Fitch Ratings has affirmed Denmark’s Long-term foreign and local currency Issuer Default Ratings (IDR) at ’AAA’ with a Stable Outlook. Fitch has simultaneously affirmed the Short-term foreign currency IDR at ’F1+’ and the Country Ceiling for Denmark at ’AAA’.
KEY RATING DRIVERS
The affirmation and Stable Outlook reflect the following key rating factors:
The track record of macro-financial stability reflected in low and stable inflation, current account surpluses and the stable banking sector despite a high level of household indebtedness and weakening housing market.
Public finances are in line with the ’AAA’ median indicators with the EU definition of general government gross debt at 46% of GDP in 2012. The Danish government’s long-standing commitment to fiscal discipline and historical record of turning deficits into surpluses strengthens the credibility of its fiscal strategy to adhere to EU recommendations to bring the 2013-2014 budget within the 3% reference level.
Concerns for the banking sector arising from the bursting of the housing bubble in 2008 and the global financial crisis in 2009 have eased, and large Danish banks in particular have improved balance sheets and capitalisation. The progress of the supervisory and regulatory initiatives in Denmark have also contributed to financial stability and the introduction of a bank resolution regime somewhat reduced the contingent liability for the sovereign. However, a few small Danish banks still remain under pressure and need more capital.
The rating remains supported by the relatively wealthy, high value-added and diverse economy. The severity of the 2009 recession and weak recovery has led to a significant rise in unemployment, although structural unemployment is estimated to be moderate.
Denmark has strong and transparent institutions, which contribute to a stable political and economic environment, outperforming the ’AAA’ rated medians in five out of six World Bank governance indicators. It also ranks very high on the Ease of Doing Business index.
The economy has strong external finances with low net external debt, low net sovereign external debt, and a positive international investment position. At 5.2% of GDP in 2012, the current account surplus is also significantly higher than the ’AAA’ median, reflecting Denmark’s position as a strong export-oriented economy.
Although lacking a strong reserve currency status, the recent eurozone crisis has shown market confidence in Denmark’s public finances and krone assets, with large safe haven capital flowing into the economy, allowing the government to borrow at record low interest rates.
The authorities have successfully exploited the favourable financing environment for Denmark by materially increasing the average maturity and duration of government debt, reducing refinancing and interest rate risk.
RATING SENSITIVITIES
The Stable Outlook reflects Fitch’s assessment that the downside risks to the ’AAA’ rating are currently not material. Nonetheless, the following risk factors individually, or collectively, may result in a negative rating action:
As a small open economy with extensive trade and financial linkages to the rest of the world and eurozone, a material worsening of the global economic outlook and/or intensification of the eurozone crisis would affect Denmark’s economic recovery and potentially place pressure on public finances and the financial sector.
A more protracted stagnation of the economy than currently anticipated due to household deleveraging and further downturn in the housing market that was accompanied by deteriorating public finances and worsening asset quality.
The political consensus on fiscal strategy and long-standing commitment to fiscal discipline in Denmark supports the rating. A reversal of this approach would be negative for the rating.
KEY ASSUMPTIONS
The ratings and Outlooks are sensitive to a number of assumptions.
Fitch’s forecasts for the general government balance and debt level are based on the assumption that the government remains committed to its current fiscal strategy.
Danish exports are reliant on the eurozone for its markets and Fitch assumes that the eurozone remains intact and that there is no materialisation of severe tail risks to global financial stability that could trigger a sharp deterioration in net exports for Denmark. Contagion through Denmark’s largest bank with some foreign operations could also threaten financial stability in Denmark, which could result in an expansion of the sovereign’s balance sheet.
Domestic demand for Danish mortgage covered bonds continues to be strong given the necessity for predominantly domestic financial institutions, insurance companies and pension funds to hold highly liquid, high quality, securities in domestic currency.
Based on Fitch assessment of the relative strength of the banking sector, it is assumed that the fiscal risk arising from contingent liabilities from the financial sector is very small.
The euro currency peg remains in place.
