ACRA affirms LT AAA to Switzerland, outlook Stable

ACRA has affirmed the following ratings to The Swiss Confederation (hereinafter, Switzerland, or the country) under the international scale:

  • Long-term foreign and local currency credit ratings at AAA;
  • Short-term foreign and local currency credit ratings at S1+.

The outlook on the long-term foreign currency credit rating is Stable and local currency credit rating is Stable. This reflects the resilience of most of the macroeconomic metrics of Switzerland even under the pessimistic macroeconomic scenario.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

Credit rating rationale

Switzerland’s AAA sovereign credit rating is based on a developed, diversified, and competitive economic structure, a moderate level of public debt, and a stable external position.  The shock absorbing capacity of Switzerland is very high, as reflected by the stability of major rating factors, despite the negative impact of the COVID-19 pandemic. In ACRA’s opinion, the risks related to an overheated real estate market and the large size of the banking sector, which may potentially become contingent liability for the government, are balanced by the high level of household assets, as well as the high quality of assets and capital adequacy of Swiss banks.

According to ACRA, the economy of Switzerland, one of the ten richest countries in the world in terms of GDP per capita, grew by 0.9% in 2019. Based on the IMF’s forecast, the growth rate may decelerate to -6% in 2020 on the back of the COVID-19 pandemic, which has a negative effect on domestic consumption and external demand. However, a recovery at 3.3% is expected in 2021. In ACRA’s opinion, the economy will partly recover in the second half of 2020, as most of the quarantine measures have already been lifted. Some leading  indicators, for example, the Swiss National Bank’s (SNB) business cycle index, which measures economic activity using a wide range of high-frequency indicators, partially recovered in the second quarter after a sharp fall in the first quarter. Due to the increased demand for Swiss franc-denominated assets and relatively weak domestic demand, ACRA expects marginal deflation this year. In other words, the inflation rate is likely to be outside the lower end of the 0–2% target corridor set by the SNB.

Unlike many developed countries, Switzerland has room to maneuver when pursuing countercyclical budget policies. This is made possible by the country’s moderate level of public debt, which amounted to 39.3% of GDP at the end of 2019 and its general government budget surpluses since 2015. This makes the country’s fiscal position resilient to this crisis. According to the IMF, the total size of the fiscal package aimed at supporting the economy is estimated at about 10.4% of 2019 GDP (including guarantees). In ACRA’s opinion, these anti-crisis measures will increase the country’s public debt to about 40-45% of GDP this year and result in a budget deficit of around 4–5% of GDP. However, in the baseline scenario, we assume that strong fiscal rules and historically good compliance with them will help fiscal consolidation to begin next year. The country’s budget rule mandates balancing the budget throughout the business cycle by allowing for a certain level of deficit during times of recession and surplus during times of economic growth. In the medium-term, maintaining public debt at a moderate level may be challenged by the need to increase spending due to the country’s population aging, which could be partially mitigated by the expected increased contributions to pension funds.

The diversified export structure and big share of pharmaceutical exports are likely to support Switzerland’s external position amid contracted external demand. The country’s competitive export-focused goods and services sector has allowed it to maintain a high positive current account balance over the past several decades. In particular, the country’s current account stood at 9.6% of GDP on average for the last five years. This led to a very high positive net international investment position of around 116% of GDP at the end of 2019.

ACRA assumes Switzerland’s export structure will allow the country to maintain a current account surplus in 2020 and beyond. At the same time, ACRA notes that investors turn to franc-denominated assets during periods of global economic slowdown and heightened international uncertainty. This triggers appreciation of the franc, which in turn negatively affects Swiss exports due to their increased cost. To prevent this in 2020, the SNB has resorted to monetary policy measures aimed at preventing appreciation of the franc, including injecting francs into the market and accumulating foreign currency liquidity. These measures resulted in international reserves increasing from 118% of GDP at the beginning of 2020 to about 131% of GDP at the end of the first quarter. This improved the external debt coverage ratio from 43.9% at the beginning of the year to 47.2% at the end of the first half of the year (assuming the same value of external debt as of the end of the first quarter). ACRA expects that the heightened risk of franc appreciation will cause the SNB to keep its policy rate in negative territory for an extended period.

Unlike the public sector, the debt load of Switzerland’s private sector is very high, which is associated with an extensive period of low interest rates. Household debt amounted to 132% of GDP at the end of 2019. This is high even when compared to European countries with similar economic structures. The lion’s share (about 90%) of household debt is made up of mortgage loans granted by Swiss banks. The fact that mortgage lending is a significant part of portfolios held by some large banks may be problematic for the country’s banking sector in the event of a sudden deep real estate price correction if and when it happens. However, this risk is hedged by the high level of household wealth (375% of GDP at the end of 2019).

It is also worth noting that at the end of 2019, the total volume of banking sector assets amounted to about 475% of nominal GDP. The sheer size of the banking sector poses a contingent liability risk and places Switzerland in the group of countries whose economies are highly dependent on the banking sector. The mitigating factors are high capital buffers maintained by the biggest banks and high asset quality.

In ACRA’s view, Switzerland can be considered a “safe haven” due to the highest level of trust in public institutions and the authorities and high quality of public governance. Over the past ten years, Switzerland has had some of the highest and most stable World Governance Indicators (WGIs) as measured by the World Bank. This is a reflection of the high quality of institutional governance and the very favorable environment for allocating resources within the economy. The high quality of the country’s institutions supports its credit rating.

Sovereign model application results

Switzerland has been assigned an AAA Indicative credit rating in accordance with the core part of ACRA’s sovereign model. One of the modifiers in the modifiers part of the model allows the Indicative credit rating to be decreased. This includes the following, which is determined by the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale:

  • Contingent liabilities and the risk of them materializing.

Positive modifiers are the following:

  • Sustainability of economic growth;
  • Potential economic growth;
  • Efficacy of structural, economic, and monetary policy;
  • Fiscal policy framework and budget flexibility;
  • Market access and sources of funding;
  • Debt sustainability;
  • Balance of payments vulnerabilities.

In view of the abovementioned modifiers, Switzerland’s credit rating has been raised by one notch. However, as the Indicative credit rating of the country is at the top of the rating scale, a Final credit rating of AAA has been assigned. There are no extraordinary factors that could result in an adjustment of the Final rating. In connection with this, the Assigned credit rating remains at AAA.

Potential rating downgrade factors

Potentially serious financial shock for Switzerland’s banking sector associated with a sudden deep price correction in the real estate market.

Issue ratings

No outstanding issues have been rated.

Regulatory disclosure

The sovereign credit ratings were assigned to Switzerland under the international scale based on the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.

The sovereign credit ratings of Switzerland were published by ACRA for the first time on September 10, 2019. The sovereign credit ratings and their outlook are expected to be revised within 182 days following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.

The sovereign credit ratings are based on information from publicly available sources, as well as ACRA’s own databases. The sovereign credit rating is unsolicited. The sovereign Issuer did not participate in the credit rating assignment.

ACRA provided no additional services to the Swiss government. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.

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