Wednesday, Aug 24, 2016

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. 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 financially stable economic system that is supported by large oil reserves, a significant fiscal buffer and solid external balance sheet. Its strengths are, however, tempered by the economy’s overdependence on oil and relatively weak governance that is affecting the pace of much needed reforms.

The rating is underpinned by Kuwait’s large proven crude oil reserves that are expected to last more than 80 years. Oil revenues have had a major role in driving Kuwait’s economic growth. It has also funded the development of a generous welfare system. With a gross domestic product (GDP) at purchasing power parity (PPP) per capita of 73,245.7 in current international dollars, it is among the world’s richest countries. It is a key member of both the Organization of the Petroleum Exporting Countries (OPEC) and the Gulf Cooperation Council (GCC). It also has one of the oldest and most financially stable economic systems within the Middle East. The economy has been largely state-led, with the private sector playing a limited role. We see the government continuing to support growth through investment spending, thanks to high financial buffers and substantial borrowing space. From a long-term perspective, however, low oil prices have made Kuwait’s growth model unsustainable.

Kuwait’s substantial fiscal buffer is a strong rating support, thanks to fiscal surpluses that had averaged above 20% of GDP over the past ten years. According to the Sovereign Wealth Fund Institute, the Kuwait Investment Authority (KIA) in June 2015 managed assets equivalent to about 326% of Kuwait’s GDP and more than 700% of the government’s total expenditure. Public debt also remains very low (2015: 4.4% of GDP). Meanwhile, the collapse of crude oil prices has helped increase the sense of urgency over fiscal reforms. For example, non-essential current government spending has been curtailed, and diesel and kerosene prices increased. Even before the oil market turmoil, fiscal surpluses had been narrowing. Published official estimates show the fiscal balance in FY2015/16 registering a surplus of 2.8% of GDP, compared to 17.4% in FY2014/15. After mandatory transfers to the Future Generations Fund (FGF) and exclusion of investment income, estimates show the fiscal balance in FY2015/16 falling into a so-called “paper deficit” of 12.5% of GDP (FY2014/15: -4.4%).

Another rating support is Kuwait’s strong external balance sheet. Its history of large current account (CA) surpluses has helped keep vulnerability to external financial and economic risks low. In 2015, it ran up a CA surplus equivalent to 10.2% of GDP. According to the International Monetary Fund (IMF), Kuwait’s gross official reserves in 2015 stood at USD29.3 billion, enough to cover 8.2 months of imports of goods and services. This did not include external assets managed by the KIA, which also form a significant buffer to external shocks. As expected, Kuwait is a net international creditor. The latest 2015 data show its net international investment position (NIIP) standing at +USD108.2 billion. Meanwhile, Kuwait’s total external debt is relatively low at 35.2% of GDP (2015). Going forward, persistently low oil prices will mean increasing pressure on Kuwait’s external balance sheet. This is despite it having the lowest external breakeven oil price among GCC countries.

The rating takes into account Kuwait’s high dependence on oil. While the Kuwaiti oil sector has helped generate massive fiscal and external buffers, the current oil market turmoil has affected its fiscal and external balance sheets. Low oil prices have caused the fiscal balance to fall into a “paper deficit” after mandatory transfers to the Future Generations Fund (FGF) and excluding investment income. The turmoil has also caused a deterioration in Kuwait’s macroeconomic environment, which in turn has increased risks in the financial sector. Empirical studies have shown that there exists a feedback loop between oil price movements, bank balance sheets, and asset prices in GCC economies. Kuwait’s overdependence on the oil sector has also given rise to structural issues like low job creation, large public sector employment, crowding out of the non-oil tradable sector, and declining productivity. Against such a backdrop, the implementation of recommended reforms to ensure long-term economic and fiscal sustainability could lead to rising social tensions.

Kuwait’s rating continues to be tempered by relatively weak governance and political bickering that involves the cabinet and the parliament. With both political will and public pressure not having yet reached critical mass, Kuwait’s political structures will likely remain more or less unaltered over the short to medium term. This will affect the pace of much needed reforms to, for example, improve the business environment which remains unattractive. In the World Bank’s Doing Business 2016 report, it ranked at number 101 out of 189 economies. All these issues will constrain economic performance, which has already been affected by low oil prices. Against such a backdrop, there could be rising discontent considering the Kuwaitis’ sense of entitlement to state-provided benefits. Kuwait also faces rising geo-political risks emanating from, among other things, security threats posed by the so-called Islamic State, which continues to be active in the troubled region.

The stable outlook reflects MARC’s expectations that Kuwait’s fiscal and external positions, which are backed by substantial buffers, will not experience a sudden and significant deterioration. We also see its fiscal and external buffers continuing to offset risks emanating from low oil prices, its overdependence on the oil sector, weak governance, as well as regional geopolitical troubles.

Quah Boon Huat, +603-2082 2231/;
Nor Zahidi Alias, +603-2082 2277/;
Afiq Akmal Mohamad, +603-2082 2274/