Scope Ratings GmbH has today affirmed the Kingdom of Denmark’s long-term issuer ratings at AAA and short-term issuer ratings at S-1+, in both foreign and local currency. The sovereign’s senior unsecured debt is also affirmed at AAA in both foreign and local currency. All Outlooks are Stable.

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Rating drivers

Denmark’s AAA ratings are supported by a wealthy and competitive economy, strong macro-economic, fiscal and monetary governance institutions and a stable political environment. In addition, a robust external sector, including sizeable foreign currency reserves backing the country’s long-standing peg of the Danish krone to the euro and a lengthy record of current account surpluses, is a credit strength. However, Denmark's small and open economy leaves the country vulnerable to external shocks. Tepid medium-run growth potential is moreover an area requiring continued policy attention. Vulnerabilities in the Danish financial system, including high levels of household debt, can be exacerbated should macro-financial imbalances be allowed to continue building up or economic conditions were to deteriorate. In Scope’s opinion, the ongoing proactive response of Danish financial supervisors is countering these vulnerabilities, and continued efforts going forward will be critical.

Denmark grew 1.9% YoY in Q1 2019 after 1.5% growth in 2018, with the economy expected to expand by 1.7% for the 2019 calendar year before 1.6% in 2020. Economic growth has shown some resilience to the recent slowdown in the euro area vis-à-vis domestic demand growth, supported by improving labour markets, steady growth in disposable incomes, and positive net trade contributions. However, consumer and business sentiment in Denmark has dipped since December 2017, and now rests near a cyclical floor. Scope will be monitoring for signs of a stabilisation in growth after a soft 0.1% Q/Q during the first quarter of the year. Scope foresees Denmark’s medium-run growth potential at only 1.2%, acknowledging working-age population growth of 0.2% (according to UN estimates), medium-run employment rate growth of fairly close to zero, and annual labour productivity growth of around 1.0%.

The objective of Danmarks Nationalbank’s monetary policy is to “ensure stable prices, i.e. low inflation”, achieved through keeping the exchange rate stable to the euro (operating within +/-2.25% of DKK 7.46 per euro). As the monetary policy target of the euro area is to keep inflation below, but close to, 2% in the medium term, the fixed-exchange-rate policy provides a framework for low inflation. Harmonised inflation was very low, at 0.5% YoY in June, down from 1.2% as of March. The central bank’s monetary policy is very accommodative, including a certificates-of-deposit rate at -0.65% since 2016 and current-account rate at 0% since 2012. In Scope’s opinion, the limited monetary policy and exchange rate flexibility, owing to the peg to the euro under ERM II, restricts the central bank’s ability to control money supply and take unconventional measures such as quantitative easing were such steps required for macro-economic sustainability. The prolonged maintenance of negative rates moreover expedites financial imbalances.

The AAA rating is supported by sound public finances, which are characterised by a balanced budget and a low public debt burden. Estimated at 33.6% of GDP in Q1 2019, Denmark’s general government debt ratio has declined from cyclical peaks of 48.7% in Q3 2011. However, going forward, the IMF projects this ratio to rise from 2021 onward, reaching 38.2% of GDP by 2024, as the central government takes a more active role in financing social housing (this expands the general government balance sheet by 11.3% of GDP). Net debt, however, will continue to decline relative to GDP, to just above 10% of GDP by 2024, as a higher level of assets matches the increase in social housing bonds. In 2019, Scope projects the fiscal surplus at 0.3% of GDP (from 0.6% in 2018), before falling to 0.1% in 2020.

Scope views Denmark’s fiscal framework constructively, with its focus on realistic medium-term budgetary targets that are consistent with both the Budget Law (which states fiscal deficits should be limited to 0.5% of GDP except during severe economic downturns) and the EU’s Stability and Growth Pact. Furthermore, Scope recognises the role of the Danish Economic Council, which monitors compliance with fiscal rules and expenditure ceilings at each governmental level in addition to evaluating long-term fiscal sustainability.

Denmark’s debt sustainability will be supported by ultra-low financing rates, with the country’s 10-year yield at well below zero. An average public debt maturity of 8.1 years (as of 2019) is moreover longer than that of most governments in Denmark’s sovereign peer group. Annual gross government financing needs are low at 4.5% and 3.9% of GDP in 2019 and 2020, respectively, according to European Commission estimates. Denmark’s debt has a high foreign ownership share, with 32% of general government debt held by the non-resident sector. This is an area of risk in the albeit unlikely scenario of a sudden stop in capital inflows to Denmark; however, a low foreign currency share (only 0.1% of central government debt is denominated in foreign currencies) represents a strong point in the debt structure. In the long run, one element that requires greater attention is increases in long-term care spending, which, according to the European Commission, could rise from 2.5% of GDP in 2016 to 3.7% by 2040.

The ratings are underpinned by Denmark’s robust external position. The country has generated a current account surplus in each year since 1998, with the surplus totalling 6.9% of GDP in the 12 months to May 2019. The current account surplus is projected by the IMF at 5.6% of GDP in 2019 before receding gradually to 4.7% by 2024. Denmark’s external position is sound with a net international asset position of 65.4% of GDP as of Q1 2019, up on -9% as of Q1 2008. Moreover, external deleveraging has brought gross external debt down to 142% of GDP as of Q1 2019, from 195% as of Q2 2010. Gross short-term external debt of 50% of GDP nevertheless remains a risk.

Denmark’s official reserves totalled a significant DKK 450bn (19.8% of GDP) in June 2019, after hitting a record high of DKK 737bn in 2015. Denmark’s credible commitment to maintaining the fixed exchange rate, backed by significant foreign currency reserves with the peg having survived periods of intense market pressure like that in 2015, provides the country with a credible safeguard against external shocks, even if the fixed exchange rate also limits the economy’s adjustment capacity.

Denmark’s credit strengths are balanced by financial vulnerabilities in the form of very high household debt and reputational damage to the banking system from the money laundering scandal at Danske Bank (A+/Negative) – the nation’s largest financial institution. Household/NPISH debt totalled 274.4% of gross disposable income in Q1 2019, up from deleveraging cycle lows of 263.7% during 2017 and represents the highest such debt ratio among OECD countries. Risks surrounding high household debt burdens have to be viewed, however, in the context of very significant household assets in the form of private pensions, equity and housing, resulting in household net worth of 582.8% of net disposable income in 2017. Nonetheless, high household debt means that vulnerabilities prevail in scenarios of a rise in interest rates, an increase in unemployment and/or a sharp decline in house prices. Amidst historically low interest rates, Danish households’ debt service has declined to 14.7% of gross disposable income by Q4 2018, materially under the 23.7% peak during 2008, thereby reducing vulnerabilities. House prices are elevated, but price growth has slowed since early 2018. Credit growth has, however, picked up modestly for households to 1.6% YoY.

Scope views positively the introduction by Danish authorities of macroprudential measures aimed at strengthening credit quality by setting lending restrictions, for example, on new variable-rate residential mortgage lending. Reforms to property taxation and real estate valuation are also expected to take effect from 2021, aimed at re-introducing the automatic stabiliser for house prices, by again establishing the direct link between housing values and housing taxes. The counter-cyclical capital buffer ratio will be raised from 1.0% to 1.5%, effective 30 June 2020, after a recommendation from the Systemic Risk Council. The Council expects to recommend a further increase of 0.5% in Q3 2019 unless the build-up of risks in the financial system slows considerably. Denmark will initially raise the buffer rate to 1.0% from 0.5% on 30 September 2019. In addition, minimum requirements for own funds and eligible liabilities took effect on 1 July 2019 for most systemic credit institutions. Denmark’s participation in the European Banking Authority’s 2018 EU-wide stress test showed that the four Danish banks can maintain excess capital relative to capital requirements even during a severe economic downturn. Continued proactive steps of regulators in safeguarding financial stability are credit-positive.

Denmark’s financial system is large (with assets of nearly 400% of GDP) and closely interconnected with that of Nordic neighbours. The financial system is exposed to the domestic housing sector, with real estate lending of mortgage banks comprising 44% of total Danish financial sector assets. In addition, mortgage banks are reliant on mortgage-covered bond funding, with Danish pension funds the primary investors. The combination of elevated housing prices, high and increasing household debt, and market reliance on continued investment of Danish pension funds into the mortgage covered bond market poses financial stability risks. Furthermore, Danish mortgage banks are exempt from having to meet the minimum requirement for own funds and eligible liabilities.

Nonetheless, Scope views the Danish banking system on the whole as resilient. Regulatory tier 1 capital increased to 21.6% of risk-weighted assets as of Q1 2019, compared to 16% in Q4 2010, and is high compared to that of most banking systems in Europe. Non-performing loans, at 1.4% of total loans as of Q1 2019, is below the cyclical peak of 6% in 2012. The scandal at Danske Bank revealed gaps in coordination between global banking regulators, demonstrated by around EUR 200bn in suspicious transactions having passed through Danske’s Estonian branch over 2007-15. Estimates on the scale of penalties against Danske have ranged from as high as USD 8.3bn to just somewhere in the hundreds of millions of dollars. Efficient anti-money laundering measures require a coordinated effort by banks and authorities. The Danish authorities have launched several initiatives to strengthen anti-money laundering efforts, including legislative changes in 2018 and 2019 and present considerations around joining the European Banking Union.

General elections were held on 5 June 2019, with the Social Democrats coming in first place and former Prime Minister Lars Løkke Rasmussen’s centre-right Venstre coming in second. On 6 June, Rasmussen resigned, and Mette Frederiksen of the Social Democrats was tasked with forming a new government. On 25 June, Frederiksen reached an agreement with the red bloc. On 27 June, she was appointed prime minister of a single-party Social Democrat government.

Sovereign rating 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 ‘AA’ (‘aa’) rating range for the Kingdom of Denmark. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.

For Denmark, the following relative credit strengths have been identified: i) macro-economic stability and sustainability; ii) fiscal policy framework; iii) debt sustainability; iv) market access and funding sources; v) external debt sustainability; vi) vulnerability to short-term external shocks; and vii) banking sector performance. No relative credit weaknesses were identified.

Combined relative credit strengths and weaknesses generate a two-notch adjustment and indicate a sovereign rating of AAA for Denmark.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope considers ESG sustainability issues during the rating process as reflected in the sovereign methodology. Denmark’s performance on sustainability factors is considered in the country’s AAA sovereign rating. Governance-related factors are explicitly captured in Scope’s assessment of ‘Institutional and Political Risk’ in its methodology, within which Denmark has one of the highest CVS scores among Scope’s rated sovereign universe on a composite index of six World Bank Worldwide Governance Indicators. Qualitative governance-related assessments reflect Scope’s QS evaluations of ‘neutral’ on ‘recent events and policy decisions’ (including consideration of the policy framework of the new government) and ‘neutral’ on ‘geo-political risk’ compared with Denmark’s sovereign peer group.

Social factors are captured in Scope’s CVS in Denmark’s high GDP per capita (of USD 60,692 in 2018), low level of risk associated with the national unemployment rate (of 3.7% in May), and high level of risk from its old-age dependency ratio. Denmark’s Gini coefficient – designating income inequality – is amongst the lowest in the world after taxes and transfers. Labour force participation has been roughly stable at around 79%. Non-EU migrants experience a high jobless rate with persistent employment gaps relative to Danes due to job-wage mismatches. Some measures being taken may alleviate this; yet labour shortages and job market mismatches continue to constrain growth. The recently agreed government pact includes the discontinuation of annual cuts to education and a focus on repatriation and temporary asylum on immigration. Social considerations and impacts of social factors on the economy are reflected in Scope’s QS evaluation of ‘neutral’ on Denmark’s ‘growth potential of the economy’, ‘neutral’ on ‘economic policy framework’ and ‘good’ on ‘macro-economic stability and sustainability’ compared with ‘aa’-indicative sovereign peers.

Denmark has maintained a strong record on environmental sustainability and recorded the third highest score (out of 180 countries) in the 2018 Environmental Performance Index – an index developed by Yale University. With Denmark's goal of full carbon neutrality by 2050 and Copenhagen's objective of becoming the world's first CO2-neutral capital by 2025, Denmark has made sustainable solutions a top priority – including buses running on clean fuel, rooftops with green vegetation, and strong infrastructure for Copenhagen cyclists. The new government agreement reached by the Social Democrats with the red bloc included an ambitious target on global warming, to cut Denmark's CO2 emissions by 70% by 2030.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that the risks Denmark faces remain manageable given the nation’s commensurate credit strengths.

The ratings/Outlooks could be downgraded if, individually or collectively: i) household debt and housing market risks were to accentuate, whether owing to a lack of proactive regulatory actions or to a weakening in economic conditions, escalating financial stability risk and adversely impacting the government balance sheet; ii) a deterioration in fiscal discipline were to result in a non-negligible increase in gross and net government debt ratios, putting into question the currently significant public finance strengths; and/or iii) risks in the banking system increased, for example, in relation to money laundering allegations, weakening Danish financial system stability and resulting in a significant rise in bank funding costs.

Rating committee
The main points discussed during the rating committee were: i) growth developments; ii) public finances developments; iii) external position/foreign reserves; iv) financial stability; v) recent political events; and vi) peer considerations.

Methodology
The methodology used for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on 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): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as 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 in which a rating may change within the next 12 to 18 months.

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 Ministry of Finance of the Kingdom of Denmark, Danmarks Nationalbank, Statistics Denmark, Finanstilsynet (Danish Financial Supervisory Authority), World Bank, European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), IMF, OECD, BIS 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 the issuance of the rating, 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.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Dennis Shen, Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director, Public Finance
The ratings/outlook were first assigned by Scope in January 2003. The ratings/outlooks were last updated on 16.02.2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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