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S&P affirms Kuwait rating of AA/A-1...outlook stable Prudent management of wealth balances difficult political environment

SYDNEY, Feb 14, (Agencies): Standard and Poor’s Ratings Services affirmed Kuwait’s long and short-term foreign and local currency sovereign credit ratings at AA/A-1, with a stable outlook on Friday. The credit ratings agency said Kuwait has rich resources which have made it wealthy and enabled it to build strong external and fiscal balance sheet positions. “The stable outlook balances our view of Kuwait’s very strong fiscal and external positions against its confrontational and, in our view, non-transparent political system, the geopolitical tensions in the region and the undiversified economy in which real GDP per capita growth has been weak,” S&P said in a statement.

The ratings on Kuwait are supported by the sovereign’s high levels of wealth and very strong external and fiscal balance sheet positions. It accumulated these by being rich in resources and managing its wealth in what we consider to be a prudent manner. The ratings are constrained by Kuwait’s difficult political environment, lack of transparency regarding decision-making and government assets, and limited monetary policy flexibility. The general government budget has shown a surplus of at least 10% of GDP for the past decade. We estimate that— including our estimate of government investment income—the Kuwaiti government will have a surplus of about 30% of GDP for the budget year ending March 31, 2014.

Our base-case scenario assumes that oil prices will remain high, averaging $96 per barrel in 2014-2017, and that oil output will increase to about 3.5 million barrels per day by 2015, from about 3.2 million in 2013. As a result, we project that the general government budget surplus will remain high, at about 20% of GDP on average over the next four years. We estimate the government’s investment income was 9% of GDP in 2013 and we assume it will remain at about this level, based on our estimate of the average return over the past five years. Kuwait increased its annual contributions to its Future Generations Fund to 25% of total revenues in the fiscal year ending in 2013, from 10% in previous years. The remaining surplus is invested by the General Reserve Fund. Both funds are managed by the Kuwait Investment Authority.

The government’s large net asset position, which we estimate at just over 2.5x GDP in 2014, is a significant ratings strength. However, disclosure on the size and structure of the government’s assets is extremely limited, in our opinion, and a rating weakness. We estimate trend economic growth, which our criteria defines as a weighted 10-year average of the change in real GDP per capita, as a contraction of about 0.8%; we expect countries with similar wealth levels to Kuwait to grow by 0.3%-1.5%. In our view, Kuwait’s high wealth level — we estimate GDP per capita at $60,000 in 2014 — means that its weak economic growth performance is not an immediate ratings concern.

However, over the medium term, Kuwait’s economic risk position could deteriorate compared with faster-growing economies. In resource-based economies, we consider that nominal economic growth could be a better indicator of prosperity and resources than real economic growth. At the same time, the size of the resident population is uncertain — especially the size of the non national population, which accounts for about two-thirds of the total population. This makes the calculation of output per capita more challenging than in most other rated sovereigns. The strength of oil exports resulted in average current account surpluses estimated at more than 30% of GDP between 2004 and 2013. Combined with the government’s policy of investing a large portion of its surplus abroad, this has caused a significant accumulation of external assets.

Kuwait is likely to record a substantial net external asset position of about 400% of current account receipts (CARs) in 2014. However, in line with our expectation of relatively flat oil exports, we now expect weaker growth in CARs. We forecast that growth will average 4% in 2014-2017, compared with an estimated growth rate of 18% during the previous four years. We estimate that Kuwait’s liquid external assets exceed external debt by close to 3x CARs. At the same time, we project that gross external financing needs will remain low, averaging around 55% of CARs plus usable reserves in the next four years. Kuwait experienced political tensions in 2012, including the suspension and dissolution of parliament and large street protests demanding better representation within the political system. Kuwait held its third parliamentary election in 18 months in July 2013. The new parliament is more diverse than that of December 2012. Liberals, Sunni Islamists, and Bedouin tribes have all increased their representation.

We expect the ruling family, the Al Sabah, to remain in power. However, continued tension between the parliament and the executive is likely to hamper policy implementation. We have factored Kuwait’s underdeveloped political and institutional framework into the current rating. In addition, Kuwait’s exchange rate is pegged to an undisclosed basket of currencies, constraining its monetary flexibility. In our opinion, monetary flexibility is limited, although we acknowledge that the exchange rate regime is consistent with Kuwait’s reliance on US dollar-based oil revenues.

We view Kuwait’s creditworthiness as susceptible to any future sharp and sustained decline in oil prices—the oil sector accounts for about 60% of nominal GDP, 90% of exports, and 80% of general government revenues (including investment income from the Kuwait Investment Authority). The stable outlook reflects our view that Kuwait’s fiscal and external positions will remain strong. We forecast that general government and current account surpluses will remain above 15% and 25% of GDP, respectively, until 2017. We also expect that Kuwait’s political system will remain confrontational, often resulting in the inefficient implementation of government policy. We anticipate that transparency with regard to government assets will remain low and that geopolitical tensions in the region will not escalate.

We expect only marginal diversification of the economy over the next two years and estimate trend growth as a contraction in per capita economic output of 0.8%. We also estimate that Kuwait’s GDP per capita will rise to about $60,000 in 2014. Apolitical consensus that helps to accelerate both domestic and foreign private investment could support transparency and the long-term diversification of the economy, which could eventually cause us to raise the ratings. Conversely, we could lower the ratings if Kuwait’s domestic political stability were to significantly deteriorate, if geopolitical risks were to materialize, or if we were to view Kuwait’s wealth level in GDP per capita terms as insufficient to offset its weak trend growth.

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