Morningstar DBRS Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Kingdom of Sweden’s (Sweden) Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, Morningstar DBRS 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 the view that risks to the credit ratings are limited. Sweden’s strong public finances and solid macroeconomic fundamentals position the country well to withstand high, although declining, inflation, elevated interest rates, and the slump in construction activity. Sweden’s healthy public finances are not expected to be significantly altered by the weaker economic activity, and after the estimated modest recession in 2023, GDP will start to gradually pick up. The government will continue to maintain a prudent fiscal stance with the structural balance remaining in surplus in the coming years, while public debt will hover around 30% of GDP. However, Morningstar DBRS views financial stability risks, as a result of the rapid rise in interest rates and the fall in property prices to remain elevated but banks’ loan losses will be contained. The expected increase in the unemployment rate is not projected to harm significantly the labour market, which will continue to remain resilient mitigating the impact of the worsening of household debt affordability. Moreover, property companies, to which banks are largely exposed, should benefit from a less restrictive monetary policy as inflation retreats.

Sweden’s AAA credit ratings are underpinned by its strong public finances, healthy external accounts, and a robust institutional environment. Moreover, while near-term growth rates remain subject to high levels of uncertainty, Sweden’s high investment rates, employment rates, and skilled labour force will 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 elevated housing prices remain a challenge for Sweden. Nevertheless, wealthy households and the expected modest deterioration in the labour market reassure. 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
Morningstar DBRS could downgrade the credit 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 credit ratings.

CREDIT RATING RATIONALE

Sweden’s 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. The European Commission (EC) projects Sweden’s GDP per capita at around 134.6% of the EU-27 average in 2024, which reflects a competitive and advanced economy with a productive labour force and one of the highest employment rates in the EU-27. GDP growth averaged 2.3% per annum during 2000-2019, and output, despite the recent deterioration, remains around 5.0% higher than the pre-pandemic level.

After a rapid post-pandemic economic recovery, Sweden’s economic performance started deteriorating in Q4 2022, with high inflation eroding real incomes and high interest rates weighing on consumption and on investment, particularly in the housing sector. The large share of mortgages with a short fixation time period, in a context of a high level of debt, make monetary tightening transmission rapid and this is worsening household debt affordability. The economy is in technical recession, and it is likely that GDP growth was slightly negative also in the last quarter of 2023. However, the whole GDP contraction last year is estimated be mild with output falling by 0.5%, according to the National Institute of Economic Research (NIER). In 2024, the economy is expected to face another year of subdued economic performance, with elevated interest rates remaining a drag on economic activity and housing investment remaining weak. Nevertheless, the economic activity is projected to pick up and to reach the potential by the end of this year. According to the government, GDP will rebound by 0.6% in 2024 before increasing to 2.7%, but there is a high degree of uncertainty surrounding these projections. A prolonged period of high interest rates could delay the recovery, intensifying the deterioration in the labour market, with the unemployment rate already expected to peak at 8.5% in 2025 from 7.7% in 2023.

A Solid Fiscal Framework and a Low Public Debt Ratio Underpin Sweden’s Creditworthiness; Deficit Will Temporarily Deteriorate in 2024

Sweden’s very strong fiscal performance, underpinned by its fiscal framework, and its low public debt level constitute important credit strengths. Pre-pandemic the budget balance was typically in surplus and the impact of the pandemic on public finance was relatively moderate. After a surplus of 1.3% of GDP in 2022, the government estimates the budget balance to have turned slightly negative (0.1% of GDP) in 2023, before it widens to 0.8% of GDP this year. This would reflect the build-up of defence spending, the weak economic activity, higher social benefits and lower tax on petrol and diesel. However, the headline deficit is expected to be larger because of the possible one-off capital transfer to the Riksbank, which would amount to 0.6% of GDP in 2024, according to the recent estimate of the central bank. This is dependent on the Riksbank’s petition to the parliament in March but could lead the headline deficit to reach 1.4% of GDP in 2024. Nevertheless, the capital transfer should not affect the structural balance that the government projects to be in surplus of 0.2% of GDP in 2024 before increasing to 0.7% in 2025. A sharper economic deterioration might translate into higher fiscal transfers to households and a more pronounced impact of automatic stabilisers, but Morningstar DBRS takes the view that the country’s fiscal position will remain solid in the medium term. Fiscal policy well remain 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 39.9% of GDP in 2020 from 35.6% of GDP in 2019, due to the impact of the pandemic, has been reversed rapidly. Stronger economic and fiscal outturns led the debt ratio to drop to 32.9% of GDP in 2022, before a further estimated fall to 30.5% of GDP last year. Strong nominal growth and a modest increase in the interest bill will contribute to keep the public debt ratio around 30% of GDP in coming years. 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 the medium-term.

The materialisation of contingent liabilities, potentially stemming from Sweden’s large public sector, exposure to financial sector-related entities, or the extension of state guarantees, could lead to a higher but still manageable debt ratio. Moreover, Morningstar DBRS 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 contained, 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 stabilises towards the target going forward.

Risks to Financial Stability are Relevant But Manageable; Households Balance Sheets are Still Resilient and Banking Sector is in Good Shape

Households’ debt affordability has worsened 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 the decline in consumption and lower housing investment. On the other hand, the consumer price index with fixed interest rate (CPIF) growth declined to 3.6% in November 2023, from the peak of 10.1% in December 2022 and it is expected to continue to fall. This should contribute to a less restrictive monetary policy going forward, benefitting also the property market. After increasing by around 30% between March 2020 and mid-2022, house prices have dropped by 13% until Q3 2023, and are expected to recover only gradually in 2024. The fall in house prices and credit growth contraction, due to monetary tightening, are improving imbalances in the financial system, however, risks to financial stability remain relevant and weigh on the Monetary Policy and Financial Stability building block. A prolonged and larger than expected fall in property prices could be a further drag on consumption. However, Morningstar DBRS 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 still favourable at 78.5% as of Q3 2023 and the deterioration in the labour market in the coming months is projected to remain contained.

The commercial property market also remains a source of risk, given banks’ large exposure. A large share of property developers are facing high refinancing risk in the context of recent interest rate increases. Although there are signs of an increase in issuances, developers are replacing market borrowing with bank lending, which translates into a further concentration in banks’ balance sheets. A less favourable macroeconomic backdrop and prolonged tight financial conditions will likely lead to some credit deterioration, but the Swedish banking system’s healthy capitalisation and liquidity buffers and its historically sound credit underwriting standards are reassuring. 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. However, 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 Competitiveness and High Savings Will Help the Country to Maintain a Strong External Position Despite Weaker External Demand

Morningstar DBRS assesses Sweden’s external position as strong and backed by a long period of large current account surpluses, which helped improve the net international investment position (NIIP). Underpinned by the private sectors’ high savings rate and Swedish firms’ solid competitiveness, the current account has averaged 5.4% of GDP over the last two decades. This, along with a shift to a positive net investment portfolio position, has contributed to a steady improvement in the NIIP, which stood at 37.1% of GDP at the end of Q3 2023. Weaker external demand in 2024, heightened geopolitical risks, and recent appreciation of the KIX effective exchange rate (5.4%) will not significantly affect Sweden’s export performance in the near-term, reflecting a favourable and supportive high savings rate and strong competitiveness. According to the NIER, the surplus in the current account should average at above 6.0% of GDP in the 2024-2025 period.

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 10% of GDP as of Q3 2023 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 favourable Worldwide Governance indicators. Given Sweden’s political fragmentation, the country 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 on occasion political turmoil. The 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 Morningstar DBRS’ view, this is translating into additional military expenditures but not as significant as to weigh 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, AND 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS 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/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (4 July, 2023).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/426441.

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 https://www.dbrsmorningstar.com/research/421590/global-methodology-for-rating-sovereign-governments (6 October 2023). In addition, Morningstar DBRS uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, 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://dbrs.morningstar.com/about/methodologies.

The sources of information used for this credit rating include Ministry of Finance (Key Indicators Forecast, 21 December 2023; Swedish National Debt Office, Sveriges Riksbank (Financial Stability Report 2023:2, November 2023, Press Release: “No provision for financial risks 2023”, January 2024), Swedish Statistiska Centralbyran (SCB), NIER (the Swedish Economy, December 2023), EC (Autumn Forecast, November 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. Morningstar DBRS considers the information available to it for the purposes of providing this credit 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

Morningstar DBRS 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. Morningstar DBRS’ outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS 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 Morningstar DBRS 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://dbrs.morningstar.com/research/426440.

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

Lead Analyst: Carlo Capuano, Senior Vice President, Credit Ratings, Global Sovereign Ratings,
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: 17 April, 2012
Last Rating Date: 4 August, 2023

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