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Middle EastJune 5 2005

Profitable prospects

Opportunities abound in Kuwait as its markets open and its banks and institutions become more outward looking. Stephen Timewell reports from Kuwait.
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Soaring oil prices have set the stage for booming economies in the Gulf – and Kuwait is no exception. But, in addition to these overflowing oil revenues, the removal of Saddam Hussein in Iraq and a variety of liberalisation measures have significantly boosted confidence among Kuwaitis and opened up the prospects for even further growth and expansion.

Kuwait is experiencing a boom era but also a time of transition. The rise in oil prices in 2003 pushed oil export proceeds up by 32.5% and helped raise the trade surplus by over 50%. But 2004 was even better. In the first 11 months of the fiscal year ending March 2005 oil revenues were up 31% at KD7.4bn ($25.5bn) and estimates suggest a budget surplus of KD2.7bn built around an unrealistically low oil price of $15 a barrel.

The record budget surplus provides the foundation for further increased government spending and, even with the 2005-2006 budget based on a modest $21 oil price, another large budget of KD2.7bn or even up to KD3.8bn is expected. Oil, which made up 46.6% of GDP in 2003, obviously plays a key role in economic expansion and helped push nominal GDP growth in 2003 to 16.4%.

National Bank of Kuwait (NBK) forecasts a possible 20% growth for 2004 while Cyprus-based rating agency Capital Intelligence (CI) estimates GDP in 2004 of KD14.3bn, which translates into a growth rate of 14.9%, still very high by world standards. For 2005, CI says: “Rates of growth are likely to be much lower – the gains from higher oil prices are already in the numbers. Even if oil prices do not slip, the room for increasing output is limited by technical factors as well as the Opec quota. The estimate is for growth in GDP of just 2.9%.”

Economic growth so far, however, does not take into account the impact of the recent splurge in capital spending, the growing business optimism and the huge volume public and private projects in the pipeline. Nor does it take into account, as yet, the impact of the opening up to foreign banking competition, the opportunities that are emerging in Iraq or the investment flows finding their way back to Kuwait. Oil is not the only catalyst in the economy and many of the country’s new opportunities are yet to be fully explored.

Enthusiastic response

Capital spending, mainly on infrastructure, has risen by 23% and 14% in the past two fiscal years respectively. Also, further capital spending (outside the budget) is under way to expand export facilities and upgrade gathering centres and pipelines. Plans for two major petrochemical projects are at an advanced stage and bankers are enthused about Project Kuwait, an important shift in strategy that allows international oil majors to participate in the development and operation of the country’s northern fields. The $7bn project is expected to increase Kuwait’s oil capacity by 350,000 barrels per day (b/d) from the current 2.4 million b/d.

With schemes to develop various islands for tourism and housing, bankers estimate projects in the pipeline to be in excess of KD20bn, enough to significantly boost the economy for years to come. Much of the new economic drive, however, stems from the removal of Kuwait’s prime threat, Saddam Hussein. His removal has boosted confidence enormously, from projects and trade to the banks and the stock market. As one banker put it: “The sword of Damocles has been lifted and the glass ceiling over Kuwait has disappeared.”

Confidence and high liquidity pushed the Kuwait Stock Exchange (KSE) index up 102% in 2003, making it among the world’s best-performing markets. The surge continued in 2004 at a reduced rate with the index climbing 34% and total market capitalisation up 23% to KD21.5bn at year-end. While there are concerns over creating another bubble, bankers are not too worried with average price-to-earnings (P/E) still around 14, far from out of control.

Due to the paucity of other direct investments in Kuwait and relatively weak international markets, the KSE has continued to be in big demand this year. The index is again on the march, gaining another 35% by the end of April when trading hit a record daily volume of KD200m. Not surprisingly banks continue to top the market as the most profitable sector with earnings of KD465m or 28% of the total 127 companies listed. Banks also continue to account for three of the top five most profitable companies, led by NBK with Gulf Bank and Kuwait Finance House (KFH) in fourth and fifth place.

‘Gateway to Iraq’

Just as Iraq has been a threat in the past, it has now changed to being a huge opportunity. Traders have already been doing well, supplying the armies in Iraq. Re-export figures are not disclosed but the real prize is in reconstruction and rebuilding Iraq. Kuwait is genuinely the ‘gateway to Iraq’ and Kuwaiti companies are keen for this phase to begin as security in Iraq improves, as they believe it will. Already two of the three telecoms operators in Iraq are Kuwaiti-owned and NBK has recently bought a small bank, Credit Bank of Iraq. The flood of investment into Iraq is only beginning.

But Iraq, once security is restored, is not the only bright spot. Under its commitment to its membership of the World Trade Organisation (WTO), Kuwait has begun to open up to international and regional banks and all the six Gulf Co-operation Council (GCC) states are beginning to see themselves as a single, open, unified market. This new liberalisation is creating new domestic and regional investment opportunities and the arrival of BNP Paribas, HSBC and National Bank of Abu Dhabi, as well as rumours of Citigroup entering, augers well for increased competition and improved financing capabilities.

Along with new foreign entrants deregulation has stimulated Kuwaiti banks to extend operations beyond their borders. Besides Iraq, NBK has recently expanded its regional network to include Saudi Arabia, Qatar, Jordan and Iran with more to come and regional expansion and regional investment banking as key objectives. KFH is expanding significantly into Malaysia and, with other banks looking elsewhere, Kuwaiti banks are now taking advantage of opportunities both at home and abroad.

On top of all these future prospects, Kuwait has accumulated a huge amount of foreign investment assets as a cushion and continues to put significant amounts into its Reserve Fund for Future Generations. This fund is estimated at $75bn and helps provide stability. In all, Kuwait has one of the highest per capita GDP levels in the region, reaching $16,800 in 2003, behind Qatar and UAE but due to increase in the years ahead.

Structural concerns

However, even though the macroeconomic and banking picture is full of strong growth and record performances and the consensus is that the high oil prices of today are here to stay, there are also major worries. Sheikh Salem Abdul Aziz Al-Sabah, governor of the Central Bank of Kuwait, highlights the need for structural economic reform. He emphasises the need to introduce taxation to reduce the dependence on oil – still 90% of revenues. Taxation, which hardly exists at present, is a sensitive subject and needs to be treated carefully but is desperately needed, Sheikh Salem says, to rectify imbalances in the budget.

He also believes, like others, that the situation where 92% of the national labour force is employed by the public sector has to be addressed and the private sector has to play a bigger role. Kuwaiti nationals account for around 950,000 of Kuwait’s 2.6 million population, which grew at around 8% in 2004. He adds that the philosophy behind education in Kuwait must change if the dependence on the state for jobs is to be reduced and Kuwaitis are to actively seek real jobs in the expanding private sector. Bankers concur that a key issue for Kuwait is the quality of manpower and management. Both represent major challenges for Kuwait in the future.

Potential for change

As regards other structural reforms, the issues of privatisation and corporate governance, among others, have a long way to go. While the banks are all privately owned, the utilities, hospitals, Kuwait Airways and many others are ripe for privatisation but parliamentary laws are necessary if these reforms are to proceed. Likewise, the KSE needs tightening up and new laws need to be implemented to avoid the crises of the past.

Looking forward, oil revenues will continue to be the bedrock of the economy and only marginal increases in production can be expected, rising to 2.7 million b/d at best. Nevertheless, the high oil prices, the opening up of the region and Kuwait’s pivotal role in Iraq provide tremendous opportunities for investment and trade and an ideal platform for broader domestic and regional growth.

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