Moody’s, the credit rating agency, reported that the continuous delay, driven by political considerations, in implementing reforms in Kuwait, such as the introduction of value-added tax and the review of public sector wages in particular, affects the effectiveness of fiscal policy in Kuwait, and expects the fiscal deficit to remain wide even with the recovery of oil prices.
The agency pointed out that the tense relationship between the government and the National Assembly extended to include financing issues in recent years, as the continuation of the impasse over the new public debt law and benefiting from the assets of the Future Generations Fund has raised the liquidity crisis and the risks of non-payment of government bonds.
The sources told Al-Rai that the possibility of the executive and legislative authorities continuing to provide only piecemeal measures will make uncertainty regarding the medium-term funding situation persist, as long as the government suffers from a financial deficit, explaining that the longer the legislative impasse, the higher the liquidity risks, which may arise from the depletion of available liquid resources and the inability of the General Reserve Fund to collect funds before the maturity dates of Kuwaiti bonds.
Moody’s pointed out that the government has proposed new legislation to expand financing options, but the bills may continue to face the resistance of the National Assembly, noting that on the positive side, the issuance of legislation that establishes financial reforms and expands government financing options may increase the flexibility of government finances and reduce liquidity risk.
In particular, the introduction of value-added tax and indirect taxes may broaden the government revenue base and lead to a structural improvement in the fiscal balance, while at the same time Kuwait has a huge stockpile of sovereign assets in the Future Generations Fund, which far exceeds GDP and government debt.
The obstacles that Kuwait faces in resolving the liquidity problem are mainly political, and not related to external factors.
The sources indicated that Kuwait’s credit position is supported by the exceptional wealth that it enjoys, as the assets of sovereign wealth funds significantly exceed the gross domestic product and government debt, in addition to its huge oil and gas reserves, and very high levels of income, explaining that against these strengths, there is the divided relationship between the executive and legislative branches that impede policy formation, undermine the state’s ability to adapt to shocks, and increase liquidity challenges, as well as regional geopolitical tensions.
Moody’s indicated that Kuwait’s credit strengths are represented by its large oil wealth and very high level of per capita income, but the credit challenges it faces are represented by a very high dependence on the oil and gas sector and the associated macroeconomic fluctuations, and the institutional weakness that is evident from the slow progress in economic and financial reforms, and the ongoing liquidity crunch in the absence of a solid financing strategy, indicating that while liquidity issues are of particular importance in the near term, risks in the medium term are broadly balanced, as evidenced by a stable outlook.
On the other hand, Moody’s reported that any evidence of continued improvement in the strength of institutions and governance in Kuwait may raise the country’s credit rating, indicating that this may arise if the relationship between the government and the National Assembly becomes more productive, leading to the formation of a smoother and more predictable policy.
Given the slow progress in economic diversification that usually precedes this, it is likely that such credit-supportive fiscal reforms will come as a result of allowing investment income from the FGF to be integrated into the budget revenues.
As for the factors that may lead to a downgrade of Kuwait’s rating, Moody’s stated that any increase in liquidity risk, especially since the repayment date of international government bonds is approaching, may lead to a rating downgrade, perhaps by more than one degree if there is a material risk of non-payment, even if investors do not face any losses in the end, given the hedges of the government’s large sovereign wealth funds, the agency is also likely to downgrade the rating if the weakness of the government’s financial strength in the medium term leads to a sharp increase in government debt.
Moody’s has set Kuwait’s economic strength score at “a2”, which is higher than the initial degree “baa3”, to reflect the very high levels of per capita income in the country, as well as the huge oil wealth.
According to the agency, Kuwait has so far the largest proportion of proven oil reserves to production among the Gulf Cooperation Council countries, which are sufficient to last about 90 years at the current rate of production, in addition to relatively low production costs, allowing the country’s hydrocarbon resources to be the long-term engine of income and wealth.
It showed that, however, Kuwait’s economy is smaller than the economies of other Gulf oil-exporting countries, as besides its greater dependence on the oil and gas sector, it leads to economic growth and nominal GDP that tends to be more volatile than its peers.
In the same context, the agency determined the assessment of Kuwait’s institutions and the strength of governance at a score of “ba2”, noting that some aspects of the institutional framework and government effectiveness witnessed weakness, as evidenced by the steady deterioration in Kuwait’s ratings on international governance indicators over the past decade, and the inability to implement reforms.
Moody’s indicated that its assessment of Kuwait’s financial strength at “AAA” takes into account the extremely low government debt burden, and unusually large financial liquidity in the form of assets managed by the Kuwait Investment Authority, and based on its estimates that the transparency ratio is 25 percent.
The assets of the sovereign wealth in Kuwait are sufficient to cover about 300 percent of the gross domestic product.
Moody’s assesses Kuwait’s external vulnerability and sensitivity risk at a score of “aa”, noting that the huge foreign exchange reserves held by the Central Bank of Kuwait and the very large stock of foreign assets held by the Kuwait Investment Authority contain significant external risks.
The agency expected that Kuwait would achieve large current account surpluses in the foreseeable future under its current assumptions for oil prices, and that the fiscal deficit would shrink to about 15 percent of GDP in the 2021/22 fiscal year, mainly due to the recovery of oil prices since 2020.
Hydrocarbon revenues increased by about 65 percent and non-oil revenues rose slightly with the easing of restrictions related to the Corona virus and the continued return of economic activity to normal.
However, high levels of spending still limit the scope for a greater improvement in public finances, and as for the government’s goal to reduce spending by at least 10 percent compared to the budgeted amount, (Moody’s) believes that the government’s ability to achieve this is limited, which will make the financial deficit in Kuwait among the widest financial deficits among the countries classified by the agency.
Moody’s considered that the management of monetary policy in Kuwait is credible and effective, as evidenced by the relatively low and stable levels of inflation since the shift from the dollar peg to linking the dinar to a basket of undeclared currencies, noting that the controls and rules of the Central Bank of Kuwait are generally strong and prudent, and this is reflected in the financial stability of the banking system during periods of macroeconomic volatility.
On the one hand, Kuwait’s BAA banking sector risk assessment reflects the limited contagion that the sector poses to the government’s balance sheet and credit profile, despite its large size. This is supported by the track record of financial stability, capitalization and high liquidity enjoyed by banks, in addition to the strength of provisions for bad loans.