IMF Concludes Article IV Consultation With Kuwait

by Lorys Charamboulos, Tax-News.com, Cyprus

15 May 2009

The International Monetary Fund has concluded its Article IV consultation with Kuwait, and reported its findings, noting a continued need for medium-term fiscal reform aimed at reducing dependence on oil revenue and rationalizing fiscal spending.

The 2009 consultation discussions were held against the backdrop of the global financial crisis and the ensuing economic slowdown. Kuwait’s economy continued to perform strongly in 2008, although signs of weakness emerged in the second half of the year. The authorities’ key challenge in the near term is to preserve financial stability and cushion the impact of the global slowdown.

Real GDP growth is estimated to have picked up to 6.4% in 2008, up from 2.5% in 2007, reflecting both higher oil production and robust non-oil GDP growth. Inflation peaked at 11.6% (on a year-on-year basis) in August and started to moderate toward the end of 2008 on weaker domestic demand and lower import prices.

High average oil prices contributed to substantial current account and fiscal surpluses in 2008. Despite rising imports, the estimated current account recorded a surplus of 45% of GDP and the budget surplus for 2008/09 is estimated at 26% of GDP, notwithstanding a large transfer to recapitalize the pension fund (10.5% of GDP).

Broad money and credit growth declined in 2008, owing to the Central Bank of Kuwait’s (CBK) measures to contain credit growth in the first half of 2008 and tight liquidity conditions in the second half of the year. After switching back from a dollar to a basket peg in May 2007, the authorities let the Kuwaiti dinar (KWD) appreciate against the US dollar in order to slow inflation. This, along with high inflation, led to a 7% appreciation in the real effective exchange rate (REER) in 2008.

The global financial crisis has affected adversely Kuwait’s financial system. Liquidity conditions tightened in the second half of 2008, reflecting capital outflows and rising concerns about counterparty risk. Consequently, the KWD interbank rate spiked in October 2008, prompting swift intervention by the authorities through large liquidity injections to stabilize the market. Since the deepening of the global crisis after the fall of Lehman Brothers, the Kuwait Stock Exchange (KSE) index fell by 50%. In October 2008, the third largest bank lost USD1.4bn, mostly on derivative transactions, leading the authorities to guarantee customer deposits at local banks and implement a successful recapitalization plan. In December 2008, the largest investment company in Kuwait defaulted on most of its USD3bn debt obligations and has been negotiating a debt restructuring.

The economic outlook for 2009 will be driven largely by the fallout from the global slowdown. Real GDP is projected to contract by 1.2% in light of lower oil production and a decline in non-oil growth, reflecting weak activity particularly in the financial and construction sectors. Lower import prices, weaker domestic demand, and a moderation in rents should bring inflation down to 6%. The fiscal and current accounts surpluses are projected to decline significantly owing to lower oil revenue.

The medium-term outlook will depend largely on developments in the global oil market and progress in the implementation of structural reforms to promote private investment. The fiscal and current account positions should improve gradually over the medium-term in line with the projected increase in oil prices.

The major risks to the economic outlook are a rapid deterioration in the balance sheet of financial institutions and a prolonged global recession that could maintain oil prices below USD50. These risks would affect adversely investor and consumer confidence, limit fiscal space, and worsen the growth outlook.

In their Executive Board Assessment the IMF noted:

"The Kuwaiti authorities’ prudent macroeconomic policies have contributed to robust economic growth, strong fiscal and external positions. Looking ahead, the key challenge faced by the authorities is to preserve financial stability and support economic activity in the face of the global financial and economic crisis."

"While the medium-term outlook remains positive, there are important challenges ahead for the Kuwaiti authorities. In the near term, the sharp decline in oil prices would affect adversely the fiscal and external balances, large oil production cuts and weaker activity in the non-oil sector are expected to slow real GDP growth, and the credit squeeze and asset price deflation could pose significant risks to the financial system. In the medium term, a key challenge is to use the oil wealth to diversify the economy and boost non-oil GDP growth through private investment."

"The financial system is strong and resilient, but risks have emerged because of the global financial crisis. The Kuwaiti authorities’ proactive measures to safeguard financial stability and sustain economic growth included the injection of liquidity into the financial system and the adoption of a financial stability law. Financial sector policies should continue to encourage consolidation and restructuring of financial institutions, upfront recognition of losses, and participation of private investors in the recapitalization of financial institutions."

"The oversight of risk management practices should be strengthened by ensuring adequate policies and procedures for identifying, monitoring, and controlling systemic risk in the financial system. The restructuring of the investment companies sector is especially important, and the authorities are interested in undertaking a Financial Sector Assessment Program update. The authorities should speed up reform of money laundering and terrorism financing legislation to make it conform to international standards."

"The authorities are commited to fiscal prudence and medium-term fiscal sustainability. It was thought that a fiscal stimulus might be in order to complement the financial stability package, given the expected slowdown in economic activity, Kuwait’s strong fiscal position, and the positive effect of a stimulus on investor confidence and private investment. On the other hand authorities’ concerns regarding a fiscal stimulus, including Kuwait’s limited absorptive capacity, uncertainty regarding future oil prices, and the possible limited effectiveness of a stimulus due to significant leakages through remittances and imports were noted."

"There is a continued need for medium-term fiscal reform aimed at reducing dependence on oil revenue and rationalizing fiscal spending. The accelerated introduction of a value added tax is to be encouraged in coordination with other Gulf Cooperation Council (GCC) countries. The authorities are supported in their intention to maintain capital spending while containing current spending, including by curbing large subsidies and transfers, reforming the pension system, and moving to merit-based public sector salaries and benefits."

"The expediting of the structural reforms are vital to boosting private sector investment, including enactment of key laws the capital markets, companies, competition, public-private partnership, and privatization laws; streamlining of business registration and other administrative barriers to investment; and enhancement of access to land by private businesses and individuals."

"The pegged exchange rate regime remains appropriate for Kuwait in the run up to the GCC monetary union, and the recent move to a basket peg may have been helpful in containing inflation. The staff find that the Kuwaiti dinar is broadly in line with economic fundamentals. In light of weakening inflationary pressures and the downside risks to economic growth, the recent easing of monetary policy is acceptable."

"The authorities intend to improve economic statistics, and the adoption of a program toward subscription to Special Data Dissemination Standard is to be encouraged. To address some data weaknesses, a comprehensive review of the role and resources of the General Statistical Office is advisable."

"The authorities' generous substantial development foreign assistance to low-income countries in and outside the region is commendable. Their active support for the Heavily Indebted Poor Countries (HIPC) Initiative, and they should continue providing debt relief to all eligible-HIPC countries."

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