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.

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; and iii) a solid external position, driven by consistent current-account surpluses. These factors increase the country’s resilience to economic shocks, including the Covid-19 pandemic as well as the strong, albeit temporary, inflationary pressures and subsequent rise in interest rates following the escalation of the Russia-Ukraine war. Challenges relate to: i) vulnerabilities in the Danish financial system, including from high levels of household debt; and ii) banking sector vulnerabilities related to property prices fluctuations.

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Key rating drivers

A wealthy and competitive economy. The Danish economy recovered rapidly from the Covid shock, growing by 7.4% in 2021 and 1.5% and 2022. Economic activity proved resilient also in 2023 with a real GDP growth rate of 2.5% despite elevated inflation and high interest rates. Economic growth was mostly driven by a buoyant performance of the pharmaceutical sector, which fostered industrial production and export activities. Outside the pharmaceutical sector, however, GDP growth remained subdued last year. Scope expects real GDP growth at 2.1% in 2024 and 1.9% in 2025, before converging towards the growth potential of 1.5% by 2027. Pharmaceutical exports will continue to support economic growth this year as will the reopening of the Tyra gas field, and the gradual recovery in non-pharmaceutical sectors. The latter will benefit from a recovery in external demand and consumer purchasing power – on the back of strong growth in real wages – as well as from easing financing conditions.

Denmark’s resilience is supported by a highly competitive and flexible labour market. The employment rate reached record-highs at 77.6% in Q2 2024, driven by a large influx of international workers and increased employment among young and older people. The tight labour market has led to a strong rise in wages, also in real terms given declining inflation. Scope expects the unemployment rate to remain low but rise modestly from 5.1% in 2023 to 5.4% in 2024 and 5.2% in 2025 as the gradual normalisation of economic growth eases capacity pressures and labour markets.

Inflation (HICP) fell steadily in 2023 and stood at 1% in July 2024, aligned with core inflation and well below the 11.4% peak of October 2022 and the euro area average (2.6% as of July 2024). The large decline was driven by the normalisation of energy costs, lower food prices and price adjustments by businesses. Scope expects the inflation rate at 2% in 2024 and 1.9% in 2025 as rising wage costs and the recovery of consumer purchase power are likely to sustain price pressures. 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 restrict the central bank’s ability to address financial imbalances, control the money supply and take unconventional measures such as quantitative easing. Danmarks Nationalbank cut its deposit rate by 25bps in June 2024 to 3.35%. This remains in line with the ECB’s monetary policy, whose interest rate on the deposit facility was cut to 3.75% in June.

Sound public finances, low public debt, excellent market access. General government finances have been in surplus for the past seven years, with an average headline fiscal balance at 2.5% of GDP. Fiscal policy has been tightened over the past two years by -1.6% of GDP in 2022 and -1.3% in 2023. This reflects the withdrawal of Covid-19 supporting measures which was partially offset by the discretionary spending to support Ukraine and compensation measures for high energy prices. Looking ahead, Scope expects the fiscal balance to remain in surplus of around 1.6% this year and 0.8% in 2025, turning to a small fiscal deficit by 2029 as the government targets a structural deficit of 0.5% of GDP in the medium term.

This gradual easing of fiscal policy should allow for an effective use of Denmark’s large fiscal space, focusing on increasing military and defence spending, the green transition, reducing fiscal pressure on workers via the personal income tax reform and raising welfare resources for municipalities. Moreover, the government retains budget flexibility to mitigate cost pressures related to health and long-term care. Denmark’s long term fiscal outlook is supported by its forward-looking pension policies given its 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. On this basis, Scope expects the gross general government debt ratio to stay well below the pre-pandemic level of 33.7% of GDP, declining to 28% of GDP this year and falling to 27.2% by 2029.

In addition, the government retains significant financing flexibility through its liquidity buffer estimated to reach DKK 227bn (8% of GDP) at the end of 2024, well above the target band of DKK 50bn-75bn¹. 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 2024 amounts to DKK 65bn (or 2.3% of GDP) and DKK 35bn (1.2% of GDP) respectively.

Solid external position and regional safe haven. Denmark’s AAA ratings are further supported by its solid external position with current-account surpluses driven by large financial sector, very high domestic savings and strong exports of high-value goods and services resulting in a net international investment position of 49.8% of GDP as of Q4 2023, up from negative 5% in 2008. Scope expects the strong performance of the pharmaceutical sector to result in continued large current account surpluses of around 10% of GDP until 2025. Danish external debt declined from above 185% of GDP in 2010 to 132% in 2023 and relates mainly to debt in the financial institutions sector (72% of GDP). Both short-term debt (59.1% of GDP) and long-term debt (72.6% of GDP) remain low by historical comparison.

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 642.4bn (23% of 2023 GDP) as of July 2024. While the krone is not considered a global reserve currency, Scope assesses it positively as a regional safe-haven currency due to the longstanding exchange rate peg.

Rating challenges: high household debt and banking sector exposure to real estate sector

Household debt level is the highest among OECD countries at 209% of net disposable income in 2023. With mortgage loans accounting for more than 80% of lending to households and businesses, high levels of debt increase vulnerability to rising interest rates, higher unemployment and sharp declines in house prices. Danmarks Nationalbank has recently highlighted a decrease in new lending for home purchases with a high debt-to-income ratio, increasing the resilience of homebuyers. However, higher interest rates make debt service more expensive, leading homebuyers to spend a larger portion of their disposable income on debt service. Moreover, the increasing proportion of variable rate mortgages in recent years – accounting for 54% of total mortgage lending in April 2024 – and the widespread use of interest-only loans amplify the negative impact of high interest rates².

However, these risks must be viewed in the context of very high levels of household assets, a strong labour market and Denmark’s generous social security system, which provide a strong safety net against short-term income shocks. In addition, Denmark’s unique mortgage system has also helped to lower household debt over the past year from 252% of net disposable income in 2021 to 209% in 2023. As most mortgage bonds in Denmark that are tied to a loan are callable for borrowers at any time, a large share of fixed-rate borrowers was able to refinance their mortgages as interest rates increased. Since the rise in long-term interest rates caused the market prices of these bonds to fall, homeowners were able to convert their loan to a higher rate mortgage, but with lower outstanding debt.

Finally, Denmark’s banking sector is highly exposed to the real estate sector, including commercial real estate. Prices for single-family houses and owner-occupied flats in Denmark fell by 6.2% and 7.2%, respectively, between Q2 and Q4 2022 but they started to increase right after, being 16% and 15% above pre-pandemic levels as of Q3 2023. Since then, growth in house prices has stagnated, reflecting a declining number of property transactions. The new property tax reform effective from January 1st, 2024 will likely contribute to reduce house prices fluctuations in the future as it aligns property taxes with the development in house prices. However, exposures to commercial real estate remains a vulnerability for Danish banks and have previously resulted in large losses.

Properties tend to be mortgaged through mortgage credit institutions and 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. Mortgage banks’ real estate lending makes up around 47% of total Danish financial sector assets as of July 2024, while loans to real estate companies account for around 38% of credit institutions’ total lending to non-financial corporations. The country’s highly interconnected financial system of mortgage credit institutions, pension funds and insurance companies can expose the financial system to global CRE market volatility. The risk of credit losses in case of a large shock is significant for banks as they tend to provide the financing to mortgage banks which ranks the lowest in terms of the underlying collateral in case of a default.

However, the banking sector has significant loss absorption capacity. The share of non-performing loans remained stable at a historical low of 1.3% in Q1 2024 (compared to a 1.9% euro area average), while regulatory Tier 1 capital to risk-weighted assets stood at 20.1% (compared to a 17.4% EU average) and profitability has improved given higher interest rates, which increased core earnings and strengthened banks’ first line of defence against losses. Still, the central bank’s semi-annual stress test indicated that some systemic credit institutions would not be able to meet their total MREL requirement during a one-year period of restricted new debt issuance and they would not be sufficiently capitalised to withstand a severe recession should their initial capital ratios be at the level of their capital targets³.

Outlook and rating sensitivities

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

Downside scenarios for the rating and Outlooks are (individually or collectively):

1. Increase in financial system risks resulting in broader systemic risks, which lead to the materialisation of contingent liabilities on the government’s balance sheet;
    
2. A significant and sustained deterioration in the medium-term economic and/or fiscal outlooks.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘aaa’ for Denmark, which was approved by the rating committee. Under Scope’s methodology, the indicative rating receives 1) zero notches positive adjustment from the methodological reserve-currency adjustment; and 2) no negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘aaa’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of Denmark’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

Scope identified the following QS relative credit weaknesses for Denmark: 1) macro-economic stability & sustainability; 2) fiscal policy framework; 3) resilience to short-term external shocks; 4) environmental factors and 5) governance factors. Conversely, Scope identified no QS relative credit strengths for Denmark. On aggregate, the QS generates a positive two-notches adjustment for Denmark, resulting in final AAA long-term ratings.

A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

For environmental factors, Denmark receives high scores in SQM indicators measuring carbon emission 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), reach carbon neutrality by 2050 and use 100% green gas in heating by 2030. The country has earmarked almost 70% of its share of the EU’s Recovery and Resilience Facility for green initiatives, well above the EU’s 37% target. Around 45.2% of energy consumption came from renewable sources in 2023. The Danish Council on Climate Change noted in February 2024 that the Danish government is likely to meet the 50-54% emissions reduction by 2025. Moreover, even though the government has not explicitly demonstrated that the 70% emissions reduction target by 2030 will be met, the reduction gap has been significantly reduced to around 2.6m tons of CO2, compared to 20m tons assessed in February 2023, mainly due to a significant downward adjustment of Denmark’s total area of carbon-rich soils⁴. In June 2024, Denmark became the first country in the world to introduce a carbon tax on agricultural emissions, amounting to DKK 120 per ton of CO2 from 2030 and DKK 300 per ton in 2035, further supporting the achievement of the country’s GHG emission reductions targets.

For social factors captured under the SQM, Denmark benefits from low income inequality, high labour force participation, 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. The integration of non-EU migrants is improving as observed by the narrowing gap of employment rates of ethnic Danes and foreign nationals. The government has taking several initiatives to address skill shortages in the labour market, raise productivity and increase labour supply implementing, among other measures, tax reductions for persons in employment to incentive people to work more. The National Reform Programme passed in May 2023 includes welfare reforms aimed at increasing employment by 45,000 full-time persons by 2030⁵.

Under governance-related factors captured in the SQM, Denmark scores well on a composite index of five World Bank Worldwide Governance Indicators, reflecting high quality institutions and a stable political environment. Prime Minister Mette Frederiksen leads a minority government following snap elections in November 2022. Minority governments, which require broad coalition-building to pass specific laws are common in Denmark, given the 2% threshold required to gain seats in parliament. Therefore, a long history of consensus-building supports long-term policy continuity.
 
Rating committee
The main points discussed by the rating committee were: i) domestic economic risk, including significant contribution of the pharmaceutical sector to the country’s GDP growth; ii) latest public finance developments; iii) financial stability risks, including financial system risks, housing market developments and private sector debt; and v) peer developments.

Rating driver references
1. Danmarks Nationalbank – Central government borrowing strategy for 2nd half 2024, June 2024
2. Danmarks Nationalbank – Higher interest rates have strenghtened the resilience of banks, but also pose a risk, May 2024
3. Danmarks Nationalbank – Higher interest rates have strenghtened the resilience of banks, but also pose a risk, May 2024
4. Danish Council of Climate Change – Status Outlook 2024, February 2024
5. Ministry of Finance – Denmark’s National Reform Programme 2023, May 2023

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), available in Scope Ratings’ list of models, published under 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 and/or Outlooks 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: Alessandra Poli, Analyst
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Ratings/Outlooks were last updated on 29 September 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis 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.