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ERA affirms AAA rating to Switzerland, outlook Stable
Thursday, 04 April 2019

Affirmation of the unsolicited credit rating AAA assigned to Switzerland stems from a sound fiscal position supported by a strong fiscal rule, very strong governance indicators, and high reserve coverage ratios.

Rating components

Macroeconomic factors

Economic factors

High

Debt and current account sustainability factors

Very high

Public finance factors

High

Private finance factors

High

Foreign exchange stability factors

Very high

Liquidity factors

Very high

Final assessment

Very high

Forward-looking factors

Political and economic stability

Very high

Efficiency and reforms potential

Very high

Final assessment

Very high

Overall score

Very high

Final rating

AAA

Macroeconomic factors of rating assessment

After a strong expansion in 2018, growth is likely to slow down, mainly as a result of a weaker external environment. Strong public finances supported by debt rule together with high reserves provide a strong cushion to tackle possible headwinds coming from external factors or imbalances in domestic private sector balance sheets.

Growth is likely to slow down:

In 2018, the Swiss economy expanded strongly. Real GDP grew by 2.5%, the most since 2010, mainly supported by net exports. With the external environment weakening, ERA expects real GDP growth to slow close to 1.5% in 2019. Household consumption is expected to remain subdued, reflecting stagnation in real wages, while investment activity is likely to remain strong in light of supportive monetary policy and high capacity utilization.

Risks to the outlook are tilted to the downside and are mainly related to international trade tensions (including the relationship between the EU and Switzerland). As an open economy (with exports accounting for almost 2/3 of GPD), Switzerland's output is largely sensitive to development in its major export markets. The potential impact of an external demand shock is, however, mitigated by a high level of export diversification in terms of both products and partners.

Moreover, should global trade tensions lead to a strong risk-off sentiment in the financial markets, a resumption of "safe-haven" capital inflows is very likely (the Swiss Franc is considered by investors as a safe haven, which is sought by investors in times of uncertainty). Such development would create an upward pressure on the CHF exchange rate and might lead to overvaluation of the real exchange rate, slowing output and employment growth.

Strong population growth:

In the medium-term, household consumption is likely to become a more important source of growth as a result of tight labor market conditions. Nevertheless, the growth is expected to hover around the potential rate estimated at 1.5%. While low by global standards, the Swiss economy, with GDP per capita (PPP-deflated) close to 65 thousand USD and very high productivity levels, is at the forefront of product and technology innovation and has only limited room for growth by means of technology transfer. Therefore, it is more dependent on domestic innovations for growth.

ERA expects the potential growth rate to remain close to current levels in the long-run with the potential to surprise on the upside. Positive factors such as very high institutional quality, leadership in R&D spending (3.37% of GDP in 2015, the third highest among OECD countries), and the ability to attract talent from abroad are likely to offset future negative contribution of the country's ageing population.

With respect to demographic development, recent years have shown the potential for a slower decline in the share of working age population in the future. The average annual population growth over the last decade was above 1%, the most since the sixties. While the major contributing factor has been migration, there has also been a pick-up in the rate of fertility. In 2017, it stood at 1.52%, one of the highest levels since the early nineties.

Population growth and fertility rate

img1

Source: Eurostat

Balanced budget and low debt levels:

Swiss public finances are strong. The debt to GDP ratio fell to 40.7% in 2018, the lowest level since 1991 (28.1% according to the Maastricht definition) and is far below the average for advanced economies, which is estimated at 71%. An important factor behind the declining debt is the country's debt rule. It was introduced in 2003 as a reaction to higher deficits and rising debt in the nineties.

According to this rule, the budget must be in balance over the business cycle. It allows certain adjustments by either allowing for deficits during recessions or forcing lawmakers to have surpluses during economic booms. The Swiss government follows this rule strictly. The highest deficit recorded during the last decade was only -0.4% GDP. In 2018, Switzerland recorded a fiscal surplus of 0.8% GDP.

General government balance and debt (% GDP)

img2

Source: IMF, Swiss National Bank

Swiss debt rule helped to keep the lid on public finances during the financial crisis and during the deflationary period in its aftermath. In ERA's view, the country's fiscal framework is sufficient to tackle future challenges, mainly related to ageing.

High household leverage:

The negative interest rate policy of the Swiss National Bank (with target 3-month LIBOR rate at -0.75%, the lowest in the world) is supporting credit growth. After a period of moderation in 2015-2017, which can be attributed to a series of macroprudential measures, credit growth has been picking up in the recent quarters. In January 2019, domestic credit growth accelerated to 3.8%, the highest since 2014.

The credit-to-GDP gap together with high private non-financial sector leverage (11.1% and 247% in Q3 2018 according to BIS data, respectively) indicate increased vulnerability to tighter financial conditions. This is especially true for the household sector with debt at almost 130% of GDP and more than 200% of disposable income (both are one of the highest in the world).

Household debt-to-GDP ratio in Switzerland compared to peers (Q3 2018)

img3

Source: BIS

Moreover, affordability risk in the mortgage sector is increasing; the loan-to-income ratio for new mortgages rose to a record high in 2017. These imbalances are very likely to persist as a result of the expected continuation of expansionary monetary policy in the low inflationary environment and increased risk taking in the banking sector, given low margins and profitability.

Nevertheless, the risks in the financial sector are mitigated by the high level of household assets (almost 700% of GDP), past willingness to adopt macroprudential measures and increasing capital and liquidity buffers in the banking sector (in both too-big-to-fail and domestically focused smaller banks segments).

High reserve coverage ratios:

Switzerland has persistently high current account surpluses, which are mainly attributed to positive trade balance supported by very high competitiveness (Switzerland ranked fourth in the most recent WEF global competitiveness rating). In 2018, the current account recorded a surplus of 10.2% GDP. ERA expects high current surpluses to continue in the coming years.

Foreign exchange coverage ratios are very high for an advanced economy. A massive build-up in foreign reserves has occurred during the past decade, when the Swiss National Bank was fighting deflationary risks by selling large quantities of Swiss francs on foreign-exchange markets in exchange for foreign assets. Foreign-exchange reserves currently exceed 100% of GDP and can cover more than 40% of external debt and 25 months of imports.

Reserves to months of imports and external debt

img4

Source: Swiss National Bank

Forward-looking factors of rating assessment

The high quality of government institutions implies a very supportive environment for future growth.

Very strong governance:

Switzerland scores among the best in the world in World Governance Indicators released by the World Bank. This implies the high quality of government institutions and a very supportive environment for the allocation of resources in the economy, and therefore for future potential growth.

These results are also supported by other rankings. According to the 2013 EU survey on income and living conditions, Switzerland has by far the highest level of trust in the political system among 35 European countries and scored among the best in trust in police and the justice system. It scores the third best in the latest corruption perception index (higher ranking indicates lower corruption).

Selected World Governance Indicators for Switzerland and EU (ERA score, 1-10)

img5

Source: World Bank, ERA

Outlook: Stable

The outlook has been assigned based on expectations of a soft landing of the country's main trading partners, stable development in the housing market, and the government's adherence to the debt rule.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12-month horizon.

Key assumptions

• Soft landing of the global economy from the current cyclical slowdown;

• No substantial deflation;

• Government's adherence to the debt rule;

• Stability in the housing market.

Potential outlook and/or rating change factors

A negative rating action may be prompted by:

• Substantial deviation from the fiscal rule;

• Stress in the banking sector resulting from elevated private sector debt.

Appendix 1. Peer-analysis materials. Stance among the peer-group sovereigns

General government debt/GDP (%)

img6

Source: Swiss National Bank, IMF

General government balance (% GDP)

img7

Source: Swiss National Bank, IMF

Appendix 2. Major sovereign indicators

Indicators

2014

2015

2016

2017

2018_E

2019_F

GDP, bln EUR

534.9

612.7

605.8

601.4

597.3

622

GDP growth rate, %

2.4

1.3

1.6

1.6

2.5

1.5

GDP per capita, ‘000 EUR

65.7

74.4

72.7

71.4

70.4

72.4

Population, mln

8.1

8.2

8.3

8.4

8.5

8.6

Unemployment, %

3.0

3.3

3.3

3.0

2.4

2.3

Consumer inflation, year-average, %

0

-0.8

-0.5

0.6

0.9

0.5

External debt to GDP, year-end %

151

157

170

180

165

178

Public debt to GDP, %

43.0

43.0

41.8

41.8

40.7

40.2

Gross Domestic Investment to GDP, %

23.2

23.1

22.9

23.9

24

24

International reserves, bln EUR

450

555

645

678

699

707

Trade balance, bln EUR

58

66

64

60

67

70

Exports, bln EUR

340

376

394

388

386

406

Imports, bln EUR

282

310

330

327

320

336

Current account to GDP, %

8.5

11.2

9.4

6.7

10.2

9.8

Appendix 3. List of material data sources

International Monetary Fund

World Bank

Eurostat

The Bank for International Settlements

Swiss National Bank



Regulatory disclosure

The unsolicited credit rating and outlook were issued in accordance with ERA methodology for sovereign entities in the version from July 4, 2018 (available at www.euroratings.co.uk, section Methodology). In the same section is a rating scale including an explanation of the importance of each rating category and a default definition. Information on the rate of historical failure is available at www.cerep.esma.europa.eu, and the explanatory statement of the meaning of those default rates is available at www.euroratings.co.uk (Regulatory Framework/Disclosure). This rating is issued as an unsolicited rating, i.e. was not initiated by the rated entity or a related third party. The rated entity did not participate in the rating process and the information and documentation for its development was obtained from publicly available sources in accordance with ERA methodology. ERA did not have access to the rated entity’s internal documents. ERA, in the context of routine care, verified all sources entering the rating process. ERA considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. No actual or potential conflicts of interest have arisen. Since July 30, 2012, ERA has been a registered credit rating agency according to Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies. The rated entity was notified on April 3, 2019, and after the notification there were no changes or amendments in the rating. The rating was first released for distribution on October 3, 2018.

Download pdf:

Switzerland_affirmation_report_05.04.2019.pdf


Approved by the Rating Committee:

Zuzana Hrebičková, Acting

Head of credit rating analysts

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