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

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

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects DBRS Morningstar’s view that the credit fundamentals of the Netherlands remain solid, notwithstanding the economic shock brought about by the global Coronavirus Disease (COVID-19) pandemic and its impact on the country’s fiscal position. While the Dutch economy posted a sharp contraction in 2020, it is estimated at a less severe than expected 4.2%, outperforming the euro area average. As the government responded to the crisis with a sizable support package, the budget position has also deteriorated substantially and the government debt-to-GDP ratio has increased sharply. The debt ratio, nevertheless, is projected to remain around 60%-64% in 2021, well below the average for the euro area. DBRS Morningstar expects government finances to return to a sound position and the government debt ratio to decline over the medium term.

The ratings are supported by the Netherlands’ advanced, wealthy, and productive economy, its strong external position and its robust institutional framework. These credit strengths counterbalance the challenges associated with the economy’s exposure to external shocks given its high degree of trade openness and the economy’s relatively small size.

RATING DRIVERS

A prolonged and severe deterioration in growth prospects or public finances, damaging the Netherlands’ resilience to shocks, would lead to a downgrade.

RATING RATIONALE

A Second Wave of COVID-19 Infections Has Slowed The Recovery of the Dutch Economy

The Dutch economy contracted less severely than expected in 2020 but the recovery is expected to be gradual. Virus containment measures, imposed from mid-March to mid-May 2020, together with disruptions in external trade, affected economic activity. In contrast to some other European countries, the first wave of the virus outbreak in the Netherlands was less severe and restrictive measures were less stringent. Moreover, with a stronger-than-expected rebound in the third quarter, the Netherlands Bureau for Economic Policy Analysis (CPB) now expects the Dutch economy to have contracted by 4.2% in 2020. However, second and a third waves of infections since September have been more severe than the first wave and have led to the reintroduction of restrictions, tighter than earlier in 2020. The CPB revised downward its growth forecast for 2021 to 2.8% under its baseline scenario, in which the CPB also assumes the virus will be contained in both the Netherlands and other European countries in the first half of 2021. The change in trade relations between the EU and the United Kingdom (UK) is also expected to have some impact on growth, despite the trade agreement. The CPB estimated in 2016 that the GDP loss in the long-term could be 0.9% under a free-trade agreement scenario for Brexit.

The economic outlook is subject to high uncertainty. It depends on the evolution of the pandemic, the vaccine rollout, the recovery in global trade, and the effectiveness of the economic support measures. As an open economy and a major European trade hub, the Netherlands is exposed to a weaker-than-expected recovery in global trade or in the economies of key European trading partners, including Germany and the UK. The UK is the Netherlands’ third-largest export destination in terms of value, and thus potential trade disruptions with the UK, as the new trade arrangement starts, poses a downside risk to the Netherlands’ economic outlook. Moreover, although DBRS Morningstar expects fiscal policy to remain supportive of the economic recovery, the uncertainty over the outlook is considerable, if infections growth re-emerges rapidly in the Netherlands and in its trading partners, or if vaccination proves less effective than expected.

To deal with the economic fallout, the government has provided support to affected businesses and households. These include wage cost subsidy schemes (the Temporary Emergency Measure to Preserve Employment, NOW, and the Temporary Support Scheme for Self-employed Persons, TOZO), which are aimed at limiting job losses. Despite this support, the CPB is forecasting the unemployment rate to increase from 3.4% in 2019 to 4.1% in 2020 and to 6.1% in 2021. This is in part because temporary contracts are unlikely to be renewed. Around 40% of workers in the Netherlands are on flexible contracts or are self-employed. Workers on flexible contracts have been more affected by the crisis compared to workers on permanent contracts, as flexible contracts are more common in the crisis-hit hospitality sector. Moreover, most support measures, while extended, are currently set to expire in July 2021.

The Netherlands’ economy continues to benefit from high levels of employment, education, and productivity. GDP per capita is one of the highest in Europe, almost 20% above the euro area average. The level of private sector savings is also sizeable. Households’ pension savings and insurance products account for just over 50% of total household assets, which are among the highest of OECD countries. Aggregate high incomes and savings provide the Dutch economy with an important degree of resilience.

The Netherlands’ external position is also very strong, largely reflecting its trade competitiveness. A robust trade performance and high net savings in the private sector have helped maintain the current account in surplus for decades. The surplus has averaged 9% of GDP over the past five years, which has contributed to the Netherlands’ large net external creditor position, on average at 66% of GDP since 2015. The strong external position provides the country with a significant buffer to absorb external shocks and supports its capacity for external adjustment. This supports DBRS Morningstar’s positive qualitative assessment for the ‘Balance of Payments’ building block.

The Netherlands’ Fiscal Position Has Deteriorated But It is Expected to Improve Over Time

The Netherlands’ comfortable fiscal space and prudent fiscal policy in previous years allowed it to implement a substantial package of measures to support the economy during the pandemic. In addition to the wage cost subsidy schemes, discretionary measures include direct support for affected sectors, liquidity assistance for businesses, loan guarantees, tax deferrals, and automatic stabilisers. The measures amount to an estimated 14% of GDP, about half of which is accounted for by state guarantees and loans. In December 2020, the government announced additional support measures worth 0.4% of GDP.

The budget position deteriorated in 2020, but DBRS Morningstar expects government finances to return to a sound position over time. After three years of fiscal surpluses, the Ministry of Finance’s forecast for the fiscal deficit in 2020 is 7.2%, as presented in the 2021 budget, while the CPB’s projection is 6.1%. With some fiscal measures scheduled to phase out later this year and assuming the economy remains on a recovery path, the fiscal deficit is projected to fall to around 5% in 2021.

The government debt ratio increased sharply in 2020. It reflected the large deficit, as well as tax deferrals and the EUR 1 billion loan to airline KLM. After falling below 49% of GDP in 2019, the Ministry of Finance is estimating the debt ratio to have reached 59.1% in 2020, still lower than the 2014 peak of 67.8%. Moreover, large loan guarantees pose a downside risk to the government’s balance sheet. Despite a higher level of debt, the government continues to benefit from very favourable financing conditions. Moreover, the Dutch Treasury has extended debt maturities in recent years and it is aiming to increase the average debt maturity to eight years. A favourable debt profile supports the shock absorption capacity of public finances. Official forecasts point to a gradual reduction in the debt ratio over time.

The long-term sustainability of public finances looks secure. Over the past decade, the Netherlands raised the minimum retirement age, adjusted pension entitlements, and restrained healthcare spending. These measures have helped lessen ageing-related spending pressures. For the longer term, the government adopted the Pension Agreement in 2019 with the aim of achieving a more robust pension system. In July 2020, the Dutch government and social partners reached consensus on the implementation of the Pension Agreement. The country’s effective public institutions, together with a robust fiscal framework, support the sustainability of public finances and overall economic policies.

Risks to Financial Stability Remain Contained

Dutch household debt relative to income, while falling, remains one of the highest of OECD countries. Household debt was 212% of disposable income in Q2 2020. Debt partly reflects tax incentives and is largely in the form of mortgages. The aggregate net worth of Dutch households is also the highest among OECD countries at almost 700% of net disposable income. Nevertheless, high household debt could exacerbate an economic downturn in case of negative shocks. In particular, households with low incomes, flexible jobs and many first-time homebuyers are exposed to income shocks and declines in house prices. Vulnerability to increases in interest rates seems limited, as residential mortgages are largely fixed-rate.

At the same time, Dutch house prices have risen to high levels in recent years. Prices are above the 2008 peak levels and have risen at a stronger pace in the main Dutch cities. Housing investment has not kept up with housing demand. High house prices could increase the risk of a correction, and a housing market slowdown could worsen if consumer confidence declines sharply, unemployment reaches high levels and income growth slows. House price falls and an economic downturn could reinforce each other. However, despite expectations of a moderate slowdown in the housing market in 2020, house prices have continued to increase. After moderating to 6.2% YoY in Q4 2019, the annual house price growth was 8.1% YoY in Q3 2020.

Given the risks to financial stability and the economy posed by high household debt and rising house prices, and as part of the government’s tax reform, the Dutch authorities started to accelerate the reduction in mortgage interest deductibility in 2020, until the target rate of 37.5% is met in 2023. Moreover, debt amortisation has been a requirement since 2013 to benefit from tax deductibility on interest expenses. This requirement has contributed to the decline in interest-only mortgages, which now account for less than 50% of total mortgages. The limit on the loan-to-value ratio was also reduced in recent years, although to a still high at 100%.

Dutch banks entered the crisis with resilient positions, but the banks’ operating environment has deteriorated with the coronavirus crisis. Dutch banks are profitable and well-capitalised. In March 2020, in response to the current economic crisis the ECB Supervisory Board provided temporary capital relief measures for euro area banks to increase their capacity to lend to the economy. Subsequently, Dutch authorities lowered the systemic capital buffers and postponed the introduction of a floor for risk weights on banks’ mortgage portfolios. Combined, these measures freed up around EUR 8 billion in capital. Looking ahead, a potential sharp increase in insolvencies, which remain low at the moment, could pose a risk to banks, as the temporary changes to bankruptcy requirements are scheduled to expire in February 2020.

The Netherlands’ Public Institutions are Effective

The Netherlands benefits from effective public institutions and consensus-driven policies, which more than offset a somewhat fragmented political landscape. No single political party won a majority in the March 2017 elections. The current government took office in October 2017, after four parties (VVD, CDA, D66 and the Christian Union) presented their Coalition Agreement. The centre-right coalition has implemented reforms to the tax system with the aim of reducing the tax burden on households and firms, and to increase investment in education, defence, healthcare and infrastructure. The main challenge the government is facing at the moment is recovering from the coronavirus crisis.

The next general election will be held on 17 March 2021 as planned. The government resigned in mid-January 2021 over a childcare benefits scandal. However, in DBRS Morningstar’s view this is unlikely to have any negative policy implications. The comparatively successful handling of the health coronavirus crisis seems to have contributed to a rise in popularity for the Prime Minister’s VVD party, as shown by voting intention polls over the past year. The trend in the polls has weakened recently while support for the right-wing Party for Freedom (PVV) has increased, but support for Christian Democratic Appeal (CDA) has also risen and the VVD is leading the polls. DBRS Morningstar expects consensus-driven policy continuity under the next government.

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/372635.

EURO AREA RISK CATEGORY: LOW

Notes:
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 euro (EUR) 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).

The sources of information used for this rating include the Government of the Netherlands, Ministry of Finance (2021 Draft Budgetary Plan), Dutch State Treasury Agency (DSTA, Outlook 2021), Netherlands Bureau for Economic Policy Analysis (Centraal Planbureau CPB, November Projections 2020), CPB Trade effects of Brexit for the Netherlands June 2016, Netherlands Central Bank (De Nederlandsche Bank DNB), Dutch National Statistical Office (Centraal Bureau voor de Statistiek CBS), European Commission (EC, 2020 Autumn Forecast), European Central Bank (ECB), Eurostat, Organisation for Economic Co-operation and Development (OECD), IMF, World Bank, UNDP, BIS, 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. 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/372636.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Co-head of Sovereigns Ratings, Managing Director, Global Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: July 24, 2020

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