DBRS Morningstar Confirms Swiss Confederation at AAA, Stable Trend

DBRS Ratings Limited (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 the risks to Switzerland’s ratings remain limited. Switzerland’s solid public finances and strong economic recovery after the pandemic help mitigate the risks posed by the weaker external environment, higher inflation and interest rates. In 2021, benefitting from the pick-up in global economic activity and the proactive policies of the government, the Swiss economy rebounded strongly posting 3.9% GDP growth, following a 2.5% pandemic induced recession in 2020. Real GDP growth is expected to come in at 2.0% in 2022. The repercussions of the continuing conflict in Ukraine are expected to deteriorate the economic outlook in the near term, with the forecasts pointing to growth of around 1.0% in 2023. Switzerland continues to have one of the lowest debt ratios among sovereigns in the AAA category estimated at 40.3% of GDP in 2022. In the face of increasing energy prices, resulting in inflation exceeding the Swiss National Bank’s 2% threshold since February 2022, the Swiss National Bank raised its policy interest rate by 50 bps to 1.0% in December 2022. Inflation in Switzerland reached its peak in August 2022 at 3.5% and gradually dropped to 2.8% in December, remaining considerably lower than in other advanced economies.

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. Switzerland benefits from a highly productive workforce, high levels of educational attainment and labor force participation. These credit strengths counterbalance the challenges associated with Switzerland’s high mortgage debt. Additionally, the decision not to sign the institutional framework agreement with the EU could gradually lead to increased barriers to trade between Switzerland and the EU. That said, Switzerland is expected and has already begun to enact appropriate policies in response to these challenges, and is firmly placed in the AAA category.

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

Growth Will Decelerate, But Fundamentals Remain Strong

Switzerland’s ratings are underpinned by its wealthy and diversified economy, and solid economic performance. GDP per capita currently stands at USD 92,435, one of the highest in the world 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 high labor force participation (82.8% as of Q2 2022) and internationally competitive industries and companies. The Swiss economy rebounded strongly in 2021 posting 3.9% growth, following a 2.5% pandemic induced recession in 2020, benefitting from strong policy support and the pick-up of global economic activity. On the back of robust domestic demand, the economy continued its growth momentum in the first half of 2022, posting 3.1% growth. In 2022 the economy is estimated to have grown by 2.0%.

However, the repercussions of Russia’s invasion of Ukraine have increased the economic headwinds, despite the limited direct links with the two countries. Signs of economic slowdown have started to emerge with the real GDP growth coming in at 0.2% in the third quarter versus the second quarter of 2022 and 0.8% year on year. The unfavorable external environment, higher energy prices, and tightening monetary policies are clouding the economic outlook for Switzerland. Switzerland’s direct exposure to Russia and Ukraine is small with limited exposure to energy, trade, and the financial sector. Nevertheless, high inflationary pressures in Switzerland’s main trading partners is curbing demand with adverse effects on export sectors of the Swiss economy.

Against this backdrop, the Swiss Federal Government’s expert group on economic forecasts (SECO) downgraded its growth forecasts to 1.0% in 2023 (from 1.9% in its June 2022 forecast), and to 1.6% in 2024 (GDP is adjusted for sporting events). Inflationary pressures have been milder in Switzerland relative to the other advanced economies. Average HICP in Switzerland is estimated at 2.7% in 2022, significantly below the euro area average of 8.4%. Price growth is relatively contained in Switzerland compared to other advanced economies primarily due to the strengthening of the Swiss franc and the relatively lower reliance on fossil fuels for electricity generation as more than ninety percent of Switzerland’s electricity generation comes from nuclear, hydro, and renewables.

The Swiss National Bank (SNB) Raises Rates and Reports Record Losses

In light of increased inflationary pressures in its latest policy meeting on 15 December 2022, the Swiss National Bank (SNB) decided to further tighten its monetary policy by raising policy rates to 1.0%. SNB’s monetary policy is focused on price stability, defined as a rise in the price index of less than 2% per year. Inflation in Switzerland exceeded its 2.0% levels since February 2022, and after reaching its peak in August 2022 at 3.5%, dropped to 2.8% in December, remaining considerably lower than in other advanced economies. The stronger Swiss franc, the lower dependance on fossil fuels, and the lower of energy consumption inn households consumption budget have contributed considerably to lower price levels in Switzerland. SNB expects inflation to remain above its target but its forecast was revised slightly downwards for 2022 from 3.0% to 2.9%, while the 2023 forecast remained unchanged at 2.4%, and 1.8% in 2024.

For 2022 the Swiss National Bank will report record high losses of CHF 132 billion according to the provisional figures that were released on 9 January 2023. After posting a profit on foreign currency positions of around CHF 27 billion in 2021, the SNB announced losses on the foreign currency positions amounted to around CHF 131 billion. The unprecedented losses reflect losses in its share and bond portfolio. SNB’s balance sheet amounted to around CHF 885 billion in November 2022 from CHF 1.06 trillion in 2021. Consequently, the bank will not be able to distribute any profits to the Swiss Federal government this year. The final figures will be announced in March 2023.

Financial Stability Risks Rise But Swiss Banking System is Strong
Switzerland’s highly open economy and historical status as a financial center are important sources of growth and prosperity for the country but can also leave Switzerland exposed to external shocks as the size of the banking sector is nearly 520% of GDP and accounts for around 5.0% of value added. The Swiss banking system is comprised of three categories: (i) two global systemically important banks – Credit Suisse (CSG) and UBS – , (ii) the domestically focuses banks (DFBs), and other banks mainly comprising of domestic banks and branches and subsidiaries of foreign banks. Both globally systemic banks have sound capital levels and funding and liquidity positions. Despite the more challenging operating environment, UBS has recorded good profitability in the first half of 2022, while Credit Suisse’s profitability was affected negatively by write-downs and major litigation costs in its Investment Bank business. In October 2022, CSG presented a strategy update for the next three years aiming amongst other things to reduce the risks in its investment banking business, cut costs and reinforce its Wealth Management business. DBRS Morningstar considers that CSG’s updated plan entails meaningful executing risks. For more details please see “DBRS Morningstar Downgrades Credit Suisse AG’s LT Issuer Rating to “A (low)”; Trend Remains Negative.”

The Swiss banking sector remains liquid, profitable and well capitalized, with the weighted average Common Equity Tier 1 (CET1) capital ratio amounting to 18.7% in Q3 2022. In addition, the asset quality of the banking sector remains strong, with the non-performing loans (NPLs) ratio at 0.63% in Q3 2022. Nevertheless, the less favorable macroeconomic environment due to the implications of the war in Ukraine and the tightening monetary conditions pose risks to the financial stability. Switzerland’s mortgage-to-GDP ratio stood high at 150% in 2021 increasing from 135% of GDP in 2015. House prices continue to increase, with single family home price growth at 6.2% in 2021 and 4.9% in the first nine months of 2022. According to the IMF, household mortgages are three times EU-levels and make up 85% of total loans and half of bank assets. Pension funds and insurers have also investment amounts of 23% and of 12% of their funds in the real estate sector.

However, SNB’s stress scenario analysis suggests that most domestically-focused banks’ capital buffers remain sufficient to cover the loss potentially stemming from relevant stress scenarios, including a severe recession combined with a large interest rate rise and simultaneous correction in real estate prices. Furthermore, SNB continues to monitor mortgage and real estate markets developments closely, and has reactivated the countercyclical capital buffer which will enhance the resiliency of the financial system. The SNB’s ongoing vigilance and proactive measures have so far averted significant increases in credit risks and support an upward adjustment in the “Monetary Policy and Financial Stability” Building Block Assessment.

Switzerland’s Creditworthiness is Underpinned by Strong Public Finances and Low Public Debt Ratio

Switzerland’s prudent fiscal policy, underpinned by its debt brake rule, constitutes a key credit strength. Since the introduction of the debt brake rule, which mandates a balanced budget over the cycle, Swiss public finances have been managed prudently with increased expenditures or reduced revenues compensated elsewhere in the budget. The support measures to mitigate the adverse impact of the pandemic on households and businesses resulted in deficits of 3.1% in 2020 and 0.5% in 2021. Public finances have improved in 2022 with a nearly balanced position, driven by strong tax growth for the cantons and municipalities and the less extensive COVID-19 support. The federal government expects a financing deficit of CHF 4.8 billion (less than 1% of GDP) in 2023, mainly due to the rescue mechanism for the electricity industry.

Since the introduction of the debt brake rule, Switzerland has managed to reduce its public debt considerably to below 40% in 2019. After a short-lived deterioration in 2020 due to the pandemic, the debt ratio declined in 2021 to 42.1% of GDP according to IMF, remaining low relative to other AAA-rated peer. The Maastricht debt ratio, which excludes pensions and healthcare, stood at 27.5% in 2021. Combined with substantial financial flexibility, these considerations help 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. All debt has been issued in Swiss francs. Interest expenditures for the general government, as estimated by the IMF, were approximately 0.1% of GDP in 2022. DBRS Morningstar views Switzerland’s fiscal management and policy to be very strong supported also by its consistent efforts to analyze and address medium- and long-term fiscal challenges.

Switzerland’s Strong External Accounts Are a Key Credit Strength

Switzerland’s strong external position is a key credit strength. Swiss external accounts are characterized by a long period of current account surplus and a positive net creditor position. Backed by its role as a financial center, an attractive location for corporations, high per-capita income levels, and a high savings rate, the current account has averaged 7.6% of GDP over the last two decades. Switzerland’s positive net international investment position of 97.2% of GDP in Q3 2022 reflects the substantial accumulated wealth of Swiss residents and official foreign exchange reserves. Compared to Q3 2021, the NIIP ratio declined by around 30 percentage points mainly reflecting valuation losses on equities and bonds. Over the last ten years, the Swiss National Bank accumulated more than CHF 700 billion. 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 has grown to around 116% of GDP as of November 2022.

Switzerland’s Ratings Are Supported By Its Strong Institutions

Switzerland’s political environment is characterized by its federal democratic system, high institutional capacity and low level of corruption as reflected in the World Governance Indicators. The stable political system combined with neutrality in international conflicts have long made Switzerland a safe haven for investors. Despite the fact that the Swiss constitution prohibits Switzerland being a member of any defense union such as NATO and disallows any military engagement, Switzerland has implemented all the economic sanctions on Russia which include financing restrictions and asset freezes, travel bans, and prohibition of sale/transfer of key technologies. The authorities have also accepted nearly 77,000 Ukrainian refugees.

Switzerland is not part of the EU and its unique relationship is based on bilateral agreements (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. Between 2014 and 2021 Switzerland and the EU negotiated on a common institutional framework to streamline Switzerland’s market access to the EU. The future of Swiss-EU relations remains uncertain after the Swiss Federal Council halted the discussions due to substantial disagreements mainly on the Citizens’ Rights Directive and wage protection (See Swiss-EU Relations At An Impasse). In February 2022, the Swiss government has proposed a broad package approach in order to facilitate a mutually beneficial balance of interests. Switzerland and the EU are now holding exploratory talks, which could eventually lead to preparations for a new negotiating mandate. The EU is Switzerland’s largest trading partner and the failure of talks could ultimately cause existing bilateral agreements to lapse resulting in modest increase in trade barriers with its EU partners. DBRS Morningstar nonetheless expects that Switzerland will continue to maintain strong relationships with its EU counterparts in the foreseeable future.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There were no Environmental/ Social/ Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings. (May 17, 2022).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/408653.

Notes:
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/401817/global-methodology-for-rating-sovereign-governments (August 29, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-andgovernance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.

The sources of information used for this rating include the Federal Council, State Secretariat of Economic Affairs (Economic Forecasts), Federal Department of Finance , Swiss National Bank (Quarterly Bulletin 4/2022, Financial Stability Report 2022); Federal Department of Foreign Affairs, European Central Bank (ECB), Eurostat, OECD, IMF (WEO October 2022), World Bank, BIS, Our World in Data, the Social Progress Imperative, the 2019 and 2020 Global Competitiveness Reports from the World Economic Forum, UNHRC, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was 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.

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 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: https://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/408654.

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Spyridoula Tzima, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas Torgerson, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: July 14, 2011
Last Rating Date: July 22, 2022

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