Highlights

Danish municipalities operate under a supportive institutional framework that is marked by a robust equalization system.  S&P Global Ratings considers that Danish LRGs have sufficient resources to fulfill their tasks, meaning their indebtedness will remain low. We consider that the extensive equalization between Danish municipalities supports their revenues and expenditure management. Strict budget discipline is enforced by tight government oversight. Additionally, the sector benefits from automatic stabilizers that compensate for budget deviations. We therefore expect Danish LRGs will maintain their stable performance, despite increased expenditures.

Denmark has accelerated its green transition.  Where possible, gas heating has been replaced with district heating or other alternatives over the past two years. We understand that Danish municipalities coordinate the transition, while district heating companies use municipal guarantees to make investments that are necessary for the infrastructure expansion. We therefore anticipate that municipalities' guaranteed debt will moderately increase over the medium term but still remain modest. The municipal funding agency KommuneKredit (AAA/Stable/A-1+) plays an important role in Danish local government's financing activities, which now focus on fossil fuel phase-out. KommuneKredit finances most of Denmark's transition to district heating and benefits from municipal support.

Trend: Stable

We consider that the central government's close oversight of the Danish LRG sector--which relies on a strict budgetary framework, extensive equalization, and automatic block grants--supports stable budgetary performance and helps contain the sector's debt.

We could revise our assessment if the central government's oversight loosened and inadequate funding of the sector resulted in deteriorating budgetary performance and rising indebtedness.

Predictability Of The Framework

In Denmark's mature institutional system, change is typically implemented gradually.  Similar to its Scandinavian peers, Danish LRGs operate in a mature and predictable institutional system. There is a broad consensus regarding the LRG system and reforms are usually undertaken gradually and approved by broad political alliances. The latest major reform of the LRG sector took place in 2007 and a recalibration of the equalization system for municipalities occurred in 2021.

The Danish public sector has three government tiers--each with well-defined responsibilities--which supports the predictability of the system.  In addition to the central government, there are five regions and 98 municipalities. About two-thirds of total public expenditure is channeled through the LRGs, while the Danish parliament (Folketinget) decides which services fall under the LRG sector's remit. State grants are typically not earmarked for a specific purpose. Instead, local governments are allowed to prioritize expenditure and service levels in different sectors as long as they do not exceed expenditure limits. Furthermore, the constitution stipulates that LRGs are subject to state supervision.

Danish LRGs' ability to withstand unwanted changes is relatively strong.  Given the large share of public expenditure allocated to Danish LRGs, they have a major influence on the national economy and have made fundamental contributions to the required consolidation of public sector finances. Although Danish LRGs do not have direct representation in parliament, they have substantial negotiating power through the Danish local government association--Kommunernes Landsforening--or Local Government Denmark (LGD). The purpose of LGD, which was founded in 1970, is to protect LRGs' shared interests and act as a negotiating body, while also providing a forum for initiatives and decisions.

Revenue And Expenditure Balance

Danish LRGs benefit from central government support and equalization.  Due to the extensive support from the central government, we consider the LRG sector's ability to cover expenditure is adequate. The regions' primary responsibility is health care, which is funded through a central government block grant and activity-based co-financing from municipalities (see charts 1 and 2). However, the regions do not collect taxes. Municipalities' responsibilities are more diverse and focus on citizen-related public services (see chart 3). Their revenue structure differs, with most revenues coming from local taxes and various transfers, including equalization (see chart 4).

Chart 1

Chart 2

Chart 3

Chart 4

That said, municipalities' tax-rising autonomy is limited.  Although municipalities have autonomy in setting local taxes, a nonbinding agreement between the central government and LGDs suggests that the average tax rate in Denmark should remain stable. Municipalities must therefore gain approval from the central government if they intend to increase the tax rate. In those cases, the central government takes into account the total tax rate for the entire municipal tier to prevent an increase in the average tax rate.

Danish municipalities operate under an extensive grant equalization system, which evens out structural differences among them.  The national equalization includes all 98 municipalities but excludes the regions since they are mainly funded through central government block grants. In 2021, the system was recalibrated to increase its robustness and the overall equalization among municipalities.

Although we anticipate rising expenditure, we expect the LRG sector's operating balances will remain sound through 2025.  We project that cash flows will cover sector-wide capital expenditure and that new borrowing will be limited. Municipalities run surpluses and regions' deficits after capital accounts are moderate (see chart 5). The risk of a significant structural deterioration in the sector's budgetary performance is limited because a special central government grant compensates for declining tax revenue growth through an automatic stabilizing formula. Additionally, this grant compensates for increasing social transfer payments resulting from an economic downturn. Historically, the LRG sector has obtained grants when facing extraordinary expenses, for example costs related to the COVID-19 pandemic and, more recently, the influx of Ukrainian refugees. Together with the equalization system, these features are critical to the robustness of LRGs' financial positions and support our expectation that Danish LRGs will report balanced accounts over the medium term.

Chart 5

Danish LRGs' financial activities, including eligible borrowing, are subject to extensive regulations and supervision by the central government.  For example, the right to raise loans is restricted to specific investment purposes--such as housing for the elderly and energy-saving measures--and requires approval from the central government. We therefore expect that the LRG sector's direct debt will continue decreasing and that total debt (which includes the guarantee) will increase only modestly through year-end 2026, compared with 2023 (see chart 6). Nearly 100% of the sector's direct debt is sourced from KommuneKredit, which also lends for other public purposes if an LRG guarantees the loan.

Chart 6

The LRG sector is regulated and heavily supervised by the central government.  Guarantees granted by LRGs' are monitored by the Ministry of the Interior and Housing. As at December 2023, Danish LRGs had extended more than Danish krone (DKK) 200 billion in guarantees, corresponding to about 28% of LRGs' operating revenues. We project this amount will increase moderately in 2025. Municipalities extended close to 70% of these guarantees toward public housing and local utility companies. The remainder was mainly used by LRGs and the central government to support loans that the central bank had provided to public enterprises. We expect the sector's guarantee exposure will increase, both in nominal terms and relative to revenues, on the back of investments by the public housing sector and local utility companies. Danish public housing, which accounts for most extended guarantees, uses loans from mortgage banks as its main funding source. In addition to municipalities' guarantees, the central government also contributes to the funding of the housing sector by purchasing covered bonds issued by mortgage banks to fund their lending.

Overall, we regard the fiscal policy framework as very strong.  Danish LRGs are subject to very tight supervision from the central government, which approves expenditure levels and funding sources annually.

The Ministry of the Interior and Housing issues an annual statement for the upcoming budget year, in which it states the total transfers for each municipality. Based on the agreed expenditure levels and other conditions in the agreement, a block grant is set, ensuring that LRGs have the necessary financing for the agreed expenditure.

Apart from adhering to the budgetary framework, LRGs need to comply with other rules and document their compliance in a quarterly report to the central government. LRGs that do not comply with these rules run the risk of being put under administration by the central government.

The Danish LRG system is characterized by a high degree of central government support and oversight.  A standard procedure for dealing with LRGs in financial difficulties exists. We anticipate that the central government would remain supportive and intervene during in the case of severe stress.

If an LRG does not comply with the nationally defined budgetary rules, the central government will take over its administration. The LRG is granted temporary approval to deviate from the overdraft rule, while steps are taken to restore the situation and improve financial management. The central government may also offer discretionary grants or loan approvals and the LRG may have to report more frequently to the Ministry of the Interior and Housing.

Special government grants are available to compensate if revenue growth declines, for example because of declining tax revenue growth or an economic downturn, as seen during the pandemic. These grants are calculated on the base of an automatic stabilizing formula and an increase in block grants compensates for revenue shortfalls.

Transparency And Accountability

Oversight by the central government is strict and LRG reports are transparent and uniform.  The Danish public finance system displays a high degree of transparency, including rules for financial management and the supervision of municipalities and regions. The Local Government Act sets out rules applicable to all LRGs, governing bodies, committees, and mayors. The political organization in the LRG sector benefits from strong administrative and operating units. The management boards comprise public servants, whose tasks and responsibilities are different to those of elected politicians.

Accounting and budgeting procedures are transparent in the Danish LRG sector, while financial information is comprehensive, reliable, and disseminated regularly.  LRGs apply the nationally determined "Budget, Accounting, and Audit Order." They use accrual accounting and the annual financial statements are audited by private firms. Danish LRGs use a variety of bookkeeping systems, with municipal financial statements required to include balance sheets, income statements, cash flow statements, and explanatory notes. Additionally, Danish municipalities and regions must report financial performance, liquidity, and debt quarterly. Detailed budgets are presented annually.

Related Criteria And Research

• Institutional Framework Assessments For Local And Regional Governments Outside Of The U.S., Oct. 31, 2024
• Denmark, Aug. 12, 2024
• KommuneKredit, June 10, 2024
• Methodology For Rating Local And Regional Governments Outside Of The U.S., July 15, 2019