Thursday, Sep 16, 2021
International Finance
Economy Feature Magazine

Will Kuwait push through the debt law?

ifm-feature-kuwait-crisis
If the Arab state overcomes the legislative gridlock—there still might be hope to access foreign debt markets and preserve its sovereign wealth assets

A common observation for the oil-rich Arab state is that the combined effects of the global oil price collapse and the coronavirus pandemic have affected its economy to deep levels. Deducing the matter, Neha Anna Thomas, the senior economist at Frost & Sullivan, told International Finance, that these factors have pushed the State into its ongoing liquidity crisis. “Kuwait is anticipated to register a 2020 GDP contraction of nearly 9 percent,” she said. This sort of scenario has highlighted the glaring economic problems that have been building up for decades in countries that are heavily dependent on oil and have lopsided distribution of income and wealth. Despite no end in sight to this scenario, the State currently has $6.6 billion worth of liquidity in its treasury and insufficient cash to cover salaries beyond October. 

Analysts at IHS Markit, told International Finance, “The global oil price collapse and coronavirus disease 2019 (Covid-19) pandemic are dual shocks affecting Kuwait’s economy. Real GDP is expected to contract this year by the most since the 1990-91 Gulf War amid shutdown measures to combat the Covid-19 virus, projected at -9.9 percent, with only a partial recovery of 2.1 percent in 2021, driven by non-oil GDP. Oil-sector GDP is expected to contract sharply as Kuwait reduces crude output by 9.1 percent in 2020 and another 7.2 percent in 2021 amid OPEC production cuts, as oil prices are expected to remain relatively low. IHS Markit expects Brent oil prices to average $41 per barrel in 2020 and $47 in 2021, down from $64 in 2019.” It is reported that the government is drawing out from the General Reserve Fund at a rate of 1.7 billion dinars each month, pointing to the fact that the liquidity will soon be exhausted if oil prices continue to remain weak and if the economy is not able to borrow from local and international markets. 

The liquidity crisis is a wake up call

Neha explained that the “current liquidity crisis has been brought about by the impact of the pandemic on the economy as well as the slide in oil prices.”  

All of this is happening at a moment when the government has estimated a budget deficit of 14 billion dinars in the current fiscal year. In the absence of borrowing in the medium to long-term there will be stringent measures implemented to public spending, and the Future Generations Fund will deplete in the coming decades, therefore disturbing the welfare of the State and its citizens. 

Amid all this downcast, Moody’s has cut Kuwait’s debt rating and reaffirmed that its ‘liquidity resources are nearing depletion’, on the back of the Finance Minister Ali Al-Sheatan’s announcement that the State might not be able to pay wages in November. Although the statement stoked panic on social media, the current scenario might have not fully reflected the country’s relatively strong financial conditions. What makes it difficult to get a grip on the matter is that Kuwait has long outdone other countries for maintaining the levels of sovereign investments and creating national wealth funds. In fact, it was the first nation in the world to have established the sovereign wealth fund in 1953, and despite having such a historic record, the State is mired in political tensions between the government and legislators in the National Assembly, dwarfing its economic growth.  

Analysts pointed out that the “fiscal deficits have been financed instead by drawing down Kuwait’s sovereign wealth assets. Kuwait Investment Authority assets are among the largest in the world, which the International Monetary Fund estimates at around $560 billion which is equal to 410 percent of the GDP as of 2019-end. However only the General Reserve Fund within the Kuwait Investment Authority is currently available for fiscal deficit use, with assets having declined to an estimated $55 billion which is equal to 40 percent of the GDP as of 2019-end, of which only around half is estimated to be liquid. Therefore, the General Reserve Fund’s readily-available funds are likely nearly depleted or will be soon.” 

Kuwait has been drawing down the General Reserve Fund to meet the deficits which is estimated to reach more than 11 percent of the GDP this year, compared to a 4.8 percent surplus last year, observed the International Monetary Fund. “Accessing the Future Generations Fund, which forms the remainder of Kuwait Investment Authority’s assets, would require special approval. However, this could be a lengthy process given the disagreements between the government and the parliament,” analysts said. 

The gridlock is limiting the scope to pass the debt law 

It is concerning that the government is failing to pass a public debt law to tackle the liquidity crisis. According to Neha, adding to the weakness in Kuwait’s present economic growth conditions is the pressure from the deadlock over the proposed debt law which would allow Kuwait to issue debt internationally. In July, the government had formally submitted a public debt law to the parliament which would allow the State to borrow $65 billion over the next three decades, including 8 billion dinars to financially support the current budget deficit.  

Good financial health is the lifeblood of any economy, but the State’s government and the parliament have been at odds over the debt law—leading up to a gridlock instead. “In order to ease the liquidity crisis, the government is working to pass debt legislation that would allow Kuwait to access overseas debt markets. However, this legislation is being challenged by government-parliament gridlock. To push forward through the liquidity crisis, we see that the government has tapped into its reserve fund, while also cutting back on  its budget,” Neha said. 

The gridlock on the debt law has become more like a litmus test for the State to fully understand its financial health. Moody’s Analytics in its report said “The recent deadlock on the funding situation directly threatens the government’s ability to function and pay salaries, which represents a significant escalation in the brinkmanship between the two branches of government.”

Recently, Kuwait elected a new parliament.  Prior to that, analysts said “the government has been unable to issue new debt since October 2017 owing to postponed debt legislation, helping to contain public debt at 12 percent of GDP in 2019. The parliament has rejected the draft debt law, although it could be passed by emergency decree.” Moody’s has warned the government that the gridlock and the ineffective debt management might weaken the State’s financial strength in the coming years. 

The former parliament had repeatedly declined the bill which was developed to allow the State to access international debt markets. “Amidst the liquidity crisis, Kuwait has had to slash its 2020-2021 budget expenditure, and more austerity measures could be expected going forward if Kuwait is not able to secure borrowings through international debt markets,” Neha said. In fact, other Gulf states have already tapped those international debt markets over the last few years leading to more issuances when oil prices crashed earlier this year. The Kingdom of Saudi Arabia, for example, made it happen. 

The proposed debt law would essentially allow Kuwait to tap into international debt markets—something that Kuwait’s  GCC counterparts are currently using. In effect, passage of the legislation would allow Kuwait to borrow from  overseas debt markets and thereby alleviate some of the ongoing liquidity pressures. Parliament-government gridlock over the legislation is not something that has recently emerged. The need to finalise the legislation however, has gained more importance in recent times amidst the coronavirus pandemic,” Neha added. 

Three years ago, the State had initiated its debut in Eurobond issuance with a subsequent lapse in the public debt-related legislation limiting the government’s ability to issue these bonds thereafter. The bond sale at the time saw more than $20 billion in investor bids, with the $3.5 billion 5-year and $4.5 billion 10-year bonds sold at a yield of 2.8 percent and 3.6 percent respectively. Despite the greater focus on the legislation, Neha said that “boosting Eurobond issuance would help the State tide through the ongoing liquidity crisis, and we see that Kuwait’s GCC counterparts have resorted  to this strategy as well and have been able to raise funds through the same.”

Declining oil prices, in part, might affect FGF 

Another stumbling block directly attributable to the financial crisis is that the Future Generations Fund automatically receives 10 percent of the State’s oil revenue each year. Currently, oil prices are at some $40 per barrel which is well below what is needed to maintain the budget of Opec member states. As part of the budget public sector salaries and subsidies account for 71 percent of spending for the 2020-2021 fiscal year. “Oil production is expected to recover only 2.5 percent in 2021 as oil prices are expected to remain relatively low,” analysts explained. In response to the crisis, it is reported that the State was considering selling 2.2 billion dinars worth of General Reserve Fund assets to the Future Generations Fund, as an alternative measure to plug the deficit. Another option would be to borrow directly from the central bank. It seems that the General Reserve Fund had 1.1 billion dinars left. 

In July, Finance Minister Barak Al-Sheatan in a statement said, “The government looks forward to the legislative authority’s cooperation.” On the other hand, lawmakers had called for more visibility from the State regarding the use of these funds, repayment options and the government’s plan to reduce heavy dependence on oil. In the last fiscal year, oil exports accounted for 89 percent of revenues in the State. “The liquidity crisis has forced the government to tap into its reserve fund, in turn weakening the long-term financial security of Kuwait, as this fund was primarily designed for a time when oil reserves  would be depleted,” Neha explained. 

It perhaps might not be entirely beneficial to the State even if it managed to pass a debt law without a ceiling, because Moody’s estimates that at least $90 billion would still be needed to plug the deficit until 2024. The growing liquidity risks is a huge liability for the State and despite that it has not sought access to its sovereign wealth fund which was established for future generations as a financial protection when the oil runs out. “While raising debt or tapping the Future Generations Fund would help cover funding needs, it would not solve Kuwait’s long-term need for diversification away from its dependence on oil, which constitutes around 90 percent of fiscal revenue and exports, and 45 percent of GDP,” analysts added. “However, it would give the government more time to enact fiscal and structural reforms.”

Economic unrest leads to cut in expenditures 

The important point here is what will be the government’s first task to mitigate the building up risks: anticipated inadequacy in payment of wages, depleting funds, weak oil prices and economic contraction. Arguably, this unrest is encouraging the government to issue between $13 billion and $16 billion in public debt by the end of the fiscal year ending March 2021, if the parliament approves the long-awaited debt law. But for now, the State will have to control its financial crisis, which is drawing down the General Reserve Fund. In September, the government had approved a cut in budgets of State entities by at least 20 percent, and is even considering making an annual State revenue transfer of 10 percent to the Future Generations Fund. It is reported that the move might help the State to save $3 billion in the current fiscal year. 

The second task is to limit spending as a combined result of these factors. “The government for example has indicated cash limitations in regards to upcoming State salary payments. Extensive deepening of austerity measures through curtailed government spending and tax hikes would hinder the economy’s recovery process from the Covid-19 induced slowdown,” Neha said. In September, the Ministry of Finance had amended the estimates for the fiscal year budget of 2020-2021 with revenues at 7.5 billion dinars and expenditures at 21.5 billion dinars. This amendment makes a huge difference because in January the State had estimated revenues of 14.8 billion dinars and expenditures of 22.5 billion dinars for the fiscal year budget. 

The act of diversifying a country’s source of income is also implemented through value-added tax, which the State will enforce next year. The tax authorities have announced that it will finally introduce a 5 percent value-added tax from April 1, 2021. For that reason, a decree was issued for the next year’s implementation of value-added tax on goods and services, excluding rent, food supplies, school fees and public transport. The introduction of value-added tax is the first time in the history of the State’s economics. Kuwait is part of the Gulf Cooperation Council and all six member countries had agreed to implement a value-added tax of 5 percent by the end of next fiscal year. For the State, things appear to be getting worse as the government has faced difficulty in cutting expenditure, especially on salaries, as it seeks to prevent rising unemployment and social unrest. At the same time, development of the private sector is a multi-year process. Therefore, as an alternative, the government has been accelerating the Kuwaitisation drive, and thousands of foreign workers have already left Kuwait this year,” analysts said. 

The former parliament had unanimously agreed to pass a new law that does not include the proposed quota system for expatriate nationalities in the State. The new law was passed after introducing amendments to the proposed quota system in an attempt to ‘rebalance’ its population. It necessitates the government to establish new mechanisms to reduce the number of foreigners within the next one year, taking into account the number of expatriates present in the State, the national development plan and the requirement of expatriate workers. “Government officials have suggested that the share of expatriates be reduced dramatically from 70 percent of the population to as low as 30 percent, possibly within a year, to improve private-sector employment of Kuwaitis and reduce outward remittances, which amount to 11 percent of GDP annually,” analysts said. “However, such a large demographic change, fully implemented in a short period, would reduce Kuwait’s population by more than half and result in a sharp contraction in GDP.” 

Over the last few years, expatriates were brought into the State to carry out specialised jobs and unskilled labour, which accounts for nearly  3.4 million of people. In October, it was reported that the parliament had already requested to replace all expatriate jobs in the government over the next one year. This move was long-anticipated  because the government had already announced in June that it will impose a ban on expatriates in Kuwait Petroleum Corporation and its subsidiaries within that period. With employment even less equally distributed, there might be freezing of all applications from expatriates and not renewing contracts for existing employees. 

Shortening the economic distress won’t be easy

The central bank had published a monthly report which found that the foreign exchange reserves had decreased by 1 percent in July from the previous month. That said, the State’s reserves had decreased to 13.78 billion dinars in July compared to 13.92 billion dinars in June. “Kuwait’s growth recovery extending into 2021 and beyond is expected to be gradual,” Neha said. 

The depleting oil prices triggered by the protracted pandemic have stoked urgency in the State’s debt management—and if necessary actions are not taken in time it would rapidly deplete the cash reserves. “Covid-19 has once again exposed the GCC’s vulnerabilities to oil price fluctuations, following the mid-2014 oil price  crash. For Kuwait and the GCC region at large, economic diversification is becoming increasingly important to mitigate  risks attached to high energy reliance, ease liquidity shortages, and improve macroeconomic stability,” Neha said. “We are expecting to  see a renewed push for diversification across the GCC at large which should help in the mitigation of economic shocks.”

Although Standard & Poor’s has pointed out that the Kuwaiti economy is dependent on oil revenues generated from 90 percent of exports, on the bright side, economic recovery is anticipated to gain momentum next year, similar to the global trend, although it might take place gradually. “The tapering of oil production cuts starting January 2021 would help boost Kuwait’s economic recovery process. It is possible that this tapering could be delayed in the context of a weakened 2021 global oil demand outlook. A  prolonged deadlock over the debt legislation stands to lead to a further deterioration in Kuwait’s 2021 outlook,” Neha concluded. With the newly elected parliament, there could be changes to Kuwait’s debt law impasse.

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