Changes set to encourage progress on Kuwait's economic diversification plans

The story of Kuwait’s economy, like so many of its neighbours, has been dominated by oil. Once a regional port for pearling and fishing, the country was part of regional Gulf trade networks intimately tied to those of the Indian Ocean. Political independence in 1961, along with its massive hydrocarbons resources, helped Kuwait to become one of the top oil producers in the world. Still, the authorities are aware that crude is a finite resource, a fact brought into the spotlight during the recent period of low oil prices.

Future Plan 

As a result, the economic development blueprint Kuwait Vision 2035 draws on the country’s trading past in order to secure its future. The blueprint aims to re-kindle Kuwait’s history as a commercial centre, while also developing sectors such as finance and real estate to make them even more competitive internationally. In order to achieve its vision, over the past decade the government has taken steps to improve the business environment, boost funding for critical infrastructure and invest in human development under the umbrella of five-year development plans.

The current iteration, the Kuwait Development Plan (KDP) 2015-20, picks up where the National Development Plan (NDP) 2010-14 left off. Kuwait’s parliament passed the KDP with a $155bn budget for over 500 projects, including infrastructure, utilities and housing investments. Major projects include the Mubarak Al Kabeer Port on Boubyan Island; the massive mixed-use development project Madeenat Al Hareer, which is commonly called Silk City; and tourist attractions on Failaka Island, 20 km off the coast. In addition to 92 new projects, the KDP also incorporated 421 projects that had not yet been implemented under the NDP.

Built On Oil

Oil has long been the foundation of Kuwait’s economy. With proven crude reserves of 101.5bn barrels and an average production of 2.87m barrels per day, Kuwait has the fifth-largest oil reserves and fourth-largest daily production within the Organisation of the Petroleum Exporting Countries (OPEC), according to OPEC data. While its fellow GCC allies are also major players in hydrocarbons markets, Kuwait stands out for the size of its oil assets relative to its population. When divided over its 3.37m people, its proven reserves of 101.5bn barrels make for a ratio of around 25,000 barrels per person, which is by far the highest in OPEC and more than double that of the next-highest country, Qatar.

Kuwait’s GDP reflects the central role that energy exports, which constitute around 95% of outward trade, play in revenue generation. The value of hydrocarbons sales rose from $96.7bn to $108.6bn between 2011 and 2013. Decreasing crude prices halved that figure to $51.8bn in 2015, according to IMF projections. Even after lower crude prices reduced state revenues, oil-related business still made up 37.5% of the country’s GDP in 2016 at market prices, according to IMF data. Kuwait’s fiscal position has shifted over the past few years, as multibillion-dollar surpluses have become slight deficits. As a result, the authorities are taking steps to adjust to the prevailing low-price environment (see analysis).

A Helping Hand 

While economic diversification and private sector participation are long-term goals, the government currently plays a major role in daily life. Nationals can draw on extensive social welfare benefits, including access to free education and health care, government jobs, subsidised water and electricity, and low-interest housing loans. These provisions are a cornerstone of the Kuwaiti political system, but they come at a price. Increasing Kuwaiti private sector participation, for instance, is a challenge because prestigious and well-paid government positions are on offer. Access to low-cost energy and water, meanwhile, has facilitated increases in utilities consumption that can put stress on the country’s generation capacity. However, lifting subsidies has been a delicate political issue. Some in the government have said cuts are necessary to eliminate waste and generate savings, while opponents have argued cuts will raise the cost of living and reduce nationals’ effective incomes, causing possible negative reverberations throughout the economy.

In April 2016 parliament passed a law raising utility rates for expatriates and foreign businesses. The electricity rate for apartments was increased from KD0.002 ($0.007) per KWh to KD0.005 ($0.016) for the first 1000 KW, KD0.010 ($0.033) for 1000-2000 KW and KD0.015 ($0.05) for over 2000 KW. There is still some disagreement over whether to extend this to Kuwaiti nationals, and debates are ongoing. When the bill was introduced it was initially rejected, and it only passed after Kuwaiti citizens were exempted from price increases. During the debate over the bill in parliament, Ahmad Khaled Al Jassar, minister of electricity and water, said the government was paying about $8.8bn a year in power and water subsidies, and that if no action is taken, subsidies will rise to $25bn as consumption is set to triple by 2035.

Water rates have also been increased to KD1 ($3.31) for 1000 gallons per month and up to KD3 ($9.92) for over 30,000 gallons per month. Also in line with the government’s strategy of rationalising spending, expatriates will no longer be covered by the public health insurance programme.

Digging In 

Still, the Kuwaiti economy, like those of its GCC allies, stands on a strong foundation thanks to savings from energy windfalls in recent years. “The richest oil exporters in the region, Saudi Arabia, Qatar, Kuwait and the UAE, have large reserves that will enable them to run deficits over the coming years, although not far beyond that,” the World Bank stated in a February 2016 report on the region’s economic status. “At current levels of spending, and an oil price of $40 per barrel, Saudi Arabia will exhaust its reserves by the end of the decade.” In the case of Kuwait, the government has an estimated $600bn saved from its multibillion-dollar surpluses in the previous decade from which it can draw if necessary.

Officials recognise that dipping into reserves is a temporary solution to the country’s fiscal challenges. As a result, they have discussed several courses of action to maintain the country’s financial position. One option being tested is subsidy reduction. In January 2015 officials liberalised diesel and kerosene prices and reduced aviation fuel subsidies, which together generated savings equal to 0.3% of GDP, according to the IMF. New taxes are also on the table. In February 2016 officials met with the five other GCC states to discuss regionwide implementation of a value-added tax (VAT). Kuwait is not alone in seeking fiscal adjustments in the face of low crude prices, and the regional bloc seems to agree that a regional implementation of VAT will reduce incentives for tax evasion or smuggling. The framework, which the GCC expects to sign by the end of June 2016, is set to put the six regional governments on track to introduce VAT between 2018 and 2019 (see analysis).

Private Participation

The government has also begun to carry out legal changes that could increase the number of state-funded construction projects in progress. Changes include the implementation of laws affecting public-private partnerships (PPPs), capital markets and foreign direct investment (FDI). In 2014 the government passed a new law that overhauls the country’s system for PPPs. By March 2015 Kuwait had passed related executive regulations, giving the law some teeth and actually bringing it into effect. The PPP law created a Higher Committee for PPPs with expanded executive powers. The committee can approve PPP procurement, request projects’ land allocations and, should the situation arise, judge a public entity’s request to terminate a project. To check its wider powers, the minister of finance oversees all the committee’s decisions, which require his or her ratification to move ahead, according to an April 2015 briefing by UK-based legal firm Ashurst’s Dubai branch.

In addition to the Higher Committee for PPPs, the new law also creates a new public PPP authority, the Kuwait Authority for Partnership Projects (KAPP), replacing the former Partnerships Technical Bureau (PTB). As with the Higher Committee for PPPs, KAPP is also invested with more executive powers and autonomy, even though it inherits its staff and assets from its predecessor. Like the PTB, KAPP will be responsible for the approval of project concepts and proposals, developing a national PPP strategy, submitting recommendations to the Higher Committee for PPPs and following up on project implementation. Unlike the PTB, however, KAPP has the power to establish public joint stock companies to carry out PPP projects. This change is set to help KAPP overcome one of the major obstacles in the old environment. Both the Ministry of Finance and the Higher Committee for PPPs oversee KAPP’s activities.

On The Ground

The new PPP law is expected to broaden the possibilities for potential investors. New regulations level the playing field for foreign companies by easing foreign ownership restrictions for companies working on PPPs with a value of less than KD60m ($198.5m). In addition, a change in the way the project value is calculated could lower projects’ value calculation, helping more firms to stay below the threshold. Projects exceeding that amount still need to form a public joint stock company and offer 50% of shares to the Kuwaiti public, with the remaining half split between the successful consortium, which is guaranteed at least a 26% stake, and the government authority linked to the project. The new law has set to the groundwork for PPPs, such as Al Zour North Independent Water and Power Project, according to Middle East corporate law firm Al Tamimi & Co., which handled legal aspects of the plant’s $1.4bn in financing in early 2014.

The Kuwaiti authorities aim to move quickly to establish more PPPs in the country. In October 2015 the government said it planned to invite private investors, both local and foreign, to join nine infrastructure projects worth up to $36bn over the next two years. Using PPPs could allow the government to shift some of the up-front costs onto the private sector, which would receive shares for the capital it puts up. “This has become an inevitable necessity because it reduces the burden on the state budget in light of falling oil prices,” Adel Mohammad Al Roumi, president of KAPP at the time, said in an interview with Reuters in October 2015. The ability to tap into private sector finance could help other projects move forward, including a $6bn railway Kuwait plans to connect to a GCC regional network by 2018 and a $20bn urban metro system, Al Roumi said.

Foreign Investment 

The largest change in the FDI ecosystem has been the creation of the Kuwait Direct Investment Promotion Authority (KDIPA). Established by a 2013 law aimed at promoting FDI, the KDIPA replaced the Kuwait Foreign Investment Bureau (KFIB), which was established in 2001, with all the latter’s assets, liabilities, obligations and decisions transferring to the former. The new organisation is set to facilitate a growing number of fully owned foreign companies in the country, which the authorities hope will encourage economic diversification. More diversity could also bring more private sector jobs for Kuwaitis and more technology and knowledge transfer to the benefit of the economy as a whole.

This drive for diverse revenue streams has taken many shapes, including a drive to increase tourism. “Kuwait’s designation as “Capital of Islamic Culture 2016” has positively resulted in an influx of cultural events and exhibitions taking place across the country, as well as having strengthened bilateral ties with foreign cultural organisations,” Ali Hussain Al Youha, secretary-general of the National Council for Culture, Arts and Letters, told OBG. “This comes in a timely manner as Kuwait increasingly looks to tourism in order to diversify its economic revenue streams.”

The new law maintains the exemptions and guarantees granted under in certain non-oil sectors the FDI Law No.8 of 2001. These include allowing foreign companies a 100% foreign equity share, thus exempting them from the 49% cap under the Kuwaiti Companies Law. However, the new law changes the structure of tax exemptions for foreign enterprises. In the past, the government offered a tax holiday on taxable profits for up to 10 years as an incentive to entice foreign capital. The new regulations removed the old tax exemption and have now linked the tax benefits to a set of specific criteria with an assigned multiplier factor based on activities the authorities would like to see grow. These activities include transfer of technology, job creation, job training, and the utilisation of local products and services. The more a foreign company hires and trains Kuwaiti nationals, for instance, the greater tax exemptions the company can expect to enjoy, according to a February 2016 report issued by PwC’s Tax and Legal Services Middle East department.

Private sector responses so far have been positive. Less than six months after the new law was introduced, IBM opened a sales and customer service centre in Kuwait as part of the firm’s programme to expand its presence in the Middle East. With major players in the global industrial, IT and telecoms sectors setting up shop, stakeholders are optimistic about the legal framework’s potential. “The law is very clever in the sense that it promotes diversity and reduces too much dependency on oil and gas. This is the key and the way forward if you are looking at Kuwait’s economy,” Sherif Shawki Abdel-Fattah, a partner at PwC Kuwait, said at a February 2015 investment seminar.

Greasing The Wheels 

While the changes are a strong start, operating in the country can still present significant obstacles for would-be entrepreneurs and investors. M.R. Raghu, the senior vice-president of published research at Kuwaiti investment firm Markaz, told Dubai-based weekly and news site Arabian Business in February 2016, “Bureaucratic challenges persist. For instance, an entrepreneur has to deal with 11 government interfaces to start a business, while other GCC peers have interfaces ranging from four to seven. The number of interfaces has a visible correlation with the number of days [needed] to complete the procedure of setting up a business.”

Steps are being taken to streamline the procedures necessary to start a business in Kuwait. To that end, the KDIPA’s takeover from the KFIB signals a step forward. The new organisation has a mandate to ease both foreign and local investment procedures and business operations by preparing introductory guidelines for newcomers and clarifying investor required procedures.

It also aims to hold the incorporation process down to 30 days. Previously, the process of incorporation could take up to eight months. “Reducing the cost of doing business and services efficiency are KDIPA’s concern,” Amr Wageeh, senior legal counsellor at KDIPA, said at an investment meeting in Dubai in March 2015.

Branching Out 

In the finance sectors, meanwhile, new regulations for foreign banks loosening restrictions on Kuwait-based institutions and developments in capital markets are all set to boost diversity and competition. In 2014 the Central Bank of Kuwait announced that it would lift branch restrictions on foreign banks, allowing them to operate multiple locations in the country. The move is set to allow foreign players to compete head-to-head with incumbent institutions by allowing them to expand their bricks-and-mortar locations. In addition, in 2015 the Financial Action Task Force, an inter-governmental organisation founded to combat money laundering, removed Kuwait from its list of countries whose transactions and assets require Anti-Money Laundering/ Counter-Terrorism Financing scrutiny.

Finally, in terms of capital markets a 2015 law enabled the Capital Markets Authority to facilitate an influx of foreign capital into the telecoms industry. In February 2016 the authority approved Saudi Telecom Company’s (STC) purchase of 128.86m shares in Kuwait-based telecoms operator Viva, raising STC’s stake from 26% to 51.8%. With a share price of KD1 ($3.31), the move brought over $400m into the telecoms market.

Outward Investment

While the new PPP regulations, creation of the KDIPA and other legal changes are helping to attract more inward investment, Kuwait still remains a significant outward investor. The country’s ample wealth and financial expertise at home make for a potent combination in driving foreign investment activity. In 2015 Kuwait recovered from a weak 2014 with FDI abroad rising to $5.4bn, up from -$10.4bn the previous year, according to the UN Conference on Trade and Development’s “World Investment Report 2016”. However, this number is down significantly from the $17bn it recorded in 2013. As oil income declines, state revenues from investment income are set to become increasingly important. The IMF estimates investment revenues will grow from 12.3% to 22.4% of total public revenue between 2013 and 2017 (see analysis).

The Kuwait Investment Authority (KIA) is a key player for coordinating and executing the country’s foreign investment. KIA grew out of the Kuwait Investment Board, and in 1982 the government established the KIA as an autonomous body responsible for managing the investment of Kuwait’s sovereign wealth. The KIA’s investment strategy tends to steer away from controlling or majority stakes in companies, except for particular real estate investment entities. Rather, it aims to spread assets around the globe to establish long-term returns. In November 2015 the KIA allocated an additional $500m to projects in Russia, in a partnership with the Russian Direct Investment Fund, following up on an investment of $500m made with the fund in 2012.

Working Together

The fisheries segment presents another potential opportunity for outward investment. In July 2016 Yousef Mohammed Al Ali, the minister of commerce and industry, met with his counterpart in Sri Lanka on the sidelines of the 14th UN Conference on Trade and Development in order to discuss potential trade in the segment. “The Kuwaiti fisheries segment has seen bans in recent years in an attempt to avoid over-fishing, and such a trade deal could help meet demand,” Faisal Al Hasawi, director-general of the Public Authority for Agriculture Affairs and Fish Resources, told OBG, “We are attempting to educate the public about the harmful effects of over-fishing on the ecosystem.”

Looking Ahead 

The KIA manages Kuwait’s General Reserve Fund (GRF), made available for use by the state as determined by the budget and agreed upon by parliament. In addition, each year a minimum of 10% of state revenue and 10% of net income from the GRF are transferred to a separate Future Generations Fund (FGF), which the KIA also manages. Created in 1976 by transferring 50% of the GRF at that time, the FGF is aimed at providing an intergenerational savings mechanism for the country, so that no one generation enjoys disproportionate benefits from oil windfalls. The FGF is made up of foreign investments in various asset classes, including traditional long-term investments such as equities and bonds, as well as alternatives like private equity and real estate. In addition to its sovereign wealth fund, the Kuwaiti government also operates the Kuwait Fund for Arab Economic Development, which it formed in 1961, the same year the country obtained political independence. The Fund offers loans on concessionary terms to support development projects in low-income developing countries. Since its foundation, it has extended its activities beyond the Middle East to over a hundred beneficiary countries, offering support by developing financial feasibility studies, training the nationals of borrowing countries, and partnering with international and regional development institutions, with a focus on areas such as agriculture, transport and energy. Throughout its operations it has offered 914 loans of various sizes to 105 countries worth a total of KD5.6bn ($18.5bn), according to the Kuwait Fund. In April 2015 Abdulwahab Al Bader, director-general of the fund, told Reuters that it would disburse $1.5bn in loans to Egypt over five years.

Outlook

While other economies in the GCC may be struggling against the effects of low oil prices, Kuwait looks to be turning a challenge into an opportunity, allowing the new price environment to boost initiatives long in the pipeline. Fiscally, the state stands on a strong footing thanks to prudent savings over the last decade. With new FDI and PPP regulations passed, it is clear that there are changes afoot via reforms that support the government’s goal of economic diversification.