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 the fact that Denmark’s strong economic and public finances limit the risks to the rating stemming from the Coronavirus Disease (COVID-19). The recessionary effect of the restrictive measures to contain the spread of the pandemic, coupled with a global downturn, will result in a sharp contraction in output this year. Although there is significant uncertainty over the shape of the recovery, Denmark is poised to recover thanks to effectively containing the pandemic thus far, a flexible economy, and an export composition that is less sensitive to the global business cycle. Given Denmark´s strong public finances, with one of the lowest public debt ratios in the European Union (EU) and very low funding costs, the government can afford to support the economy and mitigate long-lasting effects from the pandemic without materially affecting public debt sustainability.

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 potential pressures on the housing market in this more difficult environment brought about by the pandemic.

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 concentrated and interconnected financial system.

RATING RATIONALE

The Pandemic Will Trigger a Deep But Transitory Contraction in GDP This Year

Denmark has been effective in containing the spread of the pandemic, recording 11,734 confirmed infections and 580 deaths related to the coronavirus outbreak as of 3 June 2020. In per capita terms, Denmark`s figures compare favourably in the European context. Denmark, which was one of the first European countries to lockdown, with travel and school closures as soon as 14 March, has been advancing with its staggered reopening of its economy since mid-April. In the second phase, restrictions on retail shops (11 May) and restaurants (18 May) have been lifted. A partial reopening of borders will start from 15 June.

Despite the timely and sizable policy response, the government expects Denmark’s GDP to contract by 5.3% in 2020 before staging a partial recovery of 4.0% in 2021. The restrictions imposed to contain the spread of the pandemic will take a significant toll on the Danish economy, particularly but not exclusively to the hospitality, retail, and travel sectors. As a small and open economy, the impact from the global recession and potential supply disruptions are expected to weigh heavily on exports and investment in the short term. The government`s substantial support to temporarily protect jobs and household’s high levels of wealth will limit the contraction in consumption this year. While a sharp fall in GDP is expected in the second quarter of 2020, the gradual return to activity in recent weeks is encouraging.

The Danish growth outlook remains uncertain and will be subject to the evolution of the pandemic and its potential medium-term implications, both in Denmark and abroad, given the country’s outward facing economy. Nevertheless, Denmark´s wealthy, diversified, and flexible economy is well placed to weather the current crisis. On the back of an effective containment policy and timely support measures, its flexible labour market (i.e., flexicurity model) will most likely facilitate the reallocation of resources during the recovery. From a sectoral view, pharmaceuticals, wind turbines, and food products, which account for a large share of goods exports, should be less affected given their lower cyclically sensitive nature. Aside from the pandemic-related risks, other sources of risk stem from protectionism and weaker world trade, given Denmark’s large shipping sector, as well as a potential hard Brexit, given Denmark’s trade links with the UK.

Denmark Is Well Prepared Given Its Solid Public Finances And Fiscal Institutions

Denmark entered the current crisis with sound public finances, providing the government with valuable fiscal headroom to mitigate the severe impact from the pandemic without compromising fiscal sustainability. On the back of a favourable macroeconomic backdrop, the budget balance has recorded four years of surpluses averaging 1.6% of GDP annually between 2016 and 2019. The 2019 fiscal surplus of 3.7% of GDP was particularly strong due to higher than expected pension-yield taxes revenues. Denmark’s fiscal track-record is buttressed on a robust and credible fiscal framework. Given the volatility of some of its revenue sources, especially from the pension-yield taxes and oil and gas extraction in the North Sea, fiscal targets are set in structural terms.

Denmark has adopted sizable fiscal and liquidity measures to mitigate the economic effects of the pandemic. According its Convergence Plan 2020, the discretionary measures worth 4.9% of GDP, including direct support to firms to partially cover fixed costs (2.9% of GDP) and wage expenditures (1.1% of GDP), and sector-specific support to sectors particularly affected by the restrictions, among other things. In addition to this, the government has provided substantial liquidity support to business (15% of GDP) in the form of tax deferrals and state loan guarantees that will not have an immediate budgetary impact aside from the government estimated loss on state guarantees 0.5% of GDP in 2020.

The deep economic contraction and government measures to support the economy will result in a sharp deterioration in fiscal performance in 2020. The government projects a fiscal deficit of 7.2% of GDP in 2020 and of 1.8% of GDP in 2021, although outlining that the projection is subject to high uncertainty. The relatively quick expected reduction in the deficit in 2021 reflects the temporary nature of the measures expiring on 8 July 2020, the economic recovery, and a no-policy change scenario. Further measures to stimulate demand and reinforce the recovery might delay the rebalancing. On a structural basis, the government foresees a deficit of 0.1% of GDP in 2020 followed by a surplus of 0.4% of GDP in 2021. Over the longer term, the demographic developments and declining revenues from oil and gas production will put pressure on the public finances. The 2011 retirement reform, which increased the statutory retirement age and reduced voluntary early retirement, partially offsets these risks.

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

The large fiscal deficit and sharp drop in nominal GDP will result in a sizeable increase in the public debt ratio in 2020. Furthermore, some of the liquidity support measures, such as tax deferrals, will temporarily increase short-term funding needs, but without affecting the headline deficit. Overall, funding needs were revised upwards by 9% of GDP in 2020. In this context, the government expects the public debt ratio to increase to 43.2% of GDP in 2020 and 41.5% of GDP in 2021 from 33.2% of GDP in 2019. The financing model for social housing is expected to increase the EMU public debt ratio in coming years, although it will be neutral for net debt.

Despite this large increase, Denmark´s public debt ratio still is expected to be one of the lowest in Europe. 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 sector. Danish government bond yields remain 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

Monetary policy is aimed at keeping the Danish krone pegged to the euro, which anchors inflation and inflation expectations at low and stable levels. To quell temporary weakening pressures on the exchange rate amid turbulent financial markets in March, the Danmarks Nationalbank (DN) hiked its policy rate by 15 basis points to -0.6 and intervened in the FX market. To ensure good liquidity and long-term financing in various currencies at favourable conditions for the Danish banking system, the DN launched extraordinary lending facilities and activated/reached swap agreements with the European Central Bank (ECB) and the Federal Reserve. The Danish authorities released the countercyclical capital buffers, and cancelled planned increases, and the Danish FSA announced that credit institutions can on a case-by-case basis be allowed to make use of their buffer in the requirement for the Liquidity Coverage Ratio (LCR).

The sharp economic slowdown will put pressure on credit institutions' asset quality and earnings power. In Q1 2020, the large banks reported impairment charges at the highest level since the global financial crisis. However, credit institutions will face the current headwinds better capitalised and with higher excess liquidity. The DN's latest stress test in May 2020 shows that banks can withstand a severe but temporary economic slump, and are able to absorb losses at financial crisis levels or higher. According to the stress test, some non-systemic mid-size banks are at risk of failing although they pose a negligible threat to financial stability.

The overall financial sector is concentrated and interconnected, which could amplify shocks to the financial system and economy. 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. Housing market activity suffered significantly during the lockdown, and the economic contraction and higher unemployment might put downward pressures on prices this year. The covered bond market faced a short period of strained liquidity in late March that disappeared with the DN`s extraordinary measures.

Danish households’ high indebtedness, at 260.9% of seasonally adjusted disposable income in 2019, and high house valuations remain a key source of macro-financial vulnerability, according to the International Monetary Fund (IMF). Offsetting these risks, households have been deleveraging significantly in recent years and the high debt ratios tend to be concentrated in high-income households. Similarly, households’ net financial assets are sizeable. Stricter borrower-based measures to limit risky borrowers have resulted in an increasing portion of mortgages with longer fixed interest rate periods and amortising loans in recent years. Lastly, the adverse market reaction to the investigations into possible money laundering activities from Danske Bank A/S has been limited; however, the franchise or financial impact from the regulatory investigations remains unclear. A negative qualitative adjustment in the “Monetary Policy and Financial Stability” building block has been made to reflect the financial risks stemming from the banking system.

Denmark's Strong External Sector Will Help Weather The Worsening Global Backdrop

Denmark´s strong external position, both from a flow and a stock perspective, place the country in a good position to weather a substantially weaker global outlook. The current account has averaged 7.1% of GDP over the past ten years and the net international investment asset position stood at 78.1% of GDP in 2019. The global downturn and disruption in global supply chains will affect foreign trade in 2020 and will weigh on Danish exports, especially its sizable shipping service sector. The impact on pharmaceutical and food exports, which represent a large portion of exports and are less sensitive to the business cycle, is expected to be less important.

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. A strong external position, ample international reserves, sound public finances, and a strong political commitment lend further credibility to its long-standing fixed exchange rate policy. This supports DBRS Morningstar’s positive qualitative assessment for the “Balance of Payments” building block.

Strong and Stable Political Framework Supports Economic Stability

Denmark’s political environment and institutions are stable. The introduction of key reforms tends to rely on broad support across the political spectrum, ensuring its durability. This predictable macroeconomic policy framework has underpinned the country’s price and economic stability for decades. After winning the general election in June 2019, the Social Democratic Party formed a single-party minority government with the support of three left-wing parties in parliament. DBRS Morningstar continues to expect the minority to continue pushing for its green, welfare, and education initiatives during this legislature.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/362054.

Notes:
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 (17, September, 2019):
https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

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.

The sources of information used for this rating include Danmarks Nationalbank (Financial Stability 1st half 2020, 27 May 2020; Stress Test 1st half 2020, 27 May 2020), Ministry for Economic Affairs and the Interior, Ministry of Finance (Denmark’s Convergence Programme 2020, May 2020; Economic Survey, May 2020), Danmarks Statistik, World Health Organisation, Johns Hopkins University, European Central Bank, European Commission (Assessment of the 2020 Convergence Programme for Denmark, May 2020), Eurostat, OECD, IMF (IMF WEO October 2019 and April 2020; Fiscal Monitor April 2020), 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.

This is an unsolicited 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/362053.

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

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 6, 2019

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