DBRS Morningstar Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Sweden’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Kingdom of Sweden’s 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 DBRS Morningstar’s view that the risks to Sweden’s ratings are limited. Despite the substantial economic and fiscal costs created by the Coronavirus Disease (COVID-19) pandemic, Sweden continues to exhibit strong credit fundamentals and adequate capacity to respond to shocks. The pandemic disrupted activity substantially in 2020, although the contraction was more moderate than anticipated. The recovery could gather pace in the second half of this year provided that the continued deployment and effectiveness of vaccines leads to an important easing of restrictions. A strong fiscal track record and a low public debt ratio allowed the government to respond strongly to the pandemic shock without compromising its medium-term fiscal sustainability. Going forward, DBRS Morningstar expects Sweden to gradually converge towards its fiscal targets as the economy returns to its potential.

Sweden’s AAA ratings are underpinned by strong public finances, healthy external accounts, and a robust economic performance. DBRS Morningstar anticipates that the country’s sound fiscal framework will continue to support its fiscal performance. DBRS Morningstar expects Sweden’s high investment rates, employment rates, and labour force skills to continue to underpin its solid economic performance in the coming years. Nevertheless, as a small and open economy with a relatively large export sector, the country remains exposed to potential downturns in external demand. In addition, managing the risks stemming from the combination of high household leverage, banks’ large exposure to the property market, and housing prices remains a challenge for Sweden. The high level of household debt could amplify shocks, potentially triggering a deleveraging process and hampering domestic demand, with knock-on effects to the broader economy. Wealthy households and debt affordability mitigate these risks.

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 deterioration of the medium-term growth outlook or a substantial materialisation of contingent liabilities.

RATING RATIONALE

A Low Public Debt Ratio and Solid Fiscal Framework Underpin Sweden’s Creditworthiness

Sweden’s strong fiscal performance, underpinned by its fiscal framework, and low public debt levels have provided the country with ample fiscal room to respond to the coronavirus pandemic shock. The estimated fiscal impact from the measures to mitigate the economic and social impact, minimise long-term economic scarring, and strengthen the healthcare response to the pandemic is expected to amount to SEK 389 billion for 2020 and 2021 (7.9% of 2020 GDP). This includes the extension of support measures this year to compensate for the tightening of restrictions. With no immediate impact on net lending, the government has also supported business liquidity by offering state credit guarantees (SEK 300 billion or 6.1% of 2020 GDP) and temporary tax deferrals (SEK 689 billion or 13.9% of 2020 GDP) during 2020-2021.

The fiscal response and economic contraction induced by COVID-19 drove the fiscal balance to a deficit of 3.3% of GDP in 2020 from a surplus of 0.6% of GDP in 2019. Despite the substantial deterioration in public finances, the deficit was smaller than previously anticipated on the back of better-than-expected economic performance and lower-than-expected usage of available support. The government stimulus measures will continue to weigh on public finances especially in 2021 and 2022. DBRS Morningstar considers the stimulus measures warranted, given the cyclical downturn and the lingering uncertainties. Once the economy fully recovers and the extraordinary support is phased-out, DBRS Morningstar expects Sweden’s fiscal deficit to gradually converge towards its surplus target of 0.33% of GDP by 2023.

Even after the coronavirus pandemic shock, Sweden’s public debt ratio is expected to remain low and among the lowest in the European Union (EU-27). The public debt ratio, which jumped to 39.6% of GDP in 2020 from 35.1% in 2019, is projected to resume its downward trend by 2022. Furthermore, the government continues to benefit from very favourable financing costs. The materialisation of contingent liabilities, potentially stemming from Sweden’s large public sector, the 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 considers 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. The Sveriges Riksbank’s (the Riksbank) plans to repay the foreign-currency loans undertaken by the Swedish National Debt Office (SNDO) on its behalf as they mature as part of the central bank’s transition to a self-financed foreign-exchange strategy. While the risk profile of the debt is not affected by this operation, the termination of the on-lending activities could result in slightly lower Maastricht public debt ratio path for Sweden than previously anticipated. Also, the SNDO plans to redistribute part of the borrowing from kronor to foreign currency to maintain a presence in the international capital markets.

The Swedish Economy Fared Better in 2020 and is Posed for a Solid Recovery

The pandemic has taken a substantial toll on activity in Sweden, although the GDP contraction of 2.8% was milder than previously anticipated and in the EU-27 (-6.2%). Sweden’s economic structure, a sizeable and timely policy response, and softer restrictions at the onset of the crisis helped to soften the pandemic-related blow. Sweden’s relatively small hospitality sector, high level of digital skills, and high share of jobs that can be done remotely most likely left the country better prepared to absorb the pandemic shock. The impact has been uneven as the more exposed hospitality sector is still very subdued while the manufacturing sector hovers around precrisis levels. DBRS Morningstar expects the stricter restrictions in response to the worsening coronavirus pandemic situation to likely lead to a contraction in output in Q1 2021, although a less severe one than that experienced in Q2 2020, given the already-subdued activity levels in the most affected sectors and better preparedness.

While the healthcare situation remains the key source of uncertainty in the near term, the recovery is excepted to gain traction in the second half of the year provided the vaccination rollout allows Sweden to ease restrictions. The fiscal support and expansionary financial conditions, coupled with households’ strong purchasing power, will allow for a relatively strong recovery throughout 2021-2023. The Ministry of Finance expects GDP to rebound by 3.0% in 2021, 3.7% in 2022, and 2.2% in 2023. The labour market has stabilised after last year’s deterioration and unemployment is expected to decline to 7.1% in 2023 from 8.5% in 2020. While Sweden has one of the highest employment rates in Europe (82.1% in 2019), reducing the higher unemployment rates for low-skilled and foreign-born workers remains a challenge. Indeed, the pandemic has deepened these disparities in the labour market. DBRS Morningstar therefore welcomes the government’s measures to increase the employability of these groups in its 2021 Budget.

Risks to Financial Stability are Manageable, But Key Systemic Vulnerabilities Remain

The main risks to financial and macroeconomic stability remain linked to the high level of household indebtedness and banks’ exposure to the housing and commercial property markets. Since mid-1990, household debt and housing prices have been increasing steadily driven by favourable financial conditions, debt-friendly taxation, and rental regulations contributing to supply and demand imbalances building up over time. After pressure in the housing market eased in recent years with tighter macro-prudential regulations and higher supply, the pandemic has again reinforced rising housing prices and household debt. The country’s household debt-to-income ratio stood close to 200% in Q3 2020 and housing prices were up 12.6% year over year in February 2021 (according to the HOX index).

Swedish households’ high level of indebtedness could amplify the potential impact from lower income or higher interest rates, risking a material reduction in private consumption and potential second-round effects on the overall economy. DBRS Morningstar expects the underlying housing market pressures to continue as the structural problems in the functioning of the housing market and the tax incentives for debt financing remain broadly present. On the other hand, interest rates are expected to remain very low in coming years, enhancing debt affordability, and households have high savings rates and large financial assets.

The large size of the Swedish banking system relative to the economy, its interconnectedness (e.g., banks own each other’s debt), high exposure to the housing markets, and heavy reliance on wholesale funding (an important share of which is in foreign currency) could amplify confidence shocks through the banking system and the economy. However, policy support remains a key mitigating factor.

The Riksbank’s sizeable and timely monetary policy response has kept financial conditions favourable during the worst period of the coronavirus pandemic and DBRS Morningstar expects the central bank to continue to support the economy and inflation as long as necessary. The Riksbank continues to purchase assets within its stepped-up SEK 700 billion envelope to offer ample liquidity and has kept its repo rate at 0.0%. At the same time, the Swedish authorities have reduced the countercyclical capital buffer for banks to 0.0% from 2.5% and temporarily eased liquidity and mortgage amortisation requirements, among other measures.

The extensive support measures and Swedish banks’ strong starting point have helped them weather the pandemic-related shock. The major Swedish banks’ average CET1 capital ratio stood at 18.6% in Q3 2020, comfortably exceeding the capital requirement. Credit losses have been limited thus far. Major Swedish banks’ exposure to the hardest-hit sectors (i.e., hotels and restaurants, culture and leisure, and transport) was relatively small at 6% of corporate lending as of June 2020. On the other hand, the banks’ large exposure to the commercial real estate sector at 40% of total corporate lending remains a source of vulnerability. Fiscal support, including rent support in hard-hit sectors, has eased the impact on the CRE sector. A stress test conducted by the Swedish Financial Supervisory Authority suggests that major Swedish banks are resilient enough to continue providing credit even if a deeper downturn generates substantial losses.

Sweden’s External Position Remains Strong With a Competitive Export Sector

As a small and open economy that is well integrated in global value chains with significant external trade, Sweden’s exports suffered greatly from the pandemic-related disruptions during spring 2020. The relatively strong comeback of global industrial production, in spite of the lingering restrictions, and good prospects for key trading partners including Germany, the U.S., and the Nordics bode well for Swedish exports. DBRS Morningstar expects consumer-related service exports to continue lagging in the medium term compared with the goods and business-related exports because of the pandemic’s effects. Overall, DBRS Morningstar assesses Sweden’s external position as strong and backed by a long period of large current account surpluses, albeit declining over time. Driven by a high savings rate and Swedish firms’ competitiveness, the current account has averaged 5.2% of GDP over the last two decades, resulting in a net international investment position of 14.8% of GDP at the end of 2020. Finally, Sweden’s liquid currency and international reserves amounting to 10.3% of GDP in 2019 enhance its ability to weather significant shifts in investor confidence.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

Sweden’s political system is characterised by strong democratic institutions and predictable consensus-oriented policies. The minority coalition government, comprising the Social Democratic Party and the Green Party, has relied thus far on parliamentary support from the Centre Party and the Liberals to pass legislation. The government is using the flexibility built into the fiscal framework to respond to the pandemic-related shock and to stabilise the economy. In line with Sweden’s prudent fiscal track record, DBRS Morningstar expects the government to remain committed to achieving the fiscal surplus target once the effects of the pandemic wane. Deeper and politically contentious labour market and rental regulation reforms or a comprehensive tax reform remain unlikely in the near term.

ESG CONSIDERATIONS
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 https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/375971.

Notes:
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

All figures are in Swedish kronor (SEK) 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/364527 (July 27, 2020). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/373262 (February 3, 2021).

The sources of information used for this rating include the Ministry of Finance (Key Indicators Forecast 16 December 2020), Swedish National Debt Office (Central Government Borrowing Forecast and Analysis 2021-1, February 2021), Sveriges Riksbank (Monetary Policy Report, February 2021), Swedish Financial Supervisory Authority (Stability in the Financial System, November 2020), Statistiska Centralbyran (SCB), European Commission, Eurostat, Swedish Environmental Protection Agency (Sweden’s Climate Act and Climate Policy Framework) The Social Progress Imperative (2020 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), United Nations Development Programme (UNDP), and Haver Analytics. DBRS Morningstar 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.

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 rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and 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: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/375970.

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

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: April 17, 2012
Last Rating Date: October 2, 2020

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