Dwindling Reserves Force State Asset Swaps

Last week the state treasury fund, the General Reserve Fund, received an infusion of cash to help the government tide over its immediate liquidity needs and meet public sector salaries until the end of current fiscal year in March. How did Kuwait, one of the wealthiest oil-producing states in the world, end up in this dire strait of needing regular capital infusions to meet even the basic expenses of running the government?

Kuwait, once the gold-standard credit in the region, has in the span of a year suffered a string of downgrades by international sovereign credit rating agencies.
The latest lowering came at the start of February, when Fitch Ratings downgraded its outlook on Kuwait’s sovereign debt rating to ‘negative’ from ‘stable’, warning of “near-term liquidity risks associated with the General Reserve Fund (GRF).”

In September 2020, another global rating agency, Moody’s Investors Service downgraded Kuwait for the first time, citing the same increase in the government’s “liquidity risks.” The sovereign credit rating agency cut Kuwait two levels to A1, its fifth-highest investment-grade level. Moody’s now ranks Kuwait two steps lower than Fitch Ratings and one below S&P Global Ratings, another international rating agency that lowered its own assessment of Kuwait in March for the first time ever.

In a note on its latest downgrade, Fitch Ratings said in February that while it affirmed Kuwait’s long-term rating at ‘AA’, the liquid assets in the state treasury fund faced being depleted in the absence of parliamentary approval for the government to borrow on international debt markets. Fitch added, “Without passage of a law permitting new debt issuance, the GRF could run out of liquidity in the coming months without further measures to replenish it. Depletion of GRF liquidity would sharply limit the government’s ability to make good on its spending obligations and could result in significant economic disruption.”

Kuwait has not tapped global debt markets since its highly successful US$8 billion debut debt sale in 2017; not that it did not need to. Since the stark fall in oil prices in mid-2014, the country has in most years struggled to rein-in ballooning budget deficits. From a 20-percent surplus budget in 2013-14, Kuwait’s fiscal deficit declined to 17.5 percent of GDP in fiscal-year 2016-17.

Even in interim years when oil prices regained some of its luster, Kuwait has struggled to introduce meaningful economic and financial reforms that would allow it to diversify the economy from its overwhelming dependence on hydrocarbon revenues. Repeated rows and deadlocks between appointed cabinets and successive elected assemblies have led to several government reshuffles and dissolutions of parliament, hampering much needed economic reforms.

According to Fitch Ratings, Kuwait has vast foreign assets that buttress the country’s continued AA ratings. The Kuwait Investment Authority (KIA), which manages the country’s sovereign wealth fund that includes the Future Generations Fund (FGF) and the General Reserve Fund (GRF) is estimated to hold investments totalling over US$ 527 billion, or around 380 percent of the country’s GDP at the end of fiscal year 2019-20.

The FGF constitutes the bulk of Kuwait’s sovereign net foreign asset position of 471 percent of GDP or around US$489 billion. The FGF has grown over the years due to investment returns and a law mandating transfer of 10 percent of government revenue to the FGF each year. But last year, parliament permitted the government to amend this law, which now states that the 10 percent annual transfer is incumbent only in those years when the budget registers a surplus.

The rest of the assets of the sovereign wealth fund lies in the General Reserve Fund (GRF), which is estimated to have fallen for the sixth year in a row. The depletion of GRF has been hastened by the government repeatedly dipping into the fund to finance its recurring budget deficits and for repayment of domestic maturities. It is also estimated that since only around 65 percent of GRF assets are liquid, the GRF could viably finance deficits only to the end of fiscal year 2021-22.

The GRF, which serves as the state’s treasury, has in particular depleted rapidly since 2015-16 due to heavy drawdowns by the government to finance recurring budget deficits. Assets of the state’s treasury declined by KD14.7 billion from the 2015-2016 to 2018-2019 fiscal years. In fiscal year 2016-17 the pace of decline in GRF’s assets slowed slightly due to the government issuing domestic debt issuances and launching the country’s debut international debt sale that was overwhelmingly well-received by markets. However, these issuances ended in 2017-18 as the authorities could not get a renewed debt law passed in parliament.

According to a country report on Kuwait by the International Monetary Fund (IMF), the controversial and often contentious debt law was first enacted in 1987. Debt Law Bill: Law No. 50 (1987) authorized the government to borrow for 10 years and was subsequently amended by Law No. 3 (1997) to extend the period until 2017. The law sets several restrictions on borrowings, including a debt limit of KD10 billion; and debt issuance maturities of maximum 10 years.

Since the old debt law lapsed in October 2017, repeated attempts by the executive to pass a revamped bill that would allow the government to increase the debt ceiling to KD25 billion and to issue debt with tenures of up to 30 years, have been stonewalled by lawmakers who insist that the government rein-in its own wasteful expenditures and curtail corruption before piling debt on future citizens.

The largest portion of expenditure in the general budget goes to paying salaries and bonuses of government employees, but lawmakers are also adamant that the government should not infringe on salaries by reforming public sector wages as the vast majority of those employed in this sector are nationals. The deficit in the general budget in the first nine months of the current fiscal year that ends in March, has already topped KD5.4 billion, or a monthly average of KD600 million per month.

Falling oil revenues, rising expenditure, and a rapidly depleting GRF have made borrowing on the debt market no longer an option but a growing need for the country. In the current fiscal year 2020-21that ends in March, the country has struggled to not only control the budget deficit amid low oil revenues, rising government expenditures, and a rapidly depleting GRF, but has also had to cope with unexpected expenses arising from tackling the COVID-19 crisis.

However, in response to the latest downgrade by Fitch Ratings, Finance Minister Khalifa Hamada said in a statement that Kuwait’s financial position was solid, supported by the much larger Future Generations Fund. But he acknowledged the near-depletion of the GRF due to “structural imbalances” in public finances. He said boosting liquidity in the GRF was among the government’s top priorities and solutions were being explored.

One such solution that has led to the infusion of capital in the GRF at the start of this February has been swapping state assets with the FGF in return for cash. With a debt law blocked, with reforms thwarted, and parliament waiting for a new government lineup to be announced, the authorities resorted to swapping state assets with the FGF to resolve the financial stalemate. While the government cannot directly withdraw money from the FGF without parliamentary approval, no such authorization is needed in order for the fund to buy assets of the GRF.

Last week, the massive wealth fund the FGF, which invests mostly abroad and is considered a safeguard to the nation’s wealth for a time when oil runs dry, once again came to the aid of its dwindling sisterly fund the GRF by infusing the country’s treasury with capital to the tune of KD7.5 billion. Though it appears to be a new initiative to infuse capital, the government has been swapping assets with the FGF since June 2020, in order to provide the necessary liquidity to pay monthly government salaries and to finance current spending.

The recently swapped assets reportedly include lucrative stakes in Kuwait Finance House and telecoms company Zain. In the latest infusion of cash into the GRF, the government is said to have transferred the last of its performing assets, the state-owned Kuwait Petroleum Corporation, which has a nominal value of KD2.5 billion, from the government’s treasury in January to the country’s sovereign wealth fund. With the state assets now nearly depleted, it is not clear how the government will cover future financial exigencies, or its eighth consecutive budget deficit expected in fiscal year 2021-22.

In a report carried by Bloomberg News recently, a business management professor at Kuwait University, Nawaf Alabduljader was quoted as saying, “It’s a very imminent crisis now, not a long-term one like it was before. The Future Generations Fund is our life jacket but we don’t have a boat to take us to shore, we have no vision. We urgently need to restructure our economy and move away from the welfare state model.”

The brinkmanship in parliament has prompted warnings that repeated delays could carry long-term costs. Kuwait would be looking at “either the imposition of high taxes. Or, if the government fails to convince parliament, the central bank will have to resort to devaluing the dinar,” the former CEO of Boursa Kuwait Talal Fahad Alghanim, was quoted as saying by media sources.

To end on a more positive note, Fitch said in announcing its ratings downgrade that its base case, however, remains that the government would replenish the GRF even without any new legislation, and that debt servicing of KD400 million, or 1percent of GDP in 2021, would in any case continue in a timely manner. It forecast Kuwait’s economy would stage a modest recovery this year as the dual shocks of oil output cuts and the pandemic fade after the economy contracted an estimated 7 percent in 2020. Let us hope Fitch is right.

 

SOURCE  TIMESKUWAIT

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