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 economic and public finance fundamentals remain very strong despite the adverse impact of the Coronavirus Disease (COVID-19). The Danish economy’s sound foundations and strong vaccination rollout create the conditions for a robust economic recovery, although the pandemic-related risks are still lingering. Denmark’s strong public finances, with one of the lowest public debt ratios in the European Union (EU) and very low funding costs, provided authorities ample room to support the economy and mitigate long-lasting effects from the pandemic without materially affecting public debt sustainability. In line with its strong commitment and track-record of fiscal prudence, DBRS Morningstar expects the public debt ratio to return to its previous downward trend.

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 risks building up in the property market.

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 Conditions Are Set For a Strong Economic Performance Barring Significant Pandemic Surprises

Denmark’s productive, diversified, and flexible economy as reflected by its high GDP per capita is an important credit strength. Before the pandemic shock, Denmark experienced a prolonged period of economic upswing mainly driven by domestic demand and strong job creation, showing limited evidence of imbalances building up. During 2010-2019, annual GDP growth averaged 1.8%. While the pandemic shock triggered a substantial drop in GDP of 2.1% in 2020, the recession was relatively mild from an international perspective thanks to the government’s sizable response and a relatively less important contact-intensive service sector. The government’s sizable income and liquidity measures have been effective in preventing a surge in unemployment and corporate bankruptcies. The harmonised unemployment rate nudged up to 5.7% in 2020 from 5.1% in 2019.

The vaccination rollout, economic policy support, and global recovery have enabled a rapid recovery so far this year. According to preliminary estimates, seasonally and working day adjusted real GDP stood 3.9% above its pre-pandemic levels as of Q3 2021. The government estimates GDP will grow by 3.8% in 2021 and 2.8% in 2022 and to decelerate to around 1% by 2025. Private consumption and exports, which were the main drivers of 2020’s contraction, are expected to be key pillars of growth going forward. The strong recovery in private consumption following the re-opening is expected to continue benefiting from the higher savings accumulated during the pandemic and tightening labour markets. Denmark’s healthy competitiveness level and a strong growth in export markets bodes well for Danish exports. In this context, business investment is projected to be strong in coming years supported by strong exports, higher capacity utilisation, and the implementation of Denmark’s recovery plan. On the other hand, residential investment growth is expected to decelerate from 2022, after a very strong 2020-2021 performance.

As a small export-oriented economy, Denmark’s growth prospects are influenced by the evolution of its export markets and global trade more broadly, both of which should continue to recover strongly in the medium term. Households’ high savings and increasing wealth could lead to an even stronger private consumption rise. On the other hand, the main downside risks remain linked to the evolution of the pandemic and the effectiveness of the vaccines against potential new variants. In addition, greater or extended supply side disruptions adversely affecting industrial production, labour shortages from a booming economy, or the potential impact of an interest rate/asset price shock to Denmark’s highly levered households could impair growth.

Denmark Continues to Benefit from its Solid Public Finances and Fiscal Institutions

Denmark’s sound public finances provided the government with valuable fiscal headroom to mitigate the severe impact from the pandemic without compromising fiscal sustainability. The fiscal surplus averaged 1.7% of GDP annually between 2016 and 2019 on the back of a prudent fiscal management and a favourable macroeconomic backdrop. Denmark’s fiscal track-record is buttressed by a robust and credible fiscal framework enshrined in its Budget Law, limiting annual structural deficits to 0.5% of GDP and requiring multiannual expenditure ceilings. The fiscal targets are set in structural terms due to the volatility of some of Denmark’s revenue sources, especially regarding the pension-yield taxes and oil and gas extraction in the North Sea. The overall framework allows for deviation from the rules under extraordinary situations, such as the COVID-19 crisis.

In addition to the effect from automatic stabilisers, the Danish government announced a sizable package of measures to support the economy, including grants to businesses, wage compensation schemes, tax deferrals, and state loan guarantees. According to the International Monetary Fund (IMF) estimates, the fiscal impact from the COVID-19 measures stood at 2.3% of GDP for 2020-2021 and the uptake of liquidity support (mostly using tax deferrals) stood at 12.2% of GDP. The fiscal cost and uptake of liquidity measures have been much lower than originally expected, most likely due to a milder than expected recession. In spite of this substantial fiscal support package and recessionary environment, Denmark’s fiscal deficit was only 0.2% of GDP in 2020, the smallest across the European Union and well below the 6.9% deficit for the overall block. Higher-than-expected pension yield tax revenues, extraordinary tax revenue from the first payment of frozen holiday pay, and lower-than-expected take-up of the COVID-19 support measures are factors behind this.

The government anticipates the fiscal deficit to widen to 1.9% of GDP in 2021, which is better than previously expected due to stronger pension yield tax and a faster economic recovery, before turning into a surplus of 0.4% of GDP in 2022. The improvement in 2022 reflects the phase-out of one-off COVID-19 measures and the cyclical upswing. Denmark is expected to receive approximately 0.5% of 2020’s GDP during 2021-2026 from the EU’s Recovery and Resilience Facility (RRF). The funds will be mainly used to accelerate the green and digital transformation of the economy, with the green tax reform as centre piece. Over the medium-term, the government projects a small fiscal deficit of 0.5% and balanced position in structural terms by 2025. Over the longer term, demographic developments and declining revenues from oil and gas production will put pressure on public finances. Denmark’s previous retirement reforms, which increased the statutory retirement age and linked it with life expectancy over time, and reduced voluntary early retirement, partially offset these risks.

The Public Debt Ratio Remains Moderate and Financing Conditions Favourable

The public debt ratio has deteriorated due to the pandemic but remains one of the lowest in Europe. The public debt ratio (EMU debt definition) has increased to 42.1% of GDP in 2020 from 33.6% of GDP in 2019 due to the economic downturn, the budgetary impact of the COVID-19 measures, and the transitory effects from tax deferrals. DBRS Morningstar expects the public debt ratio to resume its pre-pandemic downward trend driven by the positive growth momentum, regularisation of the tax deferrals, and fiscal rebalancing, especially starting in 2022 as COVID-19 measures wane. The government projections point in this direction, with the public debt ratio expected to decline to 40.0% in 2021 and to 38.5% in 2022 and then to hover around 38% during 2023-2025. These projections include the debt-increasing effect from the social housing financing model, which nevertheless is neutral on a net debt basis.

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 sectors. Danish government bond yields remain very low, reflecting the extraordinarily policy rate and solid investor confidence in the Danish economic policy framework.

Financial Stability Risks Still Contained And Supported By the Policy Response

Monetary policy in Denmark is geared to keeping the Danish krone stable against the euro due its fixed exchange rate policy. DBRS Morningstar expects Danmarks Nationalbank (DN) policy rate to broadly follow the ECB’s refinancing rate and the central bank to intervene in the foreign exchange market to ease pressures under certain conditions. Against the pandemic shock, the announcement of massive liquidity support from the central bank and the easing of regulatory requirements helped prevented an unnecessary tightening of lending conditions in Denmark.

Despite staging a substantial deleveraging process since 2009, household debt remained elevated at 258.6% of net disposable income in 2020, the highest among OECD nations. This is an important source of vulnerability, rendering household consumption susceptible to adverse shocks, including housing price, interest rate, or income shocks. The housing market appears to be slowing down lately after a sharp increase in housing prices during the past year driven by favourable financing conditions, households’ income resilience, and shifting housing demand patterns triggered by the pandemic. DBRS Morningstar notes that some factors mitigate the risks stemming from high levels of debt and steady property price increases. The Danish household sector’s net financial assets are sizeable, albeit a large portion remain illiquid housing and pension savings. Furthermore, household debt tends to be concentrated among households with the highest incomes and the highest financial assets. 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. As the economy recovered strongly, the Danish government decided in September to increase the counter-cyclical capital buffer for banks to 1.0% as of Q3 2022 from 0.0%.

The Danish banking system has weathered the pandemic crisis from a position of strength given its high capitalisation and liquidity levels, managing to remain profitable against a challenging operating environment. The fiscal, monetary, and regulatory response to COVID-19 also played an important role. Although the retirement of extraordinary support could create some headwinds, the Danish banking system is well-equipped to withstand a severe but temporary economic slump and absorb substantial losses.

In the case of Denmark, the housing market and the mortgage covered bond market —the largest in the world as a percentage of GDP— play a crucial role 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. 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 litigation and reputational risks surrounding the investigations into possible money laundering by Danske Bank A/S at its Estonian branch between 2007 and 2015 also remain in the background.

Denmark’s Strong External Sector Is Poised to Gain From Global Rebound

Denmark exhibits a strong external position both from a flow and a stock perspective. The current account surplus averaged 7.7% of GDP over the last ten years and the net international investment asset position (NIIP) amounted to 68.8% of GDP in 2020. Despite the disruptions caused by the pandemic, the current account surplus remained sizable at 8.1% of GDP underpinned by pharmaceutical and food net goods exports, which are less sensitive to the business cycle, and freight transport on the service side. In addition to the positive goods and services balances, the country’s sizable net asset position generates a solid primary income surplus. Going forward, growing export markets and Denmark’s comparative strength in pharmaceutical and wind-energy infrastructure bode well for Danish exports. Shipping sector exports are recovering strongly, probably benefiting from higher freight rates, though tourism exports continue to lag behind.

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 their durability. This predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades. The centre-left Social Democratic Party minority government relies principally on the support of three left-wing parties in parliament to pass legislation. The Danish recovery plan aims to accelerate the green transition, channelling 59% of the funds towards green initiatives, significantly above the EU’s criteria of at least 37%.

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/388361.

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/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 Ministry of Finance (Budget Bill 2022; Economic Survey, August 2021; Updated Denmark 2025 Progress; Denmark’s Recovery and Resilience Plan), Danmarks Nationalbank (Outlook for the Danish Economy, September 2021; Monetary and Financial Trend, September 2021; Financial Stability 1st Half 2021), Danmarks Statistik, Systemic Risk Council, Ministry of Trade and Industry, European Central Bank, European Commission (Analysis of the recovery and resilience plan of Denmark; 2020 European Semester: Country Report; Assessment of the Final National Energy and Climate Plan of Denmark), The Social Progress Imperative (2021 Social Progress Index), Eurostat, OECD, IMF, 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.

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/388360.

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: September 20, 2012
Last Rating Date: June 4, 2021

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