Correction: Fitch Affirms Kuwait at 'AA'; Outlook Stable 

This is a correction to a commentary published on 9 November. The forecast for the FY16/17 fiscal deficit has been corrected to KD1bn (3% of GDP), from KD400m (1.2% of GDP) previously.

Fitch Ratings has affirmed Kuwait's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'AA' with a Stable Outlook. The Country Ceiling has been affirmed at 'AA+' and the Short-Term Foreign and Local Currency IDRs have been affirmed at 'F1+'.

KEY RATING DRIVERS

Kuwait's key credit strengths are the sovereign's exceptionally strong fiscal and external metrics and, at a forecast USD46/bbl, one of the lowest fiscal breakeven Brent oil prices among Fitch-rated oil exporters. These strengths are tempered by Kuwait's heavily oil- dependent economy, geopolitical risk, and weak measures of governance and ease of doing business. A generous welfare state and the large economic role of the public sector present challenges in the long term, given robust growth of the Kuwaiti population.

Assets and performance of the Kuwait Investment Authority (KIA) are not disclosed. We estimate that KIA assets exceeded USD500bn or 444% of GDP at end-2015. Of this amount, the Reserve Fund for Future Generations (RFFG) was an estimated USD384bn and continues to increase, due to investment income and the statutory transfer of 10% of government revenue. Meanwhile, the value of the General Reserve Fund (GRF), which holds the accumulated government surpluses of previous years, is estimated to have fallen for a second year in a row, to USD117bn, as the government tapped the GRF for financing.

In a scenario where fiscal deficits remain at the level expected for the fiscal year ending March 2017 (FY16/17), the transfer to the RFFG continues and the GRF remains the sole source of financing, the GRF would only be exhausted in five years, while tapping the RFFG would allow Kuwait to sustain its current deficits for decades.

However, the government has announced the intention to issue KD2bn of local debt and KD2.9bn of foreign debt. Local issuance has already picked up considerably, increasing by KD1bn since April 2016. Foreign issuance could take place at the beginning of 2017 or later, and although the government has initiated the process it is still working on establishing a debt management office and on developing a financing strategy. The total issuance of KD5bn would push the debt/GDP ratio to around 25% in FY16/17.

We estimate the general government surplus at 0.3% of GDP (around KD90m) in FY15/16, including an estimated investment income of KD4.7bn, and excluding the statutory RFFG transfer (KD1.4bn). Authorities exclude investment income and subtract the RFFG transfer from their calculation, resulting in a deficit of almost KD6bn. Revenues declined in FY15/16, by 46% for oil revenues and by 35% for non-oil revenues. Expenditure was 5% below budgeted levels, due to subdued wage bill growth, falling fuel costs, and a suspension of recapitalisation payments to the pension fund. Capital spending increased 13%, reaching 89% of the budget level, the highest execution rate achieved in recent years.

Under our baseline Brent oil price assumption of USD42/bbl in 2016 and USD45/bbl in 2017, we expect a fiscal deficit of around KD1bn (3% of GDP) in FY16/17. According to the government's reporting convention, our forecast deficit would be KD7.4bn, which roughly corresponds to financing needs, as the government does not intend to tap the RFFG. The government's own headline budget deficit figure is KD9.7bn for FY16/17, based on an oil price assumption of USD35/bbl.

The most visible elements of Kuwait's reform agenda are the increase in fuel prices from 1 September this year and in electricity tariffs for non-Kuwaitis, second residences, and commercial consumers starting around August 2017. The government is aiming for these increases to ultimately net as much as KD960m. In FY15/16, the Ministry of Finance also began a concerted effort to restrain spending across the central government and attached entities, which it targets full-year fiscal impact of up to KD1.2bn. In FY16/17 and FY17/18, it plans to rationalise the pricing of government services, which could yield around KD300m per year.

We assume that fiscal measures will be implemented only partly and that some of the gains will be offset by growing expenditure. Execution risks are also high for other proposed reforms, such as privatisation and increased usage of public-private-partnerships, as they could prove to be complex and politically contentious.

Opposition by the parliament to the government's reforms has triggered its dissolution by the Emir on October 16, shortly before it was due to begin its last legislative session. New elections are scheduled for 26 November. The next parliament will be less government-friendly than the outgoing one, since much of the opposition boycotted the 2013 election but have announced their intention to participate in the coming polls. If the next parliament and the government are unable to cooperate, Kuwait could return to the kind of uncertainty that it saw in 2011-2013, which saw three parliamentary dissolutions and popular protests. This could reverse Kuwait's recent progress on the country's development programme and on economic reform.

The low oil price environment has not yet meaningfully dented economic sentiment and activity, but this may change as the utility price increases feed through to inflation in 2017-2018. We expect GDP growth of 3.2% in 2016, supported by strong growth in oil production, government capital spending, and private credit. Banks remain highly capitalised, liquid, and profitable and would be well-placed to cope with any foreseeable deterioration in their loan portfolios. The combination of robust domestic demand growth and low export revenues is expected to lead to Kuwait's first-ever current account deficit in 2016.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Kuwait a score equivalent to a rating of 'AA' on the Long-Term Foreign Currency IDR scale.

Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign Currency IDR.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year-centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that could individually or collectively lead to negative rating action are:

• Sustained low oil prices that erode fiscal and external buffers.
• Spill-over from a regional shock that impacts economic, social or political stability.
• Adverse domestic political developments that are significantly more severe than the 2012 protests.

The main factors that could individually or collectively lead to positive rating action are:

• Improvement in structural factors such as reduction in oil dependence, and a strengthening in governance, the business environment and the economic policy framework.

KEY ASSUMPTIONS

We forecast that Brent crude will average USD42/bbl in 2016, USD45/bbl in 2017 and USD55/bbl in 2018.