Færøudvalget 2020-21
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SUB-SOVEREIGN
CREDIT OPINION
5 August 2021
Government of Faroe Islands (Denmark)
Update to credit analysis
Summary
The credit profile of the
Government of Faroe Islands
(Faroe Islands, Aa2 stable) reflects the
fiscal autonomy, resulting in a high level of financial flexibility, combined with a track record
of prudent budgeting. The credit profile also takes into account the government's very large
liquidity buffer, which mitigates any refinancing risk. Following significant financial surpluses
over the last four years, a financing deficit was posted in 2020, which should continue in
2021 due to the economic impact from the pandemic. Debt metrics have deteriorated in
2020 but we expect these will return to a declining trend over the next two years. We also
take into account a strong likelihood that the
Government of Denmark
(Aaa stable) will
provide support if the Faroe Islands were to face acute liquidity stress.
Exhibit 1
RATINGS
Faroe Islands, Government of
Domicile
Long Term Rating
Type
Outlook
Denmark
Aa2
LT Issuer Rating - Fgn
Curr
Stable
Please see the
ratings section
at the end of this report
for more information. The ratings and outlook shown
reflect information as of the publication date.
The impact of the coronavirus pandemic led to an increase in debt
Contacts
14%
Gross operating balance/Operating revenue (%) (LHS)
Net Direct and Indirect Debt/Operating revenue (%) (RHS)
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
2016
2017
2018
2019
2020
2021B
2022 E
Cash financing surplus (Requirement)/Total revenue (%) (LHS)
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Gjorgji Josifov
+420.23.474.7531
AVP-Analyst
[email protected]
Sam McDonald
+44.20.7772.1401
Associate Analyst
[email protected]
Massimo Visconti,
+39.02.9148.1124
MBA
VP-Sr Credit Officer/Manager
[email protected]
CLIENT SERVICES
Americas
Asia Pacific
Japan
EMEA
1-212-553-1653
852-3551-3077
81-3-5408-4100
44-20-7772-5454
B - budget; E - Moody's estimate
Source: Issuer, Moody's Investors Service
Credit strengths
»
»
»
Fiscal autonomy and stable relationship with the Government of Denmark
Structurally sound balance and large liquidity buffer
Debt metrics deteriorated during the pandemic, but will recover in 2021-22
Credit challenges
»
»
Faroese economy is narrow and relatively exposed to the fishing industry
High investment requirements stemming from the growing population
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Rating outlook
The outlook of the Faroe Islands is stable. This reflects its sound financial performance and ability to contain debt levels, good
macroeconomic metrics and a stable relationship with the government of Denmark.
Factors that could lead to an upgrade
An upgrade of the Faroe Islands' rating would require a significant reduction in debt ratios as well as a more diversified economic
structure. A stronger support assumption could also have positive rating implications, which, however, is not expected because of its
autonomous status.
Factors that could lead to a downgrade
One or a combination of the following could have negative rating implications: (1) a weakening in the Faroe Islands' relationship with
Denmark; (2) a higher than expected increase in debt level or structural financial deficits over several years; and (3) any unexpected
adverse shock from the pandemic affecting the Faroese fishing industry.
Key indicators
Exhibit 2
Government of Faroe Islands
Faroe Islands, Government of
2016
2017
2018
2019
2020
2021B
2022 E
Population (in '000)
Gross operating balance/Operating revenue (%)
Intergovernmental transfers/Operating Revenue(%)
Cash financing surplus (Requirement)/Total revenue (%)
Net Direct and Indirect Debt/Operating revenue (%)
Short-term Direct Debt/Direct Debt (%)
49.5
7.2%
10.3%
3.4%
85.5%
20.9%
50.1
11.4%
9.5%
7.3%
91.2%
9.4%
50.9
8.6%
9.5%
2.5%
76.0%
23.7%
51.7
12.8%
8.7%
7.0%
63.8%
35.2%
52.6
2.4%
8.7%
-3.3%
84.4%
19.9%
53.2
9.4%
8.2%
-3.9%
63.9%
24.2%
53.6
6.0%
8.8%
1.0%
70.9%
20.4%
B - budget; E - Moody's estimate
Source: Landsbankin Foroya (Faroe Islands Governmental Bank), Moody's Investors Service
Detailed credit considerations
The credit profile of the Faroe Islands, as expressed in an Aa2 stable rating, combines (1) a Baseline Credit Assessment (BCA) of a1, and
(2) a strong likelihood of extraordinary support from the government of Denmark in the event the entity faces acute liquidity stress.
Baseline Credit Assessment
Fiscal autonomy and a stable relationship with the Government of Denmark
The Faroe Islands consist of 18 islands located in the Atlantic Ocean, between Scotland and Iceland, with a growing population, with
more than 52 thousand inhabitants. While part of the Kingdom of Denmark, the Faroe Islands are governed by the Home Rule Act,
which gives the Faroese government full power and flexibility to set its tax rates and fees. This broad control over revenue supports
the Faroese government's financial flexibility; around 90% of the Faroese government's operating revenue is derived from sources
under its control. The Kingdom of Denmark provides an annual block grant of around DKK700 million, which accounts for close to 10%
of the Faroe Islands' operating revenue. This grant is for “Joint Matters” that have not been transferred to the Faroese government's
control. The grant is intended and indeed spent on social welfare, schools and health sectors, though the Faroese government does
have freedom over how the grant is used. The Faroese government has, in the past, implemented substantial cuts in spending, when
required.
Economic indicators in recent years have been very strong, with a gross domestic product (GDP) per capita at the Danish average
between 2015 and 2019 (as Exhibit 3 shows). GDP per capita has fallen below the Danish level in 2020 but is expected to recover back
to the Danish average by 2023. Real GDP growth rate was above the Danish average over many years in the past. Despite an increase in
the number of unemployed during the pandemic, the unemployment rate is still extremely low at around 1.5% even with the phasing
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
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out of employment support measures, introduced as an aid-package in connection with the Covid-19 pandemic (financed by state
employment agency).
Exhibit 3
Faroese GDP per capita has fallen below Danish GDP per capita due to the coronavirus pandemic
Nominal GDP per capita in DKK thousands, by year
Denmark
450
Faroe Islands
400
350
300
250
200
150
100
50
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021 (E)
E - estimate
Source: Landsbankin Foroya, Statistics Denmark, Moody's Investors Service
In recent years, the former government had implemented reforms, including fishing and pension reforms, aiming to enhance and
sustain government's financial health (see:
Fishing Policy Reform - Issuer In-Depth Report, published October 2018).
As a result from
2019 election, the new government was formed, which made some amendments, e.g. to the Act on the Management of Marine
Resources. The amended Act appears to be more favourable for the fishing industry, as it replaces the previous quota and auction
system and extends fishing licences.
The islands' 29 municipalities vary widely in terms of size, from fewer than 50 inhabitants to around 20,000. Municipalities vary also
widely in terms of financial strength, with stronger ones including Klaksvikar and Torshavnar.
The Faroese relationship with Denmark is stable. In 1948, the Faroe Islands were granted Home Rule, and, in 2005, it gained further
authority over certain matters. The Faroese government controls special matters that cover the economy, finances (independence
to raise taxes), industry, foreign trade, mineral rights and the education system.
1
. “Joint Matters” are administered by the Danish
government according to the laws of the Kingdom of Denmark, although some may be wholly or partly assigned to the Faroe Islands,
or undertaken by the Danish and Faroese authorities jointly. Currently, matters under the Danish realm comprise the police force,
judicial system and banking supervision. The Faroe Islands elect their own parliament (Lagtinget), and the islands are governed by the
Faroese government (Landsstyret), which is responsible for its own finances. In addition, the Faroe Islands have two seats in the Danish
parliament, which had some influence in Danish politics historically, particularly in parliaments with thin majorities.
Structurally sound budget and large liquidity buffer
The coronavirus has hit the Faroese economy quite severely last year and will continue to put pressure on the economic outlook;
estimated GDP fell by around 4.8%. Despite this, the operating performance of the government was relatively resilient to the negative
shock.
The 2020 results indicate that the Faroe Islands still managed to produce an operating surplus of DKK 193 million, albeit reduced
from DKK1 billion in 2019, representing 2.4% of operating revenue (12.8% in 2019). At the start of the pandemic, it was expected
there would be a financial deficit of around DKK1.1 billion in 2020 and DKK500 million in 2021. While fishing exports and tourism
services with travel restrictions were temporarily hit hard, we forecast Faroe Islands to continue its recovery in its budget in 2021, with
operating surplus rising to DKK 790 million accounting for 9.4% of projected operating revenue. The fishing industry suffered due
to the closure of restaurants during the pandemic, with catches being sold to supermarkets instead at a lower price. Subsequently,
revenues from fishing and fish farming were down in 2020 at DKK375 million, from DKK509 million in 2019. This impact was partially
offset by increases in the prices of cod and mackerel.
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To address the negative impact, the Faroese government implemented some coronavirus relief packages accounting in total for around
1% of the Faroese GDP. The measures appear to be successful in mitigating impacts of the pandemic on the budget to date. Despite
expectations of a significant decline in operating revenues, they remained stable at DKK7.96 billion in 2020 from DKK8.02 billion in
2019. The relief measures provided support on areas such as employment via the Unemployment Fund and support for the tourism
industry. In 2020, DKK159 million was spent on unemployment benefits but only DKK30.5 million came from the government's budget;
the remainder was financed by the Unemployment Fund. The Faroese government expects to spend an additional DKK40-60 million
on support measures for the tourism industry in 2021. As a result of these support measures, operating expenditures increased by
11% in 2020 with a total spend of DKK7.77 billion, up from DKK6.99 billion. Additionally, capital expenditures rose by 38% to DKK689
million, leaving an overall financing deficit of DKK272 million in 2020, the first since 2015, representing 3.3% of total revenue down
from a surplus of 7% in the previous year. A similar financing deficit is forecasted in 2021, which we expect to improve in 2022.
The Faroe Islands have a large liquidity reserve, amounting to DKK4.5 billion as of the end of December 2020 (compared with DKK3.5
billion in December 2019), which is well above the internal minimum liquidity threshold of DKK3.3 billion in 2021, based upon 15%
of GDP from two years prior. As such, the minimum liquidity threshold in 2022 will be lower than this year's due to the decrease in
GDP in 2020. In the context of the pandemic and recent funding activities, the Faroe Islands displays a liquidity reserve of DKK3.9
billion as of June 2021. According to the guidelines, this reserve is only to be used during times of heightened market stress — if the
reserve is drawn upon and drops below 15% of the GDP, it is expected to be addressed and to again reach internal limits during the
next borrowing round.
The 2020 liquidity reserve represented around 23% of the Faroese GDP or 69% of its outstanding debt (Moody's adjusted). The
reserve amount exceeds necessary borrowing requirements in any single year, and this mitigates the refinancing risk significantly. The
liquidity pool is sufficient to cover scheduled debt repayments for the next four years. In June 2020, the government issued two bonds,
amounting to DKK2.945 billion, of which DKK1.345 was refinancing of maturing debt. The remaining DKK1.6 billion was issued to pre-
fund expected deficits in 2020 and 2021. The liquidity reserve fund is invested in a portfolio of highly rated securities, with investments
spread across various asset classes with defined limits to maximise the returns. Around two thirds of the total liquidity pool is invested
in Aaa-rated securities.
Debt metrics deteriorated during the pandemic, but will recover in 2021-22
The negative effects of the coronavirus pandemic have increased the Faroese government's debt metrics in 2020, which should decline
over the next two years (Exhibit 4).
Exhibit 4
Debt increased in 2020 due to the coronavirus pandemic but is still lower than historical levels
Net direct and indirect debt to operating revenues (%) by year
250%
Net Direct and Indirect Debt to Operating revenues
200%
150%
100%
50%
0%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021B 2022E
B - budget; E - Moody's estimate
Source: Issuer, Moody's Investors Service
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The net direct and indirect debt (NDID) consists mainly of direct debt (DKK5.4 billion as of December 2020). We count another DKK1.3
billion as indirect debt, which is because of the fact that the Faroese government has guaranteed an unfunded pension liability under
Foroya Livstrygging (LIV). This translates into NDID of 84% of operating revenues as of year-end 2020. After successful repayment of
the loan of DKK1.35 billion in June 2021 which was taken out in 2016 and no plans for new borrowing, we expect NDID to operating
revenues ratio to decline to 64% at the end of this year. We forecast similar debt levels in 2022 as the Faroe Islands is aiming to
refinance the outstanding bond of DKK1.3 billion issued in 2020 due in June next year.
In addition, the government is responsible for the pensions of its civil servants. Such obligations are partly unfunded and could strain
future budgets. However, the government has flexibility to manage its obligation, which we consider a contingent liability for the
government.
Municipal debt is considered self-supporting and not included in indirect debt because the government does not provide a guarantee
on the debt, and municipalities may only incur a total debt burden up to their level of total tax income in any one year.
The Faroese government also has some off-balance-sheet activities and public companies. Overall, these are assessed as self-
supporting, so we do not include their debt into the government's NDID ratio.
The most noteworthy of these activities is a state-owned project company executing the construction of two tunnel projects. The
Faroese government has provided a minimum revenue guarantee for the benefit of the company. The tunnel project company is 100%-
owned by the government, and we consider it a contingent liability.
Faroese economy is narrow and relatively exposed to fishing industry
The Faroese economy continues to rely on the fishing industry, including fishing and fish farming, accounting for around 20% of
national GDP and 93% of the total export value of goods. This high exposure introduces economic volatility as the economy is
susceptible to exogenous factors. The variability in fish prices, factor inputs such as oil prices, and the risks of stock depletion would
have a direct impact on the Faroese economy. Over the past few years, a combination of high global demand for fish and low oil prices
has benefited the Faroese fishing sector, and indirectly government revenue.
To reduce dependencies, the Faroe Islands have also increased trade with non-EU countries, from around one-third 10 years earlier to
more than 50% now. We view the diversification in both fish species and trade partners as a partial mitigant to the concentration risk
as it reduces exposure to species-specific shocks and potential trade frictions. In 2019, the Faroe Islands signed a trade agreement with
the United Kingdom which secures the access to the UK market. The Faroese government was unable to reach an agreement with the
EU or the UK for quotas this year and subsequently increased its mackerel quota on last year.
Faroe Islands' growing population requires infrastructure investments
The Faroese population is steadily growing by about a couple of hundred new inhabitants per year (Exhibit 5). Such population growth
put pressure on the government's operations especially with regards to capital investments. The government would need to invest in
areas such as new schools, health and social service, culture and infrastructure projects.
The government expects its capital investments to reach up to DKK500 million annually over the coming years. In addition,
government companies are also planning to invest to address infrastructure needs. The pandemic did not disturb their capital spending
plans.
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Exhibit 5
The Faroe Islands has seen strong population growth over the past decade
Population (LHS) and year-on-year growth (%) (RHS)
Population (end of year)
60,000
50,000
40,000
YoY Growth (%)
Baseline
3%
2%
1%
0%
30,000
-1%
20,000
10,000
0
-2%
-3%
-4%
F - forecast
Source: Landsbankin Foroya, Moody's Investors Service
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Extraordinary support considerations
We consider Faroe Islands to have a strong likelihood of extraordinary support from the Government of Denmark. This reflects our
assessment that the current relationship with the Government of Denmark is unlikely to change in the medium term. We also take into
consideration the intensive extraordinary support provided to the islands in response to the financial crisis of the 1990s.
While Denmark has no formal obligation to provide extraordinary support to the Faroe Islands, it has historically supported the Faroese
government on a number of occasions. In the 1990s, the Faroese government borrowed — largely from Denmark, given the scale
of the crisis — to fund the nationalisation of Føroya Banki and Sjovinnubankin and to bridge the deficits of the recovery plan were
established, the Faroese began standalone borrowing, ultimately using these and other reforms' funds to repay Denmark. In 2010,
Denmark (through Finansiel Stabilitet) also assumed control over EiK, a failing bank with operations in both the Faroes and the Danish
mainland. This action is consistent with Denmark's responsibility for financial regulation (the banking sector). The relationship with
Denmark remains important as a likely source of liquidity support, were independent financing to be tested.
ESG considerations
Moody's takes account of the impact of environmental (E), social (S) and governance (G) factors when assessing sub-sovereign issuers’
economic and financial strength. In the case of the Faroe Islands, we assess the materiality of ESG to the credit profile as follows:
Environmental considerations are material to Faroe Islands' rating. The Faroe Islands have mainly exposure to sea rising level risk,
which would impact its fishing industry, and we do not expect any intervention from Denmark as the Home Rule Act gives to the Faroe
Islands the responsibility in terms of environmental policies and resources management. To counterbalance climate change risks, the
government has the ambition to be 100% green energy on electricity on land in 10 years.
Social considerations are material to the Islands' credit profile. Faroe Islands face a trend of ageing population, resulting in declining
labour supply and higher pension and social costs. Over time, these challenges can add pressure on its finances. We view the
coronavirus outbreak as a social risk under our ESG framework, given the substantial implications on economic growth, the coronavirus
relief measures implemented, and therefore the consequences on its revenues and expenditures.
Governance considerations are material to Faroe Islands' rating. Governance and management are considered good with prudent
budgetary practices associated with sound management of liquidity and debt.
Further details are provided in the “Detailed credit considerations” section above. Our approach to ESG is explained in our cross-sector
methodology
General Principles for Assessing ESG Risks.
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Rating methodology and scorecard factors
Exhibit 6
Faroe Islands, Government of
Regional & Local Governments
Baseline Credit Assessment – Scorecard
Score
Value
Sub-factor
Weighting
Sub-
factor Total
Factor
Weighting
Total
Factor 1: Economic Fundamentals
Economic Strength [1]
Economic Volatility
Factor 2: Institutional Framework
Legislative Background
Financial Flexibility
Factor 3: Financial Position
Operating Margin [2]
Interest Burden [3]
Liquidity
Debt Burden [4]
Debt Structure [5]
Factor 4: Governance and Management
Risk Controls and Financial Management
Investment and Debt Management
Transparency and Disclosure
Idiosyncratic Risk Assessment
Systemic Risk Assessment
Suggested BCA
[1] Local GDP per capita as % of national GDP per capita
[2] Gross operating balance/operating revenues
[3] Interest payments/operating revenues
[4] Net direct and indirect debt/operating revenues
[5] Short-term direct debt/total direct debt
Source: Moody's Investors Service; Fiscal 2020.
6.20
5
9
1
1
3
1
1
5
5
1
5
1
6.29%
0.56%
84.38%
24.92%
101.10%
70%
30%
1
50%
50%
3.25
12.5%
12.5%
25%
25%
25%
5
20%
20%
30%
1.24
0.20
0.98
30%
1.50
3.92 (4)
Aaa
aa3
Ratings
Exhibit 7
Category
FAROE ISLANDS, GOVERNMENT OF
Moody's Rating
Outlook
Issuer Rating
Source: Moody's Investors Service
Stable
Aa2
Endnotes
1
For more information on the division of tasks, see
Delivery of Faroe Islands' Fiscal Plan Supports Creditworthiness,
published July 2015
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REPORT NUMBER
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5 August 2021
Government of Faroe Islands (Denmark): Update to credit analysis
 FÆU, Alm.del - 2020-21 - Bilag 27: Indberetning nr. 9/2021, fra Rigsombudsmanden på Færøerne
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5 August 2021
Government of Faroe Islands (Denmark): Update to credit analysis