ShareLONDON: Fitch Ratings has affirmed Kuwait’s long-term foreign-currency issuer default rating (IDR) at ‘AA-‘ with a stable outlook.
Key rating drivers
Fundamental rating strengths and weaknesses: Kuwait’s ‘AA-‘ rating balances its exceptionally strong fiscal and external balance sheets against a political context that makes fiscal consolidation and other reforms difficult, evidenced by the absence of meaningful fiscal adjustment and the absence of legislation since 2017 to authorize debt issuance. Fiscal and structural challenges stemming from heavy oil dependence, a generous welfare state and a large public sector and low governance indicators (below the ‘AA’, ‘A’ and ‘BBB’ medians) also constrain the rating.
Exceptionally strong external assets: Kuwait’s fiscal and external balance sheets remain among the strongest of Fitch-rated sovereigns. We forecast Kuwait’s sovereign net foreign asset position will average 505 percent of GDP in 2023-24, remaining one of the highest among all Fitch-rated sovereigns and more than 10x the ‘AA’ median. The bulk of the assets are held in the Future Generation Fund (FGF) managed by the Kuwait Investment Authority (KIA), which also manages the assets of the General Reserve Fund (GRF), the government’s treasury account.
Low government debt: Gross government debt/GDP is low, at 8.7 percent of estimated GDP in the fiscal year ending March 2023 (FY22; gross government debt includes liabilities by government entities that borrow separately from the Treasury). However, assuming the passage of a debt law in FY24, limited fiscal reform and lower oil prices, we forecast government debt will more than double to 24 percent of GDP in FY25 and rise further in subsequent years, owing to projected fiscal deficits. Nonetheless, during the forecast period, we expect debt levels to remain well below the projected 2025 ‘AA’ median of 43.6 percent of GDP.
Opposition dominates new parliament: Politicians critical of government policies retained a majority of elected seats after parliamentary elections in June 2023, the third since December 2020 and the seventh since 2012. The gridlock between government and parliament has undermined the government’s ability to pass key legislation and implement significant reforms.
Fitch believes that while a joint committee bringing together the government and the national assembly has been set up and a new speaker elected unanimously, it is unclear if this will be sufficient to unlock the legislative process. Even if there is progress, opposition MPs may also not want to pass some laws without concessions on their populist demands, preventing speedy reform of fiscal rigidities.
Structural fiscal challenge: Nearly 80 percent of government spending consists of sticky current spending, including salaries and subsidies, and about 84 percent of Kuwaiti nationals in the labor market are employed in the public sector. The fiscal break-even oil price (excluding investment income) will remain high (at an average of around $90/bbl in FY23-FY25) and the non-oil primary deficit/non-oil GDP is extremely weak at around 90 percent, significantly worse than regional peers.
Fresh attempt for debt law: The government is seeking to pass a new debt law to allow relaunching government debt issuance, which has been halted since 2017. We incorporate the assumption in our forecast, notably for government debt, that a debt law is passed in FY24, despite considerable risks of further delays. In the absence of a debt law, Fitch assumes the government would still be able to meet its limited debt service obligations in coming years given the assets at its disposal. However, the difficulties in passing the law forced the government in recent years to rely on stop-gap measures, unusual for Kuwait’s rating level, to replenish the liquid assets of the GRF. The government cannot directly access the FGF’s assets without parliamentary approval.
Budget deficits to return: The budget recorded a surplus in FY22 due to surging oil revenue, marking its first surplus in the past nine years under the government’s reporting convention, which does not include KIA’s investment interest income in revenue. The fiscal surplus was KD 6.4 billion (12 percent of estimated GDP), following a deficit of KD 4.3 billion (10.1 percent of estimated GDP) in FY21. Fitch’s budget calculations include an estimate for investment interest income, which is not officially disclosed. We forecast a return to budget deficits-to-GDP ratios of 0.7 percent and 0.9 percent in FY23 and FY24, respectively, as oil prices fall, spending pressures persist, and progress with fiscal reforms remains limited. Excluding investment income, the deficits would average 9.7 percent of GDP, marking a substantial increase in financing needs.
Large expenditure increase: The FY23 budget proposes an expansionary fiscal policy, with spending up 17 percent over the FY22 outturn, despite the assumption of lower revenues due to a lower average oil price and further oil production cuts. The budget projects salaries to rise by about 14 percent over FY22, reflecting the costs of nearly 22,000 new public sector hires and increased employees’ allowances, while subsidies (including temporary electricity subsidies) are set to rise by 35 percent to cushion the impact of rising cost of living on Kuwaitis.
Oil assumptions and dependence: Our forecasts assume an average oil price of $77/bbl for FY23, down 23 percent from FY22, while oil output is likely to fall by 4.1 percent to 2.612 million b/d in FY23, due to OPEC+ supply cuts. In FY24, we assume Kuwait’s average oil price falls to $72/bbl and that Kuwait’s crude output will return to 2.676 million b/d as per outlined OPEC quotas. Kuwait aims to boost capacity to 3.15 million bbl/day by FY27, with increases both onshore and in the neutral zone. Budget outcomes are highly sensitive to changes in oil price and production. A $10/bbl change in our oil price assumption for 2023 would affect the budget balance by 4. 8 percent of GDP, other things equal. A change of 100,000 bbl/day of production affects the budget balance by 1.5 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. 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 at the 51st percentile reflecting low scores for voice and accountability, and middling scores across other governance indicators.
Rating sensitivities
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
* Structural features: Signs of greater pressure on GRF liquidity, for example, as a consequence of the continued absence of a new debt law or other extraordinary measures to ensure that the government can continue to make good on its payment obligations, including but not limited to debt service.
* Public and external finance: Significant deterioration in fiscal and external positions, for example, due to a sustained period of low oil prices or an inability to address structural drains on public finances.
Factors that could, individually or collectively, lead to positive rating action/upgrade
* Structural features/public finances: Strong evidence that Kuwait’s institutions and political system are able to tackle long-term fiscal challenges, for example, through actions to implement a clear deficit reduction plan that is resilient to lower oil prices, as well as adopt a transparent and sustainable government funding strategy.
Sovereign rating model
Fitch’s proprietary SRM assigns Kuwait a score equivalent to a rating of ‘AA’ on the Long-Term Foreign-Currency (LT FC) IDR scale. Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
Structural Features: -1 notch to reflect political constraints on enacting key economic and fiscal reforms, as illustrated by the difficulties in passing a debt law and the lack of progress on addressing structural public finance challenges stemming from heavy oil dependence, a generous welfare state and a large public sector.
We have removed the previous -1 notch on public finances as the SRM output declined from ‘AA+’ to ‘AA’ and we assessed that the model, combined with the -1 notch on the structural features, now better captures Kuwait’s structural and fiscal rigidities.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Country ceiling
The country ceiling for Kuwait is ‘AA+’, 2 notches above the LT FC IDR. This reflects strong constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.
Fitch’s country ceiling model produced a starting point uplift of +2 notches above the IDR. Fitch’s rating committee did not apply a qualitative adjustment to the model result.
Sources of information
The KIA’s assets are not officially reported by the government. Fitch estimates these assets by compounding the government’s transfers into the KIA, using assumptions about returns and asset allocations that are informed by discussions with the KIA. Fitch benchmarks government transfers into the KIA and KIA investment income against the balance of payments. Fitch has sufficient confidence in these estimates to maintain the rating.
ESG considerations
Kuwait has an ESG Relevance Score of ‘5[+]’ for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Kuwait has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Kuwait has an ESG Relevance Score of ‘5[+]’ for rule of law, institutional & regulatory quality and control of corruption as World Bank governance indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Kuwait has a percentile rank above 50 for the respective governance indicators, this has a positive impact on the credit profile.
Kuwait has an ESG relevance score of ‘4’ for human rights and political freedoms as the voice and accountability pillar of the World Bank governance indicators is relevant to the rating and a rating driver. As Kuwait has a percentile rank below 50 for the respective governance indicator, this has a negative impact on the credit profile.
Kuwait has an ESG relevance score of ‘4[+]’ for creditor rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Kuwait, as for all sovereigns. As Kuwait has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. Fitch’s ESG Relevance Scores are not inputs in the rating process; they are an observation of the materiality and relevance of ESG factors in the rating decision.
