HONG KONG: Fitch Ratings has affirmed Kuwait's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AA' with a Stable Outlook.

Key rating drivers
Kuwait's key credit strengths are its exceptionally strong fiscal and external balance sheets. These are increasingly offset by Kuwait's institutional paralysis and slow pace in addressing growing public finance challenges stemming from heavy oil dependence, a generous welfare state and its large public sector. Indicators on governance and the business environment are well below the 'AA' median.

We estimate the foreign assets of the Kuwait Investment Authority (KIA) at around $529 billion at the end of the fiscal year ending March 2020 (FY19/20), accounting for the bulk of Kuwait's sovereign net foreign asset position of 472 percent of GDP (the highest of any Fitch-rated sovereign).

Financial losses in 1Q20 largely erased double-digit gains in 2019. Of the KIA total, the Reserve Fund for Future Generations (RFFG) accounted for around USD489 billion and has grown over an extended period, due to investment returns and the statutory annual transfer of 10 percent of government revenue. Meanwhile, the value of the General Reserve Fund (GRF), which holds the accumulated government surpluses after transfers to RFFG, is estimated to have fallen for the sixth year in a row as the government tapped the GRF for deficit financing and the repayment of domestic maturities.

We expect a general government deficit of 20 percent of GDP (KD 7.3 billion) for FY20/21, reflecting our baseline assumption that the Brent price will average $35/bbl in 2020 and $45/bbl in 2021. The government is unlikely to be able to mount a significant fiscal policy response to the oil shock given the ongoing pandemic and parliamentary elections in October 2020. On the government's reporting convention (not including KIA investment income in revenue and treating the RFFG transfer as expenditure), the deficit would be over 33 percent of GDP. We estimate the fiscal surplus in FY19/20 at around 1 percent of GDP for FY19/20.

The government's authorization to issue debt has expired and it is unable to borrow, even to refinance existing maturities, which currently have to be met out of the GRF. As a result, general government debt fell to 14 percent of GDP at the end of FY19/20. Kuwait's outstanding eurobonds mature in 2022 and 2027.

Under our forecasts, the foreign assets of the GRF will be nearly depleted in FY20/21, and we assume that the government will resume borrowing and open up the RFFG for financing starting FY21/22. Accessing RFFG assets would allow the deficit to be financed at the FY20/21 level for over a decade, but will require parliamentary approval and will be politically contentious.

The government is currently making a renewed push on the debt law and is not contemplating a change in the framework governing RFFG assets. Our understanding is that Kuwait's constitution would give the Amir the flexibility to issue an emergency decree permitting debt issuance or the use of the RFFG. In our view, other extraordinary measures might be possible in order to ensure timely debt service.

The government has made minimal progress on its reform program aimed at boosting its underlying fiscal position, improving the business environment and boosting the role of the private sector as a provider of jobs for a young and growing population of Kuwaiti nationals (80 percent of Kuwaiti citizens were employed in the government sector in 2018). It has focused its efforts on regulatory and administrative measures that do not require approval from parliament, which in turn is trying to minimize the immediate costs to its constituents of reform.

We estimate that real GDP growth was around zero in 2019, weighed down by oil production cuts as per the OPEC agreement and delays to refinery upgrades as part of the Clean Fuels Project (CFP). In 2020, overall real GDP growth is likely to be positive amid an expansion of oil production and the commissioning of refinery upgrades, although disruptions related to the coronavirus will likely push the non-oil economy into recession for the year. The banking sector could absorb a rise in problem loans, being adequately capitalized, liquid and profitable.

We expect Kuwait's oil output to average to 2.8 million bbl/day in 2020 (from less than 2.7 million bbl/day in 2019). Kuwait has not yet announced an intention to raise oil output, unlike Saudi Arabia and Abu Dhabi, and our forecast increase reflects the restart of production at the Saudi-Kuwait Divided Zone.

CA deficit
We forecast Kuwait's current account deficit at 4 percent of GDP in 2020, the first current account deficit in two decades. Kuwait's bank and non-bank private sectors are net external creditors and major investors in the rest of the region, reflecting relatively muted domestic growth prospects. This supports the current account balance and Kuwait's net international investment position, which we estimate at 514 percent of GDP in 2018, exceeding the sovereign net foreign asset position by around 50 percent of GDP.

Kuwait's fiscal and external metrics are particularly sensitive to changes in oil prices and production. We estimate that a $10/bbl change in the average oil price from our baseline assumption would shift Kuwait's fiscal balance by around 9 percent of GDP. An additional 100,000 bbl/day of oil production would impact the fiscal balance by around 1 percent of GDP.

ESG governance
Kuwait has an ESG Relevance Score (RS) of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Kuwait has a medium WBGI ranking in the 49th percentile.