Kuwait's account balance returns to a surplus as oil price recovers and diversification strategies implemented

With 6% of the world’s proven oil reserves and 1% of its natural gas, Kuwait had an estimated GDP per capita of $71,943 in power purchasing parity terms in 2017, according to the World Bank. This was the eighth-highest value for any country or autonomous region, putting it behind only Qatar, Macao, Luxembourg, Singapore, Brunei Darussalam, Ireland and the UAE. Kuwait has also been a prudent saver of its petrodollars and has the world’s fourth-largest sovereign wealth fund (SWF), with the Kuwait Investment Authority (KIA) managing $592bn in assets in mid-2018, according to the SWF Institute (see analysis). In 2018 the IMF calculated this financial buffer to be equivalent to 470% of Kuwait’s GDP.

Price Fluctuations

Although this helped to cushion the economy, the sudden fall in the value of crude oil from mid-2014 to 2017 was reflected in GDP performance. According to data from the National Bank of Kuwait (NBK), the nadir was reached in the midst of this: nominal GDP declined by 32.9%, from KD49.4bn ($164bn) in 2013 to KD33.1bn ($110bn) in 2016. Over this period, oil’s contribution to GDP fell from 66% of the total, or KD32.7bn ($108bn), in 2013 to 41.1%, or KD13.6bn, ($45.1bn) in 2016.

At the end of 2016 Kuwait helped lead the charge of oil-producing countries working to address the excess supply that triggered the sharp price decline. Kuwait was a founding member of the Organisation of the Petroleum Exporting Countries (OPEC) in 1960, and it was one of six countries tasked with monitoring compliance with the production cuts agreed by OPEC countries and 10 other participating non-OPEC oil producing countries, including Russia, in December 2016. From January 2017 OPEC members agreed to cut production by 1.2m barrels per day (bpd), with the other countries committing to reductions of 558,000 bpd. For its part, Kuwait’s output declined from 2.95m bpd in 2016 to 2.7m bpd in 2017. While seen as a necessary move to stabilise the market, this resulted in a GDP contraction of 2.9% in 2017, and the value of sector output at constant prices declined by 7.2% that year to KD22.8bn ($75.6bn).

Before OPEC agreed to reduce production in November 2016, Brent crude was $46.48 per barrel, but by May 2018 the price rallied to $80, a 72% rise. In June 2018 OPEC leaders agreed to increase supply through the end of the year in response to the rebound in prices, deciding to expand output by 1m bpd, thus reducing production cut compliance from 162% in May 2018 to 100% later in the year.

Government Revenue

Fluctuating international oil prices had a direct impact on public finances. Kuwait’s oil revenue as a percentage of GDP at current prices sank by 43%, from 61.5% in 2012 to 34.9% in 2016. The makeup of government revenue also shifted, with hydrocarbons’ share easing from 94% in 2012 to 89% in 2016. Even as production volumes declined, the edging up of oil prices in 2017 saw public revenue and oil’s contribution to the economy rebounding, with the government recording earnings worth 44.2% of nominal GDP and oil revenue comprising 90.7% of that. Government expenditure peaked at 52.9% of GDP in 2015 before moderating to 50.1% in 2017. Lower oil prices helped to reduce public spending, as the value of government fuel subsidies fell by KD2bn ($6.63bn), over this period, according to the IMF. However, rising oil prices in late 2017 and throughout 2018 have helped consolidate the country’s fiscal position, with the budget deficit as a percentage of GDP projected to fall from 17.7% in FY 2016/17 to 10.3% in FY 2017/18.

The current account balance has similarly improved. In 2016 Kuwait recorded a deficit of 4.6% of GDP, the first negative balance in a number of years and one which was largely due to lower oil prices. However, as prices rose in 2017, the government registered a 5.9% surplus, and the NBK projected that this would increase to 10% in 2018. As part of policy harmonisation efforts and to diversify public revenue away from hydrocarbons, in 2016 members of the GCC agreed to implement a flat 5% value-added tax (VAT) beginning in 2018.

However, only the UAE and Saudi Arabia have adhered to this schedule, with Kuwait’s Parliament announcing in May 2018 that it would likely postpone implementation until 2021. While a parliamentary vote on the introduction of VAT is anticipated by late 2018, excise tax is expected to be rolled out sooner, both of which should bolster public revenue.

Balancing the Books

The KIA administers two SWFs. First, the Future Generations Fund (FGF) is legally entitled to 10% of public revenue, and this can be increased at the government’s discretion if inflows are particularly high, as they were over the 2011-13 period, when one-quarter of government income was transferred to the fund.

The FGF is also entitled to 10% of the annual net income of the General Reserve Fund (GRF). When revenue falls, the authorities can draw on the GRF’s assets, and this tactic, along with domestic borrowing and an international sovereign bond sale, was part of its response to the challenging economic environment in 2016 and 2017. In March 2017 the government issued a $3.5bn, five-year bond with a 2.9% yield and a $4.5bn, 10-year bond at a 3.6% yield.

Non-oil Sectors

According to the NBK, the non-oil economy grew by 2.2% in 2017, an acceleration from the 1.6% expansion seen in 2016. In September 2018 the bank estimated this would further ramp up to 2.8% and 3% in 2018 and 2019, respectively. The government’s commitment to capital spending despite the sustained period of lower oil prices likely helped to fuel growth, with the NBK reporting that in July 2018 the Ara consumer confidence index rose to 119, a 12.3% year-on-year (y-o-y) increase.

Data from Kuwait’s Central Statistical Bureau (CSB) shows that in the second quarter of 2018 non-oil GDP grew by 6.9% y-o-y, from KD5.02bn ($16.6bn) to KD5.37bn ($17.8bn). This was largely driven by 49% y-o-y growth in manufacturing, 42.3% in telecoms and 8.9% in transport, with respective contributions of KD909.5m ($3bn), KD514.8m ($1.7bn) and KD302.6m ($1bn). Over this period public administration and defence saw the greatest decline of 4.9%, from KD1.08bn ($3.6bn) to KD1.03bn ($3.4bn).

In its Article IV report on Kuwait published in January 2018, the IMF anticipated that increased consumer confidence in the country would support real non-oil GDP growth of 2.5% for the year, while higher international oil prices would help hydrocarbons GDP expand by 4.6%, contributing to overall economic growth of 3.9% at constant prices. The latter figure was more optimistic than NBK’s estimate, which put forecast real growth of 2.6% in 2018 and 3% in 2019.

Sovereign Ratings

According to an analysis by Forbes, Kuwait had the highest sovereign credit rating of any Arab country in 2018. In May 2017 international ratings agency Moody’s changed its outlook from negative to stable, reaffirming its long-term score of “Aa2”. Moody’s explained the upgrade by saying it has seen “sufficient signs” of the government’s capacity to implement fiscal and economic reforms. The agency noted it was encouraged by the establishment of a debt-management unit at the Ministry of Finance, as well as parliamentary debate over public sector compensation. The report also found that the slower pace of fiscal reforms was offset by the country’s “extraordinarily strong balance sheet with very high wealth levels and vast hydrocarbons reserves”.

Fitch joined Moody’s in giving Kuwait a favourable sovereign credit rating of “AA” with a stable outlook in May 2018, citing strong financial metrics and a forecast fiscal break-even Brent crude price of $56 per barrel – one of the lowest among oil exporters – as motivating factors. However, the agency noted these positive indicators were tempered by the high degree of oil dependency, notable geopolitical risks, and less-than-ideal governance and business environment. The report added that the substantial population growth could strain government finances, as the country has a robust social safety net and an economically dominant public sector.

Similarly, in February 2018 Standard & Poor’s (S&P) affirmed its ratings for Kuwait at “AA/A-1+” with a stable outlook. S&P stated that it could lower its outlook in the case of lower-for-longer oil prices weakening fiscal and external finances, domestic political stability deteriorating or significant escalation in regional geopolitical tensions. Nevertheless, the agency indicated the outlook could improve if there was a significant increase in oil prices, or if political reforms enhanced long-term economic diversification or institutional effectiveness. The agency views the economy as being undiversified, because in 2017 nearly 60% of GDP was derived from hydrocarbons-related activities, as was more than 90% of exports and fiscal receipts.

Diversification Efforts

Faced with a growing population and lower oil prices after mid-2014, Kuwait crystallised its reform agenda in successive strategies, first with the release of its medium-term agenda in May 2015 and subsequently the unveiling of an overarching long-term vision in January 2017.

The former is the latest iteration of the midrange development plan, which runs from 2015/16 to 2019/20. The blueprint highlights five desired end states that are being pursued through to 2035: citizen participation and respect of the law; effective and transparent government; prosperous and diversified economy; nurturing and cohesive nation; and globally relevant and influential player. The midrange plan also outlines seven pillars by which these end states are to be achieved: administration, economy, infrastructure, living environment, health care, education and capital, and international positioning.

In January 2017 the country unveiled New Kuwait, also known as the Kuwait National Development Plan, setting out long-term development priorities through to 2035, with 164 strategic programmes organised into five themes and seven pillars. These included positioning Kuwait as a global hub for the petrochemical industry and tripling foreign direct investment. At the March 2018 Kuwait Investment Forum, ministers provided updates on the progress made towards the New Kuwait goals, with reports on the level of completion of key infrastructure developments: the Clean Fuels Project to overhaul the Mina Abdullah and Mina Al Ahmadi refineries was 84.8% finished; the construction of 24 berths with a combined capacity of 8.1m twenty-foot equivalent units at Mubarak Al Kabeer Port was 51.5% completed; Al Shagaya renewable energy complex 80%; Sheikh Jaber Al Ahmad Al Sabah Causeway 83.6%; and the Municipal Solid Waste Treatment Plant 75%.

International Indices

The forum was also given updates on Kuwait’s rankings in international indices. The World Bank’s “Doing Business 2018” report, which compares the business environment for domestic firms in 190 economies, ranked Kuwait 96th in terms of ease of doing business, an improvement from 98th in the 2017 edition. The report also measures distance to frontier – how far a country is from the best existing performance of any nation for each of the indicators – and gave Kuwait a score of 61.23 out of 100, up from 59.71 the previous year. This put Kuwait ahead of the MENA average (56.72), but behind both Oman and Bahrain, which had scores of 67.20 and 68.13, respectively, and ranked 71st and 66th in terms of ease of doing business.

Meanwhile, in its “Global Competitiveness Report 2017-2018”, the World Economic Forum (WEF) ranked nations on 12 pillars, comprising its global competitiveness index. Kuwait fell from 38th out of 138 economies in the 2016-17 edition of the report to 52nd of 137 countries in 2017-18. The WEF attributed this to the deterioration of the macroeconomic environment and a revision of ICT readiness indicators supplied by the International Telecommunications Union. However, there was a smaller change in Kuwait’s index score, which stood at 4.4 in the 2017-18 report, down only slightly from 4.5 in the previous iteration. Ranked 62nd, Oman was the only GCC nation with a lower position on the 2018 index. The four remaining Gulf countries had seen some decline in their standings from 2017, although the UAE placed favourably at 17th, Qatar 25th, Saudi Arabia 30th and Bahrain 44th.

Although less favourable GDP growth was cited as being behind Kuwait’s drop down the ranking, the country placed 30th – its best-performing category – in the macroeconomic environment pillar. The WEF highlighted in the report that Kuwait should expand its innovation capacity by investing in higher education and training, creating a more inclusive labour market and making the most of its human capital. The WEF report included a survey, in which 21.7% of executives identified government bureaucracy as a main challenge to doing business in Kuwait, while 12% and 11.5% noted that corruption and restrictive labour conditions, respectively, were a concern. “Kuwait has placed improving its business environment at the core of its policies, with 14 different government agencies working together, along with technical support from the World Bank to achieve these goals,” Mona Bseiso, an economic consultant at the Kuwait Direct Investment Promotion Authority, told OBG.

Transformation Project

A number of infrastructure projects are set to support the business and economic landscapes. By late 2018 the Sheikh Jaber Al Ahmad Al Sabah Causeway project, a $3bn, 36-km bridge spanning Kuwait Bay, should be completed. Having taken five years to build, the mega-structure will link Shuwaikh Port to Subiyah, enabling vehicles to cross the bay in 20 minutes – 50 minutes less than before. This is set to boost not only connectivity and communications, but also the development of various regions of the country.

Furthermore, the Silk City initiative and Kuwait Islands Project (KIP) 2035, which entails the development of five islands off the northern coast, are intended to address untapped economic potential. An April 2018 report by the CSB forecasts that these initiatives will require KD36bn ($119bn) of primarily private sector investment, creating 408,000 non-oil jobs, 75% of which will be filled by local workers. This would represent a stark contrast to current employment patterns, as public sector roles accounted for 80% of employment for nationals in 2017, according to the IMF. The development of the KIP and Silk City is also set to lessen Kuwait’s reliance on hydrocarbons, with the aim being to reduce oil’s share of public revenue from 89% in 2017 to 51% by 2035 and its proportion of GDP from 59% to 22% over the period.

Boubyan Island – an uninhabited 863-sq-km marshland formed over centuries from Mesopotamian mud that washed down the Tigris and the Euphrates rivers – is set to be transformed into a centre for manufacturing, IT, renewable energy, eco-tourism, fish farming and logistics based around the Mubarak Al Kabeer port, which aims to serve as a commercial hub for the northern Gulf. Failaka Island, which has been largely uninhabited since the 1990 invasion by Iraqi forces, is set to be a tourism, education, historical and cultural centre. It will have a museum to showcase 5000 years of civilisation and host six private universities, attracting 60,000 students, and vocational schools dedicated to culinary arts, theatre, music, coding and science.

Meanwhile, Silk City will grow on the other side of the causeway and will feature, alongside new homes and amenities, a financial centre and theme park with around 21,000 and 5000 employees, respectively. These developments are being led by the emir’s eldest son, the First Deputy Prime Minister and Minister of Defence Sheikh Nasser Sabah Al Ahmad Al Sabah. “The emir’s son taking charge of this project is a clear indication that the government wants to see this development happen, and happen fast, in order to prepare Kuwait for the challenges of the next generation,” Reaven D’Souza, managing editor of The Times Kuwait, told OBG.

Outlook

While the far-reaching New Kuwait initiative calls for longer-term change, immediate pressure from lower oil revenues has been offset by the emergence of higher hydrocarbons prices since late 2017. Indeed, the new price environment could make the delay in the introduction of VAT less consequential from a public revenue perspective, although stakeholders have highlighted that this could leave the country exposed to oil price fluctuations in the near term. Nonetheless, the development initiatives being implemented by the state should ensure a sustainable economic growth path over the longer run.