DBRS Ratings Limited (DBRS) confirmed the Kingdom of Denmark’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.
KEY RATING CONSIDERATIONS
The confirmation of the Stable trend reflects Denmark’s strong fundamentals and DBRS’s view that the challenges Denmark faces are contained. The economy continues to grow at a healthy pace and the labour market continues to perform robustly. To address the build-up of risks to financial stability, Danish authorities introduced additional macro-prudential measures at the beginning of 2018, including limits on risky mortgages. This helps mitigate the vulnerabilities stemming from the private sector, mainly related to high household debt. The government parties also agreed in September 2018 to tighten the anti-money laundering legislation.
The ratings are supported by Denmark’s strong external position, its sound public finances, its credible policy framework, and its wealthy and diversified economy. The predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades. Denmark’s strengths offset the credit challenges associated with an interconnected financial system, high levels of household debt, and potential pressures on the housing market. The interconnectedness between banks and the insurance sector and pension funds mainly results from mortgage banks financing lending through mortgage covered bonds, in which insurance companies and pension funds invest. A shock to the financial system, including to the large covered bond market, could have an impact on the whole economy.
Given Denmark’s credit strengths, downward pressure on the ratings appears unlikely. Nevertheless, a severe shock to the economy, most likely generated by turmoil in financial markets, or a shock to Denmark’s mortgage covered bond market, which is pivotal for the Danish financial system, could pose a risk to the ratings. Either of these scenarios could weaken private sector balance sheets and have an adverse impact on the financial system and the overall economy.
Financial Stability Risks Remain Contained and Price Stability Maintained
Denmark’s financial sector is concentrated and interconnected, which could amplify shocks to the financial system and the economy. Six systemically important financial institutions (SIFIs), including mortgage banks, account for close to 90% of total bank lending. Mortgage banks fully finance lending through mortgage covered bonds, in which the Danish insurance sector and pension funds invest. The Danish pension sector manages a large portion of the sizeable households’ wealth and is an important participant in financial markets. Thus, a shock to the financial system, including to the mortgage covered bond market – the third largest in Europe – could have a significant impact on Denmark’s financially complex economy. Recent stress tests carried out by both the European Banking Authority and Danmarks Nationalbank indicate that the country’s largest banks have sufficient capital to withstand a severe recession.
The money laundering case in the Estonian branch of Denmark’s largest bank has raised concerns about financial supervision and the bank’s governance. The investigation at Danske Bank, by the Danish and Estonian authorities and the U.S. Department of Justice covering transactions between 2007 and 2015, is ongoing and the size of potential fines uncertain. Adverse market reaction has been limited, but the case could weaken confidence in the Danish banking sector, given the bank’s status as a SIFI. As a mitigating factor, SIFIs are subject to extra capital requirements. The Danish anti-money laundering (AML) rules are founded on the European AML directives and have been strengthened in recent years. Moreover, in response to the Danske’s case, the government has tightened the AML legislation further.
In the household sector, rising incomes have contributed to a lower household debt ratio in recent years. Still, household debt remains the highest among OECD countries, at 266% of disposable income in Q2 2018. Moreover, around 60% of residential mortgages are at variable rates, exposing some households to increases in interest rates. Nevertheless, the share of fixed-rate mortgages is rising. Limits on deferred amortisation mortgages have been adopted, and mortgage interest deductibility, which acts as a tax incentive to accumulate debt, is being reduced. High debt ratios are concentrated in high-income households, and households’ net financial assets are sizable, amounting to 350% of disposable income in 2016. (For further details, please see DBRS commentary “Danish and Dutch Households: Indebted, Wealthy, and Vulnerable to Rising Interest Rates?”).
House prices have continued recovering from the burst of the housing boom. The recovery has helped rebuild households’ net wealth. The price growth for owner-occupied flats was strong in 2015 and part of 2016, particularly in the Copenhagen area, and a country-wide sustained spread of this trend raised some concerns over a price correction. Nevertheless, the price growth eased in 2017 and remained at 6.7% in Q1-Q2 2018. The deceleration appears to be partly driven by increased construction. A new housing taxation system, which removes the 2001 tax freeze, is set to be implemented from 2021 and expected to have a stabilising effect on house prices (for further details, please see DBRS commentary “The Evolving Dynamics of the Danish Housing Market”, available at www.dbrs.com).
Monetary policy in Denmark aims to ensure price stability through the Danish krone peg to the euro. The krone is allowed to fluctuate within a band around a central rate, with the Danmarks Nationalbank (DNB) responding to changes. Policy interest rates are used to maintain the peg and normally track the European Central Bank (ECB) rates. As a result, the DNB lending rate and the certificates of deposit rate remain at very low levels. The annual inflation rate is below 1%.
Denmark’s Economic Performance Remains Strong and Its External Sector Robust
The economy is expected to grow steadily after temporary factors affected growth in 2018. Following a 2.3% in 2017, real GDP growth is forecast at 1.3% this year by the DNB. The temporary factors affecting growth are a negative base effect on exports and weaker-than-expected agricultural production, reflecting adverse weather. In 2019, growth is projected at 1.8%. Private consumption, supported by strong job creation and rising disposable incomes, is set to be the main growth driver. Upside risks to the outlook could derive from higher incomes and stronger external demand. Downside risks could stem from a weaker world trade, given Denmark’s large shipping sector, and tightness in the labour market that could constrain growth.
Denmark’s long-term prospects benefit from a diversified, competitive, and wealthy economy. Reforms on unemployment benefits and the pension system are increasing the structural level of labour supply and expected to improve potential GDP growth. Denmark also remains an attractive destination for investment, ranking 3rd in the world in the 2018 World Bank’s Ease of Doing Business Index. Moreover, the resilience of its economy is underpinned by a high GNI per capita and high private sector savings. Denmark’s diversified and wealthy economy counterbalances its vulnerability to external shocks, given its small size and openness.
Denmark’s current account surplus and net external asset position remain large. The current account has averaged 6.7% of GDP over the past ten years, with the goods, services and primary income accounts remaining in surplus. The net international investment position, at 29.9% of GDP on average over the same period, is accounted for by the non-bank private sector. External trade competitiveness and solid demand from Germany – Denmark’s main trading partner – is expected to continue to support Danish export performance. Income from foreign direct investment and external financial assets is also expected to remain substantial.
Public Finances Remain Sound and the Political Environment Stable
Denmark’s sound fiscal position supports its fiscal flexibility. A prudent fiscal policy, supported by a robust framework, has ensured sufficient fiscal space to support the economy during downturns without leading to large imbalances. As the headline budget balance tends to be affected by one-off factors, fiscal targets are set based on the structural balance. The structural balance (adjusted for volatile revenues from oil and gas and pension-yield taxes) is projected at -0.2% of GDP in 2018, within the statutory limit of -0.5%. Moreover, the long-term fiscal sustainability is supported by the 2011 retirement reform, which increased the statutory retirement age and reduced voluntary early retirement.
Denmark’s government debt ratio is also modest and one of the lowest in the EU. At 35.6% of GDP in 2017, the debt ratio is expected to continue to decline gradually in the coming years. The debt profile is also favourable, supporting its resilience to shocks. Debt is entirely denominated in local currency, and about half of government bonds are held by the Danish insurance and pension sector. Danish government bond yields remain low, reflecting low policy interest rates and investor confidence in the Danish economic policy framework.
Denmark’s political environment and institutions are stable. The three-party coalition government of the Liberal Party, Liberal Alliance and Conservatives, formed in November 2016, has a minority position in Parliament and needs additional support to pass legislation. The next general election is due by June 2019. DBRS expects the government to continue to implement prudent economic policies. Sound public finances, together with a strong external position, helps Denmark to maintain its long-standing fixed exchange rate policy. The predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades.
RATING COMMITTEE SUMMARY
The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. The main points discussed during the Rating Committee include financial stability risks, banking sector, households’ balance sheets and vulnerabilities.
Fiscal Balance (% GDP): 1.1 (2017); 0.0 (2018F); -0.3 (2019F)
Gross Debt (% GDP): 35.6 (2017); 35.1 (2018F); 34.0 (2019F)
Nominal GDP (EUR billions): 289.0 (2017); 295.2 (2018F); 305.1 (2019F)
GDP per Capita (EUR): 50,109 (2017); 50,902 (2018F); 52,319 (2019F)
Real GDP growth (%): 2.3 (2017); 1.3 (2018F); 1.8 (2019F)
Consumer Price Inflation (%): 1.1 (2017); 1.4 (2018F); 1.7 (2019F)
Domestic Credit (% GDP): 221.5 (2017); 222.3 (Jun-2018)
Current Account (% GDP): 8.0 (2017); 6.1 (2018F); 6.2 (2019F)
International Investment Position (% GDP): 55.6 (2017); 63.8% (Jun-2018)
Gross External Debt (% GDP): 150.2 (2017); 145.1 (Jun-2018)
Governance Indicator (percentile rank): 99.0 (2016); 95.7 (2017)
Human Development Index: 0.93 (2016); 0.93 (2017)
All figures are in Danish Kroner (DKK) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. General Government Gross Debt is calculated on a Maastricht basis. Forecasts are based on Danmarks Nationalbank and the Ministry for Economic Affairs and the Interior. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.
The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.
The sources of information used for this rating include Danmarks Nationalbank, Ministry for Economic Affairs and the Interior, Ministry of Finance of the Kingdom of Denmark, Danmarks Statistik, European Central Bank, European Commission, Eurostat, OECD, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.
This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.
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Lead Analyst: Adriana Alvarado, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: 20 September 2012
Last Rating Date: 6 July 2018
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