DBRS Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings GmbH (DBRS) confirmed the Kingdom of Sweden’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS 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’s view that the risks to the ratings are limited. After several years of strong performance, DBRS expects growth to slow down in 2019 to 1.2% from 2.3% in 2018, against a weaker external backdrop and contracting investment in housing. Resilient domestic demand continues to underpin economic growth, with a flexible exchange rate helping to absorb external shocks. A sharp contraction in housing investment is expected in 2019; however, spillovers to the rest of the economy should be contained. Sweden’s strong public finances as evidenced by its low and falling debt ratio and fiscal surplus provide valuable fiscal room to respond to potential shocks. However, high household debt, housing market dynamics and potential vulnerabilities in the banking sector continue to be sources of concern, which could be exacerbated if interest rates increase quickly.

RATING DRIVERS

The trend could be changed to Negative from Stable if Sweden’s public debt ratio trajectory were to experience a material reversal, although DBRS views this as unlikely. A materially higher public debt ratio could result from a severe deterioration of the medium-term growth outlook or the materialisation of substantial contingent liabilities related to the banking system, most likely triggered by a collapse in the housing market and sharp worsening of financial conditions.

RATING RATIONALE

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

Sweden’s sound fiscal performance over the last two decades has been underpinned by its prudent and credible fiscal policy framework. Starting in 2019, the revised fiscal framework sets a fiscal surplus target at 0.33% of gross domestic product (GDP) over an economic cycle supplemented by a debt anchor at 35% of GDP. This debt anchor for general government consolidated debt will act as an explicit multi-annual objective. An expenditure ceiling, extending for the third year ahead in the budget bill, is an overarching restriction for the budgetary process.

Sweden’s public finances remain strong and well equipped to respond to adverse developments. The general government fiscal surplus averaged 1.0% of GDP in 2016-2018 and DBRS expects it to hover around its target in coming years. Benefiting from stronger than expected revenue collection, fuelled by strong economic performance and job creation, Sweden has overperformed its budgetary targets. Following the stimulus measures implemented in last year’s budget, the fiscal stance is expected to remain relatively neutral in 2019.

The amended 2019 budget passed last December included tax cuts worth SEK 20 billion (0.4% of GDP). The 2019 Spring Bill includes mainly fully funded new expenditure measures. Overall, the government projects a fiscal surplus of 0.6% of GDP, 0.2% in structural terms, in 2019. Under a no policy change assumption, the government projects the fiscal surplus to increase to 1.9% by 2022. However, DBRS expects the implementation of the January Agreement during the current parliamentary term will probably bring the surplus gradually closer to the 0.33% target in coming years.

The long-term sustainability of public finances is well anchored. The public debt-to-GDP ratio has declined substantially over the past two decades, placing Sweden among the lowest indebted sovereigns in the European Union (EU). The general government debt ratio dropped to 38.8% in 2018 from 45.5% in 2014. The International Monetary Fund (IMF) projects the debt ratio to decline further to 29.4% by 2024. The government’s net financial asset position reached 24.7% of GDP at end-2018, mainly reflecting the social security funds.

Although Sweden’s outstanding debt stock has a relatively short average maturity and a considerable portion denominated in foreign currency, DBRS considers associated risks are small. The second-shortest average residual maturity in the EU at 4.3 years in February 2019 is compensated by a moderate debt ratio, good debt servicing capacity and favourable funding costs. Relative to the foreign currency-denominated debt, over two-thirds stems from on-lending operations on behalf of the Riksbank to help it build a precautionary foreign currency liquidity buffer for the banking sector, and therefore the central government is not subject to FX risk.

Excluding the state-provided deposit insurance scheme and European Financial Stability Facility (EFSF) guarantees, the general government guarantees stood at 9.9% of GDP as of end-2017. Nordea Group’s decision to move its headquarters to Finland from Sweden last year should reduce Sweden’s contingent bank exposures, though other potential risks to financial stability could emerge should there be a change in the effectiveness of supervision and macroprudential controls.

Sweden’s Economic Growth Remains Robust, Although the Housing Market Raises Uncertainties

Sweden’s strong economic performance, with average growth of 2.4% per annum for the last two decades, has been underpinned by a competitive export sector. Sweden’s high GDP per capita at USD 53,874 reflects a productive labour force and the highest employment rate in the EU at 81.8% in 2017. Benefiting from very favourable financing conditions, job creation, disposable income gains and the European economy recovery, investment and private consumption have been the main contributors to GDP growth between 2014-2018.

Although dwelling construction has decelerated sharply in 2018, spillovers to the rest of the economy have been contained and housing prices have stabilised. Following the house prices correction in Autumn 2017, housing investment contracted 0.7% in 2018 following a period of extraordinary average growth of 14% per annum in 2014-2017. The National Institute for Economic Research (NIER) expects dwelling to contract 7.6% in 2019 and 1.1% in 2020. In contrast, business investment will remain supportive because of higher than normal capacity utilisation.

The IMF projects Sweden’s average annual economic growth at 1.8% between 2019 and 2024. As a small and open economy, with significant external trade and financial linkages, Sweden is exposed to external developments. On the domestic front, the main uncertainty is related to the impact on consumption and investment from sharper-than-expected increases in interest rates or/and a collapse in the housing market.

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

Sveriges Riksbank has been conducting accommodative monetary policy to counteract the risk of excessively low inflation. After hiking the repo rate to -0.25% in late 2018, the Riksbank forecast that the next increase could come towards the end of the year or at the beginning of next year, provided that the economic outlook and inflation prospects develop as it expects. DBRS expects the normalization path to be gradual, and potentially delayed by weaker than expected inflationary pressures.

Managing risks associated with high levels of household indebtedness, housing market pressures and banking sector vulnerabilities remain a key challenge. Housing prices and household debt have increased rapidly in recent decades on the back of growing disposable income, cheap credit, sluggish housing supply for a prolonged period, and generous tax incentives for debt financing. According to the Organisation for Economic Co-operation and Development (OECD), real house prices have more than tripled since the mid-1990s, with price-to-income and price-to-rent exceeding their respective long-term averages by 43.3% and 72.8%, respectively, as of Q3 2018. Similarly, household debt-to-disposable income increased to 185.7% in 2018 from 90.8% in 1996.

Swedish households’ high indebtedness could amplify potential interest rate, housing price, or income shocks. The predominance of mortgages at variable rates, about 70 % of the total, exacerbates households’ sensitivity to rising interest rates. On the other hand, some aspects mitigate these risks: (1) DBRS’s expectation that monetary policy will gradually normalise, (2) households’ very low interest-to-income ratio at 2.5%, and (3) households’ high savings rate and large financial assets. The Swedish authorities have strengthened the macroprudential framework with stricter amortization requirements since March 2018 for new mortgagees with high debt-to-income levels for new mortgages and raising the countercyclical capital buffer to 2.5% starting September 2019, the highest in Europe. However, additional effort may be needed to effectively curb the increase in household debt.

The Swedish financial system is large relative to the size of the economy, with high exposures to the housing market, interconnected, and heavily reliant on wholesale funding. Market funding represents around half of banks’ funding, predominantly in foreign currency (about two-thirds), implying considerable refinancing and foreign exchange rate risks. Given the limited domestic and retail deposit source, retaining market confidence remains crucial for Swedish banks to ensure a stable source of funding. Banks’ loss absorption capacity is strong, with regulatory tier 1 capital to risk-weighted assets at 18.8% by end-2018, providing a buffer against potential adverse scenarios. Swedish banks’ profitability is good, despite the negative interest rate environment and conservative lending practices, and asset quality is solid.

Swedbank, one of the largest lenders in Sweden, is currently under investigation over money laundering allegations for its activities in the Baltic region, which could weaken confidence in the Sweden banking system. Sweden has strengthened its anti-money-laundering framework in recent years, however, close international collaboration is needed.

Sweden’s External Position Remains Strong on the Back of a Competitive Export Sector

The combination of a high savings rate and strong competitiveness have underpinned sizable current account surpluses, which have averaged 5.2% of GDP over the last two decades and stood at 2% in 2018. Since peaking at 8.2% of GDP in 2006-07, the current account surplus has experienced a gradual decline mirroring stronger domestic demand and a lower export market share. Over the same period, services exports and Sweden’s trade surplus have gained more relevance relative to goods, reflecting a more service-intensive economy. Sweden’s net international investment position, which turned positive in 2016, stood at 6.9% of GDP at end-2018. Foreign currency reserves stood at 11% of GDP in 2018.

A competitive external sector and solid merchanting flows will continue to support Sweden’s external accounts. Between December 2013 and March 2019, Sweden’s effective exchange rate (KIX index) depreciated by 16%. A weak krona and moderate wage growth have enhanced cost-competitiveness in Sweden. The IMF estimates the real effective exchange rate to be undervalued by 5% to 15%.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

Sweden’s political system is characterised by strong democratic institutions and predictable consensus-oriented policies. In January, four months after September’s general elections, the Social Democratic Party (S) and Green Party (MP) minority government secured another term in office with the parliamentary support from two centre-right parties, the Centre Party (C) and the People's Party Liberals (L). The current left-right agreement served to form a government without the need to resort to the anti-immigration Sweden Democrats, which hold a strong position in parliament with 18% of the seats. The so-called “January Agreement” between these four parties, which includes a tax reform initiative, an easing in rental market restrictions, and tax cuts, among other measures, should guide economic policy for the new government. However, implementation could become challenging considering the different political motivations of the parties supporting the current government. Importantly, DBRS expects future measures to be designed to comply with the fiscal framework targets, which enjoy broad political support.

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 Sweden’s economic performance and outlook, public finances, financial system developments, household indebtedness and the housing market, and the political situation.

KEY INDICATORS

Fiscal Balance (% GDP): 0.7 (2018); 0.6 (2019F); 0.7 (2020F)
Gross Debt (% GDP): 38.8 (2018); 34.5 (2019F); 32.8 (2020F)
Nominal GDP (USD billions): 551.1 (2018); 547.1 (2019F); 576.7 (2020F)
GDP per Capita (USD): 53,874.4 (2018); 53,005.5 (2019F); 55,342.1 (2020F)
Real GDP growth (%): 2.3 (2018); 1.2 (2019); 1.8 (2020F)
Consumer Price Inflation (%): 2.0 (2018); 1.9 (2019F); 1.7 (2020F)
Domestic Credit (% GDP): 272.9 (2017); 277.9 (2018);
Current Account (% GDP): 2.0 (2018); 2.4 (2019F); 2.5 (2020F)
International Investment Position (% GDP): 4.4 (2017); 6.9 (2018);
Gross External Debt (% GDP): 180.0 (2017); 168.0 (2018);
Governance Indicator (percentile rank): 96.2 (2017)
Human Development Index: 0.93 (2017)

Notes:
All figures are in Swedish kronor (SEK) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Fiscal balance (IMF/MoF), Gross debt (IMF/MoF), Nominal GDP (IMF), GDP per Capita (IMF), Real GDP Growth (IMF), Consumer Price Inflation (IMF), Domestic Credit (SCB/Haver), Current Account (IMF), International Investment Position (SCB), Gross External Debt (SCB). 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 Ministry of Finance of the Kingdom of Sweden (MoF), Swedish National Debt Office, Sveriges Riksbank, Statistiska Centralbyran (SCB), Valueguard-KTH, National Institute of Economic Research, 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.

DBRS 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 twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS 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.

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 17 April 2012
Last Rating Date: 26 October 2018

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