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 Stable trend reflects DBRS Morningstar's view that risks to the rating remain balanced. Denmark quickly recovered from the impact of the pandemic, with a booming economy at the end of 2021 and no evidence of lasting effects. Given this strong starting point and solid fundamentals, DBRS Morningstar believes that Denmark is well positioned to withstand the fallout from the Russian invasion of Ukraine. Higher energy prices and weaker external demand could cause real GDP to stagnate or even contract during parts of 2022 but activity is still expected to remain above trend in the coming years. A tight labour market, extraordinary household savings levels and a healthy business sector should help absorb the spike in inflation. Denmark's strong public finances, with one of the lowest public debt ratios in the European Union (EU) and very low financing costs, continue to provide ample room to support the economy against severe shocks. In line with its strong commitment and track record of fiscal prudence, DBRS Morningstar expects the government debt ratio to return to and then hover around its pre-pandemic levels in coming years.

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 Effects of Higher Inflation and Weaker External Demand To Slow Denmark’s Booming Economy

Denmark’s productive, diversified, and flexible economy as reflected by its high GDP per capita is an important credit strength. Before the pandemic, the country experienced a prolonged period of economic upswing, with annual growth averaging 1.8% during the 2010-2019 period, mainly driven by domestic demand and strong job creation. The positive impact of the labour reform, incentivising a longer working life, as well as foreign labour supply, alleviated pressures in the labour market.

The Danish economy has weathered well the pandemic shock, suffering a relatively mild contraction from an international perspective of 2.1% in 2020, followed by a strong recovery of 4.7% in 2021. DBRS Morningstar considers that Denmark’s resilient private sector, favourable economic structure, and a sizable and effective policy response have played a crucial role in this. Denmark’s economy ended 2021 on a high note, with a booming economy and no discernible evidence of long-lasting effects from COVID-19. As of Q4 2021, seasonally adjusted real GDP and employment levels were 6.1% and 3.8% above pre-pandemic levels, respectively.

The Russian invasion of Ukraine is expected to slow economic growth in Denmark, mainly through weaker external demand and higher energy inflation. While real GDP could yet stagnate or even contract during parts of this year, the government recently revised its annual growth projections from 2.8% to 3.4% in 2022 due to higher-than-expected carry-over effects from 2021. Going forward, GDP growth is expected to slow down from the 4.7% reached in 2021, however, activity and employment still are is expected to remain above trend in coming years.

Accumulated household savings during the pandemic and considerable net wealth, as well as good prospects for income growth due to a buoyant labour market, are expected to mitigate the impact of high inflation, which is assumed to be largely temporary. In DBRS Morningstar's view, the main risks to the outlook in the near term are posed by escalating geopolitical tensions, which could trigger energy supply disruptions in Europe and exacerbate inflationary pressures. While not clearly evident at the moment, additional pandemic-related production disturbances, labour shortages, or the potential impact of an interest rate/asset price shock to Denmark’s highly levered households pose additional risks to the growth outlook.

Denmark Benefits From Very Strong Public Finances and Fiscal Institutions

DBRS Morningstar views Denmark's very strong public finance metrics as a key credit strength. Denmark's fiscal-track record and low public debt ratio provide the country with valuable fiscal space to stabilize the economy against severe shocks. Denmark posted annual fiscal surpluses of 1.7% of GDP between 2016 and 2019, supported by a sound fiscal framework and a favourable macroeconomic environment. The fiscal targets are set in structural terms due to the volatility of some of Denmark’s revenue sources, especially regarding pension-yield taxes and oil and gas extraction in the North Sea. The new fiscal plan is expected to include an increase in the structural fiscal limit from 0.5% to 1% of GDP and aims for a headline deficit of 0.5% of GDP in the medium-term. Given Denmark’s solid track-record and solid starting position, DBRS Morningstar expects this relaxation to enhance fiscal planning flexibility without altering fiscal sustainability.

Fiscal performance during the pandemic was very strong, especially compared to other sovereigns, despite the implementation of considerable COVID-19 support for households and companies, including temporary salary compensation. Denmark posted a fiscal deficit of 0.2% of GDP in 2020 before returning to a surplus of 2.3% of GDP in 2021, both outperforming European Union (EU) averages of -6.8% and -4.7%, respectively. A rapid economic recovery, considerably higher-than-expected pension yield tax revenues and one-off tax revenues from the payment of the frozen holiday pay have largely explained this outperformance.

In light of the economic pressures and high inflation in Denmark, DBRS Morningstar views appropriate the government’s decision to pursue tighter fiscal policy after two years of fiscal stimulus in response to COVID-19. The government projects small fiscal surpluses for the 2022-2025 period despite the new spending policy priorities in relation to Russia’s invasion of Ukraine, including spending to accommodate refugee inflows, targeted measures to compensate for higher energy costs, and additional defense spending over time. The structural balance is projected to remain small at -0.1% of GDP during 2022-2024 and in a balanced position by 2025. DBRS Morningstar considers Denmark is well placed to accommodate higher spending related to its green transition and defense spending over time, potentially implementing offsetting measures if needed. The acceleration of Denmark’s green transition, with the green tax reform as centre piece, remains a key policy priority. Denmark plans to channel 59% of the close to 0.5% of 2020 GDP it expects to receive from the EU’s Recovery and Resilience Facility (RRF) on the green transition.

The public debt ratio increased due to the pandemic, but remains at one of the lowest levels in Europe. After increasing to 42.1% of GDP in 2020 from 33.6% of GDP in 2019, the public debt ratio (EMU debt definition) resumed its downward pre-pandemic trend in 2021 helped by a favourable economic and fiscal performance. In its latest projections, the government expects the public debt ratio to fall from 36.7% of GDP in 2021 to 33.3% of GDP in 2022, slightly below its pre-pandemic levels, and to hover around 32.0%-34.0% 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 companies and pension funds. 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 Appear Contained But High Household Debt Still a Source of Vulnerability

Given Denmark’s fixed exchange rate regime, the Danmarks Nationalbank (DN) conducts monetary policy to keep the Danish krone stable against the euro. In general, the central bank intervenes in the foreign exchange market in the face of short-term exchange rate fluctuations, relying more on the policy rate for more persistent movements. Together with its fiscal and economic policy, this has provided an environment of low and stable inflation for several decades. However, the imbalances caused by the pandemic and more recently the surge in global energy and food prices have resulted in the highest inflation levels in decades in both the euro area and in Denmark. This might require the European Central Bank to start hiking interest rates in coming months, which will be most likely mimicked by Danmarks Nationalbank. The prospect of rising rates increases risks to the real estate market.
The high level of household indebtedness, albeit declining since 2009, continues to be a source of vulnerability. Household debt remained high at 241.5% of gross disposable income in 2021, the highest among OECD nations, and some homeowners with a high debt-to-service income ratio are exposed to increases in interest rates. However, the central bank stresses that homeowners' interest rate sensitivity decreased in the 2009-2019 period and remains limited, and viewed in isolation, does not pose a threat to financial stability. After a prolonged period of house price increases, which have accelerated during the pandemic, the housing market has slowed down in recent months. Rising interest rates and higher energy bills could further dampen housing market dynamics and even lead to declining home prices. Nonetheless, the risk of a hard landing in the housing market, which could spread to other sectors of the economy, remains limited. The strength of the labour market, the net financial assets of the Danish household sector, sluggish housing supply and the concentration of debt among the most wealthy households mitigate against these risks.

The Danish banking system remains strong, characterized by healthy capitalization, liquidity and profitability metrics. While pandemic effects and the fallout from the Russian invasion of Ukraine could cause asset quality to deteriorate over time, the Danish banking system is well equipped to absorb substantial losses. Furthermore, the government decided to increase the countercyclical capital buffer for banks to 2.5% starting March 2023, in line with the Systemic Risk Council’s recommendation, given the strong economic momentum and signs of high appetite and risk taking. On the other hand, the large and highly interconnected Danish financial system, with the housing market and covered bond market—the world's largest as a percentage of GDP—strongly linked, could act as an amplifier of shocks. 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.

Denmark Benefits From A Strong External Sector And Healthy Competitiveness Levels

Denmark exhibits a strong external position from both a flow and a stock perspective. The current account surplus averaged 7.7% of GDP over the past ten years and the net international investment asset position (NIIP) amounted to 75.6% of GDP in 2021. Denmark continued to run sizeable current account surpluses, slightly above 8.0% of GDP, both in 2020 and 2021, supported by net pharmaceutical and food exports, which tend to be less sensitive to the global business cycle, and freight transport on the services side. In addition, the country's high net asset position generates a strong primary income surplus. In the future, Denmark's comparative strength in pharmaceutical and wind energy infrastructure bode well for Danish exports. The healthy competitiveness position of Danish firms places them well to absorb the prospect of faster wage growth in coming years, as expected by the government and central bank.

Although Denmark's peg to the euro reduces its external adjustment capacity, the country has successfully relied on sound economic and fiscal policies to stabilize the economy and prevent large external imbalances from building up. A strong external position, ample international reserves, sound public finances and strong political commitment underpin the high credibility of Denmark's long-standing fixed exchange rate policy. This supports DBRS Morningstar’s positive qualitative adjustment 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's governance indicators. The introduction of key reforms tends to depend on broad based 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 minority government of the centre-left Social Democratic Party relies mainly on the support of three left-wing parties in parliament to pass legislation.

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/396929.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/397128.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

The sources of information used for this rating include Ministry of Finance (Economic Survey, May 2022; Denmark’s Convergence Programme 2022, May 2022; Denmark’s Recovery and Resilience Plan), Danmarks Nationalbank (Outlook for the Danish Economy, March 2022; Financial Stability 2nd Half 2021, December 2021; Central Government Strategy 2022, December 2021; Central Government Borrowing and Debt 2021, February 2022), Danmarks Statistik, Systemic Risk Council (Recommendation March 2022), Ministry of Trade and Industry, Danish Energy Agency, European Central Bank, European Commission, The Social Progress Imperative (2021 Social Progress Index), Eurostat, OECD, IMF, World Bank, BIS, 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/397127.

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 Global Sovereign Ratings
Initial Rating Date: September 20, 2012
Last Rating Date: November 19, 2021

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