DBRS Morningstar Confirms the Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Denmark (Denmark)’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed 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 ratings remain limited. Denmark is well positioned to withstand the near term economic slowdown reflecting mainly high, although declining inflation, and the tightening in financial conditions. Challenges related to the Russian invasion of Ukraine appear less intense and the new coalition government is expected to maintain a very prudent fiscal stance, also in light of the tight labour market and stubborn core inflation. The government support to counteract the impact of high consumer prices, which is denting real purchasing power, is expected to be moderate. DBRS Morningstar views Denmark's strong public finances, benefitting from fiscal surpluses and one of the lowest public debt ratios in the European Union (EU), to continue to provide ample room to support the economy against severe shocks. A rapid post pandemic growth and higher than expected fiscal revenues contributed to the drop of the public debt ratio below the 2019 level. The ratio is projected to remain at around 30% of GDP over the coming years.

The ratings are supported by Denmark’s sound public finances, strong external position, credible policy framework, and wealthy and diversified economy. Moreover, the country’s predictable macroeconomic policy framework has underpinned its 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, especially in a context of rising interest rates and falling real income.

RATING DRIVERS
Given Denmark’s credit strengths, a downgrade to 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

Elevated Inflation and Rising Interest Rates Will Result in a Temporary Weaker Economic Performance

Denmark benefits from a productive, diversified, wealthy, and flexible economy, which is reflected in its high GDP per capita and its resilience to shocks, despite its small size and high degree of trade and financial openness. Before the pandemic, the country experienced a prolonged period of economic upswing, with annual growth averaging 1.8% during the 2010–19 period, mainly driven by domestic demand and strong job creation. The pandemic triggered from an international perspective a comparatively mild contraction in output of 2.0% in 2020, followed by a strong recovery of 4.9% in 2021 and 3.8% in 2022, mostly propelled by domestic demand.

Economic performance will slow down significantly this year mainly due to still elevated inflation and the tightening in financing conditions, both domestically and among trading partners. On the other hand, the ongoing energy crisis seems less intense than expected for Denmark and the impact from the conflict in Ukraine remains contained. Risks of a global recession, which would have severely dampened external demand, have subsided. The marked increase in the production of the pharmaceutical sector, mainly related to activities abroad, will sustain economic growth, which will decelerate to 0.9% in 2023 before rising to 1.2% 2024, according to Danmarks Nationalbank (DN). The labour market is expected to hold up in spite of weaker economic activity. Risks of inflation becoming more entrenched than expected, potentially due to stronger wage-price dynamics, could require further policy tightening that could ultimately hurt both activity and the housing market. However, accumulated household savings during the pandemic and considerable net wealth, as well as a still tight labour market, should mitigate the impact.

Denmark’s Public Finances Underpin the Ratings

DBRS Morningstar views Denmark's very strong public finance metrics and its fiscal-track record as key credit strengths, providing the country with valuable fiscal space to stabilise 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. Public finances deteriorated only temporarily as a result of the pandemic before sizeable surpluses amounting to 3.5% of GDP on average were posted over the last two years. Higher-than-anticipated tax revenues on the back of a booming economy and inflow of foreign labour, considerably higher-than-expected pension-yield tax revenues, and one-off tax revenues from the payment of the frozen holiday allowances explain this strong performance.

The near term economic deterioration is unlikely to derail the very conservative fiscal stance of the government. The new coalition aims for a tight fiscal policy in light of the solid labour market and elevated inflation. The fiscal surplus, although declining, will remain sound. The government projects a fall in the surplus from 3.3% of GDP in 2022 to 1.9% and 0.6%, respectively in 2023 and 2024. This reflects mainly support to counteract still elevated inflation, support to Ukraine related to the conflict and measures to address the backlog in the healthcare sector as well as some refund to households in 2024 related to the previous property tax payments. Over the medium term, DBRS Morningstar considers that Denmark is well placed to accommodate higher spending related to its green transition and defence pledges, potentially implementing offsetting measures if needed. Parliament has increased the structural fiscal deficit limit to 1% of GDP from 0.5% of GDP, and aims for a headline deficit of 0.5% of GDP in the medium term.

Denmark’s public debt ratio (EMU debt definition) at 30.1% of GDP in 2022, remains one of the lowest in Europe. The public debt trajectory is expected neither to be materially affected by the current economic slowdown or by the government’s fiscal stance. According to the latest budget bill, the debt-to-GDP ratio will remain at around 30% of GDP in 2024. This projection includes the debt-increasing effect from the social housing financing model, which nevertheless is neutral on a net-debt basis. In addition to the low debt level, a favourable debt profile supports the country’s resilience to shocks. Debt is mostly denominated in local currency, and about half of government bonds are held by Danish insurance companies and pension funds. While bond yields have increased significantly since mid-2022, Denmark’s interest burden is expected to remain low in coming years.

Financial Stability Risks Appear Contained but High Household Debt Still a Source of Vulnerability Amid Higher Interest Rates and Housing Market Downturn

Recent banking turmoil abroad has not had a material impact on the Danish banking sector, which shows a high level of capitalization and strict liquidity requirements. Further interest rate hikes are expected to weigh on economic activity, but to contain inflation pressures. Given Denmark’s fixed exchange-rate regime, the DN conducts monetary policy to keep the Danish krone stable against the euro. This, together with Denmark’s sound fiscal and economic policy, has provided an environment of low and stable inflation for several decades. In light of the rapid rise in inflation both in the euro area and Denmark, the DN has raised its benchmark rate by 3.45 percentage points cumulatively since June 2022, broadly following the European Central Bank (ECB), albeit widening its policy spread to counter the appreciation pressures in favour of the Danish krone. The DN is expected to continue tightening monetary policy in coming months, in tandem with the ECB, given still-strong underlying inflationary pressures.

The high level of indebtedness exposes households to and could amplify shocks, not least with regard to a sharp surge in interest rates. House prices are falling but the risk of a hard landing in the housing market, spreading to the broader economy, remains limited. As of Q4 2022, household indebtedness stood at 195% of seasonally adjusted gross disposable income, among the highest among OECD countries, which along the growing share of variable rate loans makes households more vulnerable to high interest rates. A further decline in real disposable income due to inflation, could exacerbate the downturn in the housing market, translate into lower consumption and increase loan losses. On top of this, higher interest costs are dampening the debt servicing capacity of households and worsening debt affordability. Nonetheless, 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 these risks. Furthermore, Danish households have been deleveraging and, according to the DN, homeowners' sensitivity to interest rates decreased in the 2009–19 period and remains limited. According to the DN, the introduction of the housing tax reform in 2024 could contribute to reduce house price fluctuations. This would make the housing market more stable.

Danish banks are strong, well capitalised and liquid. The system is well equipped to absorb the likely deterioration in credit quality due to the economic slowdown, high interest rates, and the unfolding economic consequences of the pandemic and the conflict in Ukraine. Furthermore, the Danish authorities decided to raise the countercyclical capital buffer for banks to 2.5% from March 2023. 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. This explains a negative assessment in the “Monetary Policy and Financial Stability” building block which reflect the risks stemming from Denmark’s large and interconnected financial system and its highly indebted households.

Denmark’s External Accounts and Competitiveness Levels Remain Strong, Despite the Intensifying Global Headwinds

Denmark exhibits a strong external position from both a flow and a stock perspective. A weaker external environment should not undermine its very strong external position. The current account surplus averaged 8.3% of GDP over the past 10 years and the net international investment asset position (NIIP) amounted to 64% of GDP in 2022. Despite lower external demand, mostly from European partners, Denmark is expected to continue to register a solid external performance. The relatively low sensitivity to the global business cycle of its pharmaceuticals, wind turbines, and food exports as well as the strong performance of its shipping sector bodes well for Danish exports. In addition to this, the country's high net asset position generates recurrent primary income surpluses, which more than offset transfer outflows. While Denmark’s terms of trade have been affected by the rise in energy prices due to its net importer position, this has been compensated for by a massive increase in freight rates albeit now normalising. Lower freight rates will likely translate into a gradual decline in the current account surplus. On the other hand, the planned restart of production in the Tyra gas field during the 2023–24 winter season is expected to give an additional lift to exports in coming years. In terms of competitiveness, Danish firms are well placed to absorb the prospect of higher wages in coming years.

While Denmark's peg to the euro reduces its external adjustment capacity, the country has successfully relied on sound economic and fiscal policies to stabilise the economy and to prevent large external imbalances from building up. A strong external position, ample international reserves, sound public finances, and a strong political commitment underpin the high credibility of Denmark's long-standing fixed exchange rate policy. This supports DBRS Morningstar’s positive qualitative assessment of the “Balance of Payments” building block.

Strong and Stable Political Framework Supports Economic Stability and the New Coalition Is Expected to Remain Fiscally Prudent

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 new coalition government, formed after the elections, and including the Social Democrats, the Liberals and the Moderates, is expected to continue to exercise fiscal prudence, and to avoid stimulating an economy operating above capacity.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There were no Environmental, Social and 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 (May 17, 2022) 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 at: https://www.dbrsmorningstar.com/research/414260.

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 (August 29, 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. 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 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at:
https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for this rating include Ministry of Finance (The Finance Bill 2023, March 2023), Ministry of Economy (Economic Report: The Danish economy is strong despite difficult times May 2023, Economic Report: Danish economy heading for a soft landing, March 2023), Danmarks Nationalbank (Outlook for the Danish Economy, March 2023; Financial Stability 2st Half 2022, December 2022), Danmarks Statistik, Danish Energy Agency, European Central Bank, European Commission (Spring 2023 Economic Forecast, May 2023), The Social Progress Imperative (2022 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: YES
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. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/414259.

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: Nichola James; Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: 20 September 2012
Last Rating Date: 18 November 2022

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