Kuwait: Fiscal education

Strong financial indicators in Kuwait have seen the country rewarded by a ratings upgrade. On July 20 Standard & Poor’s (S&P) announced that it was raising Kuwait’s long-term sovereign credit rating from AA- to AA, with a stable outlook. According to the credit rating agency, the economy’s strengths include high GDP per capita and healthy fiscal and external balance sheets, factors that have been accorded greater weight under S&P’s recently revised methodology for rating sovereign credit risk.

S&P singled out Kuwait’s fiscal balance sheet for praise, saying that the country’s public finances remain exceptionally strong. For nearly a decade Kuwait has achieved budget surpluses that, when expressed as a percentage of GDP, are routinely double-digit figures. According to the IMF Article IV staff report for Kuwait released on August 1, the country’s fiscal surplus amounted to 28% and 21% of GDP in 2009 and 2010, respectively.

Oil accounts for around 90% of the government’s revenues. With oil prices expected to remain high, the IMF has projected that the fiscal surplus will improve next year by around five percentage points, to 26% of GDP. However, despite the optimistic short-term outlook, some have expressed concern that the price of oil necessary to offset increasing government expenditure may have become too high.

According to Adnan Abdulsamad, a member of parliament and the head of the budgetary committee, the government will need to earn $85-90 per barrel of oil to cover the expenditure identified in the 2011/12 budget approved by the National Assembly on June 29. “A decade ago we needed the oil price to be at $18 a barrel to balance the budget, but now if it slips below $85 we will be forced to withdraw from the assets to pay for wages,” he said in parliament.

For the 2011/12 budget, the government has assumed that the price of oil will be $60 per barrel, an increase over the $43 per barrel projected in the 2010/11 budget but still well below prevailing prices. Because the $60 per barrel price would not supply revenues sufficient to offset planned expenditures, the parliament has, in fact, approved a deficit budget. However, the government routinely projects a deficit and ends up with a surplus, as it calculates the budget on an estimated price per barrel much lower than the actual market value ends up being over the course of the year.

On the other side of the ledger, the budget has planned expenditures of KD19.44bn ($71bn), an 11% increase over the previous fiscal year. According to KUNA, the state news agency, the two largest categories of spending are salaries for public employees, at KD4.43bn ($16.2bn), and “miscellaneous expenditures and transfer payments”, which amount to KD9.16bn ($33.5bn). The latter includes subsidies for power, water and fuel, as well as payments to social security.

Although the government is currently able to provide employment to many Kuwaitis and offer subsidies and other transfer payments while imposing few or no taxes, this system is unlikely to be tenable in the long run. In its recently published staff report, the IMF said, “medium- to long-term fiscal reforms are essential to reduce distortions and ensure intergenerational equity in the distribution of oil wealth. Untargeted subsidies, low taxation and rapid growth in current expenditure imply high and inefficient transfers of oil resources to the non-oil economy.”

In terms of specific reforms, the IMF has recommended increasing taxes, improving the targeting of subsidies and other benefits, implementing fiscal reforms and reallocating public expenditure to investment projects. The government already plans to introduce a value-added tax in 2013 and is considering an income tax for both individuals and corporations.

Increased investment has also been addressed, mainly through the National Development Plan (NDP), a four-year economic development programme approved by parliament in 2010. The IMF has said that the NDP “emphasises much-needed investment in health, education and infrastructure – with the objective of transforming Kuwait into a regional trade and financial centre, while expanding the role of the private sector in the economy”.

If successfully implemented, the NDP would likely facilitate economic diversification and reduce dependence on oil, which continues to be a concern. Indeed, at the same time that S&P raised the country’s sovereign credit rating, it also identified a dependence on hydrocarbons as one of its ratings weaknesses. Kuwait’s fiscal balance sheet remains strong today, and reducing untargeted transfers of the country’s oil wealth in favour of beneficial long-term investments should help it remain competitive in the long run.