Key rating drivers

Switzerland's 'AAA' ratings and Stable Outlook reflect a diversified and high value-added economy (GDP per capita 1.3x the 'AAA' median) and very strong governance and human development indicators. The rating is supported by Switzerland's very large net external creditor position, high and persistent current account surpluses, and the global reserve currency status of the Swiss franc. It also reflects a record of stable and prudent economic and fiscal policy, and general government debt/GDP that is below the current 'AAA' median and on a downward trend before the pandemic shock hit. The size of the banking sector (with assets equivalent to around 500% of GDP according to Swiss National Bank (SNB)) represents a contingent liability risk for the sovereign, but it has sound credit fundamentals.

Owing to a much shorter and less stringent lockdown than elsewhere in Europe, as well as the strong rebound of economic activity after the containment measures were lifted (7.2% quarter-on-quarter in 3Q20 after a contraction of 7% in 2Q20), Swiss GDP performed better than peers and was only 2% below its pre-crisis levels as of end-3Q20. As a result, we revised our GDP growth forecast to -3.3% in 2020 followed by 3.4% recovery in 2021, from previously -7.0% and 3.3% in 2020 and 2021, respectively. However, our projections include a shallow contraction in 4Q20, given the second wave of coronavirus infections and the continued travel restrictions that weigh on the recovery of service exports.

Switzerland during the pandemic outbreak

Notwithstanding the relative resilience of the Swiss economy to the pandemic outbreak, we note that there are significant risks to our projections from the path of the coronavirus and its effect on the economy, given the constantly high level of infections in Switzerland in recent weeks. In the first week of December, the government announced its intention to impose social distancing measures at the federal level and further tightening of these measures cannot be ruled out. We also note that Switzerland does not have a process for emergency authorisations of vaccines or drugs, which might lengthen the time until a medical solution to the crisis is implemented.

The rebound in 3Q20 was particularly strong in private consumption (+11.9% quarter-on-quarter) and investments (7.4% quarter-on-quarter) and we expect these components to continue driving the recovery in 2021. The former continues to be supported by the sizable government's fiscal aid package focused on income compensation. We estimate the coronavirus measures will add around CHF30.3 billion (4.3% of GDP) to federal spending this year, 80% of which is expenditure on the short-time work allowance scheme and loss of earning compensation.

As a result, Switzerland's unemployment rate increased to only 3.4% as of November 2020, up from 2.5% in January, and remains one of the lowest among European peers. We expect the unemployment rate to peak at 4.2% as of end-2021 but to return toward the pre-crisis level in 2022.

National debt

We expect the better-than-expected economic performance to translate into more favourable fiscal metrics, with the general government fiscal deficit at 4.4% of GDP in 2020 and 2.4% of GDP in 2021, compared with 8.5% of GDP and 3.3% of GDP in 2020 and 2021, respectively, at the time of the last review in July. We also note that Swiss public finances are benefiting from a favourable revenue structure. The share of value-added tax (VAT) receipts, which tend to be more volatile than GDP, is by far the lowest among European peers (9.0% of Swiss revenues compared with 18.5% average for European sovereigns), explaining the resilience of revenues.

Fitch forecasts gross general government debt (GGGD)-to-GDP to increase to 31.6% in 2020, from 25.8% in 2019 and stabilise at around 32% over the medium term, well below the current 'AAA' median of 46.6% of GDP. We view the risk of the crystallisation of the contingent liabilities (implicit and explicit) onto the government balance sheet as low, given the overall good financial health of the large state-owned companies (Swiss Post, Swisscom). However, we note that the recapitalisation of Skyguide (air navigation service provider) and financial aid to the state-owned rail company (SBB) added 0.4% of GDP to federal expenditure in 2020-2021.

In our debt projections, we assume crystallisation of around CHF3.5 billion (0.5% of GDP) in contingent liabilities from the government's loan guarantee scheme (20% of the amount disbursed), split between 2021 and 2022.

A strong and broad political commitment towards medium-term debt sustainability and a record of outperformance of strict fiscal rules support our belief that the government will reverse its upward debt trajectory over the medium term. Under our longer-term debt sensitivity projections, general government debt peaks at 32.5% of GDP in 2022 and reverts to its pre-crisis levels by 2027.

Debt sustainability is further underpinned by Switzerland's continuously favourable financing costs, reinforced by the Swiss franc's safe-haven status. The 10-year sovereign yield was -0.51% in early December, while the average nominal effective interest rate on government debt declined to 1.0% in 2019, from 1.7% in 2015, and we expect it to fall further to 0.7% by 2020. The favourable cost of debt servicing is being locked in for a long period, with the average maturity increasing to 10.7 years from 8.9 in 2015.

National bank

The SNB continued to intervene in 2H20 to counter the appreciation of the Swiss franc, although the appreciation pressure abated since the initial outbreak of the pandemic. The sight deposits, which serve as a proxy for SNB's FX interventions, increased by CHF26.7 billion (3.8% of GDP) since the beginning of July, significantly less than CHF94.4 billion (13.5% of GDP) increase in 1H20. We expect the SNB to continue to intervening with further FX purchases should appreciation pressure renew, consistent with the central bank's view on the scope for further balance-sheet expansion.

As a result of FX operations, SNB's balance sheet continued expanding at a fast clip this year. In 2020, the official FX reserves increased by CHF109 billion or 15.6% of GDP and stood at 134% of GDP at end-November 2020 (89% of GDP in 2015). However, in our view the risks relating to the unprecedented expansion of SNB's balance sheet are limited, given the SNB's high equity levels and the very prudent approach to profit distribution.

Ultra-loose monetary policy has contributed to house prices rising to historical highs, and we expect the persistent negative interest-rate environment to add to the build-up of imbalances on the real estate and mortgage markets. Mortgage interest rates have fallen to historical lows (1.1% as of end-August 2020 for a fixed interest-rate mortgage, down from 1.3% in mid-2019) and household debt remains extremely high (131% of GDP and 211% of gross disposable income), despite a low home ownership rate. However, Fitch believes that large household wealth levels (equal to 375% of GDP according to Eurostat, by far the highest among advanced European countries) will cushion potential materialisation of risks in the domestic real estate market.

The Swiss Banking sector

The Swiss banking sector has material buffers to withstand the ongoing economic shock while maintaining its lending capacity. The Tier 1 capital ratio declined slightly but remains sound, at 18.2% at end-2Q20. Asset quality remains strong, with the non-performing loan ratio at only 0.7% as of end-2Q20, unchanged from its pre-crisis levels. While asset quality may deteriorate and capital ratios may come down further in the near term, we expect the banking sector to maintain ample buffers above the regulatory minimums.

The banking sector is liquid, and the average liquidity coverage ratio improved to 172% in 2Q20 from 159% before the pandemic. The profitability of domestically focused banks, which has been a weakness for some time, is likely to remain under pressure as the low interest-rate environment persists and as impairment charges are likely to pick up from cyclical lows.

At the same time, profitability of the two internationally-focused banks, UBS Group AG (A+/Negative) and Credit Suisse Group AG (A-/Stable), has remained sound as the sharp increase in impairment charges, driven by the deterioration of the macroeconomic outlook, has been offset by the robust performance of wealth and asset management activities and by exceptionally strong investment banking results.

EU integration

On 27 September, the Swiss voters rejected the so-called the "limitation initiative" which called for the exit of the free-movement of people agreement with the EU, one of the cornerstones of the Swiss-EU bilateral agreements and a condition for Switzerland's access to the EU single market. The rejection of the initiative paves the way to finalise the institutional framework agreement with the EU, with the Federal Council resuming contact with the European Commission in early November. Fitch notes that a further delay in resolving the open institutional framework questions could lead to an erosion of other bilateral agreements with the EU and undermine the relationship with Switzerland's main trading partner.

ESG (Enviroment, Social, Governance)

Switzerland has an ESG Relevance Score of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Switzerland has a WBGI ranking at the 97 percentile, reflecting strong institutional capacity and effective rule of law.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to positive rating action/upgrade are:

• The ratings are at the highest level on Fitch's scale and therefore cannot be upgraded.

The main factors that could, individually or collectively, lead to negative rating action/downgrade:

• Structural: A sharp correction in the Swiss residential real-estate market or large losses on banks' trading and lending portfolios that would result in sizable spill-overs to Switzerland's public finances and economic performance.
• Structural: Political developments leading to a significant deterioration of relations with the EU and broader trade disruption with the bloc.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

• Fitch's proprietary SRM assigns Switzerland a score equivalent to a rating of 'AAA' on the Long-Term Foreign-Currency (LT FC) IDR scale.
• Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR.
• Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. 

KEY ASSUMPTIONS

• Fitch expects the global economy to perform in line with Fitch's Global Economic Outlook (7 December 2020), which projects eurozone growth at -7.6% in 2020, 4.7% in 2021 and 4.4% in 2022.
• We assume Switzerland will maintain effective relationships with the EU and wider international community and will ensure its legislative framework does not change significantly, particularly in areas such as corporate taxation and freedom of movement.

ESG CONSIDERATIONS

• Switzerland has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.
• Switzerland has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
• Switzerland has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver.
• Switzerland has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Switzerland, as for all sovereigns.
• Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

This information was prepared on the basis of the internet publication of FitchRatings, dated the 11.12.2020. This article is only available in the original English language version.

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