KUWAIT: Firas Mallah during an interview with Kuwait Times.

KUWAIT: A debt issue currently being contemplated by Kuwait government could put a positive spin on its economy as the country is financially very healthy and has large foreign reserves in the shape of the future generations fund and the sovereign wealth fund, said a financial expert on Tuesday.

"Borrowing money when you have good financial health and a budget deficit actually is a positive thing, because you can borrow advantageously at lower interest rates than countries that are actually stretched financially, instead of using reserve capital. You have a sovereign wealth fund which by some measures could be up to half a trillion dollars in size. The market should also be very eager to lend to a country like Kuwait, which has very little budgetary deficit compared to the size of its financial reserves," said Firas Mallah, Managing Director, MENA at Bank of Montreal Global Asset Management, Abu Dhabi.

Speaking with Kuwait Times on the sidelines of the Euromoney Conference at JW Marriott, Mallah said, the conference contemplated measures the government would take while issuing the debt and the right mechanism to control it. It is expected that the government would set up a debt management office for closely monitoring the level of debt.

The other beneficial impact is that it will create a reference for pricing. "If Kuwait as a government issues debt, then we will have a floor to measure debt, therefore any private sector company wants to issue debt can price more efficiently because it has a risk-free reference rate. It will render the market a lot more efficiency in pricing non-government debt risk," he pointed out.

The Euromoney Conference sought to send a message to the market that the government is seriously considering issuing debt, but it will not be excessive, he said. However, he is of the opinion that there needs to be more communication and clarity on the debt issue and borrowing in order to allay misgivings in the market, if any.

Most Gulf countries are either borrowing or starting to look at it. The UAE, Bahrain and Qatar have issued some bonds and Saudi Arabia has issued some bonds in local currency. Currently, the kingdom is considering an international issue. "And now it is time for Kuwait to look at it and I think the first issue might not exceed $10 billion," he said.

Rationale

Giving the rationale behind the proposed government move to issue debt, Mallah said, "when you have a budgetary deficit, there are basically four levers you can use to tackle deficit. First, you can cut your expenditures, you can always try to increase your revenues or plough into your reserves. Next option, possibly a better one will be to borrow money to plug that deficit."

Mallah, who is very knowledgeable in the areas of government debt, bonds, sukuk and wider emerging market debt, added: "I think what the Kuwait government is trying to do now is to use all these four levers together in an optimized manner. Increase in revenue can happen by increasing production volume, but that is already high. The other part which can increase is obviously the price of oil, but this is not going to happen unless by some pragmatic or dramatic change in the oil market scenario brought about either by an OPEC agreement or a surge in demand or a consensus to reduce production to a level to make higher oil prices sustainable. However, a consensus on production freeze looks hard and one government alone cannot do it. Tapping the reserves is usually a temporary measure and not a sustainable measure as it will deplete the reserves."

Cost-cutting

Cost-cutting makes more sense as it provides a good opportunity when you have a low income to make your costs a lot leaner. "All the governments in the Gulf have currently undertaken a sort of health exercise in terms of reducing the fat and making sure they trim their unnecessary burden on budgets, he said. The government may look at the possibility of issuing debt as a way to alleviate any possible budget deficit and generate money from investor demand on regional debt," Mallah explained.

It is never really a good idea to dramatically cut costs because many sectors such as construction, healthcare and education are dependent on government spending. "The government is cutting expenditure on things they think are non-critical in a temporary manner. However the government is not slashing spending on key infrastructure projects such as roads and ports which are necessary for the growth of the economy. Spending on ongoing projects will continue while it is expected that new commitments will be held off until there is more clarity on government finances. It shows there is more vision and foresight in terms of budgetary planning," he pointed out.

Oil price scenario

"There is one aspect of oil price that we cannot avoid and that's its cyclicality. Certain seasons will see more demand than others. Therefore, we will see fluctuations in oil price. At the same time, there is also an equilibrium price and we think that it is around where it should be right now like mid-$40 per barrel or high $40s. Levels above that will be a bit optimistic," Mallah commented, adding that there is a temporary cut in production from shale oil producers, but it is offset by Libya and Iran who increased their capacity. He forecast that oil production will continue and supply will increase next year.

"This year the developed world will grow at close to 1 percent to 1.5 percent at best. There are hardly any figures that will prompt us to believe that there will be an increase in oil consumption. But China will continue to grow albeit at a slower pace than it used to due to internal corrections. China could be a game-changer and we don't have any reason to believe that a change in the growth rate will be positive next year. It will continue to be more or less at the same rate as it is today. Given all these factors into consideration, oil price must hover around the current levels for the next two years. However, an OPEC agreement could change that of course," added Mallah.

By Sajeev K Peter