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 CREDIT RATING CONSIDERATIONS
The confirmation of the Stable trend reflects DBRS Morningstar’s view that Sweden’s strong public finances and solid macroeconomic fundamentals will help mitigate risks posed by high inflation, rising interest rates, amid weaker growth and falling house prices. The projected economic recession is expected to be moderate and short-lived and should not alter Sweden’s favourable public finance position unless a significant shock were to occur. The government is implementing a prudent fiscal stance to not fuel inflation, even though the economic downturn will likely lead budget balance to shift to a marginal deficit until 2024. Longer than expected high inflation is triggering a tightening in monetary policy which is exacerbating financial stability risks in the context of high household debt, the high share of mortgages with a short fixation period and banks’ large exposure to commercial real estate (CRE). However, the country’s public debt ratio at 33.0% of GDP in 2022 remains one of the lowest in the European Union (EU-27) and it is expected to continue benefitting from a prudent fiscal stance and a credible fiscal framework despite the current economic downturn.

Sweden’s AAA ratings are underpinned by its strong public finances, healthy external accounts, and a robust institutional environment. Moreover, 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, along with the rapid transmission of tighter monetary policy and declining house prices, could amplify shocks, potentially weighing on domestic demand, with knock-on effects for the broader economy. Wealthy households and sound debt affordability mitigate these risks. Moreover, the challenges stemming from the property sector are likely to put pressure on credit quality but banks are well equipped to absorb the expected rise in non-performing loans.

CREDIT 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. A significant shock stemming from the financial sector could also put negative pressure on the ratings.

CREDIT 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 is now around 5% higher than the pre-pandemic level. The European Commission (EC) projects Sweden’s GDP per capita at around 149% of the EU-27 average in 2023, which reflects a competitive and advanced economy with a productive labour force and one of the highest employment rates in the EU-27.

After a rapid post-pandemic economic recovery, Sweden’s economic performance has started to deteriorate since Q4 2022 and the country is heading towards recession this year, with high inflation eroding real incomes and high interest rates weighing on consumption and on investment, particularly in the housing sector. The economy will likely register the worst performance in the EU in 2023 reflecting also the vulnerabilities in the housing market, including the high level of indebtedness of households and typically mortgages’ short fixation period, which renders more rapid the impact from the current tightening in monetary policy. Nevertheless, the economic downturn is expected to be short-lived and mild and will not alter Sweden’s position of strength, albeit the recovery is expected to be moderate next year. According to the government, GDP will contract by 0.4% in 2023 before rebounding by 0.8% in 2024 but there is a high degree of uncertainty surrounding these projections. The impact of high interest rates could delay the recovery, although the labour market is expected to remain resilient. This continues to show signs of tightness with high vacancies, even though redundancies have been rising and the unemployment rate is at 7.5% in June.

A Solid Fiscal Framework and a Low Public Debt Ratio Underpin Sweden’s Creditworthiness; Deficit Will Deteriorate Marginally in the 2023-24 period

Sweden’s very strong fiscal performance, underpinned by its fiscal framework, and its low public debt level constitute important credit strengths. The pandemic has not materially affected Sweden’s prudent fiscal stance with the deficit deteriorating temporarily to 2.8% in 2020 before returning to a surplus of 0.7%, slightly below its five year average of 0.8% of GDP registered pre-covid. This was mostly explained by the fast recovery in the tax base, along with high dividends from state-owned enterprises and a solid economic performance, helping the debt-to-GDP ratio to fall to 33.0% of GDP (35.5% in 2019).

The economic downturn in tandem with the high cost of living will burden Sweden’s public finances both this year and in 2024 before improving in 2025. Revenues will increase slowly and the impact of higher inflation on expenditures is not expected to be compensated for by the withdrawal of pandemic support this year. Moreover, the government has provided temporary electricity subsidies, reduced petrol and diesel taxes, increased spending on defence, raised funding to municipalities and delivered additional labour market support As a result, budget will record a marginal deficit of 0.2% of GDP and 0.3%, in 2023 and in 2024, respectively, before returning to a small surplus of 0.1% in 2025, according to the latest projections of the government. 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 or longer than expected higher inflation. 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% of GDP over an economic cycle.

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 modest increase in the debt ratio to 39.8% of GDP in 2020 from 35.5% of GDP in 2019, due to the impact of the pandemic, has been already reversed. Stronger economic and fiscal outturns led the debt ratio to drop to 33.0% of GDP last year. The surge in the interest bill, projected at 0.6% of GDP on average in the 2023-24 years from 0.2% in 2021, and higher expenditures should not prevent the public debt from stabilizing slightly above 30% of GDP in 2024. The debt ratio will likely benefit from strong nominal growth and the repayment of the loan from Riksbank relative to foreign currency reserves, estimate by the EC at 3.5% of GDP over 2021-23 period. This means that, in the absence of significant shocks or expansionary fiscal measures, the public debt ratio is expected to remain consistent with the debt anchor (35% of GDP +/-5 percentage points) in coming years.

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 also 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 Sweden’s government bond yields, Sweden is expected to continue to benefit from favourable financing costs. The relatively high share of inflation-index linked bonds should weigh less on interest costs as inflation stabilizes towards the target going forward.

Risks to Financial Stability are Increasing But Manageable; Households Balance Sheet are Still Resilient and Banking Sector In Good Shape

Households’ debt affordability is worsening reflecting high inflation and monetary policy tightening but this is mitigated by the resilient employment rate and high net wealth in aggregate. Nevertheless, most indebted households could cut back on consumption more than expected and aggravate the weak economic environment, which is already suffering from low retail sales and investment. Consumer price inflation (CPIF) is gradually declining but remains elevated at 6.4% in July. Moreover, the weakening of the Krona increases the risk of a higher than expected past-through that would fuel inflation. This is leading the Riksbank to continue with its policy rate hike cycle as well as with quantitative tightening. Furthermore, higher mortgage rates and lower volumes of houses sold are already cooling down the housing market in Sweden. After increasing by 30% between March 2020 and mid-2022, house prices on average have dropped by 11% since then, and are expected to recover only in 2024. A larger than expected fall could be a further drag on consumption. However, DBRS Morningstar views households’ balance sheets in good shape in aggregate and good margins exist to continue servicing debts under stressed conditions. Moreover, the employment rate is favourable at 76.4% as of Q1 2023 and the fall in house prices is expected not to have a material impact on the household sector.

The commercial property market also remains a source of risk, given banks’ large exposure to CRE. A large share of property developers are 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. While a less favourable macroeconomic backdrop and tighter financial conditions is leading to some credit deterioration, the Swedish banking system’s healthy capitalisation and liquidity buffers and its historically sound credit underwriting standards mitigate the impact of 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, although loan losses are increasing particularly in the CRE sector (see Nordic Banks: Net Interest Income Offsets Higher Cost of Risk in H1 2023; Signs of Asset Quality Deterioration https://www.dbrsmorningstar.com/research/417715/nordic-banks-net-interest-income-offsets-higher-cost-of-risk-in-h1-2023-signs-of-asset-quality-deterioration). Moreover, 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.

Sweden’s Strong External Position and Weak Currency 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, which helped improving net international investment position (NIIP). Underpinned by the private sectors’ high savings rate and Swedish firms’ competitiveness, the current account has averaged 5.4% of GDP over the last two decades, contributing along with an improvement in the portfolio position to a positive NIIP, which currently stands at 40.2% of GDP at the end of Q1 2023. The weaker Krona, which has depreciated in real effective terms by more than 14% since January 2021, in tandem with lower imports should support net trade. Moreover, according to the latest estimates of the EC, the current account surplus should improve to 5.9% of GDP this year from 4.7% in 2022.

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 total official reserves amounting to around 11% of GDP as of Q1 2023 enhance the country’s ability to absorb negative external shocks.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

High level of inflation as well as the recent decision to end the country’s historical neutrality are not expected to undermine Sweden’s fiscal framework and broad consensus-oriented policies. Sweden’s political system is characterised by strong democratic institutions as reflected by its very favourable 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 new minority government comprising the Moderate Party, the Christian Democrats and the Liberals, with the external support of the far-right Sweden Democrats could translate into possible government instability, but broad political consensus behind Sweden’s fiscal framework and sound macroeconomic policies will continue to underpin the country’s prosperity. 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 with the support of a large share of political parties. In DBRS Morningstar’s view, this would likely result in additional military expenditures but not such as to weigh significantly on Sweden’s prudent fiscal stance. Sweden will hold an invitee status until the accession protocols have been ratified by all NATO members.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There were no Environmental/ Social/ 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 (4 July 2023) https://www.dbrsmorningstar.com/research/416784/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/418860.

Notes:
All figures are in Swedish Krona 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 (29 August 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 https://www.dbrsmorningstar.com/research/416784/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 these credit ratings include Ministry of Finance (Key Indicators Forecast, 30 June 2023; Convergence programme, 28 April 2023), Swedish National Debt Office, Sveriges Riksbank (Financial Stability Report 2023:1; Monetary Policy Report, June 2023), Swedish Statistiska Centralbyran (SCB), The National Institute of Economic Research (NIER), EC (Spring Forecast, May 2023), Eurostat, Swedish Environmental Protection Agency (Sweden’s Climate Act and Climate Policy Framework), The Social Progress Imperative (2022 Social Progress Index), 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 these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were 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 credit 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 credit 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://registers.esma.europa.eu/cerep-publication/. 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 credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/418859.

These credit ratings are 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 of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: April 17, 2012
Last Rating Date: February 03, 2023

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