LONDON, Feb 13: Standard & Poor’s Ratings Services affirmed its ‘AA/A-1+’ long- and short-term foreign and local currency sovereign credit ratings on Kuwait. The outlook is stable.
In mid-January 2016, Standard & Poor’s materially lowered its oil price assumptions for the period 2016-2019. Prices for crude oil in spot and futures markets are some 70% below mid-2014 levels, when prices began to slide. When we last reviewed Kuwait, in August 2015, we expected Brent oil prices to average $55 per barrel (/bbl) in 2016 and $65/bbl in 2016-2019. We now assume an average Brent oil price of $40/bbl in 2016 and $46/bbl in 2016-2019. Consequently, we have also revised our forecasts for Kuwait’s macroeconomic indicators, including GDP per capita, fiscal position, and current account.
Kuwait Crude (KEC) trades at about a US$5 discount to Brent. Kuwait derives about 60% of GDP, more than 90% of exports, and over 80% of fiscal receipts from hydrocarbon products. Kuwait has very large oil reserves, estimated at about 105 billion barrels or 8.4% of global oil reserves.
The sharp fall in oil prices over the past year and a half has significantly affected Kuwait’s fiscal and, to a lesser extent, its current account (flow) positions as well as its wealth levels, measured by GDP per capita.
Nevertheless, our ratings on Kuwait remain unchanged as they continue to be supported by the sovereign’s very high levels of accumulated wealth and very strong external and fiscal asset (stock) positions. The Kuwaiti government, via the Kuwait Investment Authority (KIA), has accumulated substantial assets through oil and gas production over the years; Kuwait has saved its oil wealth in what we consider to be a prudent manner. The government’s large net asset position, which we estimate at over four times GDP at the end of 2016, is a significant ratings’ strength providing a substantial buffer to lower oil prices. Nevertheless, the ratings are constrained by political risk and a very heavy reliance on oil, as well as by regional geopolitical tensions.
The general government budget has averaged a surplus of around 25% of GDP since 2001, if we include investment income from funds held by the KIA. When we include income from its vast investments and transfers to the KIA’s Reserve Fund for Future Generations (RFFG; the KIA’s long term savings fund for future generations invested abroad) in our forecasts, the Kuwaiti government will continue to run surpluses of around 8% of GDP for the budget years 2016-2019, despite the low oil prices. Excluding transfers and investment income, we forecast that on average Kuwait will run single-digit fiscal deficits between fiscal years 2015/16 and 2018/19 (April-March).
Kuwait had increased its annual contributions to the RFFG from 10% to 25% of total revenues in the last two fiscal years including in fiscal 2014/15, because higher oil prices had produced very strong revenues. Now that oil prices are sharply lower, transfers to the fund from 2015/16 onward have reverted back to 10%. The fund will still continue to grow on reinvested earnings and the continued, albeit lower, contributions. Disclosure about the size and structure of the fund and KIA’s assets is limited but we estimate them at about US$535 billion at end-2015.
Our base-case scenario assumes that, despite the sharp fall in the oil price and the risk of OPEC cuts to production, Kuwaiti oil output will remain at above 2.8 million barrels per day until 2019. Production is also likely to increase if Kuwait’s planned investment in the sector comes to fruition.
Strong oil exports led to current account surpluses averaging more than 33% of GDP in 2009-2015. We forecast these surpluses will fall to an average of 11% in 2016-2019. Given the government’s policy of investing a large portion of its surplus abroad, we estimate Kuwait had a net external asset position of more than 500% of current account receipts (CARs) in 2015. We believe that external assets will continue to rise in nominal terms — owing to ongoing external surpluses and reinvestment–but we note a significant denominator effect on the ratio due to a sharply declined denominator (CARs). At the same time, we project that gross external financing needs will remain relatively low, averaging around 80% of CARs plus usable reserves in the next four years.
We estimate real GDP growth to average about 2.4% in 2016-2019, but GDP per capita growth to remain stagnant, partly because of high population growth to an extent linked to the growth in numbers of expatriates.
Kuwait’s exchange rate is pegged to an undisclosed basket of currencies, with a likely bias to the US dollar, which constrains its monetary flexibility. We view its monetary flexibility as limited although we acknowledge that the exchange rate regime is consistent with Kuwait’s reliance on US dollar-based oil revenues and that Kuwait has sufficient resources to manage the peg.
Kuwait’s financial system remains fairly stable, in our view; its banks operate in a reasonably strong regulatory environment and have healthy capital levels. We forecast credit growth to slow slightly.
Geopolitical tensions remain, with the IS militant group in Iraq and Syria, as well as the ongoing war in Yemen, posing a potential threat to the wider region and Kuwait. In June 2015, an IS militant detonated a bomb that killed 27 people at a Shia mosque in Kuwait City; the first terrorist attack on Kuwaiti soil since the First Gulf War. Nevertheless, it did not have wider repercussions and relations between the Sunni majority and Shia minority remain reasonably good.
Domestically, the political system is dominated by a powerful government and vocal parliament (albeit with limited authority over ministerial decisions), which have clashed on many occasions and will continue to disagree on many issues. Kuwait held its third parliamentary election in 18 months in July 2013 and, owing to the boycott of the election by several opposition groups, a more government-friendly parliament was elected. Unlike the previous administration, it is more cooperative with the executive and this has led to more progress on long-planned projects. The next parliamentary elections are due in July 2017. We have factored Kuwait’s political and geopolitical framework into the current rating.
The stable outlook reflects our expectation that Kuwait’s fiscal and external positions will remain strong, backed by a significant stock of financial assets. We expect these strengths to offset risks related to the current low oil price, Kuwait’s undiversified oil economy, and what we assess as a vocal and unpredictable political system, in addition to geopolitical tensions in the region.
We could lower the ratings if a continued fall in oil prices or slow growth were to undermine Kuwait’s wealth levels, measured by GDP per capita, if Kuwait’s domestic political stability were to significantly deteriorate, or if geopolitical risks were to escalate.
We could raise the ratings if political reforms were to enhance institutional effectiveness and improve long-term economic diversification, and if geopolitical risks fade significantly, and prospects for the oil sector improve.