DBRS Morningstar Confirms the Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Denmark’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Kingdom of Denmark’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 Denmark’s strong economic fundamentals and public finances limit the risks to the rating stemming from the Coronavirus Disease (COVID-19). The Danish economy’s sound foundations and fiscal stimulus bode well for a strong recovery as restrictions are eased after the winter lockdown. Private consumption and exports are poised to make a strong comeback while the emergence of a vaccine-resistant COVID-19 variant remains the main risk to the outlook. Denmark’s strong public finances, with one of the lowest public debt ratios in the European Union (EU) and very low funding costs, provided authorities ample room to support the economy and mitigate long-lasting effects from the pandemic without materially affecting public debt sustainability. In line with its strong commitment and track-record of fiscal prudence, DBRS Morningstar expects the public debt ratio to return to its previous downward trend, albeit from a higher level.

The ratings are supported by Denmark’s strong external position, its sound public finances, its credible policy framework, as well as its wealthy and diversified economy. The predictable macroeconomic policy framework has underpinned the country’s economic stability for decades. Denmark’s strengths offset the credit challenges associated with an interconnected financial system, high levels of household debt, and risks building up in the property market.

RATING DRIVERS
Given Denmark’s credit strengths, downgrading the ratings appears unlikely. The ratings could be downgraded if one or a combination of the following occur: (1) a severe shock to the economy that materially impairs Denmark’s medium-term prospects; or (2) a substantial deterioration of the public debt ratio, which could potentially be triggered by a materialisation of contingent liabilities associated with its large and interconnected financial system.

RATING RATIONALE

The Danish Economy Should Rebound Strongly Barring Pandemic Surprises

The Danish economy has thus far proven more resilient to the COVID-19 shock than previously anticipated and more so than most other European Union peers. GDP contracted by 2.7% in 2020 as the measures to contain the spread of the pandemic, both domestically and abroad, weighed heavily on private consumption and net exports. Investment held up well primarily due to the strong construction activity underpinned by the public sector and growing house prices. In addition to the government’s sizable income and liquidity support to both households and firms, the Danish economy’s lower reliance on the contact-intensive service sector activities and high preparedness for remote working contributed to its outperformance. The extraordinary support measures, coupled with the automatic stabilisers, mitigated the impact on the labour market, with employment contracting 0.7% and the unemployment rate nudging higher to 5.6% in 2020 from 5.0% in 2019, in the face of the pandemic shock.

The lockdown over the winter to deal with a second wave of infections has slowed down the recovery and led to a contraction of GDP of 1.3% q-o-q in the first quarter of 2021. Nevertheless, Denmark’s solid economic foundations combined with the extensive fiscal support should allow for a strong recovery in activity as the restrictions are relaxed over time, subject to a sustained improvement in the health situation. In this sense, Denmark’s wealthy, diversified, and flexible economy will continue to underpin its strong performance. The re-opening of the economy and higher consumer confidence could release at least part of the pent-up demand, especially given households’ higher than usual savings and the extraordinary payout from the release frozen holiday pay. While the momentum in residential investment should gradually ease, the pick-up in exports and the implementation of its recovery plan should support investments in coming years. Given its openness and small size, Denmark’s important export sector, including a large shipping sector, remains tied to the prospects of its key trading partners and the evolution in global trade more broadly, which currently are expected to rebound strongly.

The government projects GDP to grow by 2.4% in 2021 and 3.6% in 2022, surpassing its pre-pandemic GDP this year. The risks remain linked to the evolution of the pandemic and the effectiveness of the vaccines against potential new variants. Aside from the pandemic-related risks, other sources of risk stem from Danish households’ high levels of debt and increasing property market pressures, which could amplify potential shocks to the economy. Similarly, the emergence of labour market shortages could hold back the growth impetus and erode competitiveness of the Danish economy.

Denmark Continues to Benefit from its Solid Public Finances and Fiscal Institutions

Denmark’s sound public finances provided the government with valuable fiscal headroom to mitigate the severe impact from the pandemic without compromising fiscal sustainability. The fiscal surplus averaged 1.6% of GDP annually between 2016 and 2019 on the back of a prudent fiscal management and a favourable macroeconomic backdrop. Denmark’s fiscal track-record is buttressed by a robust and credible fiscal framework enshrined in its Budget Law, limiting annual structural deficits to 0.5% of GDP and requiring multiannual expenditure ceilings. The fiscal targets are set in structural terms due to the volatility of some of Denmark’s revenue sources, especially regarding the pension-yield taxes and oil and gas extraction in the North Sea. The overall framework allows for deviation from the rules under extraordinary situations, such as the COVID-19 crisis.

In response to the pandemic, Danish authorities announced discretionary fiscal support amounting to 5.1% of 2020 GDP, including direct support to firms to partially cover fixed costs and wage expenditures, along with specific support to sectors particularly affected by the restrictions, according to the International Monetary Fund (IMF)’s latest estimates. In addition, the government has provided substantial liquidity support to business in the form of tax deferrals and state loan guarantees.

In spite of the substantial fiscal support and weaker activity, Denmark’s fiscal deficit stood at 1.1% of GDP in 2020, well below previous expectations due to higher-than-expected pension yield tax revenues (2.2% of GDP), extraordinary tax revenue from the first payment of frozen holiday pay (0.9% of GDP), and lower-than-expected take-up of the COVID-19 support measures. Denmark’s Convergence Programme 2021 (CP 2021) anticipates the fiscal deficit to widen this year to 3.3% of GDP as the pandemic-related support continues, including a one-off payment related to the closing of mink farms, only partially compensated by the additional tax revenues linked to the disbursement of the remaining frozen holiday pay. The government projects a gradual fiscal repair towards a balanced budget position by 2025 as the economy recovers and extraordinary measures are phased out. On a structural basis, the government foresees a deficit of 0.5% of GDP in 2021, gradually shrinking towards balance by 2025. Over the longer term, demographic developments and declining revenues from oil and gas production will put pressure on public finances. Denmark’s previous retirement reforms, which increased the statutory retirement age and linked it with life expectancy over time and reduced voluntary early retirement, partially offsets these risks.

Despite The Shock, The Public Debt Ratio Remained Moderate and Financing Conditions Favourable

The public debt ratio has deteriorated due to the pandemic but remains one of the lowest in Europe. The public debt ratio (EMU debt definition) has increased to 42.2% of GDP in 2020 from 33.3% of GDP in 2019. According to the CP 2021, the stock-flow adjustment, stemming from the temporary tax deferrals and new lending related to the new holiday scheme, has been the major driver of the increase. The government projects the public debt ratio to enter a gradual downward trend in 2021 to around 40% of GDP by 2025 on the back of stronger economy, regularisation of tax deferrals, and fiscal rebalancing. From a balance sheet perspective, as measured by assets minus liabilities, Denmark’s public net worth actually increased during the pandemic to 11% of GDP in 2020 from 6% of GDP in 2019, primarily reflecting a revaluation of the central government’s stake in the energy company, Ørsted A/S. Public net worth is expected to remain positive albeit decreasing until 2025. The financing model for social housing is expected to increase the public debt ratio in coming years, although it will be neutral for net debt.

In the current context, the main risks stem from the pandemic and its economic impact. Nevertheless, Denmark’s low level of public debt and favourable debt profile support its resilience to shocks. Debt is mostly denominated in local currency, and about half of government bonds are held by the Danish insurance and pension sectors. Danish government bond yields remain very low, reflecting low policy interest rates and investor confidence in the Danish economic policy framework.

Financial Stability Risks Still Contained And Supported By the Policy Response

Given Denmark’s fixed exchange rate policy, monetary policy is geared to keeping the Danish krone stable against the euro. Faced with the pandemic, Danmarks Nationalbank (DN), Denmark’s central bank, acted rapidly to stabilise the peg and prevent credit flow disruptions. The DN put in place several liquidity facilities, both in local and foreign currency, while the Danish authorities eased both the countercyclical capital buffers and liquidity requirements to pre-empt any unnecessary tightening of lending conditions. In March, the DN revamped its monetary policy instruments, resulting in a narrower interest rate corridor aiming to reduce the fluctuations in the money market, and at the same time hiked its deposit rate to 0.5%, leaving it at par with the ECB’s policy rate. The DN policy rate is expected to continue to broadly follow the ECB’s refinancing rate, while the central bank has intervened in the foreign exchange to ease appreciation pressures in the krone against the euro since February.

The Danish banking system weathered the pandemic crisis from a position of strength given its high capitalisation and liquidity levels, managing to remain profitable against a challenging operating environment. In addition to the monetary and regulatory easing effect, the massive direct support and deferred taxation from the government has provided significant room for households and corporations to absorb the shock, mitigating indirectly the risks of the banking system. The withdrawal of the extraordinary support, especially for the corporations most affected by the pandemic, is expected to hinder profitability by higher loan losses, compounding long-standing pressures from the ultra-low interest rate environment. Nevertheless, the banking system could withstand a severe but temporary economic slump and absorb substantial losses. The litigation and reputational risks surrounding the investigations into possible money laundering by Danske Bank A/S at its Estonian branch between 2007 and 2015 also remain in the background.

The high and increasing level of household indebtedness, at 242.6% of seasonally adjusted disposable income at end-2020, remains an important source of vulnerability, rendering household consumption susceptible to adverse shocks. The low interest environment, households’ income resilience, and shifting housing demand patterns due to the pandemic have spurred sales and home prices after the first lockdown. As of March, single-family house prices grew 16.4% y-o-y and owner-occupied flats 12.8% y-o-y. The DN is calling for tighter macroprudential measures to enhance the resiliency of borrowers and prevent the further build-up of financial risks. Offsetting these risks, households have been deleveraging significantly in recent years and the high debt ratios tend to be concentrated in high-income households. Households’ net financial assets are sizeable, albeit a large portion remain illiquid housing and pension savings. Stricter borrower-based measures to limit risky borrowers have resulted in an increasing share of mortgages with longer fixed interest rate periods and amortising loans in recent years.

Denmark’s financial system is large, with assets over 630% of GDP, partly reflecting the strong links between financial institutions, households, and firms, according to the IMF. The housing market and mortgage covered bond market —the largest in the world as a percentage of GDP— play a crucial role in Denmark connecting the balance sheets of mortgage banks, pension funds, insurers, foreign investors, and households. Similar to other Nordic countries, the Danish banking system has strong linkages and exposures concentrated within the Nordic-Baltic regions. A negative qualitative adjustment in the “Monetary Policy and Financial Stability” building block has been made to reflect the risks stemming from Denmark’s large and interconnected financial system and its highly indebted households.

Denmark’s Strong External Sector Is Poised to Gain From Global Rebound

Denmark exhibits a strong external position both from a flow and a stock perspective. The current account surplus averaged 7.6% of GDP over the last ten years and the net international investment asset position (NIIP) amounted to 61.5% of GDP in 2020. Amid the pandemic crisis, Denmark’s current account surplus dropped but remain sizable at 7.8% of GDP in 2020, mostly due to a smaller services trade surplus in sectors such as construction and IT services. Denmark’s small travel deficit improved slightly. Despite the disruptions caused by the pandemic, the current account surplus continued to be underpinned by the pharmaceutical and food net exports on the goods side and freight transport on the service side. The returns from Denmark’s sizable net asset position generate a solid primary income surplus. Going forward, the improving external backdrop, especially for key markets such as the Northern Europe, the United States, and China, and Denmark’s comparative strength in pharmaceutical and wind-energy infrastructure bodes well for Danish exports. The recovery in services exports, especially shipping and tourism, is expected to lag that of goods exports.

While Denmark’s peg to the euro reduces its capacity for external adjustment via exchange rate movements, the country has successfully relied on sound economic and fiscal policies to stabilise the economy and to prevent large external imbalances from building up. A strong external position, ample international reserves, sound public finances, and a strong political commitment underpin the high credibility of Denmark’s long-standing fixed exchange rate policy. This supports DBRS Morningstar’s positive qualitative assessment of the “Balance of Payments” building block.

Strong and Stable Political Framework Supports Economic Stability

Denmark’s political environment and institutions are very strong as reflected in the World Bank governance indicators. The introduction of key reforms tends to rely on broad support across the political spectrum, ensuring their durability. This predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades. The centre-left Social Democratic Party minority government relies principally on the support of three left-wing parties in parliament to pass legislation. The Danish recovery plan aims to accelerate the green transition, channelling 60% of the funds towards green initiatives, significantly above the EU’s criteria of at least 37%.

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/379696.

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 Danish kroner (DKK) 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/global-methodology-for-rating-sovereign-governments (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/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include Ministry of Finance (Denmark’s Convergence Programme 2021; Denmark’s Recovery and Resilience Plan; Economic State May 2021), Danmarks Nationalbank (Financial Stability 1st Half 2021), Danmarks Statistik, European Central Bank, European Commission (European Economic Forecast Spring 2021; 2020 European Semester: Country Report; Assessment of the Final National Energy and Climate Plan of Denmark), The Social Progress Imperative (2020 Social Progress Index), Eurostat, OECD, IMF (Policy tracker: Policy Response to COVID-19), World Bank, BIS, UNDP, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this 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

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/379695.

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: September 20, 2012
Last Rating Date: December 4, 2020

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