OREANDA-NEWS. August 18, 2015. Fitch Ratings has affirmed Denmark's Long-term foreign- and local local-currency Issuer Default Ratings (IDRs) at 'AAA' with Stable Outlooks. The issue ratings on Denmark's senior unsecured foreign- and local-currency bonds are also affirmed at 'AAA'. The Country Ceiling is affirmed at 'AAA' and the Short-term foreign-currency IDR at 'F1+'.

KEY RATING DRIVERS
Denmark's IDRs and Stable Outlooks reflect the following key rating drivers:

Denmark is a high value-added and wealthy economy with effective political and civil institutions. Income per capita and governance indicators are in line with the 'AAA' medians. It has a long track record of strong macroeconomic, fiscal and financial stability management, which navigated the economy through the severe stresses of a house price bubble crisis in 2008 and the 2009 recession.

Public finance management is strong and flexible, with a prudent fiscal framework bound by the Danish budget law, which enforces fiscal discipline at local governments through the use of expenditure ceilings. The new centre-right government that entered office in July 2015 is expected to announce its new budget in 3Q15. Fitch does not expect any material deviation from the broad strategy of deficit reduction for the period 2017-20.

The general government budget benefited from large one-off revenues (restructuring of capital pensions and outsized collection from the tax on pension pot valuation gains), leading to a surplus of 1.8% of GDP in 2014. However, we forecast the budget to worsen to a deficit of 1.3% and 2.5% of GDP in 2015 and 2016, respectively, reflecting the falling away of one-off revenues and decline in revenues from North Sea oil and gas operations. Adjusting for one-off factors, the underlying deficit is forecast to be 2% in 2015 and 2.4% in 2016, versus an estimated 2% for 2014.

Eurozone quantitative easing and the Swiss National Bank's abandoning of its EUR/CHF cap led to strong appreciation pressures on the DKK/EUR peg in 1Q15. The speculative pressures have since receded following successful policy responses by the Danish central bank to intervene heavily in foreign exchange markets and to cut its main interest rate to -0.75%. Foreign exchange reserves have since declined to 30.4% of GDP in July 2015 from their peak of 38.4% in February 2015. The government's decision to suspend bond issuance to reduce longer-term yields also demonstrated policy coherence and the resolve of the authorities to maintain the DKK/EUR peg.

Denmark's ratings are further supported by low public debt and fairly small contingent liabilities. We forecast public debt/GDP to fall sharply by 5.8pp to 39.5% in 2015 due to the suspension of bond issuance by the government and the use of central government deposits to finance 2015's deficit. Subsequently, debt is likely to increase to 43.3% of GDP in 2017, driven by larger primary budget deficits and increase in on-lending to state-owned entities. On-lending (5.2% of GDP at end-2014) continues to substitute government loan guarantees and provides greater transparency by bringing such exposures directly onto the sovereign's balance-sheet. The cyclical improvement of nominal GDP offsets these debt-increasing factors, but further consolidation measures would likely be key to placing debt on a gradual downward trajectory beyond 2017.

Denmark's strong external finances support the 'AAA' ratings. The current account has been in surplus since 1999, peaking during the financial crisis at 7.2% of GDP in 2013. Fitch forecasts the current account surplus to widen slightly to 6.8% of GDP in 2015 (2014: 6.3%). Net external debt has been on a declining trend since 2007, making Denmark a net external creditor in 2014 (3.8% of GDP).

The Danish economic recovery was stronger-than-expected in 2014, with real GDP growth outturns revised to 1.1% from an estimate of 0.8% at the time of Fitch's review in 1Q15. Our growth forecasts for 2015 and 2016 were also revised to 1.8% and 2.1% respectively, versus the authorities' potential growth estimate of 1.8%. The recovery is translating into strong improvements in the labour market, with employment growing 2.8% yoy in 1Q15 and the unemployment rate falling to 6.8% in 1Q15 from 7.6% in 1Q14.

Danish households are the most highly indebted among Fitch-rated sovereigns, with household debt/GDP at 133% at end-2014. Although this risk is partly mitigated by households' significant net asset position, the illiquid nature of these household assets (primarily pension savings) could pose problems for debt servicing for some households in the event of a severe shock (e.g. a sharp rise in interest rates). Ultra-low interest rates have led to an increase in mortgage borrowing and house purchases, resulting in the average price of owner-occupied flats rising by 9.2% yoy in 1Q15, where upward price pressure has been most pronounced. However, low long-term bond yields are also partly leading to an increasing number of households to refinance mortgages into longer-term fixed rate instruments.

RATING SENSITIVITIES
Future developments that could individually or collectively result in a negative rating action include:
-A secular deterioration in growth performance, for example due to adverse developments in the eurozone and other major trading partners, impacting on public finances and the financial sector

-A significant rise in the reliance on international investors for Danish mortgage bonds, which would increase the vulnerability of the Danish financial system during a crisis. Despite continued demand for these bonds being key to financial stability in Denmark, Fitch believes that these Danish institutions have a captive demand for liquid, high quality krone securities to satisfy their regulatory and hedging needs.

KEY ASSUMPTIONS
The ratings and Outlooks are sensitive to a number of assumptions:

Fitch assumes that the new centre-right minority government will remain broadly committed to and maintain political support for the current medium-term fiscal strategy of shrinking the general government deficit by 2020.

Fitch assumes that the Danish krone peg to the euro under the ERM2 remains in place.

Fitch assumes that Denmark and the eurozone will avoid prolonged deflation. Price developments in Denmark are closely linked to that in the eurozone owing to the fixed exchange rate regime, while the ECB's asset purchase programme should help underpin inflation expectations in the eurozone.

In the event of a Greek exit from the eurozone, Fitch assumes this would be unlikely to trigger a systemic crisis like that seen in 2012, or another country's rapid exit. However, it would increase financial market volatility and dent economic confidence.