New York, September 22, 2020 -- Moody's Investors Service, ("Moody's") has
downgraded Kuwait's long-term foreign and local currency
issuer rating to A1 from Aa2, and changed the outlook to stable,
concluding the review for downgrade initiated on 30 March 2020.
The decision to downgrade the ratings reflects both the increase in government
liquidity risks and a weaker assessment of Kuwait's institutions
and governance strength. In the continued absence of legal authorization
to issue debt or draw on the sovereign wealth fund assets held in the
Future Generations Fund (FGF), available liquid resources are nearing
depletion, introducing liquidity risk despite Kuwait's extraordinary
fiscal strength. And while the fractious relationship between parliament
and the executive is a long-standing constraint on Moody's
assessment of institutional strength, the deadlock over the government's
medium-term funding strategy and the absence of any meaningful
fiscal consolidation measures point to more significant deficiencies in
Kuwait's legislative and executive institutions and policy effectiveness
than previously assessed.
While liquidity risks are particularly relevant in the next few months,
over the medium term next one or two years, upside and downside
risks are broadly balanced reflected in the stable outlook. Kuwait
has a vast stock of sovereign financial assets currently ringfenced from
the general budget by law, securing predictable access to which
would eliminate government liquidity risk. Conversely, Moody's
sees a continued risk that the executive and legislature perpetuate stop-gap
measures in response to the funding impasse, without providing lasting
visibility on the funding of Kuwait's budget. While not Moody's
expectation, government liquidity risks would manifest if continuing
gridlock over funding led to the exhaustion of available liquid resources
ahead of the maturity dates of Kuwait's international bonds,
including the $3.5 billion tranche maturing in March 2022.
Kuwait's foreign currency bond ceiling has been lowered to Aa3,
from Aa2 and the foreign currency deposit ceiling has been lowered to
A1 from Aa2, whereas the short-term ceilings remain at Prime-1
(P-1). The local currency bond and deposit ceilings have
been lowered to Aa3 from Aa2.
RATIONALE FOR DOWNGRADE
GOVERNMENT LIQUIDITY RISK HAS RISEN IN THE ABSENCE OF LEGAL AUTHORIZATION
TO ISSUE DEBT OR ACCESS THE FUTURE GENERATION FUND
With a government debt law yet to be passed and General Reserve Fund (GRF)
assets likely to be depleted before the end of the current fiscal year
(ending in March 2021), government liquidity risks have increased.
Legislation passed by parliament so far, including the removal of
the mandatory transfer of 10% of government revenues to the FGF
and the reversal of last year's FGF transfer have only extended
the point of depletion to December 2020.
Even if the debt law is passed -- whether by parliament or by decree
from Kuwait's Amir while parliament is in recess -- it will
likely not provide a credible medium-term funding strategy,
which was a key driver behind Moody's initiating the review for
downgrade in March. The draft debt law, which has already
been rejected once by the parliamentary financial and economic committee,
contains a KD 20 billion debt ceiling which would be reached in less than
two years under Moody's baseline scenario. A lower ceiling
possibly to win parliamentary approval would be exhausted even earlier
given the large size of the government's immediate and medium-term
funding requirements. Even if the government received legal authorization
to issue debt without the constraint of a ceiling, Moody's
projects net sovereign issuance of up to KD27.6 billion ($90
billion) would be required to meet the government's funding requirements
between the current fiscal year and the fiscal year ending March 2024,
testing the capacity of the government to access such large financing.
Kuwait has one of the largest stocks of sovereign financial assets in
the world, both in absolute terms and relative to the size of the
economy and government debt burden. Securing predictable access
to these funds would eliminate government liquidity risk. However,
these funds are explicitly ringfenced from the general budget by law.
While the mandatory budget transfer to the FGF has been suspended,
the government has not given any indication nor made any formal request
to parliament to access FGF assets or income. Should the request
come through, it would be politically contentious and likely take
a long time and multiple versions to secure legislative passage.
In the meantime, government liquidity risks will remain elevated.
ONGOING INABILITY TO RESOLVE MEDIUM-TERM FUNDING SITUATION POINTS
TO LOWER QUALITY OF LEGISLATIVE AND EXECUTIVE INSTITUTIONS
The fractious relationship between parliament and the government is a
long-standing and well-known feature of Kuwait's credit
profile. While active debates in parliament contribute to checks
and balances, when the process is not conducive to agreement-seeking,
it hampers policymaking.
Historically, the impact of government inertia on the sovereign
credit profile has not been so significant since Kuwait long ran large
fiscal and current account surpluses. However, in an environment
of structurally lower oil prices and growing government expenditure,
the ongoing delay in finding a durable solution for Kuwait's medium-term
funding presents a more acute risk to the sovereign credit profile.
The persisting deadlock addressing the funding situation now directly
threatens the ability of the government to function, representing
a significant escalation in the brinksmanship between the two branches
LIMITED RESPONSE TO STRUCTURALLY LOWER OIL PRICES DEMONSTRATES CONSTRAINTS
IN CAPACITY OF FISCAL POLICY TO RESPOND TO SHOCKS
Moreover, the government's continued inability to respond
to severe revenue shocks from oil prices points to even weaker fiscal
policy effectiveness than previously assumed.
In contrast to earlier statements from the government that it would seek
to reduce its expenditure in year-on-year terms, the
passing of the budget for fiscal year 2020/21 incorporates a 1.6%
increase in expenditure, despite a budgeted 56% decline in
Kuwait has also made limited progress in reforming subsidies, which
account for 22% of government spending. In particular,
non-energy subsidies, which includes a broad range of subsidies
covering services like healthcare and education abroad, have also
remained largely untouched due to parliamentary opposition.
Kuwait's revenues remain highly dependent on hydrocarbon receipts,
which averaged 89% of government revenues between 2017 and 2019.
Progress in diversifying the non-oil revenue base has been very
slow, in part due to parliament's resistance to any measures
that would reduce the living standards of their constituents. The
implementation of a 5% VAT, as part of the Gulf Cooperation
Council (GCC)-wide post-2014 oil price shock initiative
is the single largest revenue measure that the government has explored.
However, Kuwait's parliament has still yet to ratify the VAT
treaty which would precede any VAT legislation, and Moody's
now expect the implementation of VAT to be between 2022 and 2023 at the
earliest, contrary to earlier indications from the government that
it would be in place by 2021. An excise tax on sugary drinks and
tobacco which was planned to be implemented this year has also been delayed.
Given the absence of any meaningful adjustment following the 2014-16
and the more recent oil price drops, Moody's expects the government
budget deficit will reach KD 13.7 billion (38% of GDP) this
year. While Moody's expects a reduction in the fiscal deficit
in the fiscal year 2021/22 to KD10.6 billion (25.7%
of GDP), this is underpinned entirely by a higher oil price assumption
and increased hydrocarbon production volumes as the OPEC+ production
Furthermore, Moody's expects that fiscal consolidation will
prove challenging due to the government's inflexible spending structure.
Current expenditure has increased cumulatively by over 20% since
the end of the fiscal year ending in March 2016, which has been
driven predominantly by increased spending on government salaries and
compensation. Projected growth in the Kuwaiti labour force due
to the country's young demographics, the government's
status as employer of first resort, and limited tolerance among
the leadership for higher unemployment are likely to continue to drive
growth in government payroll expenditure unless employment opportunities
in the private sector increases significantly or the government is prepared
to tolerate higher unemployment, neither of which represents Moody's
RATIONALE FOR STABLE OUTLOOK
While liquidity risks are particularly relevant in the near term,
over the medium term upside and downside risks are broadly balanced reflected
in the stable outlook.
On the downside, the likelihood that the executive and legislature
continue to deliver only piece-meal, make-shift measures
means that uncertainty over the funding situation will persist.
The liquidity risk generated by the persisting legislative impasse represents
a low probability but high severity tail-risk event. While
not Moody's expectation, government liquidity risks would
manifest if continuing gridlock over funding led to the exhaustion of
available liquid resources ahead of the maturity dates of Kuwait's
bonds, such as the $3.5 billion Eurobond tranche maturing
in March 2022. Even if passed by parliament, the debt law
would likely not durably resolve Kuwait's medium-term funding
challenges. Furthermore, while the Amir retains the power
to pass laws by decree while parliament is in recess, under Kuwait's
constitution, parliament would have the right to vote on the legislation
when it resumes after the next general election. Subverting parliament
to push legislation through by decree could worsen the already fractious
relationship between the executive and legislative branch, as happened
in 2016 when the government used the summer recess to lower fuel subsidies,
triggering a breakdown in relations between the two branches of government
and ultimately leading to the dissolution of parliament and an early election.
On the upside, Kuwait has a vast stock of sovereign assets held
in the Future Generations Fund (FGF) which Moody's estimates at 359%
of GDP as of the end of fiscal year 2019/20. The assets and the
investment income generated by the FGF are currently ringfenced from the
general budget by law, indicating the obstacles Kuwait faces to
resolve its funding challenges are primarily political, rather than
outside of the control of the sovereign.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
As a major oil exporter, Kuwait's environmental risks are predominantly
derived from carbon transition. Under a scenario of rapid transition
to low consumption of hydrocarbons globally, which is not Moody's
current baseline assumption, Kuwait's credit profile would face
downward pressure, although over the longer-term and with
sizeable buffers to provide support.
Social risks in Kuwait derive primarily from the rapid expansion of the
labour force due to the young population. The current socioeconomic
model in which the government acts as employer of first resort will continue
to place rising pressure on government spending unless the private sector
is able to attract and absorb a higher share of the growth in the Kuwaiti
labour force, or the government reduces net public sector hiring.
Lower public sector hiring not accompanied by the rising employment of
nationals in the private sector could lead to higher unemployment and
Governance risks are an important driver in the decision to downgrade
the rating. They primarily relate to the factious relationship
between the executive branch and the legislature, which has obstructed
the passage of key legislation and reduced the government's ability to
respond to shocks in a timely manner. The inability to reach agreement
on a durable funding arrangement for the government is also a demonstration
of the weak governance in Kuwait. The lack of transparency on the
size and composition of sovereign wealth fund assets is also a constraint
in Moody's assessment of institutional strength.
GDP per capita (PPP basis, US$): 66,034 (2019
Actual) (also known as Per Capita Income)
Real GDP growth (% change): 0.4% (2019 Actual)
(also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 1.5%
Gen. Gov. Financial Balance/GDP: -14.3%
(2019 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: 16.4% (2019 Actual) (also
known as External Balance)
External debt/GDP: 38.6% (2019 Estimate)
Economic resiliency: baa2
Default history: No default events (on bonds or loans) have been
recorded since 1983.
On 17 September 2020, a rating committee was called to discuss the
rating of Kuwait, Government of. The main points raised during
the discussion were: The issuer's institutions and governance strength,
have materially decreased. The issuer has become increasingly susceptible
to event risks.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Evidence of a sustained improvement in the strength of Kuwait's
governance and institutions would likely support a higher rating,
demonstrated by a more productive relationship between the executive and
legislative branches of parliament leading to smoother and more predictable
policy formation, as well as improved fiscal policy effectiveness,
evidenced by improved ability to respond to shocks and implement fiscal
adjustments that materially reduce the government's financing requirements.
While unlikely over the short-term, progress towards fiscal
diversification that reduces the government's dependence on oil
revenues and reduces the inherent volatility in government revenues could
also support a move to a higher rating level. Given slow progress
in economic diversification that would typically precede it, such
fiscal diversification is more likely to arrive as a result of legal authorization
to incorporate investment income from the FGF into general budgetary revenues.
A further increase in government liquidity risk, particularly as
the redemption date for the government's international bonds approaches,
and/or the liquid resources of the GRF to finance the deficit near depletion,
could lead to a further rating downgrade -- potentially by more than
one notch if there is a material risk of non-payment of the eurobonds,
even if the very large sovereign wealth fund buffers limited the risk
of losses to investors.
Moody's would also downgrade the rating if the government's
fiscal strength continues to weaken over the medium-term due to
a sharp increase in government debt arising from an inability to implement
fiscal consolidation measures amid structurally lower oil prices.
The principal methodology used in these ratings was Sovereign Ratings
Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631.
Alternatively, please see the Rating Methodologies page on www.moodys.com
for a copy of this methodology.
The weighting of all rating factors is described in the methodology used
in this credit rating action, if applicable.
The local market analyst for this rating is Thaddeus Best +971 (423)
For further specification of Moody's key rating assumptions and
sensitivity analysis, see the sections Methodology Assumptions and
Sensitivity to Assumptions in the disclosure form. Moody's
Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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Vice President - Senior Analyst
Sovereign Risk Group
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Moody's Investors Service, Inc.
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JOURNALISTS: 1 212 553 0376
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