Monday 23, October 2017 by Nabilah Annuar

Fitch affirms Kuwait at 'AA' with a stable outlook

Fitch Ratings has affirmed Kuwait's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AA' with a stable outlook. 

Kuwait's key credit strengths are the sovereign's exceptionally strong fiscal and external metrics and, at a forecast $50/bbl, one of the lowest fiscal breakeven Brent oil prices among Fitch-rated oil exporters. These strengths are tempered by Kuwait's heavily oil- dependent economy, geopolitical risk, weak governance and a poor business environment. A generous welfare state and the large economic role of the public sector present increasing challenges to public finances, given robust growth of the Kuwaiti population.

Assets and performance of the Kuwait Investment Authority (KIA) are not disclosed. We estimate that KIA's assets exceeded $514 billion or 453 per cent of GDP at end-2016. Of this amount, the Reserve Fund for Future Generations (RFFG) accounted for almost $400 billion and continues to increase, due to investment income and the statutory transfer of 10 per cent of government revenue. Meanwhile, the value of the General Reserve Fund (GRF), which holds the accumulated government surpluses of previous years, is estimated to have fallen for a third year in a row, to $116 billion, as the government tapped the GRF for financing.

In a hypothetical scenario where fiscal deficits remain at the level expected for the fiscal year ending March 2018 (FY17/18), the transfer to the RFFG continues and the GRF remains the sole source of financing, the GRF would be exhausted within about 10 years, while tapping the RFFG would allow Kuwait to sustain its current deficits for decades.

The government met its FY16/17 financing need by issuing around KWD 2.2 billion ($7.3 billion) of net new local debt, $8 billion of eurobonds and taking around $4 billion from the GRF. We expect the financing mix in FY17/18 to have a similar debt component, although this is conditional on the passage of the new debt law in the National Assembly, doubling the government's borrowing cap to KWD 20 billion. Assuming that the law will be passed, we see debt approaching the new cap in FY19/20, when it would be equivalent to 48 per cent of GDP.

We estimate the general government balance at KWD 74 million (0.2 per cent of GDP) in FY16/17, including estimated investment income worth around KWD 4.7 billion and excluding the statutory transfer of 10 per cent of revenue to the RFFG, worth around KWD 1.3 billion. The government does not count investment income and treats the RFFG transfer as an expenditure in its own presentation, resulting in a deficit of more than KWD5.9 billion. The balance in FY16/17 was almost unchanged from FY15/16, as a further three per cent drop in oil revenue was offset by a similar decline in current spending. A mild decline in current spending masked significant under-spending relative to the budget (nearly KWD 1.2 billion, or 6.3 per cent).

Under our baseline Brent oil price assumption of $52.5/bbl in 2017-2018, we expect the fiscal balance to be broadly unchanged at KWD 57 million (0.2 per cent of GDP) in FY17/18. According to the government's reporting convention, our forecast deficit would be KWD 6.4 billion, which roughly corresponds to the government's financing need, as the government does not intend to touch the RFFG. The government's own headline budget deficit is KWD 7.8 billion for FY17/18, mainly due to a lower oil price assumption of USD 45/bbl.

Progress on the government's "Programme for Economic and Fiscal Sustainability" has been slow, partly due to a strengthening of parliamentary opposition after elections in November 2016. The September 2016 fuel price hike has remained in place and has been upheld by courts. Utility price hikes came into effect gradually between May and September 2017 but are far lower than initially approved by parliament, remain below production costs and international rates and, as expected, did not directly apply to Kuwaiti citizens, the biggest consumers. The government has been working on non-legislative measures to limit spending, including by cracking down on employee absenteeism in the public sector, tightening bonus rules, stopping the creation of new allowances and limiting budgetary entities' fiscal discretion.

We expect that the government will continue to enjoy some success on measures that do not require major new legislation, such as multi-year budgeting, expenditure ceilings and further tightening of rules for hiring and compensation in the civil service. Progress will be slower on more comprehensive measures such as a new public sector wage law, privatisation and VAT and excise tax laws. This is due to strong political opposition in a fractious parliament and due to capacity constraints in the parliament and in the public sector. In particular, we do not factor in VAT or excise tax revenue into our forecasts.

The government commands an effective majority in parliament as its unelected ministers also have voting rights and because the authority of Kuwait's Amir, who appoints the government, is respected. However, members of parliament can and have obstructed the government's agenda by resorting to hearings of ministers and votes of no confidence. Despite a degree of consensus in many parts of society on the structural challenges that Kuwait is facing, the government's proposed answers to these challenges remain deeply controversial.

We expect Kuwait's real GDP to fall 3.5 per cent in 2017 (after 3.5 per cent growth in 2016) as oil production cuts in line with the OPEC agreement will imply an 8.3 per cent drop in production from 2016 average levels. We expect non-oil growth to pick up to 3 per cent in 2017-2019 from two per cent in 2016 amid higher government spending, particularly on investment. Despite increases to fuel prices, inflation has been muted, which along with higher oil prices and continuation of government spending should help retail trade and confidence indicators recover from their dip in mid-2016. A record number of land grants under the government's housing programme in 2016 will support residential construction activity in the coming years. Banks remain adequately capitalised, liquid, and profitable.

Kuwait has remained neutral in the dispute between Qatar, and Saudi Arabia and the UAE, instead stepping into the role of mediator. Kuwait's traditionally low-key, non-interventionist foreign policy is respected within the Gulf Cooperation Council, and we see little risk of sanctions being imposed on it for its continued ties with Qatar or Iran.

The full list of rating actions is as follows:

Long-Term Foreign- and Local-Currency IDRs affirmed at 'AA'; Outlook Stable
Short-Term Foreign- and Local-Currency IDRs affirmed at 'F1+'
Country Ceiling affirmed at 'AA+'
Issue ratings on long-term senior-unsecured foreign-currency bonds affirmed at 'AA'