Kuwait: financial report.
There has been significant progress in Kuwait since 1992-93. The state has been instrumental in restoring confidence in the post-war era by paying off household debts, increasing government salaries, and consumer subsidies as well as compensating the business sector for war damage. The government also helped in bank restructuring by buying bad loan portfolios. The most important aspect of reconstruction efforts - the rehabilitation of the oil industry was completed in 1994.
Oil output has averaged almost two million barrels a day (mnb/d) between 1994-97, compared with 937,000 b/d during 1991-93, according to the Paris-based International Energy Agency (IEA).
The reconstruction programme, however, reduced Kuwait's official foreign assets from a peak of $100 billion in 1990 to around $40 billion in 1992-93.
From the mid-1990s onwards, state reserves have been re-built.
The emirate's real GDP growth, after expanding at a robust rate of nine per cent a year between 1993-97, is projected to contract in 1998.This is due entirely to a fall in the value of oil industry output, and the impact of lower prices and production. The price for Kuwaiti crude averaged below $11.5/bbl, representing a fall of over a third in under a year. Kuwait has been adhering to its OPEC quota (1.98 mnb/d) since July 1998 in a bid to boost world oil prices. Analysts expect nominal GDP to contract by two-three per cent in 1998 and further decline this year.
The state is a major source of employment, consumption and output in the non-oil economy. The reduction in government consumption and investment spending spills over into the real economy, thereby having an adverse effect on the private-sector construction and services industries. This in turn slows the growth of domestic demand.
However, growth slowdown should compel the central bank to lower the discount rate this year, from its current seven per cent.
Government finances have came under severe pressures since early 1998. Capital investment projects are being postponed and some non-essential works have even been cancelled.
In the fiscal year 1996-97, the government ran a budget surplus amounting to Kuwaiti dinar (KD)502.4 million. But since then, plunging government revenues and ballooning recurrent spending have led to a large budget deficit of KD1,273 million in the fiscal year ending June 1998, equivalent to 14 per cent of GDP.
The 1998-99 budget, based on an average oil price of $10/bbl, projects a deficit after the mandatory 10 per cent contribution to the Reserve Fund for Future Generations (RFFG) of KD2.24 billion. Total expenditure has been budgeted at KD4.4 billion, largely funded by a series of public debt instruments and borrowing from local banks. Meanwhile, revenues are projected at KD2.4 billion, of which oil receipts comprise 77 per cent of total. The deficit for fiscal year 1999-2000 will be influenced by the oil factor, but we should not expect a concrete improvement in the government's finances over the next year or two, hence expectations of oil prices of below $16$18/bbl band.
Amid diminishing oil revenues over the next two years at least, the heavy cost of the public sector is imposing a huge constraint on public resources. Over 90 per cent of the indigenous workforce is employed by the state. Therefore wages/salaries and allowances and other recurrent spending constitutes more than two-thirds of total annual revenues. The Kuwaiti constitution promises native Kuwaitis access to one of the world's most generous welfare systems (health care and education), consumer subsidies on utilities, housing and even telephone bills, as well as a guarantee of employment. Observers say that without a rapid upturn in revenues, that the continuation of such cushioned living is untenable. However, steep reductions in subsidies is a contentious political issue across the GCC countries.
The central bank has been successful in maintaining a low inflation environment, largely helped by currency stability and lower import prices of manufactures and food/beverages. Consumer price inflation has averaged 1.3 per cent a year between 1992-98.
Unlike other GCC currencies, which are pegged to the US dollar, the Kuwaiti dinar is linked to a weighted basket of major currencies in which the dollar has the highest weighting.
A BOOMING OIL SECTOR
Development of the oil sector is the key to Kuwait's future prosperity. Blessed with almost 10 per cent of the globe's proven reserves- equivalent to 96.5 billion barrels, and a reserve-to-production ratio exceeding 100 years, the emirate's long-term aims are to increase output capacity to 3mn b/d by 2005 and 3.5mn b/d by 2010, from a current 2.5 mn b/d. An estimated $15 billion of capital investment in new oilfield installations is planned. However, the budget squeeze, if continued into 1999-2001, may lead to a scaling down of oil infrastructure projects. In the near-term, oil output may fall after OPEC's meeting on 23 March if prices remain weak during the winter months in the northern hemisphere.
The Oil Ministry is exploring ways of gaining access to foreign technology in order to enhance exploration and production techniques required for developing more marginal fields. The government is contemplating opening up the upstream oil sector to foreign investment, but only in the form of service agreements with foreign multinationals.
Recently, Royal Dutch/Shell, British Petroleum, Chevron,Total and Exxon have expressed an interest in upstream participation.
However, production-sharing agreements will most likely be off-agenda, as these are forbidden under the constitution. By law, the emirate's natural resources and revenues are the state's sole property, and foreign ownership of natural resources is forbidden.
The Burgan field is the world's second-largest with around 50 billion barrels and has low production costs.
THE EXTERNAL PAYMENTS SECTOR
Kuwait has earned annualised surpluses of $5.4 billion and $5.13 billion respectively on its trade balance and overall current account between 1993-97. During this period, higher income on overseas investments, ie interest, profits and dividends (IPDS) have also contributed to a strong balance of payments position.
But last year saw a marked deterioration in the emirate's external account, largely due to a plunge in trade surplus estimated at $2 billion, the lowest since 1993. Total exports are projected at below $10 billion, down from $14.28 billion in 1997. Imports are anticipated to have remained broadly static at $7.6 billion as weak domestic demand and decline in fixed investment undermined import growth. Earnings from foreign portfolio investments were adversely affected by downward corrections in stock markets and falling interest rates in the US and Europe - major outlets for Kuwaiti outward investment.
Should oil export earnings drop further in 1999, then the trade surplus could dip to an all-time low of $1 billion. However, despite a declining trend in external surpluses over 1999-2000 period, Kuwait should not experience an "unfilled financing gap" for the foreseeable future.
FX reserves equivalent to seven months import-coverage and offshore assets are sufficient to guarantee external financial obligations. According to Bank for International Settlements (BIS) figures, by mid-1998, Kuwait's foreign debt - comprising mostly non-guaranteed external bank claims, was $8.47 billion, equivalent to 28 per cent of GDP.
There were unfounded rumours in 1998 of the Dinar's devaluation. However, sizeable FX reserves of $4.5 billion, including gold, and undisclosed overseas assets should underpin exchange rate stability. Kuwait is a capital-exporting nation, and a creditor to the international banking sector. Its net overseas bank deposits as of June 1998 were $7.7 billion (gross deposits $16.17 billion).
REBUILDING FOREIGN ASSETS
The state of Kuwait holds significant foreign investments (both direct and portfolio), although these have declined from their pre-Gulf war peak. The emirate's investment strategy reflects elements of prudence/conservatism, and social responsibility. There are two international portfolio funds controlled by the Kuwait Investment Authority (KIA). The General Reserve Fund, set up in 1960, and is worth an estimated $20-$30 billion, and the Reserve Fund for Future Generations (RFFG), set up in 1976, which is worth an estimated $35-$45 billion. The innovative RFFG provides a safety net for Kuwait when its oil wealth is exhausted. The London-based Kuwait Investment Office (KIO) arranges and manages these investments on behalf of KIA. The Kb's portfolio holdings are heavily concentrated in long-term investments in international blue-chips, top-quality bonds such as US Treasuries or UK gilts, eurocurrency deposits and in real estate in Europe and the US. The IPDs on overseas investments constitute the second-largest source of the government's revenue after oil. However, investment income could decline as 1999 may prove a bearish year for institutional investors as Kb.
This is because corporate earnings in the US and Europe are projected to be subdued, reflecting growth slowdown in the OECD area, and a continuous depression in the key emerging markets of Asia, Latin America and Russia. At the same time, earnings on fixed-income assets such as dollar-denominated certificates of deposits,or euro-deposits will be lower because of further falls in European and US interest rates this year.
In addition, the Kuwait Petroleum Corp (the world's seventh largest oil company) has substantial downstream investment overseas, including thousands of petrol stations and refineries in Asia and Western Europe. The KPC is planning to expand its marketing and refining interests in the US.
Kuwait's abrupt reversal of fortunes in 1998 shows that despite regaining pre-war levels of output, its economy lacks diversification. Root causes of economic woes are an unhealthy reliance on a single commodity and an over-burdened public sector. Besides oil refining and petrochemicals, the manufacturing base is limited, and comprises mostly of light industries. The non-oil private sector is dominated by an oligarchy of prominent families like the Al-Kharafi family, which owns one of the Gulf's largest construction firms; its founder also helped established the National Bank of Kuwait.
The central bank governor, Sheikh Salem Abdul Aziz Al-Sabah, is in favour of economic reforms, which are essential for long-term prosperity. By the standards of GCC's countries' cautious approach, reforms in Kuwait are proceeding at a fairly advanced pace. The KIA is responsible for a privatisation programme. The government hopes that privatisation and deregulation programmes will promote the growth and diversification of the private sector, as well as providing new jobs for nationals. There are sizeable private offshore assets, estimated at $50 billion or more, which could be invested in local markets.
In absolute monetary terms, the state has to date sold off more assets than any other GCC country. Total divestment in 24 companies by the KIA since mid-1994 has yielded $3 billion, and a further $3 billion of assets will be sold off in the next few years.
Prime assets such as Kuwait Airways, the telecoms network, electricity and water suppliers, as well as the downstream activities of Kuwait Petroleum Corp, could also be partially privatised in the coming years. The privatisation programme has stimulated growth in the Kuwait Stock Exchange, the value of which peaked at $32 billion in November 1997. The KSE underwent a correction in 1998 with market capitalisation declining to $20 billion in December.
The government is keen to encourage private investments in basic infrastructural projects. Fiscal reforms, leading to more effective allocation of resources, are needed to put public finances onto a sustainable footing. A recent IMF report says amid a gloomy oil market outlook, Kuwait will need to implement new rationalisation measures to ensure medium-term fiscal and external sustainability. The government is planning to increase public utilities charges, partially remove fuel subsidies and to impose customs duties on luxury goods.
Kuwait is the second-largest banking market in the GCC region, and most banks, such as the National Bank of Kuwait (NBK), Gulf Bank and Gulf Investment Corp, showed improved earnings in 1998. The NBK controls a third of the sector's total assets and enjoys one of the highest ratings by Capital Intelligence in the region. The quality of services is on a par with the OECD-based banks. But major constraints on Kuwaiti banks remain the limited, lending opportunities in the domestic market. The US Moody's Investors Service voiced concern that a substantial increase of 25-30 per cent in private sector lending over the past two years was perhaps unjustified. The lendings were to real estate companies and non-bank financial institutions, and in the event of a prolonged economic downturn, this may lead to an increase in non-performing loans.
However, Kuwaiti banks possess strong capital bases to withstand deterioration in credit quality. The Moody's report says all banks except Kuwait Finance House, an Islamic bank, could write off over 20 per cent of loans and still remain solvent. The soundness of Kuwaiti banks is made evident by the Baal grade given by Moody's for long-term deposits/bonds and a higher rating of Prime-2 for short-term obligations. Underpinning confidence in the sector is the Central Bank of Kuwait, which adopts the 25 core principles of the Basle committee on bank capital adequacy and supervision. Foreign assets of Kuwaiti banks were $5.93 billion as of August 1998.
The government's policy is geared towards achieving sustainable growth by encouraging private sector activity and continuous investments in upstream and downstream (petrochemicals) industrial sectors. The emirate's oil wealth remains a key source of future industrialisation and socio-economic development into the 21st century. But difficult challenges lie ahead as the outlook for oil prices remains bearish.