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Middle EastMarch 15 2011

Kuwait development plan points to bright future

The unrest across the Arab world and the subsequent rise in oil prices have impacted upon Kuwait, but the tiny Gulf country seems well insulated from such issues, thanks in part to its government-approved $100bn development plan. 
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Kuwait development plan points to bright futureKuwait National Assembly has given the green light to a huge development plan.

High oil prices obviously bode well for Kuwait’s economy for the year to come, but what constitutes the Gulf state’s strength can, in some ways, also be a weakness. While its strong balance sheet – due in very large part to strong oil prices – provides comfort to the economy, Kuwait’s high dependence on oil also translates into an undiversified economy that puts it at risk of market volatility. The country's growth rate is about three times more volatile than the global median, according to International Monetary Fund (IMF) data.

Kuwait’s finances are strong, however, and its budget surplus should remain high, coming in at about 14% of gross domestic product (GDP) on the back of rising oil prices. The country also has large overseas investments, which provide a steady income stream, and some diversification away from oil revenues. 

Instability worries

The big unknown at the moment is the political situation in the Middle East and north Africa (MENA), which could impact on Kuwait in both positive or negative ways. With the current problems in Libya, as well as political turmoil in other oil-producing states impacting on oil output – or at least causing a crisis of confidence in the markets and resulting in price spikes – Gulf economies are increasing their production, which is translating into increased profits. But once again, this short-term boon could have a cost. While Kuwait is considered one of the most stable Gulf states, and was the first in the region to have an elected parliament, it is not immune from internal unrest. In the current unstable political climate in the region, further turbulence cannot be ruled out.

As things stand, however, Kuwait is resting on sound fundamentals. Going forward, the budget balance is expected to consolidate at about 15% of GDP, with revenues expanding at a rate comparable to the pace of real GDP growth, according to analysts based in the Gulf. Inflation, which peaked at 4% in 2010, is something of a concern, and Kuwait displays the second highest rate of consumer price inflation in the Gulf Co-operation Council (GCC) after Saudi Arabia. Analysts predict that it will continue to rise – albeit at a slower rate than in previous years – as the effects of the global recession diminish.

Ensuing tensions between Kuwait's parliament and government have hampered the progress of parts of the reform agenda, but there has recently been a huge step forward with the approval by the government of the $100bn development plan in February. The prime minister, Sheikh Nasser Mohammad al-Ahmad Al Sabah, narrowly survived a no-confidence vote in parliament in January – the second time this has happened in just over a year. He has been under constant political pressure ever since taking office in 2006, amid accusations by MPs of attempting to stifle the parliament.

Economic outlook

Despite a climate of strong oil prices and apparent global economic recovery, Kuwaiti banks remain deeply scarred by the global financial crisis, and the government has been looking at measures to boost the economy and foster growth. In this context, the final approval of the long-awaited development plan, aimed at boosting the economy and fostering energetic private sector activity, can be seen as a huge step forward. As a result, the IMF now considers Kuwait's economic outlook for 2011 to be “broadly positive”; however, this will depend on the pace of the global recovery, as well as the political situation across the Middle East.

Kuwait is expected to see real GDP growth of 2% this year, with the non-oil sector set to grow at about 2.5% on the back of the government spending under the development plan. When the National Assembly initially approved the plan, with an estimated Kd37bn ($100bn) of spending on both oil and non-oil economic sectors, observers predicted that this would be the trigger for the country’s economic recovery. The plan is aimed at financing much-delayed infrastructure projects, and will include an upgrade of the country’s strained energy grid, the construction of a container harbour and the development of a new business hub known as 'Silk City'.

As many observers have noted, several of the country’s long-awaited plans have, in the past, failed to materialise. Successful implementation of this latest project could have a dramatic and positive effect on the country's overall economy. The plan is expected to drive diversification, as a result of capital expenditures, and a large part of the money will fund mega projects that will stimulate economic growth over the next five years.

According to research published by Kuwaiti investment company Global Finance House, sustainable economic growth and an increase in participation from non-oil sectors over the five-year plan will guarantee a minimum sustainable level of 5% average annual real economic growth. This should play a large part in mitigating any risks related to declining oil prices or the lack of a global economic recovery. It is also expected to ease unemployment, which currently stands at about 15%. By providing jobs for young Kuwaitis, it is hoped that the development plan will help reduce youth unemployment, which, in common with many other countries in the MENA region, is causing particular concern.

Banking concerns

Kuwait's real GDP shrank by about 4.5% in 2009, the weakest performance among GCC states, then recovered, and moved back into positive territory last year. However, the banks are still causing concern. A recent IMF report said: “Although Kuwait has the financial strength to smooth out the impact of short-term oil price fluctuations on its fiscal position, a weaker-than-expected global recovery and a decline in oil prices could impact regional and domestic asset markets, investor confidence, and government spending, leading to a worsening of the balance sheet of financial institutions.” 

In addition, deterioration in the regional economic or political environment could have an impact on investor confidence. Currently, the rating agency Moody’s gives Kuwait’s government bonds a high investment grade rating, based on the country’s high per capita GDP, extensive oil reserves and a large net external asset position. Government direct debt to GDP is also low. “The accumulation of fiscal surpluses over many years has enabled the government to construct a very strong balance sheet. The government’s direct debt is insignificant, amounting to about 8% of GDP at the end of 2009. The government has no guaranteed debt,” says Moody’s.

The agency does, however, have lingering concerns about the tensions between the government and parliament, which delayed the approval of the development plan and hampered efforts to redress the country's economic situation. Industry players have been critical of these delays while others accept that the slow pace of decision-making is a feature of democratic systems.

Five-year plan

In Kuwait’s financial sector, the $100bn development plan has become the chief talking point, and in every bank and at every level, industry players speak enthusiastically of the positive contribution that it is expected to make to the country’s recovery. At Kipco, Kuwait’s mammoth investment holding company, its potential benefits for business are once again the subject of eager discussion. The company’s CEO, Masaud Hayat, says: “We are positioning the banks [there are several in the Kipco group] to take advantage of the development plan,” adding that he hopes to see Kipco involved in the Kd77bn Silk City project, which is expected to cost Kd77m.  “There are also opportunities for banks to invest in the container harbour and a 25-kilometre causeway, as well as the railway and metro system.”

In addition to the longer-term spending on the development plan, Kuwait is proposing to earmark up to Kd15bn towards it in 2011. According to the Kuwait's finance minister, Mustafa Jassim Al Shamali: “Kuwait is considering more ambitious spending in 2011, with spending expected to range between Kd12bn and Kd15bn. The global economic downturn slashed Gulf states’ revenues, but a recovery in oil prices could help the world’s largest oil-exporting region to sustain large fiscal stimulus packages this year without slipping into deficit.” He adds that the aim of the plan is to “decrease the country’s dependence on oil, but also include investment on raising oil and natural gas production.”

The idea is to get fiscal policy back on the same track as the country’s monetary policy, and ensure that they complement each other. In order to provide strong support to their economies at the height of the financial crisis, many countries adopted expansionary fiscal policies coupled with loose monetary policies in an attempt to tackle recessionary pressures. However, when the Central Bank of Kuwait followed the same trend, the fiscal policy failed to provide that much-needed support.

Analysts hoped that the 2011 budget would be an expansionary one, especially on the capital expenditure front, and would help to remedy past shortfalls. The early signs are promising.

Kuwait’s international investment position in 2009 was reported at $79.2bn (72% of the country's GDP), but this excluded the large stock of external assets held by the Kuwait Investment Authority. The KIA manages the Kuwait General Reserve Fund, the Kuwait Future Generations Fund, and any other assets committed by the Ministry of Finance, and is believed to hold in excess of $200bn. Ironically, state expenditure has been held back by government bureaucracy, and Kuwait has underspent its budget by an average of 9% a year over the past 10 years – a fact that has contributed to the build-up of fiscal surpluses.

What next?

Kuwait's economic outlook will depend on domestic downside risks, notably whether the government can meet its development plan spending targets in the light of capacity constraints and the under-spending of the capital budget in previous years.

Industry insiders are confident, however, of the country’s capability to stick to its pre-approved plan, given the importance of capital expenditure in the budget. While other domestic risks include further delays to necessary reforms, and a number of bureaucratic hurdles and regulations that could discourage the private sector, the overall mood in the country is that of optimism. “We are more relaxed, we’ve seen the worst, and 2011 is looking better!” says Maha Al Ghunaim, CEO of Global Investment House.

The financial sector will continue to face challenges in the immediate term, since any further deterioration in the balance sheets of financial institutions, or delays in the restructuring of investment companies, “would protract banks’ risk-aversion to lending, limit private-sector financing for new projects, and constrain non-oil GDP growth”, according to the IMF. While positive signs have been emerging from Kuwait, the political turmoil that has engulfed large parts of the MENA region since January has meant that markets remain jittery, and investors have once again returned to a 'wait-and-see' position. In recent weeks, a flurry of local financial institutions have been downgraded, due, in part, to their exposure to countries such as Egypt and Tunisia, which have experienced serious social and political upheaval.

Overall, however, the mood is positive. Kuwait’s political institutions, despite their shortcomings, are more advanced than those of most other countries in the MENA region and should help to absorb any lingering discontent. The approval of the development plan and the multiplier effects in the economy should also assist in keeping Kuwait both growing and stable.

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