Economy: Wealth masks Kuwait's economic stagnation

28 March 2008
With a record budgetary surplus of almost $35bn expected this year, Kuwait is one of the world’s richest countries. But its inflexible, state-controlled economy risks undermining this success.

Kuwait’s political situation may be tumultuous, but the same cannot be said of its ability to generate wealth. Today, thanks to its oil, the state can claim to be one of the richest nations in the world, with finances most economy ministers can only dream of.

The country recorded a surplus of almost KD8.4bn ($30bn) for the first nine months of the 2007-08 fiscal year, up 22 per cent year on year, according to the Finance Ministry. Extrapolate these figures for the financial year ending 31 March and they deliver a record surplus of almost $35bn, more than a third of Kuwait’s estimated $110bn gross domestic product (GDP) (see chart).

There is no secret to Kuwait’s achievements. It derives 95 per cent of its revenues from sales of Kuwait Export Crude (KEC), which is currently priced at more than $90 a barrel. As government budgets are based on a conservative oil price of less than $40 a barrel, it is little surprise that revenues exceed initial projections.

Reserve funds

To say that the state has done well out of the oil price boom since 2002 is an understatement. Over the past five years, it has amassed a surplus of more than $100bn on the back of oil exports. Much of this has gone into Kuwait’s various reserve funds, which were worth more than $215bn in 2007. Even if oil were to dry up tomorrow, there is a good argument that the state could live off its investments quite comfortably.

The rest has been allocated to increases in capital spending and wage rises for government employees, who account for more than 90 per cent of the local working population. In Feb-ruary, the government approved a series of pay rises that will give local and expatriate public sector employees an additional KD120 and KD50 a month respectively. The move adds KD200m a year to the state’s wage bill and pushes salary payments to more than 25 per cent of total annual expenditure.

Kuwaitis should feel richer in other ways too. Nominal GDP has more than doubled to $101.6bn from $38bn in 2002, according to estimates from the local Global Investment House (GIH). GDP per capita has jumped to more than $32,000 as a result, a figure that would be much higher if it were based solely on local nationals.

The Kuwaiti dinar is the world’s highest-valued currency, a position strengthened by the government’s decision last year to depeg the currency from the dollar and value it against a basket of currencies. On 25 March, one dinar was worth $3.75.

But record surpluses and a strong currency do not tell the whole story. The economy suffers from the stagnation blighting the political agenda and has more in common with the closed, centralised economies of Eastern Europe under Soviet control than the innovative, private sector-driven model adopted by Dubai and other Gulf states.

The small private sector is dominated by a handful of powerful merchant families who have strong political ties and whose companies remain beholden to public sector contracts. When the government spends, the private sector does well.

But if the spending were to stop, private companies would have few options to fall back on. As it stands, the sector only enriches the few wealthy Kuwaitis who work for private firms, with the majority of locals employed in the public sector.

The economy is also failing to attract foreign investment. Kuwait attracted just 0.3 per cent of total investment in the GCC in 2006, or $250m, despite accounting for 14 per cent of its GDP. This is partly due to a punitive tax on non-GCC companies, which pay up to 55 per cent on profits made from investments in the state.

Taxation aside, there has been little investment even from local and regional firms. The poor investment environment - an absence of available land, heavy bureaucracy, corruption and the hiatus in new build-operate-transfer concessions - has caused investors to shy away from the state as an investment destination. Kuwaiti investors are happy to invest abroad, but reluctant to do so at home.

Employing locals

“Procedural delays are the bane of Kuwait,” says Faisal Hassan, head of research at GIH. “World Bank data shows that it takes 13 procedures to start a business in the country. Also, there are a number of caveats associated with most of the approvals given to foreign promoters, including the mandatory number of Kuwaiti employees to be kept. And most importantly, key areas such as upstream oil and gas have been insulated from foreign equity participation so far.”

A lack of confidence is unsurprising given the 2007 debacle over private sector build-operate-transfer concessions. Alleging corruption in the tendering process, the government unilaterally revoked a handful of concession contracts awarded to local logistics firm Agility, despite the company having already invested millions of dollars.

The decision rocked the Kuwait Stock Exchange (KSE) and caused a minor panic among firms. Although the government’s
decision was overturned on appeal, the resulting uncertainty has done little for investor confidence. “How can you expect companies to think about investing when they could see their investments wiped out in a flash and their stock collapse,” says one European commercial attache.

There are signs that the government is moving to restore confidence. In January, the National Assembly (parliament) finally approved a long-proposed bill that will reduce taxation on non-GGC companies to a flat rate of 15 per cent from the start of the new financial year. The move, which took years of debate before finally being approved, is the first step in a series of legislation that could culminate in the imposition of income taxes on the local population. However, given the populist nature of recent parliaments, and with the oil price so high, such a scenario is unlikely.

Even with tax reform, the economy lacks the dynamism of elsewhere in the Gulf. Development of the real estate sector is slow and haphazard, hindered by restrictions on foreign ownership, artificially high land prices and a lack of non-local demand.

The construction sector, often the driver elsewhere in the region, lags behind Kuwait’s Gulf neighbours.

According to data from Gulf projects tracker MEED Projects, there are more than $190bn worth of construction projects in the state, but only 5 per cent of that has entered the construction phase. Infrastructure continues to be a major headache, with the road system badly in need of upgrading, and public transport practically non-existent.

Apart from the oil sector, only the local banking and telecommunications sectors can claim to be truly world class.

As the economy booms and liquidity increases, so inflation has become a concern. Inflation hit a 15-year high of 7.3 per cent in September, according to the Central Bank of Kuwait, despite the dinar being depegged from the US dollar in May. Food prices have risen by as much as 40 per cent year on year.

Last year’s parliamentary debate and public protests calling for the government to pay off all local nationals’ commercial loans have highlighted the government’s lack of control over economic policy.

With the surplus set to break all records, the government will have to do its utmost if it is to resist further pressure to increase public spending. But it is not all bad news. With oil prices set to remain high in the medium term, Kuwait’s economy will continue to grow.

The Kuwait Investment Authority (KIA) continues to invest internationally, helping to build up the state’s reserves. The KSE has outperformed most of its regional and global counterparts this year, thanks to investor maturity and tight regulation, and government spending on capital projects continues to increase.

“The reasons for the strong growth in the markets are still present,” says Hassan. “There is strong macroeconomic growth, strong corporate earnings, strong liquidity, high business and consumer confidence, and high oil prices.”

Ultimately, the question is whether Kuwait needs the imposition of liberal macroeconomic policies, given its oil and financial wealth. The answer lies in the 40 per cent plus of the population who are under the age of 20. There will come a point when the state simply cannot absorb such large numbers into the local workforce.

For their sake, Kuwait needs to open up the economy and reduce the reliance on the public sector. If it does not, it will face a social, demographic and economic crisis that no amount of oil will resolve.

Key fact

Political stagnation means economic growth lags behind other Gulf states

Table: Revenues and expenditures for nine months of fiscal year 2006/07 (KDm)

Nine months interim reportChangeChange (%)
2006/072007/08
Oil revenues11,38312,6201,23711
Non oil revenues62285323137
Total revenues12,00513,4731,46812
Wages and salaries8741,11123727
Goods and services4841,073589122
Projects, maintenance and land purchases5552-3-6
Electricity and water95258163170
Public works114124109
Miscellaneous expenditure and transfers2,9161,863-1,053-36
Defence Ministry4495005111
Military procurement10587-18-16
Total expenditure5,0925,068-24-0.004
Expenditure excluding emiri grant and transfers to social security fund3,3774,6811,30439
Surplus6,8968,3771,48121
After 10 per cent payment to reserve fund for future generations5,6957,0301,33523

Sources: National Bank of Kuwait; MEED

Table: Kuwait macroeconomic indicators

200220032004200520062007e2008f2009f2010f
Nominal GDP ($bn)38.147.859.483.8101.9127.4151.6174.3191.7
Nominal GDP growth rate (%)112322.939.720.825.7191510
Real GDP growth rate (%)316.510.51011.35.33.33.73.5
Per capita GDP ($)15,75518,78121,58528,02532,01539,81244,58848,41650,447
Crude oil production (million barrels a day)1.752.112.292.572.662.552.652.752.8
Average Kuwait Export Crude price ($ a barrel)23.626.934.148.758.97490nana

e=estimate; f=fprecast; na=not available; GDP=gross domestic product. Sources: Global Investment House; Standard Chartered Bank; MEED

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