Kuwait enjoys a stable economy and respectable GDP, but as government attempts to transform the country into a regional hub for commerce and finance begin to affect its citizens, will opposition parties derail planned reforms? James King reports.

Kuwait assembly

Kuwait’s progress towards economic diversification is gathering pace. Leveraging low debt levels and sizeable financial buffers, the government is intent on transforming the country into a regional commercial and financial hub by 2035.

To achieve this, it is making huge investments in infrastructure and project development, alongside a sweeping package of reforms designed to improve competitiveness. These efforts are ensuring that economic growth is ticking along well above the regional average in the Middle East.

“Kuwait’s economy performed relatively well in 2016,” says Michel Accad, chief executive of Al Ahli Bank Kuwait. “The government’s finances are in good shape, thanks in part to the relatively low oil price required to balance the government budget. This has meant that public spending has been cut much less than in other Gulf Co-operation Council [GCC] countries.” 

Cash allocation

Indeed, government spending is largely responsible for the country’s healthy gross domestic product growth (GDP), which hit 3.6% in 2016, as well as notable levels of non-oil activity, which is expected to reach between 3.5% and 4% over the next few years. Under the auspices of the Kuwait Vision 2035 plan, about $100bn has been allocated to project and infrastructure investments over the next five years. This is in addition to a recently announced Kuwait Petroleum Company spending plan, worth Kd35bn ($114.6bn) over the period.

“The outlook for economic growth is driven largely by an improving pace of implementation of government-led infrastructure projects and aggregate investment. Preliminary figures indicate that aggregate investment received a strong boost in 2015. Also, project awards remained relatively strong in 2016, indicating the investment boost is likely to persist into 2017 and 2018,” says Shaikha Al-Bahar, chief executive of the National Bank of Kuwait (NBK).

Harder to hit

According to NBK data, there are currently about $21bn-worth of projects in the bidding phase in Kuwait, most of which are likely to be awarded in 2017. While the size of this investment is impressive, senior bankers in Kuwait point out that the country’s project market is something of a moving target: some developments are being fast-tracked while others are delayed, in response to growing pressure on the public purse.

“The mega-project market is a shifting landscape because the government is prioritising the rollout of key developments and delaying others,” says Mr Accad.

Although government spending remains high, the optimisation of this expenditure is at the forefront of efforts to manage Kuwait’s deteriorating (but still respectable) fiscal position. The government conservatively includes mandatory allocations to the Future Generations Fund (FGF), while excluding investment income generated by the Kuwait Investment Authority, when calculating its fiscal balance. In doing so, official figures show double-digit deficits.

“Government finances are expected to remain in relatively small but improving deficit in the medium term, with the price of oil staying at $55 to $60 per barrel. The deficit is expected at 17% of GDP in fiscal year 2016-17 before it narrows to about 10% of GDP in fiscal year 2017-18 and to 8% in fiscal year 2018-19 on an improving price of oil and further fiscal consolidation,” says Ms Al-Bahar.

But if investment income is included and FGF contributions are excluded, the fiscal balance has narrowly remained on the positive side in recent years, according to the International Monetary Fund. Nevertheless, both scenarios are a clear departure from the double-digit budget surpluses that characterised the national books before the oil price crash.

Kuwait stats

Debt issuance

In response, the government is turning to both the local and international debt markets to meet its financing needs. For financial year 2016-17, NBK estimates that the government will need to secure additional financing of about Kd6.1bn to meet its spending obligations. Accordingly, the authorities have announced a debt issuance programme of about Kd5bn for the period. By early 2017, public debt levels had risen to Kd3.7bn, equivalent to about 10.4% of GDP, presenting something of an opportunity for Kuwait’s banks.

“Most Kuwaiti banks will be motivated to trade the bonds or sukuk, which opens new horizons for banks to invest in these two instruments: bonds for conventional banks and sukuk for Islamic banks. It is worth noting that we have strongly contributed to plugging Kuwait’s budget deficit through [investing in] Islamic tawarruq issues,” says Kuwait Finance House chief executive officer Mazin Al-Nahedh.

But it is Kuwait’s proposed inaugural international debt issuance that is making waves across the region. Following large-scale issuances from Abu Dhabi and Saudi Arabia, the authorities are looking to issue a multi-billion-dollar Eurobond in the first half of 2017. After initial reports suggested a transaction size of $10bn, estimates have been revised downwards, though the final figure is unknown.

“Kuwait’s debt issuance programme is good for banks as there will be fiscal surpluses in foreign currency for the short term, thus high levels of liquidity in the US dollar,” says Mr Al-Nahedh.

Necessary pain?

Beyond the country’s immediate spending requirements, the authorities are in the process of executing various fiscal adjustments to control expenditure. In September 2016, the government, without parliamentary approval, increased gasoline prices across the different octane grades by an average of about 70% for all residents.

The national assembly also agreed to a hike in electricity and water tariffs from May 2017 (with the effective exclusion of Kuwaiti citizens), which will add an anticipated Kd500m to the budget, equivalent to about 1.5% of GDP, according to NBK research.

But the introduction of these reforms has not been problem-free. Politically unpopular in a country accustomed to government largesse, consumers felt the pinch when core inflation, which excludes food prices, surged to 4% in September 2016. “Some low- and middle-income earners have been hit by changes to the fuel subsidy regime,” says Elham Mahfouz, chief executive of the Commercial Bank of Kuwait.

Alongside subsidy reform, efforts to improve Kuwait’s tax code are also in the pipeline. A proposed corporate income tax on local and foreign companies is under consideration, while valued added tax at 5% is likely to be introduced in 2018 or 2019, in line with its wider rollout across the GCC region. Both measures will require legislation in order to be enacted, says the NBK.

Always politics

“VAT will be a game changer if it is implemented. But the extent to which it will affect the wider economy is still unclear. Nevertheless, if the rate is set at 5%, then we can expect inflation to hit at least 5% because that cost will be passed on to the consumer,” says Vikram Isser, general manager of consumer banking at Gulf Bank.

However, the progress of these reforms and others will be contingent on Kuwait’s political climate. When the new parliament was elected in November 2016, nearly half the seats went to opposition candidates, who are set to resist subsidy reforms and other measures to control government spending.

In early 2017, the national assembly’s financial and economic affairs committee approved draft legislation calling for the abolition of price hikes on fuel already in place, as well as the increases to electricity and water rates scheduled for May.

Though Kuwait’s governance model is the most democratic in the region, its powerful parliament has frequently opposed market-based economic reforms. As such, relations between the government and legislature are characterised by a high degree of tension. In the past, this has delayed project implementation and much-needed structural adjustments, leaving Kuwait lagging behind some of its regional peers.

Opposition groups’ boycott of the previous two elections ensured there was a more supportive legislature between 2013 and 2016. The return of the opposition groups will challenge the authorities’ ambitions to impose meaningful reform, and may yet undermine these efforts.

More hurdles

Other threats to Kuwait’s reform agenda are also looming. A forecast dip in oil prices by mid-2017 is a growing probability and one that could disrupt the government’s medium-term plans. A particular concern is that US oil inventories grew for nine consecutive months to February 2017, reaching 8.2 million barrels and causing Brent Crude to fall to $52 a barrel in early March, its lowest point since November.

This is likely to damage already fragile plans to negotiate a further production cut by the Organization of the Petroleum Exporting Countries (OPEC) beyond May 2017, as struggling producers look to export more oil to minimise the impact of falling revenues. Meanwhile, increasing US shale output may undermine the outcome of any renegotiated OPEC agreement.

“A weaker oil price is a downside risk for Kuwait’s outlook. While unlikely in our view, weaker prices would put added pressure on the fiscal and external positions and could force the government to cut spending further, possibly at some point reducing or delaying capital spending plans, which could affect non-oil growth,” says NBK’s Ms Al-Bahar.

Dealing with these potential problems would be no easy task. But Kuwait has advanced, albeit slowly, despite a troublesome parliament in the past. And even if oil prices do indeed drop, the strength of the country’s balance sheet remains formidable. For these reasons, most private sector operators in Kuwait are quietly confident about the country’s prospects.

“Kuwait has one of the lowest fiscal break-even oil prices globally, and the lowest in the GCC, making it more resilient to the recent decline in oil prices,” says Adel Al-Majed, vice chairman and chief executive officer of Boubyan Bank. “In addition, Kuwait’s sovereign wealth fund, the Kuwait Investment Authority, is the oldest sovereign wealth fund in the GCC and has about $548bn in assets under management.”


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