DUBAI  - Moody's downgraded Kuwait's rating citing higher liquidity risks and weaker governance and institutional strength, as the Gulf state, battered by low oil prices, struggles to pass a law allowing it to issue international debt.

"In the continued absence of legal authorization to issue debt or draw on the sovereign wealth fund assets held in the Future Generations Fund, available liquid resources are nearing depletion, introducing liquidity risk despite Kuwait's extraordinary fiscal strength," the rating agency said.

Moody's Investor Service downgraded Kuwait by two notches to A1 from Aa2.

When Kuwait last issued debt in the international markets in 2017, its bonds traded close to paper issued by Abu Dhabi, considered the safest credit in the region, as a vast oil-driven financial wealth gave investors confidence.

But the nearly $140 billion economy is now facing a yawning deficit of $46 billion, caused by the coronavirus crisis, low oil prices, and a back and forth between government and parliament over a new debt law which is limiting its ability to boost state coffers.

Moody's said the "fractious relationship" between parliament and the government was a long-standing constraint in its assessment of Kuwait's institutional strength.

But the deadlock over funding strategy and a lack of meaningful fiscal adjustment measures "point to more significant deficiencies in Kuwait's legislative and executive institutions and policy effectiveness than previously assessed."

Earlier this month Kuwait cut around $3 billion from its 2020/2021 budget as it seeks to save money.

The debt law that the government is trying to pass would allow it to raise its debt ceiling and tap international investors. But lawmakers first want to see plans to reform the economy and shift its heavy reliance on oil, which made up 89% of revenues last fiscal year. 

($1 = 0.3061 Kuwaiti dinars)

(Reporting by Davide Barbuscia) ((Davide.Barbuscia@thomsonreuters.com; +971522604297; Reuters Messaging: davide.barbuscia.reuters.com@reuters.net))