DBRS, Inc. (DBRS Morningstar) confirmed the Swiss Confederation’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 Stable trend reflects DBRS Morningstar’s view that the economy continues to demonstrate its resilience by achieving steady growth in private consumption and gross fixed investment, despite the uncertainty caused by the war and COVID-19 infections. The Swiss economy recovered rapidly from the pandemic shock, growing by 3.7% in 2021 versus -2.4% in 2020 and GDP is estimated to rise by 2.6% in 2022 and 1.9% in 2023. After posting deficits of 2.8% in 2020 and 1.9% in 2021, the IMF expects Switzerland’s fiscal deficit to decline to 0.9% in 2022 and reach a nearly balanced fiscal position of -0.3% in 2023. Switzerland continues to have one of the lowest debt ratios among sovereigns in the AAA category (40.9% of GDP in 2021). Higher energy prices and continued supply chain disruptions have resulted in inflation in Switzerland crossing the Swiss National Bank’s 2% threshold since February 2022 with the latest inflation print at 2.9% in May 2022. Concurrent with other central banks in tightening monetary policy to fight resurgent inflation, the Swiss National Bank (SNB) surprised markets in its June meeting by raising its policy interest rate by 50 bps to -0.25% for the first time in 15 years. SNB is likely to continue to normalize monetary policy and hike rates again later this year.
Switzerland’s AAA ratings are underpinned by its wealthy and diversified economy, sound public finances, and solid external position. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Switzerland benefits from a highly productive workforce, high levels of educational attainment and labor force participation. These credit strengths counterbalance the challenges associated with Switzerland’s high mortgage debt. Additionally, the decision not to sign the institutional framework agreement with the EU could gradually lead to increased barriers to trade between Switzerland and the EU. That said, Switzerland is expected and has already begun to enact appropriate policies in response to these challenges, and is firmly placed in the AAA category.
DBRS Morningstar considers the likelihood of a downgrade of Switzerland’s ratings to be low. Nonetheless, the ratings could be downgraded if severe external shocks or a sustained deterioration in growth prospects materially affect Switzerland’s financial stability and fiscal position.
Strong Swiss Fundamentals Limit The Impact of the War on the Economic Recovery
The momentum in Switzerland’s post pandemic economic recovery continued in Q4 2021 with the Swiss economy growing by 3.7% annually in 2021 versus -2.4% in 2020. Growth was primarily led by manufacturing as the Omicron wave continued to impact services. The ongoing recovery in economic activity was also reflected in the labor market with the seasonally adjusted unemployment rate published by SECO coming in at 2.2% in June 2022. The favorable employment data has helped consumption and is likely to aid the continued recovery in the Swiss economy. Switzerland’s direct exposure to Russia and Ukraine is small with limited exposure to energy, trade, and the financial sector. Ninety percent of Switzerland’s energy comes from nuclear, hydro, and renewables. That said, while the war in Ukraine has had limited impact on economic activity in Switzerland, the indirect exposure is uncertain given Switzerland’s exposure to commodity trade finance. Furthermore, global energy and food prices have risen significantly as a result of the war, and supply bottlenecks persist. The resulting inflationary pressure is curbing demand in major trading partners, with adverse effects on export sectors of the Swiss economy. Consequently, adjusted for sporting events, the Swiss Federal Government’s Expert group on economic forecasts downgraded its growth forecasts to 2.6% in 2022 and 1.9% in 2023 from 3.0% and 2.0% estimated earlier.
The global and Swiss economic outlook remains uncertain due to the war in Ukraine and the consequent impact on energy prices. That said, Switzerland’s ratings are underpinned by its wealthy and diversified economy and its medium-term economic outlook remains strong. GDP per capita currently stands at USD 87,370 and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland’s highly productive workforce, which is characterized by high levels of educational attainment and high labor force participation (84.9% as of Q4 2021). While the Swiss economy continues to outperform that of the Euro Area due to sustained consumption and investment growth, the decision not to sign the institutional framework agreement with the EU could increase trade barriers with its EU partners and may eventually have an effect on the attractiveness of Switzerland as a business destination. At the same time, talks between Switzerland and the EU regarding Switzerland’s proposed outline of a new negotiation package to the EU to safeguard and extend bilateral cooperation are currently ongoing.
The Swiss National Bank (SNB) Reverses Its Accommodative Policy After Fifteen Years
Concurrent with other central banks in tightening monetary policy to fight resurgent inflation, the Swiss National Bank (SNB) surprised markets in its June meeting by raising its policy interest rate by 50 bps to -0.25% for the first time in 15 years. SNB’s monetary policy is focused on price stability, defined as a rise in the price index of less than 2% per year. Inflation in Switzerland crossed 2.0% levels since February 2022 rising to 3.4% in June 2022. The SNB stated that price increases are being passed on more quickly – and are also being more readily accepted – than was the case until recently and that its tighter monetary policy is aimed at preventing inflation from spreading more broadly to goods and services. Also, in contrast to the past, the SNB noted that the Swiss franc is no longer highly valued and its depreciation is also contributing to the rise in inflation. Revising up its inflation forecast higher to 2.8% for 2022, 1.9% for 2023, and 1.6% for 2024 (from 2.1% for 2022, and 0.9% for 2023 and 2024 earlier), the SNB expects inflation to remain higher for longer and does not rule out further increases to stabilize inflation. While rates still remain negative at -0.25%, DBRS Morningstar expects the SNB to continue to normalize monetary policy and hike rates again later this year.
Financial Stability Risks Rise But Banks Are Well Capitalized
Switzerland’s highly open economy and historical status as a financial center are important sources of growth and prosperity for the country but can also leave Switzerland exposed to external shocks as the size of the banking sector is nearly 520% of GDP. Switzerland’s two global systemically important banks – Credit Suisse and UBS – have sound capital levels and funding and liquidity positions. Both banks’ profitability has benefitted from increased client activity and high valuations which led to higher assets under management and strong growth of revenues, in their wealth management as well as investment banking activities. CS had significant risk management failures in 2021, which translated into a large quarterly loss and flagged an urgent need to improve risk management and culture throughout the organization. While the capital position was reinforced by a capital raise in 2021, the full reputational and franchise impact of risk management shortcomings on Credit Suisse’s profitability could be more visible in coming quarters.
Domestic banks profitability increased slightly in 2021 due to improved cost efficiency and lower provisions for credit losses which led to an improvement of their capital position by retaining earnings. That said, risks to financial stability remain. Domestic banks’ exposure to mortgage and residential real estate markets have increased and the war could lead to a worse than expected economic slowdown, thereby impacting the quality of credit portfolios. With mortgage growth outpacing income growth, Switzerland’s mortgage-to-GDP ratio has been gradually rising from 135% of GDP in 2015 to 150% of GDP in 2021. As per the IMF, household mortgages are 3 times EU-levels and make up 85% of total loans and half of bank assets. Pension funds and insurers have also investment 23% and 12% of their funds in the real estate sector. However, SNB’s stress scenario analysis suggests that most domestically-focused banks’ capital buffers remain sufficient to cover the loss potential stemming from relevant stress scenarios, including a severe recession combined with a large interest rate rise and simultaneous correction in real estate prices. Furthermore, SNB continues to monitor mortgage and real estate markets developments closely, and recently reactivated the countercyclical capital buffer which will help maintain the banking sector’s resilience. The SNB’s ongoing vigilance and proactive measures have so far averted significant increase in credit risks and support an upward adjustment in the “Monetary Policy and Financial Stability” Building Block Assessment.
Switzerland’s Low Public Debt Ratio and Solid Fiscal Framework Underpin its Creditworthiness
Sound fiscal management remains a key credit strength for the Swiss Confederation. Since the introduction of the debt brake rule, which mandates a balanced budget over the cycle, Swiss public finances have been disciplined with increased expenditures or reduced revenues compensated elsewhere in the budget over a six year period. The pandemic resulted in Switzerland posting a deficit of 2.8% in 2020 and 1.9% in 2021, with IMF expecting a deficit of 0.9% in 2022 and a near balanced fiscal position of -0.3% in 2023. Given the pandemic-related outlays, the Federal Council has proposed a temporary extension of the period and earmarking of extra SNB dividends.
Switzerland’s public debt levels remain low relative to other AAA-rated peers despite an increase in pandemic-related expenditures. The pandemic resulted in the general government gross debt ratio rising from 39.8% in 2019 to 42.2% in 2022. The Maastricht debt ratio, which excludes pensions and healthcare, rose from 25.2% in 2019 to 27.5% in 2021 and is expected to stabilize at marginally lower levels. Combined with substantial financial flexibility, these considerations help the country to stand out among other highly-rated sovereigns. The government’s debt maturity structure remains favorable, with average maturity of marketable debt (bonds and T-bills) at 11.2 years. All debt has been issued in Swiss francs. Interest expenditures for the general government, as estimated by the IMF, were less than 0.4% of GDP in 2021. With highly transparent public finances and consistent efforts to analyze and address medium- and long-term fiscal challenges, DBRS Morningstar views Swiss fiscal management and policy to be very strong.
Switzerland’s External Accounts Remain a Key Credit Strength
Swiss external accounts are characterized by a structural current account surplus and a positive net creditor position. Switzerland’s persistent current account surpluses averaging 10% of GDP over the last two decades reflect its role as a financial center, an attractive location for corporations, high per-capita income levels, and high savings rate. Switzerland’s positive net international investment position of 86.2% of GDP in Q1 2022 reflects the substantial accumulated wealth of Swiss residents and official foreign exchange reserves. Over the last decade, the Swiss National Bank accumulated nearly CHF 700 billion. The SNB is responsible for managing the currency reserves that are currently allocated in an 80:20 ratio between bonds and equities. Due to its foreign exchange intervention, the SNB’s balance sheet has grown to 138% of GDP as of March 2022.
Strong Swiss Institutions Limit Impact of the Impasse in the Swiss- EU Institutional Framework
The future of Swiss-EU relations remains uncertain after the Swiss Federal Council halted discussions for a common institutional framework to streamline Switzerland’s market access to the EU due to substantial disagreements mainly on the Citizens’ Rights Directive and wage protection (See Swiss-EU Relations At An Impasse). Switzerland is not part of the EU and its unique relationship is based on around 20 main agreements (amongst them two packages known as Bilaterals I & II) and several other agreements ensuring, among other things, access to the EU’s single market for several sectors. The failure of talks could ultimately cause existing bilateral agreements to lapse resulting in higher administrative costs and over the long run erode the attractiveness of Switzerland as a business destination. However, with the Swiss proposing the outline of a new negotiation package to the EU to safeguard and extend bilateral cooperation, continuing to make their contribution to selected EU member states in the form of cooperation programs and remaining closely aligned with its neighbors on many shared policy priorities, DBRS Morningstar expects the Swiss to maintain strong relationships with their EU counterparts in the foreseeable future.
Supporting Switzerland AAA ratings is its political environment, characterized by its federal democratic system, high institutional capacity and low level of corruption. Stable politics combined with neutrality in international conflicts have long made Switzerland a safe haven for investors. While the Swiss constitution prohibits Switzerland being a member of any defense union such as NATO and disallows any military engagement, Switzerland has enforced all the economic sanctions on Russia which include financing restrictions and asset freezes, travel bans, and prohibition of sale/transfer of key technologies. The authorities have also accepted nearly 60,000 Ukrainian refugees.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis.
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/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/400291.
All figures are in CHF 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 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 sources of information used for this rating include the Federal Council, State Secretariat of Economic Affairs (Economic Forecasts), Federal Department of Finance (Budget 2022), Swiss National Bank (Quarterly Bulletin June 2022, Financial Stability Report 2022, Monetary Policy Statement June 2022); Federal Department of Foreign Affairs, European Central Bank (ECB), Eurostat, OECD, IMF (WEO April 2022), World Bank, BIS, Our World in Data, the Social Progress Imperative (2021 Social Progress Index), the 2019 and 2020 Global Competitiveness Reports from the World Economic Forum, 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 is an unsolicited credit rating.
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 January 21, 2022
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: https://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, Global Sovereign Ratings
Initial Rating Date: July 14, 2011
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