DBRS Morningstar Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Sweden’s (Sweden) Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed 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 solid macroeconomic fundamentals help mitigate risks posed by high inflation, rising interest rates, and a gloomier external backdrop. The projected economic recession is expected to be moderate and short lived and should not alter Sweden’s favourable public finance position. The direct impact of the Russian invasion of Ukraine has been limited, although elevated international energy prices have put higher pressure on inflation in Sweden. Financial stability risks remain contained but it will be important to monitor rising interest costs in the context of high household debt and banks’ large exposure to commercial real estate. The country’s public debt ratio, estimated at 31.6% of GDP in 2022, remains one of the lowest in the European Union (EU-27) and will continue to benefit from a prudent fiscal stance and a credible fiscal framework.

Sweden’s AAA ratings are underpinned by its strong public finances, healthy external accounts, and robust economic performance. While 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 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 elevated 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’s Temporary Economic Slowdown Will Not Alter its 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, and output reached the pre-pandemic level in the first quarter of 2021. The European Commission estimates Sweden’s GDP per capita at around 150% of the EU-27 average in 2022, which reflects a competitive and advanced economy with a productive labour force and one of the highest employment rates in the EU-27.

The economy rapidly recovered from the shock of the pandemic, expanding 5.1% in 2021 and an estimated 2.8% in 2022. However, the economy is expected to enter a recession this year before recovering gradually in 2024. Higher inflation and interest rates will curb consumption and weigh on investment, particularly on housing, along with lower external demand from trading partners. Latest projections from the government point to a GDP contraction of 0.7% this year before a recovery of 1.0% next year. The recovery should be supported by declining inflation and a resilient labour market. Limited trade and financial links with Russia and lower gas intensity usages shelter Sweden from a severe impact of the Russian invasion of Ukraine, although the country will not be immune from the possible resurgence of high energy prices. This could potentially exacerbate the inflationary and economic challenges, followed by the impact of rising interest rates on the property market.

A Solid Fiscal Framework and a Low Public Debt Ratio 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. Sweden’s public finances were not immune to the pandemic but the deficit deterioration to 2.7% of GDP was contained, cushioned by a mild GDP contraction and less stringent restrictions. Lower expenditures, a rapid recovery in the tax base and a solid economic performance enabled the deficit to narrow to 0.1% in 2021, before shifting to the estimated surplus of 0.7% of GDP last year.

The economic downturn will burden Sweden’s public finances both this year and in 2024 before improving in 2025. Lower revenues and the impact of higher inflation on expenditures are expected to be compensated for by the withdrawal of pandemic support, but the government plans also to reduce petrol and diesel taxes, increase spending on defence, raise funding to municipalities and deliver additional labour market support. This follows the announcement of an electricity support scheme which should be budgetary neutral. The government expects the budget to be broadly in balance in 2023-2024 before returning to a surplus of 1.0% of GDP in 2025. DBRS Morningstar takes the view that the Ministry of Finance’s very strong fiscal projections, using a no-policy change assumption, are subject to downside risks stemming from a more pronounced economic deceleration. Also, the government’s commitment to increase defence spending towards 2% of GDP will add to 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 39.65% of GDP in 2020 from 35.2% of GDP in 2019. Sweden has already reversed this deterioration, with public debt dropping to the estimate level of 31.6% of GDP in 2022, driven by the stronger economic and fiscal outturns. In addition, the public debt ratio is projected 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, 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 takes the view 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 Central Bank projects the policy rate close to 3% at the start in 2023. Consumer price inflation (CPIF) reached 10.2% YoY in December 2022 but the Riksbank expects a gradual fall to 5.7% on average this year and below the target of 2% in 2024, reflecting lower energy prices as well as contained risk of an inflation-wage spiral despite the large share of contracts that will be renegotiated over the first months of 2023.

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 to 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 207% in Q2 2022 and the predominance of mortgages with variable interest rates, households are particularly exposed to increases in interest rates. While households in aggregate have good margins to continue servicing their debts under stressed conditions, households most vulnerable 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 15% in November 2022 compared to its peak in March 2022.

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. Moreover, a large share of property developers is facing high refinancing risk in the context of rising interest rates. Developers are replacing market borrowing with bank lending, which translates into a further concentration in banks’ balance sheets. 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, contributing to a positive net international investment position which achieved 37.9% of GDP at the end of Q3 2022. Sweden’s export volumes experienced a strong comeback following the pandemic but weaker external demand has been putting negative pressure on the trade balance and in turn on the current account surplus. According to the latest estimates of the European Commission, the current account surplus may have declined to 3.3% of GDP last year from 5.4% in 2021, and after a year of stabilization it should increase again to around 4.2% in 2024. 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 11.7% of GDP as of Q3 2022 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 Worldwide 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. The outcome of legislative elections last September resulted in a new minority government comprised of the Moderate Party, the Christian Democrats and the Liberals, with the external support of the far-right Sweden Democrats. The agreed agenda includes a focus on immigration, integration, climate and energy, healthcare and security. Despite possible government instability, broad political consensus behind Sweden’s fiscal framework and sound macroeconomic policies will 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 NATO members and the Swedish parliament.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social or Governance factors 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 (17 May 2022).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/409347.

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/401817/global-methodology-for-rating-sovereign-governments (29 August 2022). In addition, DBRS Morningstar uses 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 (17 May 2022) in its consideration of ESG factors.

The sources of information used for this rating include Ministry of Finance (Key Indicators Forecast 22, December 2022; Budget bill for 2023, November 2022), Swedish National Debt Office, Sveriges Riksbank (Financial Stability Report 2022:2; Monetary Policy Report, November 2022), Swedish Statistiska Centralbyran (SCB), The National Institute of Economic Research (NIER), December 2022,European Commission (Autumn Forecast, November 2022), Eurostat, Swedish Environmental Protection Agency (Sweden’s Climate Act and Climate Policy Framework), The Social Progress Imperative (2022 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/409346.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Global Sovereign Ratings
Initial Rating Date: 17 April 2012
Last Rating Date: 5 August 2022

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