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S&P Global revises its Kuwait outlook to stable from negative

KUWAIT: S&P Global Ratings revised its outlook on Kuwait to stable from negative and affirmed the ‘A+/A-1’ long- and short-term foreign- and local-currency sovereign credit ratings. The transfer and convertibility assessment remains at ‘AA-‘.

Outlook

The stable outlook primarily reflects the favorable oil price and domestic production prospects over the next two years. It is also based on our expectations that Kuwait will implement additional fiscal financing mechanisms on top of withdrawals from the government’s main treasury buffer, the General Reserve Fund (GRF). This could, for example, include unblocking longstanding constraints on borrowing, by introducing a new debt law, which would allow a wider range of financing options when fiscal deficits re-emerge at a future time.

Downside scenario

We could lower the rating if no sustainable comprehensive financing arrangements are agreed over the next two to three years. This could happen, for instance, because of ongoing tensions between the government and parliament rendering the government unable to implement fiscal reforms, pass the debt law, or authorize other necessary budget-financing mechanisms.

We could also lower the rating if we concluded that the government would not have full ready access to the Future Generations Fund (main portion of Kuwait’s sovereign wealth fund; FGF) for budgetary and debt repayment needs, contrary to our current assumption.

Upside scenario

We could raise the rating if the government successfully implemented a comprehensive structural reform package aimed at improving fiscal financing mechanisms, diversifying the economy and reducing the non-oil deficit. We view this scenario as unlikely over the next two to three years.

Rationale

The outlook revision to stable primarily reflects a significant further increase in the price of oil (Kuwait’s key export item) in recent months, which we expect to be sustained until at least the end of 2023. Although we still expect oil prices to average $55 per barrel (/bbl) from 2024, we project an average oil price of just above $100/bbl for 2022 and $85/bbl for 2023. We estimate that at current spending levels, an oil price of around $75-$80 balances Kuwait’s fiscal books.

Additionally, OPEC+ production quotas are continuing to ease, with Kuwait increasing oil sector output, which also supports fiscal revenue and economic growth. We consider that these favorable terms of trade developments will allow Kuwait to overcome past fiscal financing pressures in place during 2020-2021. Kuwait has previously faced liquidity constraints since liquidity at the government’s main treasury buffer, the GRF, had diminished substantially by the end of last year while alternative financing arrangements, such as the passage of debt law allowing the government to borrow or authorization to withdraw resources from the much larger FGF were not in place.

We estimate that the GRF is being replenished at the current oil prices and the cumulative fiscal surplus over 2022-2023 should allow Kuwait to cover the deficit we forecast for 2024 and part of 2025. Beyond the projected fiscal deficits over 2024-2025, Kuwait faces limited government financing needs over the forecast horizon through 2025.

Following the repayment of a $3.5 billion Eurobond in March, Kuwait’s general government debt now stands at just 3.5 percent of GDP. We expect Kuwait’s interest expenditure to remain low over the next four years, amounting to under 1 percent of revenue on average. The outlook revision and affirmation are also based on our base-case scenario that Kuwait will adopt measures diversifying its sources of fiscal financing over the next two to three years. Without additional reforms, such as passage of the debt law, authorization to more readily access the FGF or optimizing public sector spending, fiscal deficits are set to return by 2024 with Kuwait potentially returning to GRF depletion once again.

We forecast Kuwait’s economy will grow by 8 percent in 2022, followed by 5.5 percent in 2023, mostly on account of rising oil production as OPEC+ cuts are discontinued.  Tensions between the government and parliament remain elevated, as in the past, resulting in policy paralysis and lack of structural reform implementation.  Nevertheless, we expect that over the next two years the authorities will adopt measures diversifying Kuwait’s sources of financing, such as the debt law, either via parliamentary vote or through a decree issued by HH the Amir.

Kuwait’s economy depends heavily on oil, which makes up an estimated 90 percent of exports and government revenue. The oil sector directly constitutes nearly 50 percent of the country’s GDP and even more if we take oil-related activities into account. Consequently, Kuwait is set to notably benefit from the currently favorable terms of its trade. We expect oil prices to average $102/bbl this year, followed by $85/bbl in 2023 and $55/bbl from 2024. In parallel, Kuwait’s oil output has been rising in line with OPEC+ production cuts being gradually phased out.

Kuwait’s oil production averaged 2.4 million bbl per day (mmbpd) in 2021 and we expect it will rise to 2.75 mmbpd in 2022 and 3 mmbpd in 2023, remaining in compliance with OPEC+ agreements. Kuwait is also aiming to increase oil production to 3.5 mmbpd by 2025. This is based on additional investments to increase output at existing fields, as well as fuller use of the partially idle production within the Partitioned Neutral Zone with Saudi Arabia. It is not certain whether these targets will be successfully met as early as 2025, but we still expect production to increase further to 3.1 mmbpd in 2024 and 3.2 mmbpd in 2025 from the current levels.

We consider that domestic pandemic-related risks have effectively abated. Kuwait has vaccinated about 85 percent of the population and all previous internal restrictions have been lifted, which supports economic activity in the non-oil sector. Overall, we now project economic growth at 8 percent this year and 5.5 percent in 2023, mainly on account of rising oil output. We expect this to be followed by more modest growth rates of around 2 percent over 2024-2025.

Beyond the favorable economic environment for Kuwait in the near future, its structural reforms continue to persistently lag peers’. Apart from Qatar, Kuwait remains the only country in the Gulf Cooperation Council (GCC) that has still not implemented value-added tax (VAT), while cutting spending is difficult politically, given that most represents public sector wages and subsidies.

With currently favorable oil prices and rising oil production volumes, we estimate that the GRF is being replenished. We forecast Kuwait’s general government budget will be in surplus of 11.5 percent of GDP in 2022, followed by a 6.3 percent of GDP surplus in 2023.

The additional liquidity accumulated over 2022-2023 should allow Kuwait to cover the fiscal deficit in 2024 and part of 2025. We forecast a general government deficit of about 14 percent of GDP annually in 2024-2025 against our expectations.  Reports of late payments to public entities and suppliers emerged at the beginning of this year, indicating liquidity pressures at the GRF. We understand that the government is currently taking measures to settle these and, amid stronger fiscal performance, we expect this issue will be addressed by the end of 2022.

Mirroring its strong government asset position, Kuwait’s balance-of-payments position is also solid and supports the sovereign rating. We estimate that at year-end 2021 its net external creditor position was equivalent to about 480 percent of GDP, which is among the strongest of all rated sovereigns. We estimate that Kuwait posted a current account surplus in 2021 of 21 percent of GDP, supported by recovering oil prices and production volumes, as well as primary income receipts from managing the sizable stock of KIA assets.

We forecast the current account surpluses will average 30 percent of GDP over 2022-2023 before gradually diminishing to 5 percent-7 percent of GDP over 2024-2025. We expect Kuwait’s exchange rate will remain pegged to an undisclosed basket of currencies. This basket is dominated by the US dollar, the currency in which most of Kuwaiti exports are priced and transacted. Although this monetary regime has served Kuwait well in the past, we note that it constrains the country’s ability to conduct an independent monetary policy to help cushion against fluctuations in the economic cycle. The local currency debt market is also less developed than that of similarly rated peers. Similar to trends in other countries, inflation has been rising in Kuwait and we project it will average 4 percent in 2022. This is still notably lower than in most developed and emerging markets.

The difference is primarily explained by sizable government subsidies, particularly for energy, which has been among the key factors driving inflation up elsewhere. Across the Kuwaiti banking sector, nonperforming loans (NPLs) were low entering the pandemic in 2020. Banks’ high provisioning buffers allowed them to write off exposures with manageable adverse effects on earnings and asset quality. We now expect NPLs and cost of risk to gradually normalize on the back of a more supportive economic environment. We also expect that higher interest rates will support banks’ profitability.

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