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. Sweden’s strong public finances and quick economic recovery from the Coronavirus Disease (COVID-19) pandemic shock help mitigate the risks posed by high inflation, higher interest rates, and a gloomier external backdrop. Sweden surpassed its pre-pandemic output level by mid-2021, outpacing previous expectations and most advanced nations, and its labour market tightened considerably. The Russian invasion of Ukraine has exacerbated already existing inflationary pressures, which became more persistent and broad-based, and triggered a faster-than-expected monetary policy tightening. Against this backdrop, growth is expected to decelerate in the near term, with a cessation of Russian gas to Europe as the main risk. The housing market has started to cool down after a period of strong price growth, and DBRS Morningstar views financial stability risks as contained. Sweden’s public finances remain very strong despite the substantial measures implemented to deal with the effects of the pandemic. The country’s fiscal deficit and the public debt ratios remained among the lowest in the European Union (EU-27) in 2020 and 2021. DBRS Morningstar expects Sweden’s public finance metrics to continue the improvement path started in 2021 in coming years, guided by its strong and credible fiscal framework.

Sweden’s AAA ratings are underpinned by its strong public finances, healthy external accounts, and a robust economic performance. While the near-term growth is subject to significant uncertainty, DBRS Morningstar expects Sweden’s high investment rates, employment rates, and skilled labour force to continue to underpin its solid economic performance in the coming years. On the other hand, as a small and open economy, with strong commercial and financial links with the rest of the world, the country remains exposed to potential shifts in external demand and/or global financial conditions. 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, a lasting and material weakening of fiscal policy, and a substantial materialisation of contingent liabilities.

RATING RATIONALE
Sweden will Face Intensified Headwinds from a Position of Strength

Sweden’s credit fundamentals are underpinned by its high GDP per capita, sound economic performance, and limited output volatility despite its small size. GDP growth averaged 2.3% per annum during 2000-2019. Sweden’s high GDP per capita, around 158% of the EU-27 average in 2021, reflects a competitive and advanced economy with a productive labour force and one of the highest employment rates in the EU-27. After the initial pandemic shock, the Swedish economy recovered rapidly from the middle of 2020, benefiting from strong policy support and a comparatively smaller contact-sensitive sector. This was reflected in a milder real GDP contraction of 2.2% compared with the 5.9% for EU-27 GDP, and a sharp bounce back of 5.1% in 2021. Sweden’s real GDP had already surpassed its pre-pandemic level at the start of 2021, driven by the strong recovery in the manufacturing sector, the information and technologies sector, and the professional services sectors, among others. The labour market metrics also exhibited a rapid improvement and labour demand remained strong.

The repercussions from Russia’s invasion of Ukraine are clouding the outlook. The high level of inflation, increasing interest rates and less favourable external backdrop, especially in Europe, pose important headwinds to Swedish growth in the near term. So far, economic activity remains solid after a soft start of the year, with GDP growth in Q2 2022 at 1.4% QoQ and 4.2% YoY, according to flash estimates. The Ministry of Finance expects GDP growth to decelerate to 1.9% in 2022 and to 1.1% in 2023, before growth recovers to around 2% per annum in 2024-25. The high level of inflation and increasing interest rates are expected to hit household’s purchasing power and to slow down consumption growth in the next couple of years. Similarly, this more challenging environment is expected to weigh on exports, investment, and ease labour market tightness in coming months, compared to the situation before Russia’s invasion of Ukraine. At the moment, the main risk is linked to a halt in energy supplies to Europe, potentially exacerbating the inflationary and economic challenges, followed by the impact of rising interest rates on the property market and new supply chain disruptions.

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

Sweden’s very strong fiscal performance, underpinned by its fiscal framework, and its low public debt level constitute important credit strengths. Prior to the pandemic, Sweden recorded five consecutive years of fiscal surpluses between 2015 and 2019 with an annual average of 0.8% of GDP and its public debt ratio stood at 34.9% of GDP in 2019. The economic contraction triggered by the pandemic and the government’s sizable response to soften its impact took a toll on public finances, with the fiscal deficit reaching 2.7% of GDP in 2020. However, DBRS Morningstar notes that the deterioration has been more limited than in many other advanced nations, in part thanks to Sweden’s better economic performance. Similarly, public finances have improved considerably in 2021, with the fiscal deficit narrowing to 0.3% of GDP driven by a rapid recovery in tax bases amid a strong economic recovery and less extensive coronavirus support. Expenditures dropped by 2.4% of GDP in 2021 as result, while revenues remained broadly constant as a percentage of GDP.

In its latest forecast in June 2022, the Ministry of Finance projects another small fiscal deficit of 0.2% of GDP in 2022 before Sweden returns to a surplus of 0.8% of GDP in 2023 and strengthens towards a surplus of 1.6% of GDP by 2025. This includes new unfunded measures worth SEK 45 billion for 2022 to deal with the fallout from Russia’s invasion and the pandemic announced in the Spring Budget Bill and amending budgets. DBRS Morningstar considers the MoF’s very strong fiscal projections, using no-policy change assumption, are subject to downside risks stemming from a more pronounced economic deceleration as well as from the implementation of the next administration’s policy agenda for the upcoming legislature. Also, the government commitment to increase defence spending towards 2% of GDP will add spending pressures over the next decade. Nevertheless, DBRS Morningstar continues to expect fiscal policy to remain well anchored around its surplus target of 0.33% over time.

Sweden’s low public debt ratio, among the lowest in the EU-27, provides the country with ample room to implement counter-cyclical fiscal policy if needed. The pandemic triggered an increase in the public debt ratio to 39.6% of GDP in 2020 from 34.9% of GDP in 2019. Sweden has already reversed part of this deterioration, with public debt dropping to 36.2% of GDP in 2021, driven by the stronger economic and fiscal outturns. In addition, the public debt ratio is projected to be lower than before the pandemic and to pierce the lower band of the debt anchor (35% of GDP +/-5 percentage points) in coming years, assuming no new policies or shocks.

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. Despite the rapid increase in Swedish government bond yields, Sweden is expected to continue to benefit from favourable financing costs.

Risks to Financial Stability are Manageable but Key Systemic Vulnerabilities Remain

In the face of high and increasing inflation, the Riksbank has decided to significantly tighten its monetary policy after years of extreme accommodation. The Riksbank increased the policy rate to 0.75% in June 2022 from 0.25% and decided to accelerate the reductions of its asset holdings in the second half of this year. The central bank projections suggest additional hikes taking the policy rate close to 2% at the start of 2023. Consumer price inflation (CPIF) reached 8.5% YoY in June 2022, the highest over the past 30 years; the central bank expects it to remain stubbornly above 7.0% for the remainder of the year before returning closer to the 2.0% inflation target from 2024.

While a less favourable macroeconomic backdrop and tighter financial conditions could lead to some credit deterioration, the Swedish banking system’s healthy capitalisation and liquidity buffers and its historically sound credit underwriting standards mitigate the risks. Furthermore, in order to increase the resilience of the banks to future crises, the Swedish Financial Supervisory Authority decided to increase the countercyclical buffer to 2% effective in June 2023, after slashing it to 0% at the onset of the pandemic. Asset quality remains strong, with loan losses remaining relatively contained throughout the pandemic, helped in part by government support to workers and companies in the hardest hit sectors. 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. The combination of higher interest rates, high inflation, and a slowdown in activity will put pressure on the property market. Given its elevated debt-to-income ratio at 208% in Q1 2022 and the predominance of mortgages with variable interest rates, households are particularly exposed to increases in interest rates. The central bank forecasts the interest-to-income ratio to increase towards 5% at the beginning of 2025, roughly the same level as in 2008, after several years of remaining low despite the increasing indebtedness. While households in general have good margins to continue servicing their debts under stressed conditions, households might need or precautionarily decide to cut back consumption to do so, risking second round effects to the overall economy. Furthermore, higher mortgage rates and weaker developments in real disposable income are already cooling down the housing market in Sweden. After increasing by 24.1% between March 2020 and March 2022, housing prices (HOX Sweden price index) have dropped by 5.8% in June 2022 compared to its peak in March 2022. The central bank expects housing prices to continue to correct but to bottom out above pre-pandemic levels.

The commercial property market also remains a source of risk, especially given that the property sector represents around 50% of banks’ non-financial corporate lending and 50% of the outstanding volume of corporate bonds in Swedish kronor, according to the Riksbank. Companies in the sector are generally highly leveraged and therefore vulnerable to interest and income shocks. While property companies have managed relatively well the pandemic effects thus far, the Riksbank warns that property companies have increased their debt relative to their earnings during the pandemic and certain segments could continue to underperform due to structural changes. DBRS Morningstar will continue to monitor risks on this front.

Sweden’s Strong External Position will Help the Country Weather Greater External Headwinds

DBRS Morningstar assesses Sweden’s external position as strong and backed by a long period of large current account surpluses. Underpinned by the private sectors’ high savings rate and Swedish firms’ competitiveness, the current account has averaged 5.3% of GDP over the last two decades, resulting in a net international investment position of 20.8% of GDP at the end of 2021. After a slump created by the pandemic, Sweden’s export volumes experienced a strong comeback and exceeded their pre-pandemic levels already last year, especially in the case of goods exports in spite of the dampening effects of global supply-chain disruptions. Going forward, foreign trade growth is expected to decelerate amid a slowing global economy, high energy prices, and tightening monetary policy in Sweden and abroad. Sweden’s small, open, and financially and commercially integrated economy remains exposed to potential swings in investor confidence, financial conditions, or global demand. Nevertheless, Sweden’s liquid currency, in the context of a flexible exchange rate mechanism, and international reserves amounting to 10.3% of GDP in 2021 enhance the country’s ability to absorb negative external shocks.

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 its political fragmentation, Sweden is accustomed to minority governments that may require the support of parties outside government to pass laws, promoting political compromise and consensual policy making, although not without political turmoil. Following Stefan Löfven’s resignation, Magdalena Andersson was elected Prime Minister in November 2021 and is leading a Social Democratic Party minority government. The next parliamentary elections, scheduled for 11 September 2022 could result in a change in the political scene after two legislatures with minority governments led by the centre-left. While the next government could veer the policy direction in certain areas, DBRS Morningstar expects broad political consensus behind Sweden’s fiscal framework and sound macroeconomic policies to continue to underpin the country’s prosperity. Finally, Russia's invasion of Ukraine resulted in a historic change in Sweden's defence policy, ending its historical neutrality and leading to its application for NATO membership. Sweden will hold an invitee status until the accession protocols have been ratified by the NATO members and Swedish parliament.

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/401056.

Notes:
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/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 (Key Indicators Forecast 22 June 2022; Spring Budget 2022), Swedish National Debt Office, Sveriges Riksbank (Financial Stability Report 2022:1; Monetary Policy Report, June 2022), Swedish Financial Supervisory Authority (Stability in the Financial System, May 2022; Decision Regarding The Countercyclical Buffer Rate, June 2022), Statistiska Centralbyran (SCB), The National Institute of Economic Research (The Swedish Economy June 2022), European Commission (2022 Country Report – Sweden), Eurostat, Swedish Environmental Protection Agency (Sweden’s Climate Act and Climate Policy Framework), The Social Progress Imperative (2021 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), 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.

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 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: 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/401054.

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: February 4, 2022

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