Scope Ratings AG today confirms Switzerland’s long-term local-currency issuer rating at AAA, following the release of its revised sovereign rating methodology, and converts its status from subscription to public. The agency also assigns a long-term foreign-currency issuer rating of AAA, along with a short-term issuer rating of S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in both local and foreign currency was also rated at AAA. All Outlooks are Stable.

Rating drivers

The AAA rating is underpinned by Switzerland’s exceptionally strong fundamentals, moderate levels of indebtedness and sound fiscal management. The credit profile is further supported by the country’s strong external position, the safe-haven status of the Swiss franc, and highly developed capital markets.

Switzerland benefits from an exceptionally wealthy and well-diversified economy with a high level of labour productivity. The growth has been gaining momentum since the effects of the sharp exchange-rate appreciation (following the Swiss National Bank (SNB)’s decision to exit the exchange-rate floor) have unwound. In the first quarter of 2017, year-on-year growth stood at 1.1%, driven by both external and domestic demand. Scope expects GDP to grow by 0.9% in 2017, and to accelerate to 2.0% in 2018, with the biggest contributions coming from private consumption, supported by improving labour market conditions, and exports, helped by the recovery in the euro area.

The SNB’s monetary policy has been effective in controlling appreciation pressures, preventing prolonged periods of sustained deflation, and helping the economic recovery through negative interest rates and currency interventions. However, as inflation stays weak and upward pressures on the Swiss franc remain (notwithstanding recent depreciation), Scope expects no policy changes in the near future, and only a gradual increase in the policy rate over the medium term following a recovery in domestic economic performance and a rise in major central banks’ key interest rates.

Scope notes that the Federal Council’s current tax-reform proposal, if implemented, will have a positive effect on Switzerland’s attractiveness as an investment destination for multinationals.

In Scope’s opinion, Switzerland has adequate fiscal space given its balanced public finances and moderate public debt burden, and its position is further bolstered by current negative financing costs. Fiscal performance remained strong in 2016, with a general government surplus of 0.2% of GDP representing a slight deterioration from 2015. Scope expects the headline deficit to average around 0.4% of GDP over the medium term, with the confederation remaining the largest positive contributor to the budget. The country’s sustained favourable fiscal record is underpinned by the rules-based fiscal framework introduced in 2003 and anchored by the Federal Constitution. The rule requires the confederation to maintain a cyclically adjusted balanced budget on an ex-ante basis. Scope notes that the rule has contributed to significant reductions in government debt and proven to be resilient in periods of economic downturn.

Scope assesses Switzerland’s medium-term public debt dynamics as favourable, owing to relative robustness across several scenarios over the projection horizon to 2022. In 2016, public debt as defined by the IMF stood at around 45% of GDP (Maastricht-defined debt was around 30%). Scope expects the ratio under the IMF definition to decrease to below 39% by 2022, supported by positive primary balances and extremely low financing costs. However, long-term challenges to debt sustainability remain due to adverse demographics. According to the long-term sustainability report published by the Federal Department of Finance, the rise in demographics-related expenditure will correspond to around a 24-pp increase in the debt-to-GDP ratio by 2045.

Switzerland benefits from highly liquid capital markets, a strong public debt structure reflected in an increasing average term to maturity (to 23.5 years for bonds issued in 2016), and low refinancing risks. The Swiss government borrows in local currency, which eliminates exchange-rate risks.

Switzerland has an open and very competitive external sector as reflected in a long history of large current account surpluses. The economy benefits from well-developed capital markets and the safe-haven status of the Swiss franc. The export base is highly diversified, both in terms of products and destination markets. Since 1981, Switzerland has persistently generated large current account surpluses, which averaged around 10% of GDP between 2006 and 2016, resulting in a positive net international investment position of 131% of GDP in 2016. The Swiss economy remains vulnerable to unexpected currency movements, however, particularly appreciation pressures on the exchange rate in cases of large capital inflows during periods of international financial uncertainty. This was demonstrated by the need for the SNB’s currency interventions and sizeable expansions of its balance sheet.

The financial sector is a central pillar of the Swiss economy. The sector’s total assets are approximately 500% of GDP, owing primarily to two global systemically important Swiss banks (G-SIBs) – Credit Suisse (A+/stable outlook) and UBS (AA-/stable outlook) – making Switzerland’s banking system one of the largest financial sectors in the world relative to GDP. Overall asset quality remains high at Swiss banks, reflected in continuous low levels of non-performing loans (of below 1% of total loans). However, the prolonged environment of very low interest rates has put pressure on banks’ profitability. Important vulnerabilities stem from rising household debt (amounting to around 127% of GDP in 2015), and Swiss banks’ high mortgages exposure (which account for over 93% of total household financial liabilities), reflecting risks in a period of historically low interest rates. These exposures will prove challenging due to imbalances in the real estate sector, as depicted by rising house price-to-income ratios. Debt risks are moderated, however, by Swiss households’ large financial assets, amounting to 363% of GDP in 2015. In Scope’s opinion, competition between banks could move profit margins further down and increase risk-taking incentives.

Scope views positively the authorities’ efforts to address the too-big-to-fail (TBTF) issue through revised TBTF2 regulations, which came into effect on 1 June 2016. The new regulations are more stringent, leading to improvements in the capital ratios of Credit Suisse and UBS. However, given the interconnectedness between the economy and the financial sector, measures aimed at achieving full implementation of regulatory requirements remain essential.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative ‘AAA’ (‘aaa’) rating range for the Swiss Confederation. This indicative rating range can be adjusted by up to three notches on the Qualitative Scorecard (QS) depending on the size of relative credit strengths or weaknesses versus peers based on analysts’ qualitative analysis.

For the Swiss Confederation, the QS signals relative credit strengths for the following analytical categories: i) economic policy framework, ii) fiscal performance, iii) market access and funding sources, iv) current-account vulnerabilities, v) financial-sector oversight and governance. No relative credit weaknesses are indicated.

Relative credit strengths generate no adjustment and signal a sovereign rating of AAA for Switzerland.

The results have been discussed and confirmed by a rating committee.

For further details, please see Appendix 2 of the Rating Report.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s assessment that the risks Switzerland faces remain manageable given its significant strengths.

The Outlook could be changed if: i) a sharp correction in the housing market weighs on growth and financial stability and/or ii) exchange-rate appreciation becomes uncontrollable, damaging competitiveness and economic growth.

For the detailed research report, please click HERE.

Rating committee

The main points discussed within the rating committee were: (1) Switzerland’s growth potential, (2) the SNB’s monetary policy, (3) recent developments in the Swiss franc, (4) fiscal performance, (5) public-debt sustainability, (6) the debt-brake mechanism, (7) peers consideration.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available at www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA) at http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.

The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.
Rating prepared by John Francis Opie, Lead Analyst.
Person responsible for approval of the rating: Dr Stefan Bund, Chief Analytical Officer.
The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.
The senior unsecured debt ratings as well as the short-term issuer ratings were assigned by Scope for the first time.

As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the Swiss Confederation are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of ratings under review, in order to conclude the review and disclose ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: The Swiss National Bank (SNB), Swiss Federal Statistical Office, State Secretariat for Economic Affairs, European Commission, Eurostat, ECB, IMF, OECD, WB and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
© 2017 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings AG, Scope Analysis, Scope Investor Services GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope cannot, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided “as is” without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be, viewed by any party as opinions on relative credit risk and not as a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will independently assess the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk; they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell or store for subsequent use for any purpose the information and data contained herein, please contact Scope Ratings AG at Lennéstraße 5, D-10785 Berlin.

Scope Ratings AG, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 161306, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund; Chair of the supervisory board: Dr. Martha Boeckenfeld