Moody’s Investors Service (“Moody’s”) has on Thursday affirmed the government of Kuwait’s long-term local and foreign currency issuer ratings at A1. The outlook remains stable. The decision to affirm the ratings is underpinned by Moody’s assessment that Kuwait’s balance-sheet and fiscal buffers will remain strong for the foreseeable future, which preserve macroeconomic and external stability and anchor the credit profile.

Balanced against this key credit strength is the persistently challenging political environment that limits the prospects for reforms that would reduce the vulnerability of the economy and government finances to long-term carbon transition risks. The stable outlook reflects balanced risks to the ratings. Effective implementation of measures to reduce the government’s exposure to oil revenue and diversify the economy, which Moody’s does not currently factor into its baseline assumptions for at least the next two years, may raise the resilience of Kuwait’s credit profile to oil price fluctuations. By contrast, accelerating global momentum towards carbon transition that lowers the demand for and price of oil, in the absence of reforms including the passage of legislation to expand the government’s financing options, may reintroduce liquidity risks and weigh on the credit profile longer term. Kuwait’s local and foreign currency country ceilings remain unchanged at Aa2.

The narrower-than-average two-notch gap between the local currency ceiling and the sovereign rating reflects the country’s stable balance of payments through episodes of oil price volatility, against the economy’s exposure to a key revenue source and a challenging domestic political environment that constrains reform and diversification prospects. The zero-notch gap between the foreign currency ceiling and local currency ceiling reflects very low transfer and convertibility risks, given the country’s very large net external creditor position that includes ample foreign exchange reserves held by the central bank.

Kuwait’s credit profile is supported by its large sovereign wealth buffers and very low debt level, and Moody’s expects the government’s balance sheet to remain extraordinarily strong for the foreseeable future. Furthermore, in the current environment of high oil prices and rising production agreed by the Organization of the Petroleum Exporting Countries (OPEC) with some other major oil exporting countries, Moody’s expects the government to reaccumulate liquid assets in its General Reserve Fund (GRF), which will eliminate liquidity risk – even if self-imposed – for at least the next two to three years. Moody’s estimates that liquid sovereign wealth fund (SWF) assets managed by Kuwait Investment Authority (KIA) far exceeded the size of its GDP at the end of 2021 and dwarfs the government’s debt of just below 6 percent of GDP at the end of fiscal 2021 (year ending March 2022). The size of Kuwait’s SWF assets as a share of GDP is one of the three largest globally, together with Norway and Abu Dhabi. With the sharp increase in oil prices this year driven by the Russia-Ukraine military conflict, coupled with higher oil production under the OPEC+ agreement, Moody’s expects Kuwait’s stock of SWF assets to grow over the next two years. This is driven by Moody’s forecast that Kuwait will run a fiscal surplus of 7-8 percent of GDP in fiscal 2022 and around 2-3 percent of GDP in fiscal 2023, based on the rating agency’s oil price assumptions of $105 and $95 per barrel on average in 2022 and 2023, respectively. Moreover, with very limited amounts of debt to repay and no requirement to transfer surpluses to the Future Generations Fund (FGF, which is at the discretion of the finance minister after the change in law in September 2020), Moody’s expects the surpluses to be accumulated in GRF as liquid buffers.

The reaccumulation of assets after seven consecutive years of drawdown because of fiscal deficits will bolster Kuwait’s credit profile and eliminate the need for government financing and any associated liquidity risk while the fiscal balance is in surplus. While these needs will return from fiscal 2024 onwards, when, based on Moody’s oil price assumptions, Kuwait will again run fiscal deficits, the near-term period of high oil prices provides time to the government to take some measures that would allow it to finance its deficits. Meanwhile, the large proportion of SWF assets invested in liquid, foreign currency assets help preserve macroeconomic and external stability. Moody’s estimates that Kuwait runs a very large net international investment position because of FGF and foreign exchange reserves are ample.

At the same time, Kuwait’s very high exposure to developments in the oil sector weighs on the resilience of its credit profile because of the long-term transition away from hydrocarbons. Moreover, compared to many hydrocarbon producing peers that are making progress in fiscal and economic diversification away from reliance on hydrocarbons, prospects for reforms and diversification will remain weak in Kuwait, hampered by the country’s political climate. In Kuwait, oil revenue accounts for around 90 percent of government revenue while hydrocarbon exports make up around 80 percent of total exports; the contribution of the hydrocarbon sector is among the largest across sovereigns that Moody’s rates. Although the government has sought to introduce fiscal reforms, it has yet to implement any nonoil revenue measure since the oil price shock in 2015, unlike other countries in the Gulf Cooperation Council (GCC).

The country’s focus on welfare for citizens through wages and subsidies also implies limited scope for deep expenditure cuts as wages and subsidies account for around three-quarters of spending. As a result, Kuwait’s fiscal balance is significantly more volatile compared to GCC peers. As for economic diversification, the government has made some initial progress, but prospects remain limited. The completion of the Clean Fuels Project in 2021 and the likely completion of the Al-Zour refinery this year will provide some downstream diversification within the hydrocarbon sector. However, other projects aimed at spurring non-hydrocarbon sectors such as transport and logistics – including the Silk City and the Mubarak Al-Kabeer port – have faced delays, with the economic returns still uncertain. Economic diversification prospects are in part limited by Kuwait’s still weaker economic competitiveness compared to GCC peers. In Moody’s view, the inability to implement fiscal and economic reforms and lack of progress in diversification stem from the fractious relationship between the government and parliament.

In particular, the possibility of Kuwait’s balance-sheet strength significantly eroding over time will increase with the acceleration in carbon transition trends if institutions are unable to adjust to an environment of lower oil prices and demand. The stable outlook reflects balanced risks to the ratings. On the upside, the implementation of reforms to reduce the government’s reliance on oil revenue may raise the resilience of the credit profile to oil price fluctuations and longer-term carbon transition risks. The government has been considering various types of nonoil revenue but has yet to push any new tax through parliament. Moody’s does not currently factor any such measures into its baseline assumptions for at least the next two years. Moody’s expects Kuwait’s oil production to increase over 2022-23 and underpin real GDP growth of 8 percent this year and 5.5 percent next year.

Kuwait has the ability to increase oil production further if allowed by OPEC+, as its expected capacity for fiscal 2022 is 3.1 million barrels per day (mbpd), compared to an average production of around 2.7mbpd that is likely this year. On the downside, Kuwait is highly vulnerable to accelerating momentum towards carbon transition that may reduce the demand for and price of oil.— Moody’s Investors Service./KT