DBRS Morningstar Confirms Kingdom of Norway at AAA, Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the Kingdom of Norway’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 our view that Norway’s strong credit fundamentals offset the risks from the pandemic and the Russian invasion of Ukraine. Norway’s proactive policies enabled output to recover the pre-pandemic level faster than most of its European peers, with mainland GDP growth coming in at 4.2% in 2021 from -2.3% in 2020. The labor market has recovered with employment higher than pre-pandemic levels. While the Russian invasion of Ukraine has led to uncertainty on the economic outlook, Norway’s trade and financial linkages with the two countries are small. That said, the surge in commodity prices and continued supply side disruptions have driven inflation up further, prompting Norges Bank to revise its policy rate forecast from 2.0% to 2.5% by the end of 2023.

Norway’s AAA ratings are underpinned by its public-sector wealth, prudent management of its oil-related revenue windfalls, strong external position, and sound institutional framework. However, Norway faces several structural challenges. The country is reliant on the petroleum sector (oil and gas), household debt is high, and the population is aging. Nevertheless, Norway is well-positioned to deal with these challenges and has substantial buffers to absorb shocks. The key backstop is Norway’s sovereign wealth fund (SWF), the Government Pension Fund Global (GPFG), with a market value of NOK 11.5 trillion that is equivalent to 335% of mainland GDP in March 2022. The SWF is both a current source of income (supplementing the annual budget) and a future source of resilience (buffering shocks during downturns), as reflected by the large transfers to the national budget seen during the pandemic. The country’s flexible exchange rate provides another important tool to absorb negative shocks.

RATING DRIVERS

Norway is firmly placed in the AAA rating category, but could be downgraded by one or a combination of the following factors: (1) a worsening of financial conditions and medium-term growth prospects that is severe enough to materially affect Norway’s financial stability and fiscal position; and (2) a significant loosening of the government’s commitment to a prudent fiscal policy.

RATING RATIONALE

Norway’s Ratings Benefit from Its Prudent Management of Oil Proceeds and Its Strong Public Sector Balance Sheet

Public finances benefit from a conservative management of oil sector revenues. To avoid the impact of oil price volatility on government revenues, Norway’s fiscal framework stipulates that the State’s net cash inflow from the petroleum industry (receipts from the sale of oil and gas reserves and oil and gas taxes) be transferred to the GPFG, with the proceeds invested entirely overseas. GPFG is the largest sovereign wealth fund in the world and its market value has grown from its first deposit of NOK 2 billion in 1996 to NOK 11.5 trillion in March 2022 (equivalent to 335% of mainland GDP). The fiscal policy guidelines also require petroleum revenue spending over time to be limited to the expected real rate of return on the fund, estimated at 3%, unless determined by the parliament. The pandemic resulted in an increase in public spending in the form of increased transfers to households and firms which resulted in Norway’s structural non-oil fiscal deficit rising from NOK 235.8 billion (equivalent to 2.9% of the value of GPFG) in 2019 to NOK 364.9 billion in 2020 (3.6%) and NOK 397.2 billion in 2021 (3.6%). As most of the support measures have been eased out, the government in December estimated that the structural non-oil deficit will decline to NOK 322.4 billion (2.6% of the GPFG) in 2022.

Nevertheless, Russia’s invasion of Ukraine will likely result in a slight increase in the deficit. The Norwegian government has proposed an additional NOK 3 billion in spending to increase the preparedness of its armed forces, taking defence spending to 2% of mainland GDP. Furthermore, the government has announced a temporary electricity subsidy to provide support to households to deal with high electricity prices. That said, the government’s overall budget plans still imply tighter fiscal policy than in 2021.

Norway’s public sector balance sheet constitutes one of its key credit strengths relative to other AAA-rated countries. The country’s general government gross debt is among the lowest debt ratios among advanced economies, at 42.7% of GDP in 2021. In most countries, the main purpose of government borrowing is to finance budget deficits. In Norway, the non-oil budget deficit is covered by transfers from the GPFG and therefore does not trigger any borrowing requirement. The pandemic-related fiscal spending in 2020 and 2021 took the form of a higher non-oil fiscal budget deficit, that was financed by larger transfers from the GPFG. Consequently, the pandemic related shock has been affecting net rather than gross government debt. However, the government borrows in local currency to fund government lending schemes, and to ensure a well-functioning financial market in Norway. DBRS Morningstar expects the general government gross debt ratio to slightly decline and stabilize around 40% of GDP in the coming years.

With financial assets far exceeding total debt, the government’s net asset position stood at 298.2% of GDP as of December 2021. This is largely explained by the sovereign wealth fund whose market value was equivalent to 289.1% of mainland GDP at the end of December 2021. Given the fiscal guidelines and the government’s asset position, Norway’s gross government debt is generally insulated from negative shocks. This lends support to ’Debt and Liquidity’ building block assessment.

Norway’s Economic Recovery Continue But War in Ukraine Adds to Uncertainty to the Outlook

Norway’s expansionary fiscal and monetary policies through the pandemic enabled the economy to recover from a -0.7% contraction in 2020 to 3.9% growth in 2021. Both employment and unemployment rates have improved upon the pre-pandemic position, with the unemployment rate down to 2.3% in February 2022 from the peak of 10.6% registered in March 2020. While Russia’s invasion of Ukraine has led to uncertainty on the economic outlook, Norway’s financial and trade interlinkages with the two countries is small. Moreover, the growth momentum is likely to continue as the impact from Omicron has been less severe than expected. Norges Bank in its March 2022 monetary policy review projects mainland GDP to rise by 4.1% in 2022 with consumption and exports as the main drivers. That said, higher electricity prices fueling inflation and rising policy rates could dampen private consumption.

Norway’s wealthy and stable economy, with a balanced income distribution, underpins its AAA ratings. However, as a small and open economy, Norway remains exposed to potential downturns in external demand and similar to all economies, a prolonged conflict in Ukraine or a resurgence in COVID-19 could hinder Norway’s performance. While the economy remains reliant on oil, Norway’s approach to managing oil revenues has helped to limit the economy’s vulnerability to oil price shocks. Over the medium- to long-term, the main challenge for the Norwegian economy will be to successfully re-tool the oil-dependent economy towards other tradable sectors.

Norges Bank Raises Rates Back to Pre-pandemic Levels; Financial Vulnerabilities Remain

Norwegian policy rates are back to pre-pandemic levels. Norges Bank was the first central bank among the advanced economies to raise rates in September 2021 and has continued with its hiking cycle. In its latest policy meeting on March 23, Norges Bank raised rates from 0.5% to the pre-pandemic policy rate of 0.75%. High energy prices, a surge in freight rates and long delivery times, and wage pressures have driven headline Consumer price index (CPI), core inflation and inflationary expectations up further. Despite government support to compensate for the surge in electricity prices, headline core and CPI inflation currently stand at 2.1% and 3.7% in February 2022 – both higher than Norges Bank’s operational 2% target of inflation. Norges Bank’s latest assessment suggests a higher policy rate leading to a revision in its policy rate forecast from 2% to 2.5% at the end of 2023.

Banks in Norway remain liquid, profitable and well-capitalized, but the overall system faces some financial vulnerabilities. One of the key challenges facing Norway is the growing financial imbalances that have built up as housing prices and household debt have outpaced disposable income growth. Real house prices have been rising for over two decades fueled by lower residential mortgage rates, growth in household income, high net immigration, and supply constraints. As a result, the household debt-to-disposable income ratio remains high at 217.9% in Q4 2021. According to Real Estate of Norway, house price inflation has moderated from double-digit levels seen last year to 6.3% year-over-year as of February 2022. The decline in house price inflation is attributed to higher lending rates and a normalization of household consumption patterns. In addition to household mortgages, another vulnerability is the high commercial banks’ exposure to commercial real estate which currently at 47% of banks’ total corporate exposures.

Against this background, Norway benefits from a credible and independent monetary policy authority and proactive regulators. Authorities have undertaken a series of banking regulatory measures and macro-prudential policies to contain risks, including a debt-to-income ratio ceiling at five times borrowers’ annual income and the loan-to-value ratio at 60% for secondary housing in Oslo. Similar to its Nordic peers, while the wholesale funding ratio is high at 47% of total funding, banks low loan losses and strong capital and liquidity buffers mitigate the risks to financial stability. Asset quality remains very strong: the Norwegian banking sector has one of the lowest ratios of non-performing loans (NPLs) as a share of total gross loans at 0.3% in Q4 2021. The average CET1 ratio for the seven largest banks was at 18.0% at year-end 2021. For the banking sector as a whole the average CET1 ratio at year-end 2021 was 18.8%. In March, Norges Bank raised the countercyclical capital buffer requirement back to pre-pandemic levels of 2.5% with effect from March 2023.Norges Bank has stated that the countercyclical capital buffer requirement will be raised back to pre-pandemic levels of 2.5% by December 2023.

Norway’s Strong External Position Provides a Significant Buffer to Absorb Shocks

Norway’s 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 Norway’s sizeable energy surplus, high per-capita income levels, and high savings rate. The current account balance surged to 15.3% in 2021 and due to high energy prices is expected to rise further in 2022 before stabilizing at the five year average of around 6% of GDP. Norway’s large positive net international investment position of 283.5% of GDP as of December 2021, is due to the substantial accumulation of foreign assets through the GPFG. In addition to the backstop from the sovereign wealth fund, Norway’s floating currency acts as a shock absorber in the face of the global economic volatility. The krone, as measured by the import-weighted exchange rate index I-44, has been appreciating since December. Despite lower risk appetite, the appreciation reflects the rise in oil prices following the Russian invasion and rising interest rates.

Norway’s Ratings Are Supported by Its Strong Institutions

Norway benefits from strong political institutions with an established track record of a consensus-based approach to macroeconomic policy. The country is characterized by strong rule of law, a robust regulatory environment, and low levels of corruption. According to the World Bank’s Worldwide Governance Indicators, Norway ranks highly compared to other advanced economies in all areas of measured governance. This is conducive to a stable and predictable policy framework. After two consecutive terms under the minority center-right coalition, a new center-left coalition led by Jonas Gahr Stoere government was appointed by King Harald V on October 14, 2021. The new government consists of a center-left coalition between Jonas Gahr Stoere’s Labor Party and the Centre Party. DBRS Morningstar expects the coalition to rule until the end of the legislative term and to focus on management of the energy sector and Norway’s relations with the European Union (EU).

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/395037.

Notes:
DBRS Morningstar notes that this document was amended on April 28, 2022 to remove the disclosure for unsolicited ratings in the U.S.

All figures are in NOK 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).

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.

The primary sources of information used for this rating include the Government of Norway, the Ministry of Finance of Norway (Budget 2022), Norges Bank (Monetary Policy Review March 2022), Statistics Norway, the Financial Supervisory Authority of Norway, Norges Bank Investment Management, Norsk Forbund for Innkjop og Logistikk/Danske Bank, TNS Gallup, UN, IMF, BIS, Energy Information Administration, Real Estate Norway, WEF, the social progress imperative (Social Progress Index), 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 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 October 15, 2021.

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

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, Co-Head Global Sovereign Ratings
Initial Rating Date: 21 March 2012

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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