DBRS Morningstar Confirms Swiss Confederation at AAA, Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the Swiss Confederation’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the 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 Switzerland’s credit fundamentals remain solid, despite the economic shock from the Coronavirus Disease (COVID-19). Switzerland’s contraction at -2.6% in 2020 was less than initially expected and far smaller than the EU average at -6.0%. Switzerland’s performance reflected the country’s strong public finances, which allowed for swift and sizeable support measures to the economy, its low dependence on contact-intensive industries, its competitive export sector and its well-capitalized financial institutions. While the pandemic-related stimulus resulted in a deterioration in the deficit, Swiss public finances have been disciplined and anchored by the debt brake rule. The increase in deficit to -2.6% in 2020 from a surplus of 1.4% in 2019 remained nevertheless under control and is likely to be cyclical and short lived. Moreover, Switzerland continues to have one of the lowest debt ratios among sovereigns in the AAA category (42.9% of GDP in 2020). Coupled with exceptionally low funding costs, this provides the government ample fiscal headroom to mitigate long-lasting effects from the pandemic without compromising fiscal sustainability.

Switzerland’s AAA 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. These credit strengths counterbalance the challenges associated with the uncertainty related to COVID-19, the moderately increasing risks to financial stability arising from the search for yield, and increasing borrowing by domestic investors in the real estate market. Additionally, the decision not to sign the institutional framework agreement with the EU could, over the long-term, gradually lead to increased barriers to trade, between Switzerland and the EU.

RATING DRIVERS

DBRS Morningstar considers the likelihood of a downgrade of Switzerland’s ratings to be low. Nonetheless, the ratings could be downgraded if severe external shocks or a sustained deterioration in growth prospects materially affect Switzerland’s financial stability and fiscal position.

RATING RATIONALE

Swiss Economy Likely to Rebound Sharply Amid Strong Fundamentals

The pandemic and the measures implemented to contain it resulted in the Swiss economy contracting 2.6% YoY in 2020, far lower than the EU-27 average of -6.0%. This was largely due to targeted restrictions, Switzerland’s strong public finances which led to the swift implementation of a stimulus package, the low dependence on contact intensive industries, competitive export sector and well capitalized financial institutions. While the recovery starting in Q3 2020 was interrupted by the second wave of the virus in January 2021, the impact of the second wave was much less than that of the first wave of the pandemic. The progress on vaccinations and easing of containment measures will likely aid GDP growth from Q2 2021 onwards. Both the Swiss National Bank and IMF expect growth of 3.5% in 2021, which would imply that Switzerland would return to pre-crisis real output as early as Q3 2021.

While the pace of the recovery will depend on the vaccine rollout and mutations of the virus, Switzerland’s ratings are underpinned by its wealthy and diversified economy and its medium-term economic outlook remains strong. The Swiss economy ranks highly in international comparisons; GDP per capita currently stands at USD 82,341 and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland’s highly productive workforce, which is characterized by high levels of educational attainment and nearly 80% labor force participation. Switzerland continues to outperform Euro Area growth due to sustained consumption and investment growth. However, the Swiss economy faces several risks in the medium to long term. As a safe haven currency, the Swiss franc remains vulnerable to appreciation pressures arising from risk aversion while the search for yield could increase financial stability risks. Additionally, the decision not to sign the institutional framework agreement with the EU could increase trade barriers with its EU partners and may eventually have an effect on the attractiveness of Switzerland as a business destination.

Relations with the EU Hit a Roadblock But Strong Swiss Institutions and Stable Politics Could Minimize the Impact

Following seven years of negotiations to streamline market access agreements with the EU, the Swiss Federal Council called off talks due to substantial disagreements on citizen’s rights directives, wage protection and state aid rules on May 26, 2021. Switzerland is not part of the EU and its unique relationship is based on around 20 main agreements (amongst them 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. The EU has long been wanting to streamline the relationship similar to other non-EU members such as Norway, which is part of the European Economic Area. Discussions which started in 2014, resulted in a draft institutional framework agreement in 2018 between the Swiss and EU. However, the agreement was not signed and negotiations were eventually unilaterally called off by Swiss authorities in May 2021, given the substantial disagreement among stakeholders which included cantonal governments, trade unions, and the business community. The EU has stated that failure to come to an agreement on the proposed institutional framework will result in the lapsing of existing bilateral agreements and in certain areas end the possibility of new treaties being signed between Switzerland and the EU. For more details please see Swiss-EU Relations At An Impasse.

While the failure of talks could bring up new challenges for the Swiss-EU relationship, DBRS Morningstar expects the Swiss to continue to operate harmoniously with their EU counterparts in the foreseeable future. The Swiss political system is characterized by federalism, a high level of civic participation in local matters, and a high degree of social cohesion. Stable politics combined with neutrality in international conflicts have long made Switzerland a safe haven for investors.

Public Finances Remain Strong Despite the Ongoing Pandemic Related Stimulus

Switzerland’s sound fiscal position and solid fiscal framework provided the country ample fiscal space to respond to the coronavirus pandemic shock without affecting its AAA ratings. The first fiscal package for the year 2020 represented CHF 74 billion or 10.4% of GDP in 2020, of which CHF 41 billion was accounted for by state guarantees and loans (not fully used) includes extension of short-time work allowances, extended payment periods for taxes, temporary, interest-free deferral of social-security contribution payments for affected companies and a guarantee program up to CHF 20 billion to support bridging loans to SMEs. A second package for the year 2021 estimated at CHF 24 billion 3.3% of GDP, includes again extension of short-time work allowances and a support program for companies particularly affected (cases of hardship)..

The COVID-19 policy measures have resulted in a deterioration in Switzerland’s fiscal performance. Following five years of fiscal surpluses averaging approximately 1% of GDP, Switzerland’s fiscal deficit rose to -2.6% of GDP in 2020. The ongoing support measures are likely to result in a deficit of -3.8% in 2021 before narrowing to -0.0% of 2022. To finance the packages, the Federal Council has passed various supplementary credits for the 2020 and 2021 budgets. However, as Swiss public finances have been disciplined and anchored by the debt brake rule, the pandemic-related increase in deficits is likely to remain cyclical and short lived.

While the deficit is likely to be partly financed by the government’s liquidity reserves, the contraction in growth will result in the general government gross debt ratio rising from 40.6% in 2019 to 43.1% of GDP in 2020. The Maastricht debt ratio, which excludes pensions and healthcare, rose from 25.9% in 2019 to 28.1% of GDP in 2020. Despite this increase, Switzerland’s public debt levels are low which combined with substantial financial flexibility, helps the country to stand out among other highly-rated sovereigns. The government’s debt maturity structure remains favorable, with average maturity of marketable debt (bonds and T-bills) at 10.2 years and all debt has been issued in Swiss francs. Currently, all marketable debt of the Swiss government has a negative yield to maturity (YTM).

The Swiss National Bank (SNB) Maintains Its Accommodative Stance

The Swiss National Bank continues to maintain its highly accommodative stance with a view to ensuring price stability and providing ongoing support to the Swiss economy. Policy rate and interest on sight deposits at the SNB are at -0.75% and given that the SNB views the Swiss Franc as highly valued, it is continuing with its policy of unsterilized FX intervention as necessary. SNB’s proactive measures, such as easing financial conditions for Swiss businesses, providing a COVID-19 refinancing facility (CRF) for banks, and federal guarantees, have so far averted a rise in credit risks and have resulted in an upward adjustment in the “Monetary Policy and Financial Stability” Building Block.

Similar to most countries worldwide, headline inflation prints in 2021 have been edging higher due to higher oil prices, supply side bottlenecks, and high service price inflation particularly in the tourism sector. Following average inflation of -0.7% in 2020, the latest inflation print (June) came in at 0.6% YoY. The SNB’s new conditional inflation forecast for the 2021-23 period is slightly higher than in March and stands at 0.4% for 2021, and 0.6% for both 2022 and 2023. The long-term inflation expectations are well anchored at around 1%, and have remained stable despite the pandemic.

Foreign exchange reserves reached a high of USD 1.084 trillion in December 2020 following USD 125 billion intervention in 2020. Exchange rate movements in 2021 resulted in reserves currently marginally lower at USD 1.074 trillion. Earlier this year, the Biden Administration removed the ‘currency manipulator label’ imposed on Switzerland in December 2020. The SNB maintains its narrative that policy of forex intervention is only to limit the appreciation of the currency and to combat deflationary risks, rather than to attempt to gain competitive advantage in trade.

Banks are Well Positioned to Meet Financial Stability Risks

Switzerland’s historical position as a financial center is an important source of growth and prosperity for the country but can also leave Switzerland exposed to external shocks. The size of the banking sector is nearly 500% of GDP. While the pandemic’s impact on the economy has been less severe than expected with none of the stress scenarios materializing, risks to financial stability remain. The SNB in its latest financial stability report stated that uncertainty around the outlook could impact asset quality and high levels of public and private debt are now more vulnerable to income and interest rate shocks. For Switzerland, strong growth in both bank credit and real estate prices have resulted in the build-up of imbalances on the mortgage and residential real estate markets. With mortgage growth outpacing income growth, Switzerland’s mortgage-to-GDP ratio has been gradually rising from 135% of GDP in Q1 2015 to 156% of GDP in Q1 2021.

However, contrary to initial fears, the pandemic has so far not adversely impacted either the global systemically important banks (G-SIBs) or the smaller domestic Swiss banks. The profitability of the G-SIBs – Credit Suisse and UBS – in 2020 exceeded the average of recent years. Similar to banks worldwide, they benefited from the public support measures and the swift recovery of the financial markets. Furthermore, the diversified income structure of both CS and UBS resulted in an improvement of their capital position relative to last year. However, recent events at Credit Suisse have raise concerns about the Group’s risk management and risk appetite and which could add pressure on the Group’s earnings, franchise and capital in the medium to long-term.

Similar to the G-SIB’s, the profitability of the domestically focused banks also increased as credit losses remained low. Thanks to the public support measures, the pandemic had little impact on mortgage and real estate market and the narrowing of interest margins slowed. Consequently, even the domestic banks were able to further build up their capital base in 2020.

Switzerland’s External Accounts Remain a Key Credit Strength; Reserves Exceed USD 1 Trillion

Swiss external accounts are characterized by a structural current account surplus and a positive net creditor position. The persistent current account surpluses averaging 10% of GDP over the last two decades reflect Switzerland’s role as a financial center and the high domestic savings rate. Over the last decade, the SNB reserves have risen from USD 340 billion in 2011 to USD 1 trillion currently. The SNB is responsible for managing the currency reserves that are currently allocated in an 80:20 ratio between bonds and equities. Due to its foreign exchange intervention, the SNB’s balance sheet stands at 146% of GDP as of March 2021. This compares with the US Federal Reserve at 33% of GDP, the European Central Bank is at 57%, and the Bank of Japan at 131% of GDP. However, unlike the G3 central banks, the increase in SNB assets was primarily due to purchases of foreign rather than domestic assets. Accumulation of net savings and official foreign exchange reserves have resulted in a positive net creditor position of 107% of GDP as of March 2021.

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/382059.

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 CHF 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/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). Other applicable methodologies include 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).

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

The primary sources of information used for this rating include the Federal Council, Federal Department of Finance, Swiss National Bank, Swiss Federal Statistical Office, State Secretariat for Economic Affairs, OECD, IMF, European Commission, UNDP, World Bank, World Economic Forum, Social Progress Index, Reporters Without Borders and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on January 22, 2021.

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

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.

Lead Analyst: Rohini Malkani, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Global Sovereign Ratings
Initial Rating Date: July 14, 2011

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

DBRS, Inc.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 312 696-6293