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 credit ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS' view that Sweden's credit fundamentals remain very strong despite challenges related to high interest rates, global trade policy uncertainty, and a slow pace of recovery in the construction sector. Following an estimated 0.3% economic recovery in 2024, GDP growth is set to gather pace to 1.8% this year, before accelerating to 2.6% in 2026, according to the European Commission (EC). Moreover, Sweden's healthy public finance position with limited fiscal deficits and low public debt is not expected to be significantly hampered by higher defence spending in coming years. The government forecasts that the fiscal deficit will improve to 1.4% of GDP in 2025 from an estimated 1.6% last year and will continue to fall to 0.7% next year. However, as parliamentary elections approach in 2026, some fiscal slippage is possible. The new net lending target, based on a budget balance, rather than on a surplus of 0.33% of GDP over the economic cycle, will be effective by 2027 and will not materially affect the fiscal stance in Morningstar DBRS' view. Financial stability risks remain relevant, even though they are declining as interest rates fall and Commercial Real Estate (CRE) companies improve their balance sheets.

Sweden's AAA credit ratings are underpinned by its strong public finances, healthy external accounts, and a robust institutional environment. Moreover, Sweden's high investment and employment rates and its skilled labour force will continue to underpin a 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, with loans to property companies representing around 61% of total loans to non-financial corporations, and elevated housing prices remain a challenge for Sweden. Nevertheless, wealthy households in aggregate and the stabilization of the labour market are reassuring. Moreover, the challenges stemming from the CRE sector are slowly abating, even though credit quality is likely to deteriorate, although from very good levels, with Swedish banks well equipped to absorb the expected rise in nonperforming loans.

CREDIT RATING DRIVERS
Morningstar DBRS could downgrade the credit ratings if Sweden's public debt ratio trajectory were to experience a material deterioration, because of a severe worsening of the macroeconomic performance, or a substantial deterioration of fiscal accounts, including a potential crystallisation 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 Recovery Is Underway but High Interest Rates and Uncertainties Over Trade Policies Could Be a Drag

Sweden's credit fundamentals are underpinned by its high GDP per capita level, historically sound economic performance, and limited output volatility despite the country's small size. The country's macroeconomic framework reflects a competitive and advanced economy with a productive labour force and one of the highest employment rates in the EU-27. Sweden's GDP per capita in current prices is high at around 133% of the EU-27 average in 2024.

Sweden's economic performance has been weak since Q4 2022, reflecting high inflation and elevated interest rates weighing on consumption and on investment, particularly in dwellings. The large share of mortgages with a short fixation period, in the context of a high level of household debt, made monetary tightening transmission rapid. This has worsened households' debt affordability and, along with the negative wealth effect due to declining house prices, translated into a contraction in private sector consumption in 2023. The improvement in the net trade balance did not prevent GDP from contracting by 0.2% in 2023, but economic activity has since started recovering, although slowly, with GDP estimated to have expanded by 0.6% in 2024, by the government. Looking ahead, Morningstar DBRS projects GDP growth will continue to improve as monetary policy will be less of a drag, reflecting a continuation in the easing interest rate cycle thanks to the stabilisation of inflation at the 2% target. This, in turn, will contribute to the recovery in housing investment, while household consumption will benefit from stronger purchasing power, also a result of lower taxes. The EC projects GDP to rise to 1.8% and 2.6%, respectively, in 2025 and 2026, with domestic demand being the main driver. Risks to the economic outlook are mainly related to a prolonged period of high interest rates and the impact of trade protectionist policies, which could weigh on both export and business confidence.

Some Fiscal Easing Possible As Elections Approach; New Net Lending Target Unlikely to Materially Alter the Conservative Fiscal Stance

Sweden's very strong fiscal performance, underpinned by its fiscal framework, and its low public debt level constitute important credit strengths. After years of moderate fiscal tightening, the fiscal deficit is modestly increasing, reflecting higher defence spending, a one-off capital injection to the Central Bank (Sveriges Riksbank) to restore its capital position, and lower taxes and higher transfers. The fiscal deficit is estimated to have widened to 1.6% of GDP last year from 0.8% in 2023, and it will likely gradually decline to 0.7% of GDP in 2026, according to the government's latest December 2024 projections. However, as elections approach in 2026, Morningstar DBRS does not rule out some fiscal easing.

The new fiscal balance target, proposed by a parliamentary committee including major parties, is not expected to materially affect the government's conservative fiscal framework. The net lending target level will change from the current surplus target, equivalent to a third of a per cent of GDP over a business cycle, to a balanced budgetary target and will be effective as of 1 January 2027. The transition to this new target will likely result in a more expansionary fiscal policy, but the impact on public finances is expected to be modest. Moreover, it will provide more fiscal room to implement countercyclical fiscal policies and to accommodate higher spending for infrastructure and defence.

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. Stronger economic and prudent fiscal outturns led the public debt ratio to drop to 31.5% of GDP in 2023 from 40.1% of GDP, before increasing to an estimated 32.8% of GDP at end-year 2024 as result of weak growth and higher deficit. Sound nominal growth and a modest increase in interest expenditures will contribute to keeping the public debt ratio slightly above 31.0% of GDP in coming years. In the absence of significant shocks or material 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 also takes the view that the associated risks to Sweden's relatively short average debt maturity and high share of foreign currency-denominated debt are contained. This relates to Sweden's comparatively low level of debt, steady demand for Swedish government bonds, and the use of derivatives to hedge currency risk. Despite the increase in Sweden's government bond yields because of past monetary policy tightening, the country is expected to continue to benefit from favourable financing costs. The relatively high share of inflation-index linked bonds is projected to decline with fewer issuances over the next years, making the debt less sensitive to inflation.

Risks to Financial Stability Are Decreasing but Remain Relevant; Households' Balance Sheets Are Resilient, and Banking Sector Is in Good Shape

With inflation normalising and monetary policy easing, financial conditions are improving. This bodes well for macroeconomic and financial stability. Both highly indebted borrowers, considering the large share of mortgages at variable rate, as well as CRE companies, whose banks are largely exposed, will likely benefit from lower interest rates. This will contribute to boosting consumption as well as enabling indebted companies to roll over their debt at cheaper conditions going forward. After peaking at 10.2% in December 2022, growth of the consumer price index with a fixed interest rate (CPIF) dropped considerably, and it has stayed consistently below the 2% target since June 2024. This led the Riksbank to cut policy rates starting from May 2024, with a cumulative fall of 150 basis points to 2.5% in December 2024. Although uncertainty over the future evolution of inflation remains elevated, considering the impact of trade policies, electricity regulation, new wage agreement, and the dynamics of the Swedish Krona, the Riksbank is expected to continue to ease monetary policy, which in turn, will help financial conditions to further improve.

Although the financial burden is expected to improve for households and companies, the fall in interest rates along with the improvement in purchasing power will likely contribute to a rise in house prices. Credit growth has significantly moderated, but in a context where households are highly indebted, banks are largely exposed to CRE companies, and house prices are overvalued, the risk of financial instability is relevant. All these factors weigh on the negative adjustment in the Monetary Policy and Financial Stability building block. However, Morningstar DBRS views households' balance sheets to be in good shape in aggregate and good margins exist to continue servicing debts under stressed conditions. Moreover, the employment rate (15-74 years old) is still favourable at 68.4% as of end November 2024, and the labour market is expected gradually improve, with the unemployment rate peaking at 8.6% in September 2024 and expected to decline at 8.1% by 2026, according to the government. Moreover, some of the CRE companies have registered an improvement in their balance sheets and are able to refinance their debt, even though there is still a basket of companies that are heavily indebted and exposed to material refinancing risks.

Subdued domestic demand is translating into an increase in bankruptcy rates, and consumer credit banks appear more vulnerable with growing loan losses. These banks, although representing a small share of total assets in the banking system, might pose some systemic risks at group level, according to the Riksbank. However, the overall banking system is experiencing very low levels or increases in nonperforming loan ratios, but a less favourable macroeconomic backdrop and more prolonged tight financial conditions will likely lead to a deterioration in asset quality. Nevertheless, the Swedish banking system's healthy capitalisation and liquidity buffers and its historically sound credit underwriting standards are reassuring.

Strong External Position Underpinned by High Savings and Sound Competitiveness; Weaker Currency Important Mitigant Factor Against Potential U.S. Tariffs

Sweden's credit ratings benefit from a strong external position backed by consistent and large current account surpluses and a rising positive net international investment position (NIIP). Underpinned by the private sectors' high savings rate and Swedish firms' solid competitiveness, the current account has averaged 5.2% of GDP over the past two decades. This, along with an improvement in investment portfolio balance led to a steady increase in the NIIP, which stood at 52.5% of GDP at the end of Q3 2024.

Sweden's small, open, and commercially and financially integrated economy remains exposed to potential swings in investor confidence, financial conditions, or global demand. As other trade-oriented economies in the EU, Sweden, with around 9% of total goods exported to U.S., is exposed to potential U.S. tariffs. This is further amplified by the fact that the automotive industry could be one of the most affected sectors, and one-fourth of the Swedish exports to the U.S. are vehicles. Against this background, Morningstar DBRS views the sound export diversification and the flexible exchange rate as important mitigant factors against the potential impact of the U.S. tariffs. Barring major shocks, the country will likely continue to benefit from a strong external position, and the surplus in the current account is expected to average at above 5.7% of GDP in the 2025-26 period, according to the National Institute of Economic Research (NIER).

Sweden's banking system is highly integrated in the international financial system, and its dependence on wholesale funding in foreign currency is a source of vulnerability in case of a drop in investor confidence. However, this risk is mitigated by the sound level of international reserves, which stood at SEK 464 billion (7.4% of GDP) as end-November 2024.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies, Despite Political Fragmentation

Despite political fragmentation, the country's institutional quality is robust as reflected by very favourable World Bank Worldwide governance indicators. The country is accustomed to minority governments that may require the support of parties outside of the government to pass laws, promoting political compromise and consensual policy making, although not without occasional political turmoil.

The external support of the far-right Sweden Democrats to the current minority government, comprising the Moderate Party, the Christian Democrats, and the Liberals, could translate into possible government instability. However, broad political consensus behind Sweden's fiscal framework and sound macroeconomic policies will continue to underpin the country's prosperity as well as preserve predictable macroeconomic policies. 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. This is translating into additional military expenditures but not as significant as to weigh materially on Sweden's prudent fiscal stance.

ENVIRONMENTAL, SOCIAL, AND 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 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at https://dbrs.morningstar.com/research/445693.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 Ministry of Finance (Key Indicators Forecast 24 - December 2024; Budget bill for 2025 - September 2024, ), Swedish National Debt Office, Sveriges Riksbank (Financial Stability Report 2024:2 - November 2024; Monetary Policy Report - December 2024), Statistics Sweden (SCB), National Institute of Economic Research (NIER, The Swedish Economy - December 2024), European Commission (Autumn Forecast - November 2024), Eurostat, Swedish Environmental Protection Agency (Sweden's Climate Act and Climate Policy Framework), The Social Progress Imperative (2024 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 Macrobond. 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 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/445694.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Senior Vice President, Sector Lead, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 17 April 2012
Last Rating Date: 12 July 2024

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