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Kuwait: Buying Time

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Kuwait may be slow with fiscal reforms, but it can afford to take its time

editor's pickThursday 08, November 2018

Kuwait packs a lot of financial punch for its size. It boasts the world’s oldest sovereign wealth fund, the world’s most expensive currency   and is the seventh richest country in the   world per capita. It’s easy to forget that these  economic accolades haven’t simply been bought with black gold. In what   is referred to as its golden era from the 1940s to the 1980s, Kuwait’s liberal values cradled a respected theatre   industry, the freest press in the Arab   world and a literary renaissance in the Middle East.

As creator of the world’s first Sovereign Wealth Fund and the first stock exchange in the Gulf, Kuwait was also a posterchild for diversification   away from oil.  It’s easy to forget because today Kuwait derives around 55 per cent of   its GDP, more than 90 per cent of its   exports, and about 90 per cent of fiscal   receipts from hydrocarbon products.   Frictions between a cabinet handpicked by the Emir and a democratically elected parliament has stunted Kuwait’s   diversification efforts, leaving it lagging behind its GCC peers.  

Fighting back  

The squabbles that have delayed Kuwait’s fiscal reforms have left the   country economically paralysed. The tendering process of several public private partnerships stalled in 2017, and   the planned introduction of VAT has been   pushed back to 2021. The parliament also   delayed the passing of a new debt law   after the previous one expired in October   2017, blocking any debt issuance thus far   in 2018.   At the end of 2017, Kuwait’s entire   cabinet resigned rounding off a year of   mixed fortunes. Overall, real GDP growth   contracted an alarming 2.9 per cent in   2017, according to S&P.

The oil sector contracted by 7.2 per cent; however, growth in the non-oil sector held up at 2.2  per cent, as households and government   relaxed their purse strings and began   to spend.  Kuwait has carried over many of these positive themes into 2018, however the country’s financing needs remain large and deeper reforms are needed to sustain them. While Kuwait has sound financial buffers, keeping its population in the lifestyle to   which it has become accustomed isn’t   cheap. Kuwait’s citizens have enjoyed a   generous welfare state and a prominent public sector that employs 80 per cent of the national workforce. Kuwaiti authorities would rather watch their reserves slowly   erode than break that social contract.  

Buying security

Luckily for Kuwait, some savvy investments decades ago means it can   afford to take its time. Sheikh Abdullah Al-Salem set up the Kuwaiti Investment Authority (KIA) in 1953, which is now   thought to have assets of $580 billion, or 460 per cent of GDP, although its   performance is not disclosed. The Reserve for Future Generations Fund (RFFG) was created in 1976 to provide financial security when Kuwait’s oil reserves   finally dry up. It was seeded with a deposit   of a mere few hundred thousand pounds in   the Bank of England; today it is thought to   be worth $420 billion. To sustain the fund’s   growth, 10 per cent of all oil revenues are   siphoned off and transferred into it.  

The General Reserve Fund holds the   accumulated government surpluses after   transfers to the RFFG; the government has   been tapping this fund for financing, and its   value is thought to have fallen for the fourth   year in a row, according to Fitch. While the   RFFG would allow Kuwait to sustain current   deficit levels for decades, Fitch estimates   that the GRF could sustain the country for   five years before it runs out.   “We estimate that Kuwait's net   external asset position will remain very   strong at more than 6x current account   payments over 2018-2021,” S&P said. “Moreover, we project that the current account receipts plus usable reserves will cover the country's gross external   financing needs over the next four years.”  

Banking is bright

These nest eggs have given Kuwait ample   space to smooth fiscal consolidation, and   Kuwait’s banking system has reaped the   rewards of this financial security. According  to the IMF, resilient non-oil activity and   strong financial sector oversight has kept the banking system sound.   High capitalisation, steady profitability and good asset quality characterise Kuwait’s financial sector. Moody’s said   that Kuwait’s banks will be supported by steady non-oil economic growth and solid financial fundamentals over the next year. The rating agency expects annual   domestic credit growth of around six   per cent over the next 12 to 18 months.  

Household credit growth will be the key driver on the back improving economic   sentiment and steady employment growth.   While corporate credit growth will be   slower, due to corporate repayments and   moderation in the development project   space, banks will still find opportunities   for corporate credit and non-cash business   arising from substantial active projects, Moody’s said.   "Non-performing loans levels will   stabilise at around two per cent of   gross loans amid favourable domestic   conditions," said Alexios Philippides, an   Assistant Vice President and analyst at   Moody's.

"We also believe that banks have cleaned up their portfolios before this year's implementation of IFRS 9 accounting standards by mobilising   the large pool of general provisions  accumulated in recent years, which will   help limit impairments going forward." The main risks as far as the rating   agency is concerned are adverse domestic   political and geopolitical developments or   renewed weakness in oil prices. Any of   these factors could flatten confidence   and subdue equity markets and the real estate sector, to which banks are exposed, potentially reducing business growth and   pressuring banks' asset quality.   Kuwaiti banks, however, maintain strong loss absorption buffers, with the   system's Basel III Tier 1 capital ratio at   15.8 per cent as of December 2017.

The rating agency also says that significant  general provisions will allow banks to  migrate to IFRS 9 without a negative impact on capital.   Moody's also expects that growth in deposits together with current excess liquidity will allow banks to grow their   loans without increasing their reliance on   confidence-sensitive market funding over  the next 12-18-months. The CBK has been proactive in  improving supervision and regulation, the IMF noted, although the sector could do more to enhance its crisis management  and liquidity forecasting frameworks.  

Welling up

 Nonetheless, it seems Kuwait’s banks   won’t have too much to worry about.   While an initial drop in confidence in   2014 soured activity in the nonoil   sectors, there have been signs of   recovery. Moody's forecasts non-oil GDP   growth of 3.5 per cent in 2018 and 4.0   per cent in 2019, driven by growing   government spending.   Non-oil activity expanded by 2.8 per   cent in the first quarter of this year, according to World Bank data, which   helped to lift aggregate GDP growth   to 1.6 per cent—the first positive in   five quarters.   However, out of all the countries   in the GCC, Kuwait remains the most   dependent on hydrocarbons and oil   will continue to have the biggest   impact on its economy. Luckily, for   the foreseeable future, that impact is   likely to be positive. Kuwait is the   fifth largest OPEC oil producer, and   one of the few OPEC members with   spare oil production capacity. Plans to   invest $115 billion in the oil sector   over the next five years should further   boost oil production, according to the   World Bank.  

The recovery in oil prices over the   past year, which are close to three and- a-half year highs, and rising public sector employment has also bolstered   household spending and sentiment, as reflected in buoyant retail spending. Following a correction in 2016 and 2017, real estate prices have also stabilised. Rising oil prices are providing much relief to Kuwait’s finances. While lower oil prices since 2014 have caused Kuwait's central   government balance to remain deep in   deficit, the country is becoming fiscally   fitter every year. During 2017 the central government deficit narrowed to 14.6 per cent of GDP, from close to 18 per cent in 2016, owing to higher oil revenues. S&P   estimates that temporarily higher oil prices  in 2018 will support a further reduction in the deficit to 10.6 per cent of GDP in fiscal 2018.  

The new black

However, Kuwait can’t afford to be carried   by higher oil process. Over the next   few years, several projects in power, infrastructure, and housing, currently in   various stages of implementation, are   expected to come to fruition.   In March, the government unveiled   its Northern Gulf Gateway project, which aims to add $220 billion to the   country's GDP, attract up to $200 billion in   foreign direct investment creates 400,000   knowledge-based jobs and tempt 3-5   million visitors to Kuwait.   The project would fuse Kuwait into   China’s Belt and Road Initiative, a 21st   Century take on the Silk Road made up of a “belt” of overland corridors and a maritime “road” of shipping lanes. Kuwait is the first   GCC country to sign up to China’s efforts to   tie Southeast Asia to Eastern Europe and   Africa, a swath of the globe that accounts   for 71 countries, half the world’s population   and a quarter of global GDP.  

At the epicentre, Kuwait has the   opportunity to become a major commercial   centre and a base for a network of railways   which start from China and pass through   Central Asia and Gulf states.   China could be a powerful ally as Kuwait   seeks to model itself on Hong Kong under   its revised 2035 plan, the aim of which   is to become a leading regional financial, commercial and cultural hub by 2035.   The plan involves transforming five   islands into economic zones with an   investment value of up to $160 billion. They   would also double as tourist attractions   that would hopefully entice investments   in commercial and residential complexes   as well as infrastructure.  

The best laid plans

The New Kuwait Vision 2035 is actually   a second draft of a plan that was first   released in 2010, and quickly thwarted by   political gridlock, geopolitical tensions and   overly-ambitious plans to compete with   established financial centres in the region.  It was quickly binned when Sheikh Nasser resigned as Prime Minister in 2011. The new plan faces the same hurdles   as geopolitical tensions remain high, policymaking continues to be delayed   by domestic bickering and Kuwait’s   never-ending red tape still threatens to   deter investors. For the same reasons, there is a worry   that the Government's policy response to   its current challenges will be limited. Higher   oil prices and large fiscal buffers provide a   dangerous incentive to keep the status quo.   “We expect reform momentum   aimed at diversifying revenues will slow   further in the context of higher oil prices   during 2018,” S&P said.

“We expect the government to focus on moderating   expenditure growth by somewhat limiting  new employees in the public sector, strictly enforcing current welfare policies   to reduce overspending, and charging   nominal fees to cover the cost of providing   services to its citizens.”  The authorities also plan to introduce excise taxes on certain goods in 2019. The government intends to divest   underutilised assets and privatise around   40 assets over the next 25 years. It is currently studying the feasibility of   privatising the North Shuaiba power   plant, fixed line and broadband telecoms   infrastructure, the Ministry of Electricity   and Water Central Workshop, and the   national stock exchange.  

However, “Notwithstanding plans   to further curtail current spending and  introduce revenue measures, including a value-added tax, more ambitious efforts are needed to bring the fiscal balance closer to levels implied by intergenerational equity considerations, reduce financing needs   more rapidly, and create space for growth enhancing   capital outlays,” the IMF said.  Kuwait may currently boast the   strongest finances among GCC countries, but it cannot afford to become complacent. Kuwait was once a trailblazer for Arab economies that it now lags behind.  Unless it rediscovers its pioneering spirit   and rises above petit squabbles, it will   always be playing catch-up with countries   it once inspired.  

TAGS : Kuwait, Vision 2030, IFRS 9, S&P, IMF, OPEC, Silk Road

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