When Kuwait raised $8bn in its first international bond sale in March 2017, Deputy Prime Minister Sheikh Jaber Al Mubarak Al Hamad Al Sabah said the country intended to be a prudent borrower, and it can afford to be. Kuwait’s economy may be dominated by oil, but it can tolerate a lower fiscal break-even price for the commodity than any of its Gulf neighbours. The country enjoys an “AA” credit rating from Fitch Standard & Poor’s thanks to a track record of saving during the oil industry’s boom years from 2003-14. Meanwhile, Moody’s affirmed Kuwait rating at Aa2 and in May 2017 changed the rating outlook on the government of Kuwait to stable from negative. 2017/18 BUDGET: Kuwait projected a third consecutive budget deficit for FY 2017/18, albeit smaller than in the previous period. A deficit of KD7.9bn ($26.1bn) was anticipated for the financial year starting on April 1, 2017, including transfers to the Future Generations Fund (FGF), compared to KD9.7bn ($32.1bn) in 2016/17 and KD6bn ($19.8bn) in FY 2015/16, according to NBK Bank. Excluding the FGF transfers, the deficit was KD6.6bn ($21.8bn) in FY 2017/18 and KD8.7bn ($28.8bn) in FY 2016/17. Spending in FY 2017/18 was projected at KD21.2bn ($70.1bn), according to the state news agency KUNA, against revenues of KD13.3bn ($44bn). The deficit forecast took into account a mandatory 10% contribution from revenues to the FGF.
The budget forecast oil revenues for FY 2017/18 of KD11.7bn ($38.7bn), a 36% increase on FY 2016/17. In that financial year, the Ministry of Finance (MoF) estimated total revenues of KD10.2bn ($33.7bn), 16% lower than the KD12.2bn ($40.4bn) projected in FY 2015/16, against spending of KD18.9bn ($62.5bn), which was 1.5% below forecast spending of KD19.2bn ($63.5bn) in FY 2015/16. At the time of the budget forecast in late January 2017, Brent crude was trading at $55 a barrel, but the revenue forecast estimate assumed an average oil price in FY 2017/18 of $45. Although Kuwait oil trades at a lower price than the international Brent crude price, the forecast price in the budget was regarded as conservative at the time. In FY 2016/17 the Kuwait budget assumed a price of $35 per barrel, but according to monthly data from the US Energy Information Administration (EIA), the average price for Brent crude for that period was $48.30. In the previous year, FY 2015/16, the Kuwait budget assumed a price of $45, and although Brent crude sold above this price, at $47.30, Kuwaiti oil sold for an average of $43, and thus below the estimate. In February 2017 the average price of Brent crude was $54.87, according to the EIA, while NBK Bank reported the price for Kuwaiti oil at $52.50.
Fiscal Buffers
Although the country is facing a third consecutive year of budget deficits, it is important to see these fiscal difficulties in the broader context. In the five years prior to the oil price collapse in mid-2014, Kuwait had an average annual surplus equivalent to 21% of GDP. Indeed, apart from a few years that followed the Iraqi invasion in 1990-91, and the FY 1998/99 oil price slump, Kuwait’s budget has been in surplus since the early 1980s.
During difficult times it has been able to fall back on its two sovereign wealth funds, which are administered by the Kuwait Investment Authority (KIA), an independent government body headed by the minister of finance. There are two separate sovereign wealth funds (SWFs): the General Reserves Fund (GRF), which was established in 1952; and the FGF, which was created by emiri decree in 1976.
When it was established, the FGF received 50% of the assets then held by the GRF, and a law was drafted ensuring it would receive a minimum of 10% of government revenues each year and 10% of the GRF’s net income. From 2011 to 2013 Parliament increased the amount transferred to the FGF from government revenues to 25% to ensure the huge surpluses created by surging oil prices were invested for the future. All of the FGF’s investments are abroad, and withdrawals from it are prohibited unless sanctioned by law. The only exception was following liberation from Iraq, when $85bn was withdrawn from 1990 to 1994 to fund reconstruction, which has since been repaid.
The GRF holds all government assets, including public enterprises such as the Kuwait Fund for Arab Economic Development and Kuwait Petroleum Company. The state must authorise withdrawals from the GRF through the annual budget, but up to 80% of its assets are believed to be liquid cash and cash assets. According to the Sovereign Wealth Fund Institute, KIA’s combined assets in 2016 were $524bn. In the Gulf region, only the UAE’s $828bn Abu Dhabi Investment Agency fund is larger, with the SWFs of Saudi Arabia and Qatar at $514bn and $320bn, respectively. The IMF used a slightly more conservative estimate of KIA funds at the end of 2015, at $530bn, with two-thirds held by the FGF and a third under GRF control.
Funding The Deficit
Although it is rich in assets, Kuwait is keen to maintain its credit ratings to reduce the cost of borrowing as it seeks to cover the shortfall in earnings that is likely to persist until there is a significant rally in oil prices. In 2016 it drew funding down from the GRF but also established a debt management committee, headed by the undersecretary of the MoF, which includes members from KIA and the central bank. Its mission is to create a comprehensive debt management strategy, and the committee is being supported by a debt management unit within the MoF. According to analysis by NBK Bank, the MoF had issued KD1.5bn ($5bn) in domestic bonds and Islamic instruments by the end of November 2016 and the debt level had risen to KD3.1bn ($10.3bn), which is equivalent to approximately 9.4% of GDP. At the start of 2017 Kuwait’s credit ratings with Moody’s, S&P and Fitch was “Aa2”, “AA” and “AA”, respectively.
International Bond
When it came, Kuwait’s international debt issuance was well timed, with the sale taking place two days before the US Federal Reserve raised interest rates by 25 basis points (bps), its third hike since the FY 2008/09 global financial crisis. The sale raised a total of $8bn and generated $29bn in bids, according to Bloomberg. Kuwait offered $3.5bn in five-year bonds with a yield of 2.88% and $4.5bn in 10-year notes with a yield of 3.62%. There was a spread of 75 bps and 100 bps on the five and 10-year bonds, respectively.
According to local media reports, a total of 26% of the five-year bonds were bought by investors from within the MENA region, 24% of buyers were from the Americas, 46% went to European and UK investors, and 4% to Asian buyers. Of the 10-year bonds sold, some 4% went to investors in Asia, 19% to Europe, 51% to the Americas and 26% to the MENA region. The Kuwait sale was managed by Citigroup, HSBC Holdings, JP Morgan Chase and Co, Deutsche Bank, NBK Capital and Standard Chartered.
Regional Comparisons
Kuwait was the last country in the Gulf region to tap international debt markets, with other GCC members collectively raising over $48bn in bond sales in 2016 alone. The UAE, which shares S&P’s “AA” status with Kuwait, raised $5bn in 2016, while Qatar, which is also rated “AA”, issued $5.5bn in international bonds in 2015 and a further $9bn in 2016. By far the biggest bond sale came from Saudi Arabia, rated “A-” at the time, with a $17.5bn issuance in October 2016, which set a new record for an emerging market. Earlier, in April 2016 Saudi Arabia had raised a further $10bn in international syndicated loans. Bahrain, which is rated “BB”, raised $1.5bn in 2015 and a further $600m in 2016, while Oman, a non-OPEC producer, waited until 2016 to tap international markets for $5.5bn.
With the lowest fiscal break-even oil price in the GCC, Kuwait could afford to take its time in deciding to follow its neighbours’ lead. “It is a sensible option for the government to pursue an issuance and the international debt capital markets are open to this strategy,” Rani Selwanes, managing director of investment banking at NBK Capital, told OBG. “After all, Kuwait, along with Abu Dhabi, is the strongest emerging market in the world. According to leading credit rating agencies, they both have ‘AA’ status.”
After seeing its sale over-subscribed by three times, there is surely the potential for Kuwait to be tempted to return to international markets. However, the country’s rulers are sending out a much more cautious message than this by saying that Kuwait intends to be a prudent borrower. In an analysis of the merits of foreign and domestic debt issuance for Kuwait, the IMF noted in a January 2017 report that any decision to raise finance on international markets should be coupled with a strategy to tighten fiscal controls to reduce the vulnerability of the economy to future price shocks in global oil markets.
The IMF also recommended that if Kuwait wished to raise money in international markets, it would be prudent to be more transparent about the value of assets held by KIA and the country’s SWFs.
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