DBRS Morningstar Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Sweden’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Kingdom of Sweden’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 the risks to Sweden’s ratings are limited. Despite the substantial economic and fiscal costs of the Coronavirus Disease (COVID-19) pandemic, Sweden continues to exhibit strong credit fundamentals and ample room to support the economy. Comparing internationally and against expectations, the Swedish economy and the public finances have been more resilient to the pandemic shock thus far. After a sharp contraction in 2020, the recovery in activity is expected to strengthen on the back of sustained economic policy support and easing restrictions, although the spread of the Delta variant is a key downside risk. A strong fiscal track record and a low public debt ratio allowed the government to respond strongly to the pandemic shock without compromising its medium-term fiscal sustainability. Going forward, DBRS Morningstar expects Sweden to gradually converge towards its fiscal targets as the economy returns to its potential.

Sweden’s AAA ratings are underpinned by strong public finances, healthy external accounts, and a robust economic performance. DBRS Morningstar expects Sweden’s high investment rates, employment rates, and labour force skills to continue to underpin its solid economic performance in the coming years. Nevertheless, as a small and open economy with a relatively large export sector, the country remains exposed to potential downturns in external demand. In addition, managing the risks stemming from the combination of high household leverage, banks’ large exposure to the property market, and housing prices remains a challenge for Sweden. The high level of household debt could amplify shocks, potentially triggering a deleveraging process and weighing on domestic demand, with knock-on effects on the broader economy. Wealthy households and debt affordability mitigate these risks.

RATING DRIVERS
DBRS Morningstar could downgrade the ratings if Sweden’s public debt ratio trajectory experiences a material deterioration, although this is viewed as unlikely. A materially higher public debt ratio could result from a severe worsening of the medium-term growth outlook or a substantial materialisation of contingent liabilities.

RATING RATIONALE

The Economic Recovery is Strengthening But Pandemic-Related Uncertainty Lingers

The Swedish economy has proven more resilient to the pandemic than originally expected and compared with most European peers. Sweden’s GDP contracted by 2.8% in 2020, well below the drop seen in the EU-27 GDP (-6.0%). A strong welfare state, sizable and targeted policy response, and a relatively smaller weight of the hospitality, travel, leisure and entertainment sectors have softened the impact. The rapid recovery in goods exports and manufacturing production have led the recovery, while the contact-intensive sectors now stand to benefit the most from the phasing out of restrictions that started in June 2021 on the back of the pandemic and vaccination progress in Sweden. The economic recovery has surprised on the upside so far and the Ministry of Finance now expects GDP growth at 4.4% in 2021, although the recent pandemic developments could dampen the momentum. The unemployment rate remains high at 8.4% in July 2021; however, hiring and vacancies are rapidly picking up pace.

Sweden’s GDP growth averaged 2.3% per annum during 2000-2019, underpinned by its knowledge-based, competitive economy that is well integrated in global value chains. Sweden’s high GDP per capita rests on a productive labour force and one of the highest employment rates in the EU. Going forward, the sustained economic policy stimulus, projected employment gains, households’ higher than normal savings, and ongoing global recovery bode well for private consumption, exports, and the investment outlook for 2021-2024. The rapid spread of the Delta variant globally poses a significant downside risk. Even if Sweden progresses with eliminating most restrictions, its large export sector could suffer from setbacks to global trade recovery and value-chain disruptions. Finally, the pandemic has exacerbated two longstanding challenges: (1) the risks linked to high household debt and housing market pressures, and (2) Sweden’s relatively higher unemployment rates among the low-skilled and foreign-born workers.

A Low Public Debt Ratio and Solid Fiscal Framework Underpin Sweden’s Creditworthiness

Sweden’s strong fiscal performance, underpinned by its fiscal framework and low public debt levels have provided the country with ample fiscal room to respond to the coronavirus pandemic shock. The estimated fiscal cost from the measures to mitigate the economic and social impact, minimise long-term economic scarring, and strengthen the healthcare response to the pandemic is expected to amount to SEK 385 billion for 2020 and 2021 (7.9% of 2020 GDP). With no immediate impact on net lending, the government has also supported business liquidity by offering state credit guarantees (SEK 300 billion or 6.1% of 2020 GDP) and temporary tax deferrals (SEK 689 billion or 13.9% of 2020 GDP) during 2020-2021.

The better-than-anticipated macroeconomic backdrop in Sweden has limited the hit to fiscal revenues as well as resulted in lower than expected usage of available support. Compared with most European countries, the worsening in public finances has been less acute. The fiscal balance turned to a deficit of 3.0% of GDP in 2020 from a surplus of 0.6% of GDP in 2019. The stronger than expected economic indicators prompted an improvement in fiscal projections. Based on fiscal policies already introduced or announced, the Ministry of Finance projects the fiscal deficit to narrow to 1.8% of GDP in 2021 and to 0.6% of GDP in 2022, and to return to budgetary surpluses in 2023-2024. These projections include the government planned budgetary measures worth around SEK 74 billion to support the recovery in 2022. DBRS Morningstar expects the government to utilise the available room to introduce new measures while remaining in keeping with its surplus target of 0.33% over time.

Even after the coronavirus pandemic shock, Sweden’s public debt ratio is expected to remain low and among the lowest in the European Union (EU-27). Following the increase to 39.7% of GDP in 2020 from 35.1% in 2019, the public debt ratio is now projected to resume its downward trend in 2021, one year earlier than previously anticipated. Including the planned fiscal stimulus for 2022, the Ministry of Finance projects the public debt ratio to drop to 31.0% of GDP by 2024 on the back of the improving economic and fiscal outturns. The Sveriges Riksbank’s (the Riksbank) amortisation of foreign currency loans with Swedish National Debt Office (SNDO) will dampen borrowing by SEK 60 billion per year in 2021-2023.

The materialisation of contingent liabilities, potentially stemming from Sweden’s large public sector, the exposure to financial sector-related entities, or the most recent extension of state guarantees, could lead to a higher but still manageable debt ratio. DBRS Morningstar considers that the associated risks to Sweden’s relatively short average debt maturity and high share of foreign currency-denominated debt are small, given the comparatively low level of debt, steady demand for Swedish government bonds, and the use of derivatives to hedge currency risk. The government continues to benefit from very favourable financing costs.

Risks to Financial Stability are Manageable But Key Systemic Vulnerabilities Remain

The Swedish banking system has withstood well the pandemic shock. The banks’ strong starting position, the Riksbank’s ample monetary policy response, and temporary regulatory easing, have helped avoid credit or funding cost disruptions. On aggregate, Swedish banks entered the crisis with strong capitalisation and liquidity positions exceeding regulatory requirements, as well as higher profitability and lower credit losses compared with European peers. Loan losses have remained relatively contained, helped in part by government support to workers and companies in the hardest hit sectors. Although the Riksbank has already started tapering its net asset purchases, and it is scheduled to conclude at year-end, its forward guidance points to an unchanged policy rate of 0% at least until Q3 2024. On the other hand, the Swedish banking system is relatively large, concentrated, interconnected, and reliant on wholesale and foreign funding, rendering it susceptible to potential shocks, including changes in investor sentiment.

The main risks to financial and macroeconomic stability remain linked to the high level of household indebtedness and banks’ exposure to the housing and commercial property markets. After some reprieve during 2018-2019 due to tighter macroprudential measures and higher housing supply, the pandemic has triggered a sharp increase both in household indebtedness and housing prices. The household debt-to-income ratio stood at 207% in Q1 2021 and the housing price index grew 13.6% year over year in July 2021 (according to the HOX index). Higher household indebtedness increases further the financial sector’s underlying vulnerability to shocks. While households are expected to have good margins to service their debt in stressed conditions, potential shocks could force a sharp reduction in consumption, risking second round effects to the overall economy. If there are no changes to the fundamental drivers of the supply and demand imbalances in the property market (i.e., regulations, rental-setting system, taxation), tighter macroprudential measures will be needed to manage the risks. The Swedish Financial Supervisory Authority has already announced that the temporary amortisation exemption will not be extended and countercyclical buffer could be increased as soon as Q3 2021.

The banks’ exposure to commercial real estate companies is high, around 40% of total corporate lending. Companies in the sector are generally highly leveraged and therefore vulnerable to interest and income shocks. According to the Riksbank analysis, property companies have managed relatively well the pandemic effects thus far, although performance has been uneven. Companies with properties in logistic and housing appear to have fared better than those with properties in the retail, hotel, or office sectors. The extent of the impact from longer-term trends in terms of e-commerce and remote working exacerbated by the pandemic, remain unclear.

Sweden’s External Position Remains Strong With a Competitive Export Sector

As a small and open economy that is well integrated into global value chains, Sweden’s exports suffered greatly from the pandemic-related disruptions during spring 2020. The relatively strong comeback of global industrial production, in spite of the lingering restrictions, and good prospects for key trading partners including Germany, the U.S., and the Nordics bode well for Swedish exports. Overall, DBRS Morningstar assesses Sweden’s external position as strong and backed by a long period of large current account surpluses, albeit declining over time. Driven by a high savings rate and Swedish firms’ competitiveness, the current account has averaged 5.2% of GDP over the last two decades, resulting in a net international investment position of 18.0% of GDP at the end of 2020. Finally, Sweden’s liquid currency and international reserves amounting to 9.7% of GDP in 2020 enhance its ability to weather significant shifts in investor confidence.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

Sweden’s political system is characterised by strong democratic institutions as reflected by its very strong World Bank Governance indicators. Given the political fragmentation, minority governments requiring outside parliamentary support to pass legislation have been the norm in Sweden, fostering political compromise and consensual policy making. After losing a no-confidence vote in parliament triggered by the government’s plan to allow for market-based rent setting for newly built apartments in June 2021, the Social Democratic Party (SDP) and Green Party minority coalition government was reinstated in July 2021 helped by the abstention of the Centre Party and Left Party. More recently, prime minister Stefan Löfven announced his decision to stepdown as prime minister and SDP’s chairman in November. This increases political uncertainty ahead of the 2022 Budget discussion in parliament and the next parliamentary elections scheduled for September 2022. Regardless of these budgetary and electoral outcomes, DBRS Morningstar expects broad political consensus behind Sweden’s fiscal framework and sound macroeconomic policies to continue to underpin the country’s prosperity.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/383521.

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 Swedish kronor (SEK) 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/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include the Ministry of Finance (Key Indicators Forecast 26 August 2021; Sweden’s Recovery and Resilience Plan), Swedish National Debt Office (Central Government Borrowing Forecast and Analysis 2021-2), Sveriges Riksbank (Financial Stability Report 2021:1; Monetary Policy Report, July 2021), Swedish Financial Supervisory Authority (Stability in the Financial System, June 2021), Statistiska Centralbyran (SCB), European Commission, Eurostat, Swedish Environmental Protection Agency (Sweden’s Climate Act and Climate Policy Framework) The Social Progress Imperative (2020 Social Progress Index), Nasdaq OMX Valueguard-KTH Housing Index (HOX), Organisation for Economic Co-operation and Development (OECD), Bank for International Settlements (BIS), International Monetary Fund (IMF), World Bank (WB), United Nations Development Programme (UNDP), and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

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/383519.

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

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: April 17, 2012
Last Rating Date: March 26, 2021

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