of the most radical policy proposals. Encouragingly on September 27, 2020, the Swiss people voted 62:38 against the popular initiative "For Moderate Immigration" (Limitation Initiative), thereby preserving the free movement of people with the European Union (EU). DBRS Morningstar views this development as supportive of Switzerland's strong credit fundamentals. Had the initiative succeeded, it would have required the Swiss Federal Council to renegotiate the existing Agreement on the Free Movement of Persons with the EU. (see DBRS Morningstar’s Commentary: Switzerland: Referendum Result Supports Strong Credit Fundamentals at: https://www.dbrsmorningstar.com/research/367490)
However, uncertainty on the Swiss-EU relations will likely remain elevated. Switzerland is not part of the EU and its unique relationship is based around 20 main agreements and a large number of secondary agreements ensuring, among other things, access to the EU’s single market for several sectors. The two parties have been negotiating an institutional agreement, aimed at ensuring a more uniform and efficient application of existing and future market access agreements. The EU is Switzerland’s most important trading partner and accounts for 51% of all Swiss exports and 69% of all Swiss imports come from the EU. While negotiations have been ongoing since 2014, Brexit could speed up the resolution of the open issues regarding the current level of wage protection in Switzerland, certain aspects of State subsidies and the EU citizen’s rights directive, which goes beyond free movement of workers. On 11 November 2020, the Federal Council decided on its position regarding necessary clarifications with the EU.
The potential consequences of the recently agreed EU-UK trade deal on the future relationship between Switzerland and the EU currently remain difficult to assess. The extent to which it could affect the planned increase in the level of harmonization between Swiss and EU rules will continue to be a key question. Nevertheless, DBRS Morningstar now considers that the conclusion of the EU-UK trade deal is likely prompt an acceleration of the negotiations around the institutional agreement between Switzerland and the EU in coming month.
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/372631.
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.
All figures are in CHF 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.
The primary sources of information used for this rating include Federal Department of Finance, Swiss National Bank, Swiss Federal Statistical Office, State Secretariat for Economic Affairs, OECD, IMF, European Commission, UNDP, 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 is an unsolicited credit rating.
This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
The last rating action on this issuer took place on July 24, 2020.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, 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.
DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
Lead Analyst: Rohini Malkani, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Global Sovereign Ratings
Initial Rating Date: July 14, 2011
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