S&P lowers Kuwait ratings to ‘AA-’

Outlook stable; lower oil prices to have negative economic and fiscal implications

LONDON, March 28: S&P Global Ratings lowered its long-term foreign- and local-currency sovereign credit ratings on Kuwait to ‘AA-’ from ‘AA’. The outlook is stable.

At the same time, we affirmed our ‘A-1+’ shortterm foreign and local currency sovereign credit ratings on Kuwait.

We revised our transfer and convertibility assessment for Kuwait to ‘AA’ from ‘AA+’.

As a “sovereign rating” (as defined in EU CRA Regulation 1060/2009 “EU CRA Regulation”), the ratings on Kuwait are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar. Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is S&P Global Ratings’ revision of its hydrocarbon price assumptions for 2020 and beyond. The next scheduled publication on the sovereign rating on Kuwait will be on July 17, 2020.

Outlook

The stable outlook reflects the balance between risks from Kuwait’s high reliance on the hydrocarbons sector and delays to structural reforms, against the country’s sizable accumulated fiscal and balance-of-payments buffers, which provide the authorities policy space to maneuver over the short to medium term.

Downside scenario

We could lower the ratings over the next two years if reform efforts, such as taxation and labor market changes, and measures to diversify the economy remain sluggish, increasing the burden on Kuwait’s fiscal and balance-of-payments metrics. We could also lower the ratings if we considered that Kuwait’s monetary policy flexibility had reduced or regional geopolitical tensions materially deteriorated, with potential disruptions to key trade routes.

Upside scenario

We could raise the ratings if wide-ranging political and economic reforms enhanced institutional effectiveness and improved long-term economic diversification, although we think such a scenario is unlikely over our forecast horizon 2020-2023.

Rationale

On March 19, 2020, S&P Global Ratings materially lowered its oil price assumption for 2020. This follows an earlier significant downward revision of its price assumptions on March 9, 2020. Prices for crude oil in spot and futures markets are more than 55% lower than levels observed during the summer of 2019 when prices increased due to rising geopolitical tensions. When we last reviewed Kuwait (“Summary: Kuwait,” published Jan 17, 2020), we expected Brent oil prices to average $60 per barrel (/bbl) in 2020 and to gradually decline to $55/bbl from 2021. We now assume an average Brent oil price of $30/bbl in 2020, $50 in 2021, and $55/bbl from 2022.

Oil prices plummeted following OPEC’s failure to agree on further production cuts during meetings on March 6. OPEC+ did not agree to a proposed reduction of 1.5 million barrels per day (mmbbl/d) to address an expected significant drop in global demand partly due to the spread of the coronavirus. The proposed reduction was in addition to the current 2.1 mmbbl/d production decrease set to expire at the end of March. Shortly after the meetings, Saudi Arabia announced that it was immediately slashing its official selling price and would increase its production to over 12 mmbbl/d in April after the current production cut expires. These actions possibly signal that, despite a collapse in global demand and shrinking physical markets, Russia and OPEC have engaged in a price war to try and maintain market share and market relevance. Oil markets are now heading into a period of a severe supply-demand imbalance in second-quarter 2020. In line with our economic outlook, we anticipate a recovery in both GDP and oil demand through the second half of 2020 and into 2021 since the most severe effects from the coronavirus outbreak moderate.

In our view, the terms-of-trade shock will hamper Kuwait’s economy. We have previously highlighted that Kuwait’s trend real GDP growth is below that of countries at a comparable level of economic development. We now consider that the risks for Kuwait have increased further. Although it remains unclear whether Kuwait will follow Saudi Arabia to the same extent in ramping up oil production, we expect an increase in output to above the budgeted levels of 2.8 mmbbl/d, which should provide some short-term economic support. Nevertheless, we anticipate this boost may be offset by lower oil prices pushing down domestic consumption and investments, as companies reevaluate potential projects, including in the oil and related sectors.

Beyond the direct impact of the drop in oil prices, Kuwait’s economic prospects remain vulnerable to a sharp downturn. This is because around 80% of its exports are destined for Asia, where several countries have already been substantially affected by the coronavirus outbreak, leading to a contraction in oil demand. Additionally, the spread of coronavirus will likely hit Kuwait’s domestic economy directly, constraining growth in non-oil sectors. So far, close to two hundred cases of COVID-19 have been recorded in Kuwait and the government has ordered businesses to shut down for several weeks, alongside a partial curfew.

Overall, adjusted for population growth, we project Kuwait’s trend economic growth will remain negative over the medium term. We now forecast GDP per capita at just under $22,000 for 2020, down from almost $29,000 previously. Although Kuwait remains a wealthy economy, this forecast represents a material downward revision of relative income levels and consequently the country’s aggregate debt-bearing capacity.

Apart from lower growth, we note that Kuwait’s reform momentum has been slow in recent years, even compared with other states in the Gulf Cooperation Council. Beyond some expenditure adjustments following the previous drop in oil prices in 2014, progress has been limited. Specifically, the introduction of taxes has long been delayed, while reforms to diversify the economy and modernize the labor market have achieved limited results. This presents mediumterm risks, in our view, since there is typically a substantial time lag between reform implementation and results, particularly in sectors like education.

Kuwait has also yet to pass a revised debt law authorizing the government to borrow, raising questions about how future central government deficits will be financed. Although the sovereign wealth fund is substantial at about 500% of GDP, the portion of it readily available for budgetary needs – the so-called General Reserve Fund (GRF) – is much smaller, estimated at around 50% of GDP, and is continuously being used. Kuwait’s use of the GRF will likely accelerate, since we project deficits will widen in line with the decrease in oil prices. Absent passage of the debt law, it remains unclear whether Kuwait could face a hard budget constraint or start drawing on assets in the Future Generations Fund, which happened only once before, during the Gulf War. Drawings from this fund require special legislation.

We forecast that, in line with lower oil prices, Kuwait’s general government balance will be in deficit exceeding 10% of GDP in 2020 before gradually returning to surpluses over the medium term. Our fiscal projections include investment returns generated through managing the sovereign wealth fund but we recognize downside risks to 2020 investment returns due to ongoing market volatility.

Importantly, our ratings on Kuwait remain supported by the country’s substantial amounts of accumulated fiscal and external buffers, which we project will average close to 500% of GDP over the next four years and afford the authorities room for a policy response. The ratings are constrained by the concentrated nature of the economy and relatively weak institutional settings compared with nonregional peers in the same rating category. We don’t expect this to change over the medium term.