OREANDA-NEWS. Fitch Ratings has affirmed Sweden's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'AAA' with a Stable Outlook. The issue ratings on Sweden's senior unsecured foreign and local currency bonds have also been affirmed at 'AAA'. The Country Ceiling has been affirmed at 'AAA' and the Short-term foreign currency IDR at 'F1+'.

KEY RATING DRIVERS
Sweden's 'AAA' ratings reflect its high income per capita, strong governance and human development indicators, and a track record of sound economic policy implementation.

The December Agreement between the government coalition and the main opposition block avoided holding fresh parliamentary elections, which had been scheduled for March 2015. The Agreement should also ensure that the current and future governments are able to secure parliamentary approval for their budget proposals. In its Spring Fiscal Policy Bill, the government introduced a range of small spending increases totalling SEK8bn (around 0.2% of GDP) this year and an additional SEK12bn in 2016. These spending increases will be wholly financed by tax rises.

The budget deficit was 1.9% of GDP in 2014. Fitch expects the deficit to fall back to 1.5% this year, and 0.7% in 2016, thanks to steady economic growth. The gross general government debt-to-GDP ratio rose to 43.8% in 2014, from 38.7% in 2013, leaving it around 1 percentage point lower than the 'AAA' median. Stock-flow adjustments, including currency effects, accounted for four-fifths of the rise in the debt ratio. We expect the debt ratio to peak at 44.3% this year, before edging back to 42.8% in 2016.

Low public deficits and high private savings translate into a current account surplus. The current account surplus has averaged 7% of GDP over the past 10 years, and was 6.8% of GDP in 2014, higher than the 'AAA' median of 6%.

Despite a slight pick-up in 1Q15, inflation is still well below the central bank's 2% target. Between February and April, the Riksbank loosened policy by cutting the key monetary policy interest rate to -0.25%, lowering the expected path for interest rates, and announcing the purchase of SEK80bn-SEK90bn (around 2% of GDP) of government bonds.

While inflation has stayed low, economic growth has been steady. Real GDP rose by 2.4% in 2014, driven principally by domestic demand. Private consumption rose in line with GDP, while investment was around 7.5% higher than in 2013, largely reflecting a boom in residential construction. Fitch expects export growth to pick up over the forecast horizon, as economic conditions in Sweden's main export markets improve. At the same time, we think that domestic demand will remain the driver of growth. Fitch forecasts that GDP growth will be 2.5% this year, and 2.8% next year. This compares favourably with our forecasts for growth in developed markets in the next two years, especially in Europe. We expect unemployment to edge down and average 7.3% in 2016.

Fitch believes that high household indebtedness presents a risk to the macroeconomic outlook in Sweden. The combination of strong growth in real incomes, low interest rates and the structural features of the Swedish housing market is translating into further house price rises. Annual house price inflation was just under 15% in 1Q15. The aggregate household debt to income ratio rose to 171.5% in 1Q15 from 168.4% in 4Q13.

Last November, the Financial Supervisory Authority (FSA) proposed the introduction of an amortisation requirement for mortgage loans by Swedish households as a way of moderating the increase in the debt stock. The regulations were intended to come into force in August this year. However, a court ruling in April raised doubts on the authority of the FSA to introduce regulations with force of law. The FSA has therefore decided to suspend the introduction of these regulations, pending clarification from the government on its authority to introduce rules in this area. Fitch expects that these regulations will eventually be introduced and that they will have a marginally positive effect in terms of moderating the rise in household debt, albeit on a gradual basis.

The Swedish banking sector is large relative to the size of the economy (assets are around 220% of GDP); the banking sector is also inter-linked and concentrated with the major groups' assets (including overseas) amounting to around 380% of GDP. Swedish banks are well-capitalised (the four major groups had an average Common Equity Tier 1 capital ratio of 18.4% at end-1Q15) and have lower funding costs compared with many European peers. At the same time, they are structurally more reliant on wholesale funding, leaving them vulnerable to market funding shocks.

RATING SENSITIVITIES
The Outlook is Stable, which means Fitch does not expect developments with a high likelihood of leading to a rating change. However, future developments that could, individually or collectively, result in downward pressure on the ratings include:

-A severe macroeconomic shock - potentially originating in the household sector - leading to a pronounced deterioration in the public finances through higher deficits, rising debt and lower GDP growth.
-A sizeable systemic shock to funding conditions in the financial system could translate into pressure on the sovereign rating, given the relative size of the banking sector.

KEY ASSUMPTIONS
Fitch assumes that the Swedish authorities remain committed to the current fiscal policy framework.

The government debt-to-GDP ratio is expected to peak at 44.3% this year, before edging back to 42.8% in 2016. In its debt sensitivity analysis, Fitch assumes on average a primary balance of 0.9% of GDP, trend GDP growth of 2.3%, GDP deflator growth of 1.7%, and a nominal effective interest rate of 1.6%.

Fitch assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term.