Morningstar DBRS Confirms Swiss Confederation at AAA, Stable Trend

DBRS Ratings Limited (Morningstar DBRS) confirmed the Swiss Confederation's Long-Term Foreign and Local Currency - Issuer Ratings at AAA. At the same time, Morningstar DBRS confirmed the 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 Morningstar DBRS' view that the risks to Switzerland's credit ratings remain limited. Switzerland's solid public finances and strong macroeconomic fundamentals have helped mitigate risks posed by the weaker external environment. Swiss economic growth moderated in 2023, due to the weaker external environment and tighter financing conditions. Switzerland's prudent fiscal policy, underpinned by its debt brake rule and the low public debt level at 38.3% of GDP in 2023 will continue to provide ample room to support the economy against severe shocks. The crisis at Credit Suisse Group AG (CS) resulted in a state facilitated takeover of CS by UBS Group AG (UBS), highlighting Switzerland's financial flexibility to weather potential shocks. The new group presents higher concentration risks for the Swiss banking sector, however, risks to the sovereign balance sheet have receded.

Switzerland's AAA credit ratings are underpinned by its wealthy and diversified economy, sound public finances, and solid external position. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Switzerland benefits from a highly productive workforce, high levels of educational attainment and labor force participation. These credit strengths counterbalance the challenges associated with Switzerland's high mortgage debt and the contingent liability risks posed by the large banking sector. After months of exploratory talks, in March 2024, Switzerland and the European Union (EU) announced that negotiations on a package of measures will begin, aiming to deepen their bilateral relations. The package includes new agreements on electricity, food safety, and health and participation in EU programmes. The EU is Switzerland's largest trading partner and the failure of agreement on Swiss-EU relations could ultimately result in an increase in trade barriers with its EU partners. Nonetheless, we expect that Switzerland will continue to maintain strong relationships with its EU counterparts in the foreseeable future.

CREDIT RATING DRIVERS
Morningstar DBRS could downgrade the credit ratings if severe external shocks or a sustained deterioration in growth prospects materially affect Switzerland's financial stability and fiscal position. Moreover, a materialization of substantial contingent liabilities stemming from the financial sector could put negative pressure on the credit ratings.

CREDIT RATING RATIONALE

Economic Activity Starts to Normalize Gradually, Swiss Fundamentals Remain Strong

After growing by 2.4% in 2022, the Swiss economy's growth rate moderated in 2023, mainly reflecting the challenging external environment, primarily weaker external demand and tighter financing conditions. Real GDP growth came in at 1.3% in 2023 mainly driven by private consumption. Weak performance was observed in the manufacturing and the construction sectors as well as in financial sector activities. Annual inflation stood at 2.8% in 2022, below the euro area average of 8.9%, before slowing down to 2.1% in 2023 and to 1.3% in June 2024. Price growth was relatively contained in Switzerland compared to other advanced economies primarily due to the lower reliance on fossil fuels for electricity generation, low energy intensity in Swiss manufacturing and the strengthening of the Swiss franc. In the first three months of 2024 the Swiss economy grew by 0.3% on a quarterly basis, supported by the services sector and private consumption. On the back of easing financing conditions and an improved external environment, the Swiss Federal Government's expert group on economic forecasts (SECO) foresees growth of 1.2% in 2024 and of 1.7% in 2025 (GDP is adjusted for sporting events). Downside risks to the outlook include renewed inflation, a prolonged period of high interest rates, or an intensification of global geopolitical tensions.

Switzerland's AAA credit ratings are underpinned by its wealthy and diversified economy, and solid economic performance. GDP per capita currently stands at USD 100,413 one of the highest in the world and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland's highly productive workforce, which is characterized by a highly educated labor force and high labor force participation (84% as of Q1 2024) and internationally competitive industries and companies.

Switzerland's Strong External Position Remains a Key Credit Strength

Switzerland's credit ratings are supported by its strong external position. Switzerland's current account surpluses, averaging around 6% of GDP over the last ten years reflect its role as a financial center, its high value-added exporting industries, high per-capita income levels, and high savings rate. From a stock perspective, Switzerland benefits also from a large net international investment asset position (NIIP) amounting to 112.8% of GDP in Q1 2024. This reflects the substantial accumulated net wealth of Swiss residents and official foreign exchange reserves. Switzerland's overall foreign exchange reserves rose from USD 340 billion in 2011 to USD 1,111 billion in 2021, and are currently over USD 800 billion.

Strong Public Finances and a Low Debt Ratio Underpin Switzerland's Creditworthiness, Contingent Liability Risks for the Sovereign From Credit Suisse Group AG's Acquisition Have Receded

Switzerland's prudent fiscal policy, underpinned by its debt brake rule, and its low public debt ratio constitute an important credit strength. The debt brake, which was introduced in 2003 at the federal level mandates a balanced budget over the business cycle. Higher expenditures have to be financed by increased revenues or corresponding expenditure cuts. In addition to the federal government, most Swiss cantons also have implemented similar regulations. After recording deficits of 3.1% of GDP in 2020 and of 0.3% in 2021, due to the measures to mitigate the impact of the pandemic, the public accounts improved to a general government surplus of 1.2% of GDP in 2022 and to 0.5% in 2023. The general government's result is expected to remain positive in 2024 and 2025.

Switzerland's credit ratings are also underpinned by its healthy public sector debt position with the public debt ratio remaining low relative to other AAA-rated peers. After increasing from 39.7% in 2019 to 43.2% in 2020 the debt ratio resumed its downward trajectory. The economic recovery and the withdrawal of fiscal measures resulted in the debt ratio declining to 37.7% in 2022 before increasing marginally to 38.3% in 2023. The Maastricht debt ratio, which excludes pensions and healthcare, increased from 25.6% in 2019 to 28.2% in 2020 and has now stabilized at around 26% of GDP. Switzerland's low public debt levels combined with substantial financial flexibility and favourable debt profile supports the country's resilience to shocks and helps the country to stand out among other highly-rated sovereigns. All debt is denominated in local currency, and despite the increase in bond yields in 2022, interest expenditures for the general government, as estimated by the IMF, will remain low.

The contingent liability risks associated with the takeover of Credit Suisse by UBS have reduced significantly. In August 2023, UBS terminated the Public Liquidity Backstop (PLB) with the Swiss National Bank (SNB) of up to CHF 100 billion, guaranteed by the Swiss government and also decided to terminate the CHF 9 billion Loss Protection Agreement (LPA) with the Swiss government. Therefore, the Confederation will not have to assume any losses. With highly transparent public finances and consistent efforts to address medium- and long-term fiscal challenges, Morningstar DBRS views Swiss fiscal management and policy to be very strong.

Inflation Back to SNB's range of price stability; Banking Sector Has Remained Resilient, But Risks Remain

Following a rate cut in March 2024 of 0.25 percentage points, the SNB lowered its policy rate again in June 2024 bringing it to 1.25%. Since June 2023 inflation has fallen back to below 2%, making it possible for the SNB to ease its monetary policy. SNB forecasts average annual inflation at 1.3% for 2024, 1.1% for 2025 and 1.0% for 2026, based on the assumption that the policy rate is 1.25% over the forecast horizon.

After a challenging year for the Swiss banking sector, marked by the state facilitated takeover of Credit Suisse by UBS, the situation has stabilized. In March 2023, the mounting issues at Credit Suisse, a result of shortcomings in its governance and risk management, combined with the failure of the Silicon Valley Bank (SVB) in the U.S., resulted in temporary financial market instability eventually leading to a state-facilitated merger with UBS. The merger of the parent bank was completed at the end of May 2024 and that of the Swiss entity in July 2024. The full integration is scheduled to be completed by the end of 2026. The large size of the new group, results in a higher concentration in the Swiss banking system, which could ultimately increase contingent liability risks. However, the combined entity will have to comply with capital requirements that reflect the change in its systemic importance. Following an assessment of the `too-big-to-fail' regulation relative to the Credit Suisse crisis, in April 2024 the Federal Council proposed a package of measures with a main focus on strengthening the financial sector's regulations and aims to present two packages for implementation and parliamentary approval in the first half of 2025.

The Swiss banking system has showed resilience in the current weaker macroeconomic environment with banks remaining liquid, improving profitability and with sound capitalisation. The financial sector is one of the most important pillars of the Swiss economy contributing around 9% of GDP and employing around 5% of the total workforce. However, the size of the banking sector, which is nearly 430% of GDP, suggests that shocks to banks, especially if systemically important, can have more pronounced effects on the economy. In addition, banks' exposure to the real estate market remains a source of vulnerability for financial stability. Following the interest rate increases in 2022 and 2023, real estate price growth has started to slow down, with single family home prices growing by 0.2% on an annual basis in Q1 2024, after growing by 4.65% in 2022 and by 0.75% in 2023, according to the SNB. However, high demand and low supply will most likely keep the housing market tight. Switzerland's household debt-to-GDP ratio remains high at 130% at the end of 2023, nevertheless risks are mitigated by the large and liquid balance sheet of households. Furthermore, the SNB continues to monitor mortgage and real estate market developments closely and has reactivated the countercyclical capital buffer which aims to enhance the resiliency of the financial system

Strong Institutions and Policy Continuity Support the Credit Ratings

Switzerland's political environment is characterized by its federal democratic system, high institutional capacity and a low level of corruption as reflected in the World Governance Indicators. The stable political system, combined with neutrality in international conflicts, has long made Switzerland a safe haven for investors. Following the October elections, the parliament elected the Federal Council in December 2023. The composition of the Council signals economic policy continuity.

Switzerland is not part of the EU and its unique relationship is based on bilateral agreements (two packages known as Bilaterals I & II) and several other agreements ensuring, among other things, access to the EU's single market for several sectors. Between 2014 and 2021 Switzerland and the EU negotiated on a common institutional framework to streamline Switzerland's market access to the EU. The Swiss Federal Council halted the discussions due to substantial disagreements mainly on the Citizens' Rights Directive and wage protection in May 2021. In December 2023, the European Commission announced that a Common Understanding was reached after 18 months of exploratory talks. In March 2024 Switzerland and the European Union (EU) announced that negotiations on a package approach will be launched, aiming to deepen their bilateral relations. The package includes new agreements on electricity, food safety, and health, participation in EU programmes, Swiss-EU cohesion contributions, and institutional provisions in the existing agreements on free movement of people, overland transport, civil aviation, agriculture, and mutual recognition of industrial goods. The EU is Switzerland's largest trading partner and the failure of talks could ultimately result in an increase in trade barriers with its EU partners. Morningstar DBRS, nonetheless, expects that Switzerland will continue to maintain strong relationships with its EU counterparts in the foreseeable future.

ENVIRONMENTAL, SOCIAL, AND 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at https://dbrs.morningstar.com/research/436363/.

Notes:
All figures are in Swiss franc 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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030 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 these credit ratings include Federal Council, State Secretariat of Economic Affairs (Economic Forecasts June 2024), Federal Department of Finance (Federal Finances at a glance, March 2024),Federal Council (Switzerland and the EU: cooperation and negotiation, Swiss National Bank (Quarterly Bulletin 2/2024, Financial Stability Report 2024); Federal Department of Foreign Affairs (Switzerland's European Policy, June 2024), European Central Bank (ECB), Eurostat, OECD, IMF (Switzerland: 2024 Article IV Consultation-Press Release; Staff Report; Informational Annex; and Statement by the Executive Director for Switzerland, WEO April 2024), Eurostat, World Bank, BIS, Our World in Data, the Social Progress Imperative, Global Competitiveness Reports from the World Economic Forum, UNHRC, and Haver Analytics. Morningstar DBRS 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

Morningstar DBRS 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. Morningstar DBRS' outlooks and 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/436364/.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Spyridoula Tzima, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: July 14, 2011
Last Rating Date: January 19, 2024

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