Challenges cloud measured reform By IMF/KUNA

LOWER OIL PRICES, OUTPUT WEIGH ON NEAR-TERM UNDERLYING FISCAL POSITION WEAKENED Opposition to cuts in wage bill, subsidies … new taxes complicate fiscal adjustment

KUWAIT CITY, Jan 27: The International Monetary Fund (IMF) issued Monday, the final statement prepared by its mission in Kuwait from Jan 7 to 20 in the framework of the periodic consultations for 2020, which showed that the growth of the local economy reached 0.7 percent in 2019.

The Governor of the Central Bank of Kuwait (CBK) Dr Mohammad Al-Hashel, in a statement to KUNA, outlined the mission’s final statement content and the nature of the structural challenges facing the Kuwaiti economy and the ways to confront them.

The statement also praised CBK efforts in strengthening the banking and financial sector and increasing its fortification.

The mission statement came within three main axes, the recent macro-financial developments in Kuwait, the macroeconomic outlook and risks and the policy discussions, Al-Hashel said.

The website of the IMF published Monday the statement and praised the improvement in the growth of non-oil sectors in Kuwait, which reached about three percent last year, driven by the power of government and consumer spending.

Subdued oil prices and output are weighing on near-term growth prospects and external and fiscal balances. The current conjuncture and the exhaustible nature of oil underscore the need to diversify the economy and ensure adequate savings for future generations. While large financial assets, low debt, and a sound banking sector underpin Kuwait’s resilience, the recent run-up in spending has worsened the fiscal position and eroded liquid buffers. Without a course correction, the fiscal and financing challenges would intensify and the window of opportunity to proceed at a measured pace would narrow.

The Kuwaiti authorities have embarked on financial and structural reforms to boost private sector growth and employment of Kuwaitis. They are undertaking reforms to improve the business climate, strengthen competition, reduce the role of the state in the economy, deepen capital markets, and foster the development of small and medium enterprises. The needed fiscal adjustment however is proving difficult due to opposition to reducing the public wage bill, subsidies, and transfers, or introducing new taxes. To build broad support, the adjustment should be: (i) designed in a growthfriendly and socially equitable manner; (ii) supplemented by reforms to cut waste, improve the quality of public services, and strengthen government accountability and transparency; and (iii) accompanied by a vigorous communication campaign.

The IMF mission highly values the candid discussions with the authorities and expresses its gratitude for their hospitality and excellent cooperation.

Recent Macro-Financial

Developments

Nonoil growth strengthened in 2019, but lower oil prices and output are weighing on the oil sector. Nonoil growth was propelled by strong government and consumer spending, the latter on the back of a credit recovery. Oil output however is expected to contract by 1 percent, broadly in line with the OPEC+ agreement. Taken together, this would bring overall growth to about 0.7 percent in 2019 from 1.2 percent in 2018. The current account surplus is estimated to have narrowed to 8½ percent of GDP in 2019 on account of lower oil exports. Inflation rose to 1.1 percent, reflecting higher food and transport prices and slower housing rent deflation.

While the consolidated fiscal balance improved in FY2018/19, the underlying fiscal position weakened. The nonoil balance excluding investment income fell by about 6 percentage points of nonoil GDP as government spending rose significantly. It grew by almost 25 percent in dinar terms from FY2016/17 to FY2018/19, mostly in hard-toreverse expenditure categories. The public wage bill has grown by about 6 percent annually (despite low inflation) over the same period, as the government was compelled to absorb new graduates into the already oversized public sector. To make room for new labor force entrants, the retirement age for civil servants was lowered by 5 years, widening the state pension fund’s actuarial gap to about 45 percent of GDP.

Fiscal financing needs have remained large. The consolidated balance after mandatory transfers to the Future Generations Fund (FGF) and excluding investment income amounted to a deficit of about 8 percent of GDP in FY2018/19. With the new debt law awaiting parliamentary approval, the government has been unable to issue debt since October 2017. Instead, it has continued to rely on the General Reserves Fund (GRF) for financing.

Kuwait’s financial assets continued to grow, but readily available buffers declined. According to the mission’s estimates, assets of the Kuwait Investment Authority (KIA) surpassed 410 percent of GDP by end-2019, as the FGF continued to receive mandatory transfers from the government and generated strong returns on its assets. However, the continued drawdown from the GRF for fiscal financing reduced its estimated total and liquid balances to 56 and 24 percent of GDP by June 2019.

Credit has rebounded thanks to supportive prudential and monetary conditions. Credit growth accelerated, spurred by Central Bank of Kuwait’s (CBK) decision in late 2018 to increase ceilings on personal loans and supported by favorable monetary conditions. The CBK skillfully deployed various monetary policy instruments to support lending to the economy while maintaining the attractiveness of the dinar. As the Fed Funds rate rose in 2018, the CBK kept

its policy lending rate unchanged (except in March), raising only the repo rate (a benchmark for deposits). While the CBK skipped the first two U.S. Federal Reserve interest rate cuts in 2019, it followed suit after the October cut. As a result, bank lending rates have remained broadly unchanged since 2018.

The banking system remains sound. The systemwide capital adequacy ratio (CAR) reached 17.6 percent in September 2019, and banks have plentiful short-term liquidity. Nonperforming loans net of specific provisions stood at 1.2 percent, while loan-loss provisioning is high at 229 percent. Net interest income has declined due to a narrowing spread between bank lending rates and the cost of funds.

7. Equity markets outperformed. Equity markets have staged a recovery since mid-2016, in part benefitting from portfolio inflows thanks to the inclusion of Kuwaiti equities in the FTSE Russel and MSCI EM (expected in 2020) indices. MSCI Kuwait surged 29 percent in 2019, compared to 15 percent for MSCI GCC and MSCI EM, with market capitalization reaching an all-time high of US$35 billion in December 2019.