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      FRIDAY, 26/07/2019 - Scope Ratings GmbH
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      Scope affirms the Kingdom of Sweden’s credit rating at AAA with a Stable Outlook

      A wealthy and diversified economy, current account and budget surpluses, low public debt, and a strong institutional framework support the ratings. Financial stability risks, high private debt and the growth slowdown are challenges.

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

      For the rating action annex, click here.

      Rating drivers

      Sweden’s AAA ratings are supported by the country’s wealthy and diversified economy, strong fiscal framework and low public debt, dual current account and fiscal surpluses, strong institutional framework and stable governance, and its strengthening of institutions tasked with financial governance. Challenges include ongoing imbalances in financial asset markets, exacerbated by the still highly accommodative monetary policy, high and rising levels of household and corporate debt as well as banks’ significant short-term external debt levels.

      The Swedish economy grew 2.0% YoY in Q1 2019, with growth in the 2019 calendar year expected to slow to 1.75% (after 2018 growth of 2.4%), followed by 2.0% in 2020. Indicators of business and consumer sentiment have weakened sharply since mid-2018, concurrent with a global and regional economic slowdown. Growth will, however, be supported going forward by net exports, as domestic demand moderates, resulting in lower import growth. Growth will also tick higher in 2020 as private consumption and investment growth improve. Scope foresees Sweden’s medium-run growth potential at around 1.75%, acknowledging working-age population growth of 0.4% (according to UN estimates), steady labour force participation growth, and annual labour productivity growth of around 1.0%.

      The objective of monetary policy to “maintain price stability” is defined as holding CPIF: CPI with fixed interest rates at around 2%, within a 1%-3% band. Scope considers the September 2017 change in the central bank’s objective, from targeting headline CPI to targeting CPIF, to be prudent, eliminating drawbacks arising from changes in policy rates on mortgage interest rates on headline CPI levels. This related to the fact that higher/lower official rates led undesirably to higher/lower inflation via changes in headline CPI’s mortgage rate component. Headline inflation stood at 1.8% YoY in June while CPIF was 1.7% YoY – within the central bank’s band; however, inflation is expected to decline in the months ahead due to lower energy prices.

      In December 2018, the Riksbank raised its repo rate for the first time this cycle by 25 bps to -0.25%. July Riksbank forecasts indicate that the next hike is likely at either the end of 2019 or early 2020, with the central bank projecting increases of roughly 40 bps in both 2020 and 2021. Scope views gradual rate increases, as currently projected by the central bank, constructively, helping redress risks to financial stability. Riksbank announced the end of its QE programme in December 2017. It was decided in April that the Riksbank will purchase government bonds for a nominal amount of SEK 45bn, with effect from July 2019 to December 2020, to maintain the existing level of holdings. In Scope’s opinion, the QE programme alongside negative rates, while having countered deflation risk, has also supported the build-up of financial imbalances. Proposals (within the next two years) for monetary governance changes include: i) ceasing daily manual fine-tuning transactions; ii) setting the deposit rate at the policy rate minus 0.1%; and iii) allowing the lending rate to remain at, or close to, the policy rate plus 0.1%. This will automate the operational framework and narrow the interest rate corridor – reducing volatility in short-term money market rates.

      Sweden’s AAA ratings benefit from the nation’s credible fiscal policy framework, introduced in the 1990s, which has anchored a significant fall in general government debt from around 60% of GDP at the end of the 1990s to 36.3% as of Q1 2019. As of 24 June, the central bank owns around 34% of outstanding government bonds – meaning the outstanding stock of government debt owned by the global private sector amounts to under 30% of GDP. The surplus target for general government net lending was cut from 1% to 0.33% of GDP over the economic cycle from 2019 onwards. Taking into account Sweden’s low debt level and significant spending and investment needs, a lower surplus target is justified if it brings necessary public and private sector investments for higher long-term growth and employment and, for example, addresses climate challenges. Current discussions around the further easing of fiscal targets should aim to maintain Sweden’s strong fiscal framework through the cycle. Follow-ups of the surplus target are now more stringent, with a clearer definition of a target deviation and a plan to return to the target in the event of a deviation. The Swedish Fiscal Policy Council, the independent evaluator of the government’s fiscal policy, has been assigned a clearer role in the follow-up process.

      Scope projects the government fiscal surplus at 0.25% of GDP in 2019, after 0.9% of GDP in 2018 – as revenue growth falters under weaker economic conditions and limited fiscal stimulus of SEK 4.5bn (<0.1% of GDP) from the Spring Fiscal Policy Bill is phased in. The surplus will level out at around the 0.33% surplus target over 2020-24. The IMF foresees public debt/GDP declining to 29.4% of GDP by 2024 (with net debt declining to 3.0% of GDP by that year, from 5.9% in 2018), helped by balanced budgets and continued economic growth. Declines in debt will be supported by very low financing rates globally, with Sweden’s 10-year yield at 0% at the time of writing. An average public debt maturity of 4.6 years (as of 2019) is, however, below that of most governments in Sweden’s sovereign peer group. Nonetheless, annual gross government financing needs remain moderate at 5.6% and 4.8% of GDP in 2019 and 2020, respectively, according to European Commission estimates. Risks are posed by Sweden’s debt composition, with high foreign ownership (31% of general government debt is held by the non-resident sector) and a high foreign currency share (35% of central government debt including swaps is denominated in foreign currencies). In the long term, one element that requires greater policy attention are increases in long-term care spending, which, according to the European Commission, could rise from 3.2% of GDP in 2016 to 4.1% by 2040, owing to longer life expectancies and higher coverage rates of long-term care recipients.

      Sweden benefits from a robust external position. As a country with net international assets (of 16.4% of GDP as of Q1 2019, with this ratio having improved from -16.3% as of Q1 2014), Sweden has enjoyed over two decades of current account surpluses. Sweden’s current account surplus totalled 2.6% of GDP in the year to Q1 2019 – about the same level as in the year to Q1 2018. The IMF forecasts the current account surplus at 2.4% of GDP in 2019, and to remain more or less stable thereafter – reaching 2.9% of GDP by 2024. Sweden’s gross external debt totalled 172% of GDP as of Q1 2019, down from a peak of 202% in Q1 2015; however, gross short-term external debt of 60% of GDP – mostly owed by Swedish banks and in significant part in foreign currency – is a core vulnerability.

      Financial stability risks represent the key challenge. Developments in the Swedish housing market (reflecting a longstanding supply-demand imbalance) and risks associated with high household indebtedness remain rating-relevant vulnerabilities. As such, policy actions within housing and tax policy, the gradual tightening of monetary policy and tight macroprudential policies are needed. Real estate prices for permanent dwellings have stabilised somewhat since Q2 2018, after declining 2.0% between Q4 2017 and Q2 2018 but remain 63% higher on levels from Q1 2009 and 344% higher than those from Q3 1993. Sweden’s corporate debt amounted to 186% of GDP in Q1 2019 – up slightly from 175% as of Q2 2016. Household debt, at 181% of gross disposable income in Q1 2019, has moreover nearly doubled from 98% at the start of the century and is very high compared with levels in other EU countries, meaning household balance sheets could be stressed in scenarios of a sudden increase in interest rates, a rise in unemployment and/or a sharp fall in house prices.

      At the same time, Scope considers rating risks from financial imbalances to be mitigated by the continued proactive actions of regulators, such as mortgage amortisation requirements for new loans with a loan-to-value ratio of above 50% and a stricter amortisation requirement for households with mortgages of over 4.5 times gross income. Sweden will raise its countercyclical capital buffer rate from 2.0% to 2.5%, effective September 2019 – after which it will have the highest such rate in the world alongside Norway and Hong Kong. Owing in part to regulatory steps and the soft housing market, lending to households has moreover moderated to 4.9% YoY as of June, from 2016 peaks at 8.7% YoY – helping bring growth in household debt more in line with growth in income levels. The Swedish government has appointed a committee of inquiry that will propose, by 1 October 2019, ways to incorporate the contents of a new banking package into Swedish law, along Basel III lines. Under changes to Pillar 1 and Pillar 2 requirements, automatic restrictions imposed on banks when their capital levels decline will occur at an earlier stage. Swedish banks will also need to meet a new leverage ratio requirement, alongside a net stable funding ratio, the latter meaning that a certain share of banks’ lending with a maturity of longer than a year must be funded by either deposits or market funding with a maturity of more than one year. Binding minimum levels are to be introduced regarding systemically important banks’ MREL requirements and how they ought to be met.

      The European Banking Authority's 2018 stress test showed that the major Swedish banks (including Nordea, since the bank still had a Swedish parent company when the stress test began) are resilient to a sharp deterioration in the economy. Nonetheless, vulnerabilities and risks in the Swedish banking system, including its continued size (2.8 times Swedish GDP), heavy reliance on wholesale (foreign) funding, deep interconnectedness with other Nordic and Baltic banking sectors, and, in some cases, exposure to liquidity risks, cannot be understated. The change of headquarters by Nordea, the largest financial services group in the Nordic region, from Sweden to Finland in 2018, has, however, reduced the comparative size of the Swedish banking sector to the economy. In addition, ongoing money laundering investigations into Swedish banks could affect confidence in the banking system and risk higher funding costs. As a result of the risk-weight floor for Swedish mortgages being moved from Pillar 2 to Pillar 1, Swedish banks’ weighted average regulatory tier 1 capital decreased to 18.5% of risk-weighted assets as of Q1 2019, from 23.4% as of Q3 2018. Still, non-performing loans are low in the Swedish financial system at 0.5% of total loans.

      Parliamentary elections in September 2018 resulted in a hung parliament. On 18 January 2019, Stefan Löfven of the Social Democratic Party was re-elected prime minister of a Social Democrat-Green Party minority coalition, with parliamentary support from the Centre Party and the Liberal Party.

      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 Sweden. 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 Sweden, 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) vulnerability to short-term external shocks; vi) banking sector performance; and vii) banking sector oversight and governance. A relative credit weakness is signalled for: i) financial imbalances and financial fragility.

      The combined relative credit strengths and weaknesses generate a two-notch adjustment and indicate a sovereign rating of AAA for Sweden.

      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. Sweden’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 Sweden has the second-highest CVS score on a composite index of six World Bank Worldwide Governance Indicators among Scope’s rated sovereign universe, with high scores across Voice & Accountability, Political Stability, Government Effectiveness, Regulatory Quality, Rule of Law, and Control of Corruption. Qualitative governance-related assessments reflect Scope’s QS evaluations of ‘neutral’ on ‘recent events and policy decisions’ as well as on ‘geo-political risk’ compared with Sweden’s sovereign peer group.

      Social factors are captured in Scope’s CVS in Sweden’s high GDP per capita (of USD 53,873 in 2018), medium level of risk associated with its national unemployment rate, and high level of risk from its old-age dependency ratio. Sweden tied for seventh in the world on the United Nation’s 2018 Human Development Index – an indicator predicated on life expectancies, educational achievement and income levels. Sweden’s Gini coefficient – designating income inequality – is very low by international standards after taxes and transfers. Social considerations and impacts of social factors on the economy are reflected in Scope’s QS evaluations of ‘neutral’ on Sweden’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.

      Sweden maintains a strong record on environmental sustainability and recorded the fifth highest score in the 2018 Environmental Performance Index. According to the OECD’s 2014 Environmental Performance Review of Sweden, Sweden is a leader in many fields of environmental policy. It is among the most innovative OECD countries in environment-related technology and has pioneered multiple policy instruments, many based on the principle of internalising a price on environmentally damaging activities. Sweden’s goal to cut greenhouse gas emissions continues to progress and the government has committed to ambitious climate goals. With neighbouring countries, Sweden shares a responsibility for the Baltic Sea, a very vulnerable marine ecosystem. Sweden should maintain an emphasis on marine ecosystem objectives in comprehensive environmental protection policies. In the 2019 Spring Budget, SEK 2.0bn was dedicated to further reforms geared towards Sweden’s transition towards becoming a fossil-free welfare nation.

      Outlook and rating-change drivers

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

      The ratings/Outlooks could be downgraded if, individually or collectively: i) a sharp correction in the housing market significantly damaged the resilience of the economy, household balance sheet and banking system; ii) Sweden’s fiscal framework were to deteriorate and/or fiscal dynamics were to worsen significantly, resulting in a materially higher level of government debt; and/or iii) a global or regional economic crisis were to spill over into the Swedish economy and financial system, moreover damaging the government balance sheet.

      Rating committee
      The main points discussed during the rating committee were: i) monetary policy update; ii) growth potential; iii) fiscal framework and debt developments; and iv) financial sector oversight; and v) peer developments.

      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 Sweden, the Sveriges Riksbank, the Riksgälden, European Commission, European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), IMF, OECD, 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
      © 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions 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 does not, 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 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 assess independently 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 such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5, D-10785 Berlin.

      Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Directors: Torsten Hinrichs and Guillaume Jolivet.

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