CREDIT ANALYSIS REPORT

STATE OF KUWAIT - 2017

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Report Date Oct 2017 Product  
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Rationale

MARC has affirmed the State of Kuwait’s (Kuwait) foreign currency sovereign rating of AAA with a stable outlook based on MARC’s national rating scale. The rating reflects MARC’s opinion of the sovereign’s ability to meet its foreign currency obligations in full and on time, without respect to specific securities or payment obligations. The rating also serves as a country ceiling for ringgit-denominated debt issued locally by issuers domiciled in Kuwait. Transfer and convertibility (T&C) risks are reflected in the country ceiling. The analysis is based solely on information available in the public domain. The government of Kuwait has no debt rated by MARC.

The AAA rating reflects Kuwait’s stable economic system that is supported by large oil reserves, large financial buffers with low debt and a strong external balance sheet. Its strengths are, however, tempered by the economy’s dependence on oil and weak governance and institutions, the latter of which have affected the pace of reforms.

The rating is underpinned by Kuwait’s substantial proven crude oil reserves. One of the world’s richest countries, it has one of the Middle East’s oldest and most financially stable economic systems. Thanks to oil revenue, which continues to play a major role in driving economic growth, the government’s fiscal reserves are significant. Its spending on investment has helped to develop the non-oil sector, a crucially important move to diversify the economy because Kuwait’s growth model is no longer sustainable against a backdrop of low oil prices. The Kuwaiti economy remains largely state-led with a limited role for the private sector. As such, the government faces many challenges in its efforts to reduce the economy’s susceptibility to oil price cycles, lift private sector growth and boost job creation. It also faces many governance issues. The first Kuwait Development Plan (2010-2014), for example, was only partially implemented for that reason.

Kuwait’s substantial financial buffers with low debt are strong rating supports. The Kuwait Investment Authority (KIA) is estimated to hold financial assets equivalent to more than 460% of gross domestic product (GDP) – with roughly two-thirds in the Future Generations Fund (FGF) and one third in the General Reserves Fund (GRF). The latter, available for drawdown to plug fiscal deficits, is about 2.8 times the size of the government’s annual expenditure. Gross public debt remains low, though it ballooned recently because of deficit financing. The government’s fiscal financing options include drawing down on GRF assets and borrowing in the domestic and/or external market. Like most of its regional neighbours, Kuwait was ill-prepared for the oil price collapse. While there is now an increased sense of urgency and purpose in its reform efforts, we expect Kuwait’s fiscal reforms to remain challenging because spending cuts are politically sensitive. In addition, it must contend with weak institutions and a poor doing business environment that have hampered economic and income diversification efforts.

Another rating support is Kuwait’s strong external balance sheet, thanks to a history of large current account (CA) surpluses. For example, its CA surplus over the 2011-2014 period had averaged an astounding 40.3% of GDP. Its vulnerability to external financial and economic risks has thus remained low, even though the CA surplus has trended downward significantly because of the oil price collapse. Going forward, Kuwait’s external balances could deteriorate further if oil prices do not firm up. Meanwhile, 1Q2017 data show Kuwait’s CA registering a surplus for the fourth consecutive quarter, thanks to slightly better oil prices. In 2016, Kuwait’s international reserves rose to USD31.5 billion, enough to cover 6.9 months of imports of goods and services. Note that this figure does not include external assets – which also serve as a buffer to external shocks – managed by the KIA. Kuwait is a net international creditor, with the latest available data showing its net international investment position (NIIP) standing at +USD108.2 billion (2015).

The rating takes into consideration Kuwait’s continued high dependence on oil, which essentially means that the development model has been mostly funded by oil and natural gas revenue. This overdependence has caused structural issues that include a state-led economy with large public sector employment, low job creation and declining productivity. Though there have been efforts to diversify the economy and income, the results have been relatively insubstantial because of weak institutions and a poor doing business environment. Meanwhile, whipsawing oil prices can cause GDP growth rates to fluctuate wildly and dampen consumer and business sentiments. Lower oil prices affect investment, thereby reducing the rate of labour and capital accumulation, and in turn lowering growth contributions. Kuwait’s fiscal and external balances have been affected, and budget financing needs have emerged. As the global oil market remains uncertain and geopolitical tensions continue to escalate, we do not expect any let-up in the challenges ahead for the Kuwaiti economy.

Kuwait’s rating continues to be tempered by relatively weak governance and institutions. Its institutions are lowly ranked in the World Bank’s Worldwide Governance Indicators (WGI) project. Its doing business environment is similarly graded, as evidenced by its ranking in the World Bank’s Doing Business report. The fact that its elected parliament is often truculent and tensions between it and the ruling Al-Sabah family persist, do not help. However, we expect rising concerns against a backdrop of still disappointing crude oil prices to generate a renewed sense of urgency and purpose in the government’s reform efforts. The six-pillar reform strategy is a case in point. It focuses on reforming public finances and promoting a greater role for the private sector so that it can generate economic growth and jobs for nationals. With regard to fiscal reforms, the government is working on the introduction of expenditure ceilings, as well as legislation for the introduction of a value-added tax and a corporate tax for domestic companies.

The stable outlook reflects MARC’s assumptions that oil prices have stabilised and regional security issues will not worsen significantly. We also assume that Kuwait’s fiscal and external buffers will not experience a sudden and substantial deterioration and the government remains assiduously committed to its reform efforts. Our expectation is that the buffers will continue to offset risks related particularly to the economy’s overdependence on the oil sector, as well as global and regional uncertainties.

Major Rating Factors

Strengths

  • Stable economic system supported by large oil reserves;
  • Large financial buffers and low debt; and
  • Strong external balance sheet.

Challenges/Risks

  • Dependence on oil; and
  • Weak governance and institutions.
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