Higher oil prices and increased crude oil production ensured a bonanza for Kuwait’s main export and the state budget, while a brighter outlook resulting from the regime change in Iraq and from increased government spending provided a solid boost to domestic activity. Optimism and ample liquidity were evident in the continued boom in local stock and real estate markets, though the gain in share prices was somewhat more modest compared to 2003.
Iraq-related business activity remained vibrant, with local companies garnering a significant share of contracts awarded by coalition forces and the provisional authority. Though the traffic of foreign companies using Kuwait as a launching pad for their activities in Iraq slowed down significantly with the deteriorating security situation there, the flow remains significant enough to lift demand for local services.
Growth confirmed
Recent official statistics confirmed the strong expectations for growth in 2003. Soaring oil output and prices resulted in substantial growth in domestic output, with provisional estimates of GDP at KD12.4bn ($42bn), up 18% from a year ago. Real growth is also estimated to have been in the double digits. Non-oil activities saw growth slow down slightly, with initial estimates below expectations. The initiation of trade with Iraq and substantial activity related to servicing its recently liberated neighbour to the north provided a much-needed boost to Kuwait’s economy, particularly the private sector.
Oil prices continued to surprise, with strong global demand boosting Kuwait’s oil price revenues thus far in 2004. Oil accounted for 89% of budget revenues in fiscal year 2003/2004, which closed in March with an estimated record surplus of KD1.5bn or 12% of 2003 GDP. Though non-oil revenues came in lower, this was to be expected as payments from the United Nations Compensations Committee (UNCC) shrank. The price of Kuwait export crude (KEC) averaged $30.9 a barrel during the first half of 2004, a 15% increase over the 2003 average. Estimated production also rose by 3.6% to average 2.3 million barrels a day, as strong demand has pushed the 10 OPEC producers’ output to record highs.
The high price of oil has ensured a continuation of record surpluses in the government budget. Despite an official projection of a deficit, the fiscal year 2004/2005 is likely to see a surplus of at least KD1bn, going up to as much as KD3bn based on prevailing scenarios for oil prices. These scenarios suggest that KEC could average $29–$36 a barrel, well above the $15 assumed in the official budget projection.
Besides using the surplus to accumulate foreign investment assets – now estimated at KD22bn in Kuwait’s Fund for Future Generations, which normally receives 10% of all budget revenues – the government has sought to boost spending. Budget expenditures during the fiscal year 2003/2004 increased by more than 10% to represent as much as 44% of 2003 GDP. The employment-related part of the budget, which makes up almost half of total government expenditures, saw particularly strong growth. It is here that the government is facing the most pressure as it seeks to meet a growing demand for jobs by an increasing number of Kuwaitis entering the workforce. This part of the budget is also proving to be a boon to the private sector, which is flourishing on the solid growth in consumer spending driven by the increasing spending power of households.
Capital spending
Capital spending has been a main focus of fiscal policy over the last three years. The bulk of spending on development and maintenance projects relate to upgrading Kuwait’s infrastructure in power and water as well as public works. The capital spending budget was raised by 22% in fiscal year 2003/2004. The recently approved budget for fiscal year 2004/2005 projects growth of 3.2%, though actual growth is likely to remain in the double digits, since the actual spending rate has been steadily improving after having fallen significantly under budget for a number of years.
Capital spending in the oil sector, which falls outside the purview of the general budget but is equally significant, is also expected to rise. There are ambitious and urgent plans to increase the country’s production and export capacity, besides improving efficiency, now that production has been running near sustainable capacity since spring of last year. Planned projects include expanding export facilities and upgrading gathering centres and pipelines.
In the downstream sector, plans for two major petrochemicals projects are in the advanced stage, with at least one approaching implementation in 2004. Project Kuwait, a scheme that invites international oil majors to participate in the development and operation of the country’s northern fields under operating services agreements, is also progressing. Local oil officials indicate that the project will be presented to the national assembly in the autumn for approval.
The private sector has also boosted overall investment activity, led by residential, investment and commercial property development. Gross capital formation rose by 10% in 2003. Still, net capital accumulation remains at less than 5% of GDP, with private investment opportunities significantly constrained in the absence of privatisation, and much-needed economic and administrative reforms. Some preliminary liberalisation measures have already been adopted, such as the recent enactment of implementing regulations governing foreign direct investment (FDI). The FDI law was passed in 2001, allowing for 100% ownership and the possibility of a 10-year tax holiday. However, for long-term investors, tax reform remains essential. The government has drafted a law reducing corporate taxes from their current high level, but the proposal has yet to be discussed by the National Assembly.
National income
Buoyed by a higher oil price and increased production, oil GDP rose by 32% in 2003 as had been expected. Higher refining volume and margins also contributed to increased value added. However, growth in the non-oil sector was below expectations, at 4.5%, compared to 6.1% in 2002. While activity was strong after Iraq’s liberation, a lull in activity preceding and immediately after the end of the fighting in Iraq appeared to cause a substantial dampening in growth. Oil’s share of total GDP rose to 51% from 45% in 2002.
Services and trade were the main contributors to overall growth in non-oil activities as they typically had been in the past. However, growth in the leading sectors did not meet expectations, with some seeing slower growth compared to 2002. In 2003, services and trade should have benefited the most from a surge in activity following the end of the war in Iraq and the resumption of trade with that country. Foreign companies doing business in Iraq chose to base their offices in Kuwait, which would have boosted demand for services related to their work. Retail and wholesale trade would also have benefited from the direct opportunities available in supplying markets in Iraq, as would financial services. The latter was the only sector to show a mild improvement in growth in value added. It is highly likely that GDP estimates will eventually be revised upwards.
Kuwait’s current account showed a larger surplus in 2003 from higher oil and refinery exports, though it remained below levels seen in 2000 and 2001. The current account surplus rose to KD2.3bn, or 18% of GDP. The increase was slightly tempered by a rise in imports of 17% that reflected strong domestic demand, in part due to Iraq-related activity. Kuwait is heavily dependent on imports of goods and services, which represented 46% of domestic demand.
Investment income, which normally contributes to a significant part of the current account surplus in view of the country’s sizeable foreign asset holdings, dropped by a relatively small 2.5% to KD1.1bn, or 8% of GDP, following several years of more substantial declines. Rising interest rates and a general improvement in global markets and corporate profits should begin to show up in higher investment income in 2004.
Relative to other Arab countries, Kuwait’s economic performance ranks high compared to the small size of its population. At KD5008 per capita, GDP is the third highest in the region after Qatar and the UAE. With the population growing at 5.2% in 2003, growth in per capita GDP of 10.7% was below that of the aggregate economy. Population growth has accelerated over the past three years on account of a rising number of expatriates, who made up 64% of the 2.55 million residents and 81% of the country’s labour force at the end of 2003. Demographic growth, rising income and rapid expansion in consumer lending has made consumers the main driver of sustainable growth in the economy.
Banking and finance
Strong domestic activity fuelled the demand for credit and other banking services, thus improving the profitability of Kuwaiti banks, notwithstanding low interest rates. Consolidated profits of the country’s nine banks were up 22% in 2003 as well as in the first quarter of 2004. More than half of the growth in domestic credit was in personal facilities, about two-thirds of which are in consumer and housing loans, with the bulk of the balance financing share trading. Personal facilities have been growing at an accelerating pace, topping 36% over the 12 months ending June 2004. Another sector exhibiting strong appetite for credit has been real estate, which accounted for almost a quarter of the increase in credit over the last 12 months.
Low interest rates and ample liquidity available at banks have facilitated the expansion in credit, no doubt as investors sought better returns than bank deposits. Interest rates in Kuwait have tended to exhibit a high degree of correlation with US dollar rates for more than two decades. For example, the spread between one-month customer deposits in Kuwaiti dinars and US dollars has remained between 50 and 100 basis points (bps) for much of the last eight years. Lending rates are tied to the central bank’s discount rate that was recently raised by 25 bps to 3.5% following a similar hike by the US Fed.
Interest rate policy is dictated by an exchange rate regime that pegs the dinar to the dollar. Before 2003, the dinar was pegged to a basket of major currencies dominated by the dollar. At the start of 2003, Kuwait adopted a flexible peg to the dollar in preparation for a planned currency union among Gulf Cooperation Council members by 2010. The central bank initially set the parity rate at KD0.29963/dollar, and allowed it to drift gradually within the permitted 7% band to reflect the depreciation in the dollar versus other major currencies. However, the exchange rate has remained fixed at KD0.2947/dollar since last November.
Improved business prospects, in addition to a rise in corporate profits, made investors bullish on local stocks. Listed companies reported a 92% increase in their aggregate profits in 2003 and another 50% in the first half of 2004. Banks have been consistently the most profitable sector contributing 27% of total reported earnings in 2003 as well as the first quarter, though investment companies surpassed them slightly this year.
National Bank of Kuwait (NBK) is the largest and most profitable company in Kuwait, with roughly a 10% share of aggregate market capitalisation and earnings. The bank has a unique record of consistently rising profitability since its inception in 1952, and has earned the highest credit ratings among Arab and emerging market banks from international rating agencies such as Moody’s, S&P and FitchRatings.
The Kuwait Stock Exchange (KSE) was probably the best performing in the world in 2003, with the price-weighted general market index advancing by 102%, while market capitalisation rose by 71%. This year, the index logged more modest increases of 14% through the end of June, though market capitalisation dropped slightly as gainers were mainly among the smaller issues. Market capitalisation stood at KD17bn at the end of June reaching 137% of 2003 GDP.
Trading volume
Trading activity, which rocketed upwards last year by 143%, maintained its rapid pace this year. Annual turnover relative to market capitalisation advanced slightly this year after hitting 93% in 2003. The market price-to-earnings (PE) ratio, dropped from 15.2 at the end of 2002 to 13.2 at the end of 2003, and further to 11.2 by the end of June 2004. This valuation measure has been deflated by the gains garnered by Kuwaiti companies from their significant exposure to the local market, with investments representing a major part of their activities.
Activity in the real estate market picked up over the last two years, reflected in rising sales, building permits and bank lending to that sector. The value of properties sold was up 29% in the 12 months to May 2004, while the average price per unit sold advanced 13%. Investment and commercial properties received more interest, with sales up 49% and average prices by 25%. Permits were up by 2% during 2003 following a rise of 19% in 2002. Their increase was pulled down by a drop in residential permits arising from slower approvals of government-subsidised loans to first-time Kuwaiti homeowners.
Randa Azar-Khoury is chief economist at National Bank of Kuwait
