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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Kingdom of Sweden’s long-term issuer and senior unsecured debt ratings at AAA in both local and foreign currency and maintained the Stable Outlook. The short-term issuer rating has been affirmed at S-1+ in both local and foreign currency with Stable Outlook.

Summary and Outlook

The Kingdom of Sweden’s long-term AAA/Stable ratings are underpinned by the following credit strengths: i) the country’s wealthy and diversified economy; ii) a strong fiscal framework and low level of public debt; and iii) a robust external position driven by consistent current account surpluses, a net international creditor position and international reserves that shield the country from short-term shocks. Challenges relate to: i) financial stability risks, including from high levels of household and corporate debt; and ii) risk of a severe correction in the housing market.

The Stable Outlook reflects Scope’s view that the risks Sweden faces over the next 12 to 18 months are well balanced.

The rating/Outlook could be downgraded if, individually or collectively: i) the fiscal outlook deteriorated, resulting in a significant increase in public debt; and/or ii) there is a significant deterioration in the economic outlook, for example resulting from a sharp correction in the housing market.

Rating rationale

The first driver supporting Sweden’s AAA ratings is the country’s wealthy and diversified economy. Sweden’s economy rebounded quickly from the Covid-19 crisis, growing by 4.8% in 2021 following a mild contraction of 2.8% in 2020. By early-2021, economic output reached pre-pandemic levels on the back of strong private consumption, recovering investments and contact-related services. The strong growth momentum continued during the first half of 2022 but has since slowed significantly due to the fallout from the Russia-Ukraine war. While the two countries account for less than 2% of Swedish exports, wider inflationary pressures and the close interconnection with European electricity markets caused energy prices to surge. This has resulted in increasingly tighter financial conditions and a cooling of the housing market.

Scope expects GDP to increase by 2.7% in 2022, but contract by 0.3% in 2023 as the economy enters a new phase of higher interest rates which significantly curb consumer spending and constrain corporate profit margins in some sectors. Risks to the outlook remain tilted to the downside as inflationary pressures could worsen, financial imbalances could result in the materialisation of financial stability risks and international geopolitical tensions could intensify.

Inflation has been increasing rapidly since mid-2021, rising from 2.4% in August 2021 to 9.0% in August 2022. Even when excluding the impact of higher energy prices, core inflation was still exceptionally high at 6.8%, well above the Riksbank’s target of 2%. Inflation is projected to increase further in the short term, reaching 11% at the beginning of next year before easing in 2024. In response, the Riksbank’s Executive Board raised the policy rate by one percentage point to 1.75% in September and, while the outlook remains highly uncertain, Scope expects further rate hikes with the policy rate reaching 2.25% by the end of 2022. However, policy rates are then expected to only increase marginally in 2023 as economic growth slows sharply and private sector borrowers adapt to the higher interest rate environment.

Sweden’s labour market has recovered strongly from the Covid-19 shock and remains tight despite the slowing economic growth. The employment rate reached its highest level in more than a decade at 69.3% in August. Similarly, the unemployment rate fell to 6.9% in August, remaining well below the pre-pandemic level of 7.4% in January 2020. While wage growth has been muted so far, the large increase in inflation and broad labour shortages across most sectors and regions is likely to push up wages. Pay deals for more than 2 million wage earners (or more than 35% of the country’s total workforce) are due to be renegotiated during the spring 2023. Scope expects that the economic slowdown and falling corporate profit margins will lead to a higher unemployment rate, averaging 7.7% in 2023, up from 7.4% in 2022.

The second driver supporting Sweden’s AAA rating is its strong fiscal framework and low public debt ratio. The credible fiscal policy framework enabled the government to implement an effective fiscal response to the Covid-19 pandemic with a focus on the green transition and inclusion objectives. It also places the government in a strong position to shield households from rising energy prices and from increased military spending requirements following the escalation of the Russia-Ukraine war.

The debt-to-GDP ratio increased from 35% in 2019 to almost 40% in 2020, before declining to 37% last year. Scope expects debt-to-GDP to fall below pre-pandemic levels this year, reaching 33.5%. Slower economic growth and rising spending pressures are then expected to increase debt levels to around 36% by 2024 before gradually declining. The debt level is therefore set to remain within the limit of the 35% (+/-5%) of GDP threshold specified in the fiscal framework. Sweden’s debt level remains one of the lowest among EU member states.

The strength and resilience of the public finance position enabled the government to adopt a large package of fiscal measures during the Covid-19 pandemic. This amounted to SEK 385bn of budgeted measures in 2020-21 (7.2% of 2021 GDP) and an additional SEK 989bn (18.4% of 2021 GDP) in various forms of liquidity, loans and guarantees. The forming of a new government following the September elections is delaying the announcement of further support measures in light of the cost-of-living pressures. Scope expects that a mix of tax cuts and increased subsidies to households and businesses will be implemented.

Government projections from May 2022 published in the convergence programme estimate a surplus of 0.2% of GDP this year due to higher revenue from consumption taxes as a result of higher inflation. Scope expects budget deficits of around 2% of GDP in 2023 and 2024 reflecting an expected outflow of capital from tax accounts, partially offsetting higher tax income, and a fiscal policy set to remain expansionary in the short term. This particularly reflects increased expenditure in social care services to support Ukrainian refugees and higher defence spending given the objective to spend 2% of GDP in the near term, up from SEK 76.6bn (1.3% of GDP) in the 2022 budget. Moreover, Scope expects additional support in the form of tax cuts and subsidies to households and businesses to help with rising electricity prices, beyond the 0.3% of 2021 GDP already introduced in March.

Sweden’s AAA rating is further supported by its robust external position and the regional safe haven status of its currency. Sweden is an open, diversified economy that has benefited from current account surpluses over the last two decades and has a net external creditor position. Paired with a stable level of reserves, the latter shields the country from short-term shocks. The current account surplus widened to 6.1% of GDP in 2020, but has since been declining, reaching 2.4% in Q2 2022. The decline is due to higher imports of services and a weaker export performance. Particularly car and truck manufacturers were impacted by supply chain disruptions which hampered production. However, full order books of exporters and the easing of supply chain problems, indicate continued stable activity in the sector. Scope expects that the wider economic slowdown will result in a slowing of new orders and therefore a decrease in goods exports next year. The IMF projects that the current account balance will stabilise at just under 4% in the medium term.

In addition, Sweden’s external debt stood at 178.1% of GDP in Q2 2022, 8 pps higher than in 2021, but significantly lower compared with 2009 debt levels of around 200% of GDP. External debt is mainly related to financial institutions (60% of total external debt), intercompany lending (21%) and non-financial corporates (15%), while the central bank and government account for the remaining 5%. Sweden’s international reserves, amounting to 11% of GDP in July 2022, provide a buffer against financial market volatility.

Official reserve assets averaged USD 44bn in 2021 (7% of GDP) and stood at USD 44.2bn in July 2022. Given Swedish banks’ high dependence on wholesale funding in foreign currency and the disruptions that can occur to such funding in times of financial distress, it is important for Sweden to maintain adequate levels of foreign reserves. Sweden’s net international investment position continued to improve, reaching 20% of GDP in 2021. It increased further during the first half of 2022 mainly due to a greater decline of the Swedish stock market compared with international stock markets. This caused foreign-held assets in Sweden to decrease more in value than Swedish assets abroad.

Despite these key credit strengths, Sweden’s ratings remain constrained by the following challenges:

First, there are growing financial stability risks, particularly from high levels of household and corporate indebtedness. Private sector debt stood at 268% of GDP, the highest on record and the highest among Nordic economies. Debt levels of Swedish households fell slightly during the pandemic from a peak of 95% in Q1 2021 to 92% in Q1 2022. However, their debt-to-income ratio has increased by more than 35 pps in the past 10 years and exceeded 200% in early 2022.

Household debt mainly relates to mortgages and nearly half of mortgages have refinancing terms of less than one year, so rapidly rising interest rates are expected to pressure household incomes during 2023 and beyond. Debt levels of non-financial corporations also remain at their highest level on record at 181% of GDP in Q1 2022. Corporate debt has mainly grown in the form of bank loans and more than 40% of total loans relate to real estate companies where refinancing risks have increased. Banks’ exposure to the commercial real estate sector represents between 10% and 25% of banks’ lending activity. Stress tests conducted by the Financial Supervisory Authority indicate that higher credit losses could materialise for the sector if financing costs remain elevated as highly leveraged real estate companies would face lower earnings.

While financial stability risks are elevated, the Swedish banking sector enters the phase of rising interest rates from a relatively strong position. The country’s large banking sector is concentrated in five major banks that are highly interconnected and dependent upon global financial markets for funding. The sector remained resilient during the Covid-19 crisis, supported by significant capital buffers, stable CET1 ratios of around 20% and low levels of non-performing loans. Given rising energy and commodity prices, the risk of an economic slowdown and expectations of higher interest rates, the Swedish Financial Supervisory Authority decided in June to increase the countercyclical capital buffer to 2%, effective from June 2023, after having reduced it to 0% during the pandemic.

Second, as the housing market has started to cool, the risk of a more severe market correction remains. The HOX Index (which measures Swedish residential real estate prices) reached its peak of 303.4 in March 2022. Since then, it has declined every month, falling 8.7% by August. Scope expects further falls in house prices in the region of 15% from March 2022 levels, reflecting a broad market correction in response to rapidly rising interest rates.

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

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative credit rating of ‘aaa’ as regards Sweden. The ‘aaa’ indicative ratings can thereafter be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Sweden, the following relative credit strengths have been identified: i) macroeconomic stability and sustainability; ii) fiscal policy framework; iii) debt sustainability; iv) resilience to short-term shocks; v) environmental factors; and vi) governance factors. Sweden’s relative credit weaknesses are: i) financial imbalances.

The combined relative credit weaknesses and strengths identified in the QS generate a two-notch positive adjustment to the ratings and indicate a sovereign credit rating of AAA for Sweden.

A rating committee has discussed and confirmed these results.

Factoring of environment, social and governance (ESG)

Scope explicitly factors in ESG sustainability issues during its rating process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) as well as in the methodology’s qualitative overlay (QS).

Environmental factors are explicitly considered in the rating process via the environment sub-category under the ESG risk pillar. Sweden receives high scores in the CVS indicators measuring CO2 emissions per GDP, the exposure and vulnerability to natural disaster risks, and the ecological footprint of consumption compared with available biocapacity. In line with other advanced economies, the country receives a lower score for the CVS indicator measuring greenhouse gas (GHG) emissions per capita. Scope assesses Sweden’s QS adjustment for ‘environmental factors’ as ‘strong’. The country is on track to meet its EU GHG emission reduction target of 50% by 2030. In addition, it aims to meet 100% of its electricity needs from renewable sources by 2040 and become a net-zero economy by 2045. According to the Climate Policy Council of Sweden, however, policies need to be further strengthened in order to achieve the ambitious neutrality target in 2045. In 2021, around 29% of energy consumption came from fossil fuels, 22% from nuclear and 49% from renewable sources, in particular hydropower. The country has a low dependence on natural gas, which accounts for only 2% of its total energy consumption. Sweden was one of the first countries to implement a carbon tax in 1991 and currently imposes it at SEK 1200 (around EUR 110) per tonne, which is among the highest levels in the world, although still applied to a limited share of carbon emissions.

Sweden benefits from favourable demographics and from an advanced social safety net, contributing to low income inequality. The employment rate is among the highest in the EU and the gender-employment gap is among the lowest in the EU. The level of digital skills among the population is very high. The country has accepted a very large number of refugees, but integration has proved challenging and employment levels among refugees remain relatively low. Organised crime has become an increasing concern and was a key topic during the September elections.

Sweden benefits from the high quality of its institutions and a stable political environment despite past fragile government coalitions. The right-wing coalition including the Moderates, Sweden Democrats, Christian Democrats and Liberals secured a small majority in September’s general elections. The Moderates’ leader Ulf Kristersson has been mandated to form a new government, a process which is likely to take some time. Given their election success, the far-right Sweden Democrats will play a fundamental role in the creation of a new ruling coalition.

Rating Committee
The main points discussed by the rating committee were: i) domestic economic risk; ii) public finance risks, including fiscal framework and debt dynamics; iii) external risks; iv) financial stability risks, including housing market and private sector debt; v) ESG considerations; and vi) peer developments.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation  YES
With Access to Internal Documents                               NO
With Access to Management                                         YES
The following substantially material sources of information were used to prepare the Credit Ratings: the Rated Entity, public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks is/are UK-endorsed.
Lead analyst: Eiko Sievert, Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on January 2003. The Credit Ratings/Outlooks were last updated on 5 November 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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