As stock market indices have tumbled across the world in response to the global financial crisis, the Kuwait Stock Exchange (KSE) has been no exception.

The impressive gains the KSE made in the first half of 2008 have disappeared.

On 24 June, the KSE’s main index hit a peak of 15,654 points, up almost 25 per cent on the beginning of the year, but over the subsequent three months these gains have been wiped out.

The exchange closed at 11,951.70 points on 5 October, the first time it had fallen below 12,000 points for almost 16 months.

Company share prices across a range of sectors have been hit hard.

In the year to 1 October, shares in KSE-listed islamic finance institution Investment Dar Company fell 10.5 per cent, International Financial Advisors’ shares dropped 39.8 per cent, and Commercial Real Estate shares lost almost 30 per cent.

The traditionally strong banking sector has also suffered losses. In the first nine months of the year, National Bank of Kuwait (NBK) stocks fell 3.9 per cent, Commercial Bank of Kuwait shares lost 11.8 per cent and Gulf Bank of Kuwait shares fell 14.4 per cent.

These losses resulted in the news on 9 October that the Kuwait Investment Authority (KIA) is planning a possible $15bn injection into the KSE, as well as a possible withdrawal of money invested in foreign markets.

Investors had been demanding for weeks that the government invest locally to support the market.

Seeking protection

Before the KIA’s plans became public, investors has been calling for the resignation of Saleh al-Falah, director general of the KSE, and in early October, local media reported that two Kuwaiti banks had appealed to the Central Bank of Kuwait to protect them from collapse.

On 7 October, one trader filed a lawsuit to compel the government to temporarily close the exchange to protect small investors from incurring further losses.

The central bank has assured the market that it will provide whatever liquidity is necessary to the domestic banking system, and in early October it injected a small amount of capital into the market, prompting a fall in interbank lending rates.

In an effort to stimulate lending, it has also cut interest rates by 125 basis points, to 4.5 per cent, and increased the permissible loan-to-deposit ratio for local banks to 85 per cent from 80 per cent, adding KD1bn ($3.7bn) to banks’ lending capacity.

In early October, the KIA also committed KD280-300m to a series of local stock investment funds and offered to deposit $55m with local banks.

But a KD300m investment is small compared with the fund’s existing investments in the bourse, which amount to more than KD3bn, and local bank deposits have been offered at a punitive interest rate of 7 per cent.

Despite the KIA’s most recent offer of $15bn of funds to the KSE, the government insists that there is adequate liquidity in the banking system and that economic fundamentals remain strong.

Despite the turmoil in the markets, the government has a good case. Kuwait has the fourth largest oil reserves in the world, and production of about 2.5 million barrels a day in a high-price environment assures it has a strong revenue stream.

In 2007, Kuwait enjoyed gross domestic product (GDP) growth of 6.6 per cent, per capita GDP of $35,564, and a budget surplus of more than KD11bn.

By the end of the year, it had accumulated foreign reserves of $16.6bn, up from $12.6bn in 2006 and $8.9bn in 2005.

Earnings growth

The country’s banks are also in good shape. The sector is expected to post full-year earnings growth of 34 per cent, up from 26 per cent in 2007, according to investment company Kuwait Financial Centre (Marzak).

In early September, ratings agency Fitch Ratings upgraded the long-term ratings of five Kuwaiti banks to reflect the country’s improved ability to provide support to the banking system.

Although stock prices are falling, bank’s earnings are increasing.

NBK’s earnings were up 10.5 per cent in the nine months to September 30, compared with the same period last year, while Commercial Bank of Kuwait enjoyed 28.6 per cent growth in profits.

Gulf Bank has also started growing again after a fall in net profits growth in the second quarter, according to estimates from Kuwait-based investment company Global Investment House (GIH).

NBK says its corporate banking, investment banking and wealth management businesses will all continue to benefit from the economic boom in the GCC.

“We expect all areas to continue to flourish, unaffected by the global financial crisis,” says Ibrahim Dabdoub, chief executive officer (CEO) of NBK.

The economy’s exposure to global financial markets is also limited.

Foreign direct investment in Kuwait is negligible, inter-national project financing is almost non-existent, and the local banking system is flush with liquidity.

The KIA has come under fire for the $5bn it invested in US investment banks Merrill Lynch and Citigroup in January, but the estimated $270m loss it has incurred as a result is small compared with the country’s financial resources, and is more than offset by the gains it has made from other overseas deals.

US impact

“Our region is relatively sheltered from the fallout of high-profile bankruptcies on Wall Street,” says Dabdoub.

“Over the longer term, Kuwait and other GCC financial centres may be able to capitalise on the loss of con-fidence in major international banks and governments.”

Jasem al-Sadoun, managing director of the local Alshall Consulting, agrees that the country’s economic fundamentals are sound, and is supportive of the government’s broadly non-interventionist policy.

“You interfere when macroeconomic fundamentals such employment or economic growth are at risk, but this is not the case,” he says.

“The other reason to interfere would be to support the finance and banking sector, but this is protected by a strong central bank regime. So there is no real risk to the economy.”

But if Kuwait is so well insulated from global events, why has the KSE fallen in value? The fall is partly psychological: the collapse of major global stock indices has undermined confidence in financial markets everywhere.

“Although there is no direct effect [on Kuwait], there is a fear of equity as an asset class,” says Salah Fulaij, CEO of NBK Capital, the Kuwaiti institution’s investment banking arm. “People start to think they are better safe than sorry.”

Regional factors also have a role to play. Although Kuwait’s integration into the global financial system is limited, it is influenced by events elsewhere in the GCC.

Falling global markets have had a psychological impact across the Gulf, and local factors have accen-tuated the regional downturn.

In Dubai, a bellwether for the region, money that had been invested in the dirham in expectation of a revaluation against a weakening dollar has begun to exit the system in response to the dollar’s recovery, while fears of a slowdown in the emirate’s real estate market have also had an impact on the Dubai bourse.

National factors are also affecting the availability of capital to invest in the Kuwait exchange. Although the KSE is the oldest stock market in the Gulf, and the third largest after the UAE and Saudi Arabia, its limited capacity makes it susceptible to volatility.

“Stock market capacity is a limitation for every small country,” says Rout. “The market capitalisation is only about $200bn, so when major share issues come up, it has an impact.”

Telecoms offerings

Liquidity has been taken out of the market in recent months as investors have saved up funds to parti-cipate in a KD1.2bn capital increase by local telecoms company Zain, which took place between 17 August and 18 September, and to a lesser extent the initial public offering of shares in the country’s third mobile phone operator, Kuwait Telecom, between 24 August and 18 September.

As in Dubai, money has also exited the KSE as investors have unwound their positions in the dinar in the face of a strengthening dollar.

As part of its drive to control inflation, the central bank has also introduced regulations to limit liquidity in the banking system.

“Loan growth has been curtailed and borrowing eligibility has been cut down,” says Rout. “The fall in liquidity has had an impact on the stock market.”

A lack of market regulation is also an issue. Plans for the creation of a capital markets authority are under discussion, but until they are implemented, probably in 2009, stocks on the KSE remain relatively opaque and are therefore less attractive to risk- averse investors.

In the meantime, the government will hope that confidence returns to the market sooner rather than later.

Whatever the causes of the KSE’s downturn, if it does not begin to turn a corner in the coming weeks, the administration will come under increasing pressure to take action and go beyond the stated plans of the KIA as revealed on 9 October.

“Pressure is growing from the influential people running the banking and financial service companies, and from members of parliament,” says Al-Sadoun.

Falling inflation in July and August may encourage the central bank to relax its liquidity restrictions, which could in turn facilitate the return of capital to the market.

But market sentiment will be the more fundamental factor, and in that the KSE is at the mercy of global developments as much as local ones.