Economic activity in Kuwait’s non-oil sector continued to expand in 2016, albeit at a slower pace, reflecting the impact of lower oil prices, said an IMF report.

Non-hydrocarbon growth slowed from 5 per cent to an estimated 3.5 per cent in 2015, as higher uncertainty weighed on consumption. Notwithstanding an improvement in project implementation under the five-year Development Plan (DP), available indicators point to a further modest softening in nonoil growth this year. Inflation, which has been hovering at around 3 per cent, is set for an uptick to about 3-1/2 this year, reflecting the recent gasoline price increases.

Notwithstanding efforts to contain government spending, the fiscal and external accounts have deteriorated markedly and budget financing needs have emerged.

The authorities’ principal measure of the fiscal balance—which excludes mandatory transfers to the Future Generations Fund (FGF) and investment income and better reflects the government’s gross financing challenge—has swung into a large deficit (17.5 per cent of GDP in 2016/17). Even when including investment income and before transfers to the FGF, fiscal surpluses have vanished.

The financial sector has remained sound and credit conditions favourable. As of June 2016, banks featured high capitalization (capital adequacy ratio of 17.9 per cent), robust profitability (return on assets of 1 per cent), low nonperforming loans (ratio of 2.4 per cent), and high loan-loss provisioning (206 per cent coverage). Bank liquidity has been comfortable. Credit to the private sector has been increasing at a solid pace, driven mainly by instalment loans.

Executive Board Assessment

In concluding the 2016 Article IV Consultation with Kuwait, Executive Directors endorsed staff’s appraisal, as follows:

Kuwait is well positioned to mitigate the impact of lower oil prices on the economy. The fiscal and external positions have deteriorated significantly and nonhydrocarbon growth has moderated—from 5 per cent in 2014 to about 3.25 per cent this year—as a result of the drop in oil prices. However, large financial buffers and low debt provide policy space to implement the necessary fiscal consolidation gradually while increasing public investment to support growth.

Against this backdrop, the fiscal and external positions are projected to improve as adjustment proceeds and oil prices recover somewhat, and nonoil growth is projected to regain momentum to about 4 per cent over the medium term supported by a continued improvement in project implementation under the five-year Development Plan. The main risk to the outlook stems from a further sustained decline in oil prices. Slow project implementation, more volatile global financial conditions and spillovers from heightened regional security risks could also affect economic prospects.

Nonetheless, “lower-for-longer” oil prices call for steadfast implementation of reforms. The government’s six-pillar reform strategy is rightly focused on reforming public finances and promoting a greater role for the private sector in generating growth and jobs for nationals. Efforts to streamline current spending, including the recent gasoline and utility price reforms, and measures to facilitate business licensing are steps in the right direction. Maintaining consensus in favour of economic transformation and sustaining the reform momentum is paramount for the success of the strategy.

Fiscal reforms should focus on addressing underlying fiscal vulnerabilities and be designed so as to minimize any dampening impact on growth. Gradual removal of fuel and electricity subsidies and control of the wage bill through a well-designed reform that avoids significant upfront costs would help reduce budget rigidities, while the introduction of the VAT and business profit tax and the repricing of government services would go a long way in diversifying revenue away from oil.

These fiscal reforms should be designed and sequenced with a view to striking a balance between generating fiscal savings in line with intergenerational equity levels and mitigating the drawbacks of fiscal consolidation on economic activity. A comprehensive medium-term fiscal framework based on a top-down approach and articulated around clearly‑specified medium-term fiscal objectives would help guide the consolidation plans and reduce implementation risks.

Fiscal financing options should be assessed within a comprehensive asset/liability management framework with due consideration to macro-financial linkages. Consistent with the government’s current approach, a balanced financing mix that combines continued drawdown of assets in the GRF, measured amounts of domestic bond issuance and some external borrowing would mitigate potential crowding out of private sector credit while maintaining a high level of liquid buffers.

Continued progress toward strengthening the institutional and legal frameworks, including to support a more comprehensive and longer-term view on asset and liability management, improving debt issuance processes, and fostering increased transparency would ensure effective debt management and support the development of domestic fixed income markets.

Steps can be taken to further strengthen financial sector resilience. In light of the potential risks from a sustained further decline in oil prices and given the financial sector risks inherent to a largely undiversified economy, the CBK initiatives to enhance financial sector surveillance are welcome. A formal framework for operationalizing macro-prudential measures, reforms to facilitate debt recovery, developing a liquidity forecasting framework, and strengthening the crisis management framework, including by introducing a special resolution regime for banks and a deposit insurance mechanism, would help further enhance financial sector resilience and ensure orderly resolution of banks in the event of stress.

The peg to an undisclosed basket of currencies is appropriate and can be further underpinned by fiscal adjustment. The peg has provided an effective nominal anchor. A moderate current account gap can be largely closed by increasing fiscal savings as recommended over the medium term.

Labour market reforms and efforts to promote the role of the private sector are important to foster diversification and boost job creation for nationals. Better aligning labour market incentives is necessary to encourage nationals to take on private sector jobs and private firms to create opportunities for them. Greater use of privatization and partnerships with the private sector will help boost productivity, private sector investment and job creation for nationals.

Relying on stronger legal and institutional frameworks that foster competition and reduce hidden costs and contingent liabilities for the government is important for the success of this strategy. This should be combined with further steps to improve the business environment, including reforms to facilitate access to land and finance, reduce the burden of administrative procedures and excessive regulations, foster competition, and facilitate SMEs’ access to finance. – TradeArabia News Service