Fitch Affirms Denmark at 'AAA'; Outlook Stable
KEY RATING DRIVERS
Denmark's 'AAA' IDRs and Stable Outlook reflect the following key rating drivers:
Denmark is a highly advanced, diversified and wealthy economy. Income per head is above the 'AAA' median, and governance indicators are in line with the highest-rated sovereigns. Denmark has a track record of sound macroeconomic policy implementation and macro-financial stability, despite the severe stresses after the bursting of the house price bubble in 2008 and in the 2009 recession.
External finances are a rating strength. Fitch estimates that in 2014 the current account surplus was 6.1% of GDP. We estimate that a pick-up in domestic demand growth will lead to the surplus falling back to 4% by 2016. The current account surplus has averaged 4% since 2003. A structural current account surplus has resulted in a large positive net international investment position and low external debt compared with rating peers (net external debt of 2.9% of GDP compared to the 'AAA' median of 17.8%).
Monetary policy developments in the eurozone and Switzerland have resulted in considerable inflows of foreign currency and upward pressure on Denmark's currency peg with the euro. In response, the Danish central bank has intervened in the foreign exchange market and cut its main interest rate to -0.75%. Foreign exchange reserves increased by DKK106.6bn in January, reaching an overall level of DKK564.1bn (almost 30% of GDP). The government has announced that it will suspend government bond issuance until further notice. Fitch believes this demonstrates policy coherence and the resolve of the authorities to maintain the DKK/EUR peg.
The Danish economy has been growing, albeit slowly, since mid-2013. We estimate that real GDP rose by 0.8% in 2014. We expect a pick-up in domestic demand to push up economic growth to 1.4% this year and 1.9% in 2016. Unemployment will edge down and average 6.4% in 2015.
Recent public finance outturns have been affected by one-off tax measures. We estimate that the general government balance turned from a deficit of 0.7% of GDP to a 1.7% surplus in 2014. However, this turnaround was not due to a sharp fiscal policy correction but rather the impact of temporary revenues associated with the reallocation of capital pension schemes. Deficits of 2.3% and 2.8% are expected in 2015 and 2016. We expect that the government debt will fall to 40.6% this year from an estimated 46% in 2014 due to the suspension of bond issuance by the government and the use of central government deposits to finance this year's deficit. The debt ratio is then expected to edge up in 2016 to 42.8%.
The fiscal framework is characterised by compliance with the Danish budget law and the EU's fiscal compact and stability and growth pact. Denmark employs expenditure ceilings at the central and local government levels, and adheres to its medium-term objective of a 0.5% structural deficit. There is strong political support for the government's target to balance the budget by 2020 and this strengthens Denmark's long-standing commitment to fiscal discipline.
Danish households are the most indebted amongst Fitch-rated sovereigns. Household debt at 3Q14 was around 141% of GDP (291% of disposable income). A substantial net asset position mitigates the risks. At the same time, the illiquid nature of these assets (primarily pension savings) could pose problems for debt servicing for some households in the event of a severe shock (for example a sharp rise in interest rates).
Large Danish banks have generally remained resilient in terms of asset quality, capitalisation and liquidity. In October, the Danish Financial Supervisory Authority (FSA) conducted an Asset Quality Review of the Danish financial institutions included in the EBA's EU stress test. The review and assessment did not significantly change the perception of the credit quality of the participating Danish groups. In September, the FSA presented its proposal for a Supervisory Diamond for mortgage banks, which contains limits on mortgage banks' risks and is supposed to limit interest-only, high LTV and high-frequency refinancing mortgages as a proportion of total lending, and serve as an early warning mechanism for bank risks.
The Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could, individually or collectively, result in negative rating action include:
-A significant setback in growth prospects, related either to worsening conditions in the euro area and other main trading partners, or fears about household indebtedness accelerating the deleveraging process further, impacting on public finances and the financial sector, would be negative for the ratings.
-Continued demand for Danish mortgage bonds by Danish financial institutions, insurance companies and pension funds, is key to financial stability in Denmark. Fitch's baseline is that domestic demand for these instruments will persist due to their need for liquid, high quality krone securities; a significant rise in reliance on international investors for these bonds would increase the vulnerability of the financial system in a crisis.
The ratings and Outlooks are sensitive to a number of assumptions:
Fitch assumes that the Danish krone peg to the euro under the ERM2 remains in place.
There is currently strong and broad political consensus for fiscal discipline in Denmark. Fitch assumes that fiscal policy by the incumbent or incoming government following the 2015 general elections will remain committed to its current medium-term fiscal strategy of closing the general government deficit by 2020.
Fitch also assumes gradual progress in deepening financial integration at the eurozone level and that eurozone governments will tighten fiscal policy over the medium term.