Moody's Investors Service has placed Kuwait's Aa2 long-term issuer rating on review for downgrade. During the review, Moody's will assess the extent of the impact of the further sharp fall in oil prices, which Moody's expects to remain low for several years, on Kuwait's economic performance and the balance sheet of its government in the coming years.
In particular, the review will allow Moody's to determine the extent to which Kuwait's economic and fiscal strength insulate it from the need to take a rating action to reflect the impact of the price shock.
Moody's expects to complete the review within two months, according to a statement released by the agency on Friday.
Kuwait is highly dependent on hydrocarbons to drive economic growth and to finance government expenditure.
Oil and gas accounted for over 90 percent of total goods exports and roughly 63 percent of nominal GDP in 2014, the latest date for which full-year official statistics are available.
It also provides around 77 percent of total government revenues. Between September 2014 and September 2015, the oil price roughly halved. Since then, it has fallen a further 40 percent.
Moody's recently revised its oil price assumptions for Brent to USD 33 per barrel in 2016 and USD 38 per barrel in 2017, rising only slowly thereafter to USD 48 by 2019.
The structural shock to the oil market is weakening Kuwait's government balance sheet and its economy, and therefore also its credit profile.
Moody's projects that between 2013 and 2015, revenue as a percentage of GDP declined by 17.5 percentage points and the fiscal balance turned into a deficit of 1.1 percent of GDP in 2015 from a surplus of almost 35 percent in 2013.
Moody's estimates that, during the same period, the country's current account surplus relative to GDP fell to six percent from around 40 percent, and nominal GDP contracted by more than 30 percent.
Assuming a limited policy response, the depressed oil prices for the coming years would imply a further reduction in government revenues of around 16 percent in 2016 and only a gradual recovery thereafter, with total revenues only recovering to 2009 levels in nominal terms by the end of 2019.
With average annual expenditure growth of about 4.5 percent per year between 2016 and 2019, this would result in an average fiscal deficit of around five percent of GDP for the time period.
Assuming a funding mix of 80 percent via debt issuance and 20 percent from government reserves, this would imply a rise in Kuwait's general government debt stock to around 25 percent of GDP by 2019, up from 7.6 percent in 2014.
That would shift Moody's assessment of the government's fiscal strength to 'Very High' from 'Very High (+)'. Set against that negative impact, the government retains very significant financial buffers.
While transparency is limited, Moody's estimates that total government assets managed by Kuwait Investment Authority amounted to around USD 580 billion (or roughly five times of estimated 2015 GDP).
In addition, foreign currency reserves at the Central Bank of Kuwait were USD 25.7 billion at the end of 2015. Kuwait operates a slightly more flexible exchange rate system than its Gulf Cooperation Council peers. The Kuwaiti dinar is pegged to a basket of currencies, rather than to the US dollar.
However, while no official basket composition is published, it is likely to be dominated by the US dollar. During 2015, the Kuwaiti dinar has depreciated by about 3.7 percent against the US dollar, but has gained about 1.2 percent since beginning of the year.
As such, the impact from currency depreciation on the local currency value of the government's hydrocarbon revenues has been very limited.
However, foreign exchange reserves at the Central Bank of Kuwait have fallen to USD 25.7 billion in December 2015, from USD 29.3 billion a year earlier, thereby reducing Kuwait's external buffers against future shocks somewhat.
The government has introduced a limited number of measures to mitigate the impact of low oil prices on its economy and balance sheet, such as a partial fuel subsidy reform in early 2015, and reduced allowances for government entities' travel expenses and overseas medical treatment for Kuwaiti nationals.
While it has stated its intention to consider wider-reaching fiscal reforms, including further subsidy rationalization, prioritization of capital projects, and revenue-enhancing tax reforms, there is little clarity on the likely content or effectiveness of these measures.
The rating review will allow Moody's to assess the credibility and sustainability of those plans and the government's ability to mitigate the impact on its credit standing.
It will assess the clarity, scope and ambition of the government's plans relative to the scale of the task, the time required for them to bear fruit, and the reliance that can therefore be placed on them to sustain Kuwait's credit strengths.
In addition, during the review period, Moody's will evaluate the outlook for Kuwait's medium-term economic diversification plans and how these will affect the rating agency's assessment of Kuwait's economic strength, currently scored as 'Very High (-)'. Moody's will also assess how far the country's extraordinarily strong fiscal buffers (including the Sovereign Wealth Fund) mitigate the negative impact of the oil price shock on growth and finances, factoring in the limited degree of transparency surrounding the composition of these assets.