Dubai: Moody’s Investors Service has downgraded Kuwait’s long-term foreign and local currency issuer rating to A1 from Aa2, and changed the outlook to stable.
“The decision to downgrade the ratings reflects both the increase in government liquidity risks and a weaker assessment of Kuwait’s institutions and governance strength,” Moody’s said in a statement.
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In the continued absence of legal authorization to issue debt or draw on the sovereign wealth fund assets held in the Future Generations Fund (FGF), available liquid resources are nearing depletion, introducing liquidity risk despite Kuwait’s extraordinary fiscal strength. And while the fractious relationship between parliament and the executive is a long-standing constraint on Moody’s assessment of institutional strength, the deadlock over the government’s medium-term funding strategy and the absence of any meaningful fiscal consolidation measures point to more significant deficiencies in Kuwait’s legislative and executive institutions and policy effectiveness than previously assessed.
“While liquidity risks are particularly relevant in the next few months, over the medium term next one or two years, upside and downside risks are broadly balanced reflected in the stable outlook,” the rating agency said.
Kuwait has a vast stock of sovereign financial assets currently ringfenced from the general budget by law, securing predictable access to which would eliminate government liquidity risk. Conversely, Moody’s sees a continued risk that the executive and legislature perpetuate stop-gap measures in response to the funding impasse, without providing lasting visibility on the funding of Kuwait’s budget.
Moody’s Kuwait’s foreign currency bond ceiling has been lowered to Aa3, from Aa2 and the foreign currency deposit ceiling has been lowered to A1 from Aa2, whereas the short-term ceilings remain at Prime-1 (P-1). The local currency bond and deposit ceilings have been lowered to Aa3 from Aa2.
Explainging the rationale for the rating downgrade Moody’s said with a government debt law yet to be passed and General Reserve Fund (GRF) assets likely to be depleted before the end of the current fiscal year (ending in March 2021), government liquidity risks have increased.
Legislation passed by parliament so far, including the removal of the mandatory transfer of 10 per cent of government revenues to the Future Generations Fund (FGF) and the reversal of last year’s FGF transfer have only extended the point of depletion to December 2020.
Even if the debt law is passed -- whether by parliament or by decree from Kuwait’s Amir while parliament is in recess -- it will likely not provide a credible medium-term funding strategy, which was a key driver behind Moody’s initiating the review for downgrade in March.
The draft debt law, which has already been rejected once by the parliamentary financial and economic committee, contains a KD 20 billion debt ceiling which would be reached in less than two years under Moody’s baseline scenario. A lower ceiling possibly to win parliamentary approval would be exhausted even earlier given the large size of the government’s immediate and medium-term funding requirements.
$90 billion funding need
Even if the government received legal authorization to issue debt without the constraint of a ceiling, Moody’s projects net sovereign issuance of up to KD27.6 billion ($90 billion) would be required to meet the government’s funding requirements between the current fiscal year and the fiscal year ending March 2024, testing the capacity of the government to access such large financing.
Limited response to low oil price
Moody’s said the government’s continued inability to respond to severe revenue shocks from oil prices points to even weaker fiscal policy effectiveness than previously assumed.
In contrast to earlier statements from the government that it would seek to reduce its expenditure in year-on-year terms, the passing of the budget for fiscal year 2020/21 incorporates a 1.6 per cent increase in expenditure, despite a budgeted 56 per cent decline in revenues.
Kuwait has also made limited progress in reforming subsidies, which account for 22 per cent of government spending while Kuwait’s revenues remain highly dependent on hydrocarbon receipts, which averaged 89 per cent of government revenues between 2017 and 2019. Moody’s expects that fiscal consolidation will prove challenging due to the government’s inflexible spending structure.
Why stable outlook
While liquidity risks are particularly relevant in the near term, over the medium term upside and downside risks are broadly balanced reflected in the stable outlook.
On the upside, Kuwait has a vast stock of sovereign assets held in the Future Generations Fund (FGF) which Moody’s estimates at 359% of GDP as of the end of fiscal year 2019/20. The assets and the investment income generated by the FGF are currently ringfenced from the general budget by law, indicating the obstacles Kuwait faces to resolve its funding challenges are primarily political, rather than outside of the control of the sovereign.