Rating action

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

Summary and Outlook

The Kingdom of Denmark’s long-term AAA/Stable ratings are underpinned by the following credit strengths: i) the country’s wealthy and competitive economy; ii) sound public finances and a low level of public debt; iii) a solid external position, driven by consistent current-account surpluses; and iv) a strong institutional framework and stable governance. These factors increase the country’s resilience to economic shocks, including from the Covid-19 pandemic and rising inflationary pressures following the Russia-Ukraine war, and they provide the government with fiscal space to support the economy with countercyclical fiscal measures. Challenges relate to: i) banking sector vulnerabilities related to high property prices; and ii) vulnerabilities in the Danish financial system, including from high levels of household debt.

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

The rating/Outlook could be downgraded if, individually or collectively: i) a severe economic shock resulted in a material decline in medium-term growth prospects; ii) the fiscal outlook deteriorated, resulting in a significant upward trend in government debt-to-GDP ratios; and/or iii) banking system risks increased and resulted in broader systemic risk, leading to the materialisation of contingent liabilities on the government’s balance sheet.

Rating rationale

The first driver supporting Denmark’s AAA ratings is the country’s economic resilience, demonstrated during the pandemic and the current energy crisis. Economic output rebounded strongly by 4.9% in 2021 following a decline of 2.0% in 2020 due to the Covid-19 pandemic. Growth during the first half of 2022 was mixed, with GDP declining by 0.5% in Q1 compared with the previous quarter and growing by 0.9% in Q2. Consumption is likely to remain weak during the second half of 2022 due to lower purchasing power of households and declining house prices, although high levels of savings in recent years help cushion the impact of rising inflationary pressures. Following the rapid recovery after the Covid-19 pandemic, Scope expects the Danish economy to grow by 2.3% in 2022, followed by a 0.3% contraction in 2023 as persistent price pressures and a slowdown in key export markets remain a drag on growth. From 2024, Scope expects a gradual return to Denmark’s medium-term growth potential of around 1.5% per year.

Denmark has a highly competitive and flexible labour market. The unemployment rate fell to 5.1% in 2021. Given continued labour shortages and high levels of job vacancies, Scope expects the unemployment rate to fall to 4.4% in 2022 and rise moderately to 4.9% in 2023. Despite the tight labour market, wage growth has been modest so far, leading to a decline in real wages. This is unlikely to persist, and there remain upside risks to wage growth if inflation expectations become more entrenched.

Inflation (HICP) reached 9.9% in August 2022 compared with the same month in 2021. This is the highest level on record. Energy, food and transport prices have been rising sharply, and core inflation is expected to reach 5.1% in 2022 and remain elevated at 4.5% in 2023 and 3.2% in 2024. Denmark’s central bank pegs its exchange rate to the euro. As euro area monetary policy targets an inflation rate of 2% over the medium term, the fixed-exchange-rate policy provides a framework for returning inflation to a low and stable level. However, limited monetary policy and exchange rate flexibility restricts the central bank’s ability to address financial imbalances, control the money supply and take unconventional measures such as quantitative easing. Danmarks Nationalbank increased its deposit rate to 0.65% in September. This remains in line with the ECB’s monetary policy, whose interest rate on the deposit facility stood at 0.75% in September.

The second driver supporting Denmark’s AAA ratings is the country’s sound public finances and low level of public debt. In response to the fallout from the Russia-Ukraine war, the Danish government plans to gradually raise defence spending from 1.4% of GDP in 2020 to 2% of GDP by 2033. Announced support measures for households and businesses include a temporary, voluntary scheme to spread the costs for electricity, gas and district heating bills over several years, a reduction in the electricity tax and subsidies for low-income households. The government plans to increase the limit on the structural deficit from 0.5% of GDP to 1% of GDP and target a government deficit of 0.5% of GDP in the medium term. This will allow for more effective use of Denmark’s large fiscal space while providing budget flexibility to accommodate increased military spending and fund investments to support the green transition. Scope expects the fiscal balance to remain in surplus of around 1.1% this year, down from 2.6% in 2021, and gradually decline and turn into a small deficit in the coming years. Denmark’s fiscal outlook is further supported by its forward-looking pension policies given an ageing population. The retirement age increases to 67 this year and is expected to rise to 68 by 2030, after which it will be linked to future increases in life expectancy.

The general government debt ratio declined in the years before the pandemic, falling from 46.1% of GDP in 2011 to 33.7% in 2019. Fiscal support measures caused the ratio to increase to 42.2% in 2020, which compares favourably to an average of around 50% in peer countries with AAA ratings. Scope expects the continued fiscal surpluses and fast economic recovery following the pandemic to lower the debt ratio to 31.9% this year, which is below pre-pandemic levels. Spending pressures due to an ageing population and continued investment needs are likely to result in a broadly stable public debt level over the next few years.

The government retains significant financing flexibility through its cash buffer of DKK 123bn (4.5% of GDP), well above the target band of DKK 50bn-75bn. The buffer supports the government’s efforts to maintain stable issuance volumes to investors and allows for some flexibility should market conditions result in a lower issuance than planned. The target for sales of domestic government bonds and short-term loan programmes in 2022 amounts to DKK 65bn and DKK 35bn respectively.

Denmark’s AAA ratings are further supported by its solid external position, driven by current-account surpluses that have been consistently above the peer group average. The IMF forecasts Denmark’s current-account surplus will decrease slightly from 8.8% in 2021 to 7.4% in 2023 and remain above 7% during the subsequent five years. This follows more than two decades of persistent current-account surpluses, reflecting Denmark’s large financial sector, very high domestic savings and strong exports of high-value goods and services. Danish exports recovered quickly and grew by 8% following the pandemic shock, which led to a decline in services activities, particularly in the transport, construction and IT sectors. While Denmark has a highly competitive and less cyclically sensitive export sector, the economic slowdown among key trading partners is likely to slow export growth to 2.4% this year and only 0.3% in 2023.

Danish external debt declined from above 185% of GDP in 2010 to around 145% in 2019 before increasing again at the onset of the pandemic. It stood at 151% in 2021 and relates mainly to debt in the financial institutions sector (93% of GDP). Short-term debt relative to total gross external debt has also declined, from 52% in 2010 to 44% in 2021. Reflecting Denmark’s high level of domestic savings, the country’s external position remains sound, with a net international investment position of 72.7% of GDP as of 2021, up from negative 5% in 2008. This is in line with the peer group average.

Denmark’s central bank has intervened repeatedly in foreign-exchange markets since October 2019 to support the krone's peg to the euro. It has succeeded in maintaining the peg in line with its primary mandate. Denmark’s credible commitment to maintaining its fixed exchange rate is backed by its large official reserves, totalling DKK 560.7bn (22% of 2021 GDP) as of September 2022. While the krone is not considered to be a reserve currency, it is seen as a regional safe-haven currency due to the longstanding exchange rate peg.

Despite these key credit strengths, Denmark’s ratings face the following challenges:

First, the banking sector is highly exposed to real estate markets and vulnerabilities related to high property prices. House prices increased by more than 20% in the period between the onset of the pandemic and Q2 2022. The economic slowdown and rising interest rates make a correction in the housing market likely. The central bank’s June financial stability report noted the rising number of mortgage loans with deferred amortisation granted by credit institutions, even to homeowners with high loan-to-value ratios. This increases vulnerabilities to a downturn in the housing market, although households’ sensitivity to higher interest rates at an aggregate level has fallen in recent years due to a shift towards fixed-rate mortgages.

The financial system is exposed to the domestic housing sector, with mortgage banks’ real estate lending comprising around 44% of total Danish financial sector assets as of August 2022. Denmark’s high level of household savings and assets held in the pension system facilitated the development of the world’s largest mortgage-covered bond market. A sharper correction in the housing market could result in spillover effects in Denmark’s highly interconnected financial system of mortgage credit institutions, pension funds and insurance companies.

The banking sector enters the current period of slowing growth and rising inflation from a relatively strong position. The share of non-performing loans stood at 1.2% in 2021 (compared to a 1.8% peer group average) while regulatory Tier 1 capital to risk-weighted assets stood at 20.3% (compared to a 19.1% peer group average). However, there are large differences across credit institutions, and the central bank’s semi-annual stress test indicated that some systemic credit institutions come close to breaching the combined capital buffer requirements in a severe recession scenario. The Systemic Risk Council recommended that the countercyclical capital buffer be increased to 2.5% from March 2023, and all systemic credit institutions are expected to meet the higher capital requirements.

Second, there are vulnerabilities in the Danish financial system, including from high levels of household debt. Household debt amounted to 248% of net disposable income in 2021, the highest among EU and OECD countries. High levels of mortgage debt have increased vulnerability to rising interest rates, higher unemployment and sharp declines in house prices. However, these risks must be viewed in the context of very high levels of household assets, with Danish households’ net worth at 956% of their net disposable income in 2021, the highest level in the EU and OECD. This provides a strong safety net against short-term income shocks.

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 rating of ‘aaa’ for the Kingdom of Denmark. The qualitative scorecard (QS) can adjust this indicative rating by up to three notches depending on the size of relative qualitative credit strengths or weaknesses versus a peer group of countries.

For the Kingdom of Denmark, the following relative credit strengths have been identified: i) macroeconomic stability and sustainability; ii) fiscal policy framework; iii) resilience to short-term external shocks; iv) environmental factors; and vi) governance factors. Relative credit weaknesses are: i) fragility due to financial imbalances.

The combined relative credit strengths and weaknesses 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 explicitly factors in ESG sustainability issues during its ratings process via the sovereign methodology’s standalone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) as well as in the qualitative overlay (QS).

With respect to environmental factors, Denmark receives high scores in CVS indicators measuring carbon emissions per unit of GDP and exposure and vulnerability to natural disaster risks, with lower scores for greenhouse gas (GHG) emissions per capita. Scope assesses Denmark’s QS adjustment for ‘environmental factors’ as ‘strong’. The country aims to reduce GHG emissions by 70% by 2030 (relative to 1990 levels) and reach carbon neutrality by 2050, and it has recently set a goal of achieving 100% green gas in heating by 2030 to reduce its dependence on Russian gas. The country has earmarked 60% of its share of the EU’s Recovery and Resilience Facility for green initiatives, well above the EU’s 37% target. In addition, it issued its first green bond in January with an expected issuance volume of up to DKK 15bn. Around 39% of energy consumption came from renewable sources in 2021, and coal consumption has declined rapidly in recent years, from 19% in 2010 to just 7% in 2021. The Danish Council on Climate Change noted in February 2022 that while the Danish government has adopted significant mitigation measures and climate initiatives, there is still a reduction gap of 10m tonnes of CO2 to reach the 70% emissions reduction target by 2030, and further policy initiatives will be required to fill this gap. The council suggested introducing a general tax on GHG emissions as the basis of climate policy action in the run-up to 2030.

Factors related to Denmark’s social profile are captured in Scope’s CVS, where the country benefits from low income inequality and high labour force participation. Denmark benefits from high GDP per capita and an advanced social safety net, which contributes to low income inequality. However, an elevated old-age dependency ratio places rising demands on welfare services, particularly healthcare. Non-EU migrants experience a high jobless rate with persistent employment gaps relative to Danes due to insufficient job qualifications. The ‘Denmark can do more’ reform plan and greater investment in education and digitalisation should help increase labour market participation in future.

Governance-related factors are explicitly captured in Scope’s assessment of a composite index of six World Bank Worldwide Governance Indicators where Denmark has the highest CVS score in Scope’s rated sovereign universe. Denmark benefits from high quality institutions and a stable political environment. Prime Minister Mette Frederiksen has called a general election to be held on 1 November following a scandal over the slaughter of the country’s entire mink population (17m animals) in 2020. Since gaining representation in parliament requires only 2% of the vote, many political parties are represented (currently more than 10), and minority governments are common, requiring broad coalition-building to pass specific pieces of legislation. A long history of consensus-building therefore supports longer-term policy continuity.

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   NO
With access to internal documents                                NO
With access to management                                          NO
The following substantially material sources of information were used to prepare the Credit Ratings: 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 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 12 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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