It a time when the global financial crisis is grabbing the headlines, it is easy to forget that in some countries, other economic issues are dominating the thoughts of local policy makers.

Like its GCC neighbours, Kuwait has been affected by the downturn in markets, and has also had to intervene to alleviate its impact on the Kuwait Stock Exchange (KSE).

But throughout the tumult of recent weeks, the government has maintained that its focus remains on monetary policy and, specifically, bringing inflation under control.

“The Central Bank of Kuwait’s board of directors – re-emphasises the banks’s keenness on taking the preventive and precautionary measures – that contribute to sustaining monetary stability, curbing inflationary pressures and strengthening the soundness of the domestic banking sector,” the central bank said in a statement to the press on 22 September.

Rising inflation

Inflation has been the key issue for Kuwait’s economy since the beginning of the year. In January, year-on-year inflation reached 9.5 per cent, and by February it was in double digits.

It hit a high of 11.4 per cent in April and, according to the latest data published by the central bank, reached close to that peak again in June, at 11.35 per cent.

“When you get double-digit inflation, you know it is something consumers and households will feel,” says Randa Azar-Khoury, group chief economist at the National Bank of Kuwait (NBK).

Thanks to Kuwait’s abundant hydrocarbon resources – the government earned KD17.7bn ($66.3bn) in oil revenues in 2007 – it is a wealthy nation.

According to the International Monetary Fund (IMF), Kuwait’s estimated gross domestic product (GDP) per capita of $46,397 in 2008 puts it in the top 20 worldwide.

In the GCC, it trails only Qatar and the UAE, and it compares favourably with Bahrain, Oman and Saudi Arabia, all of which have estimated per capita GDP of $20,000-25,000.

The impact of an expected global recession on oil demand has pushed prices down dramatically in recent weeks, from a peak of more than $145 a barrel in July to $72.17 a barrel on 21 October, the lowest for 12 months. But this is unlikely to threaten Kuwait’s economic growth.

“Government expenditure is the prime factor in the equation,” says one Kuwait-based senior banker.

“If we earn $100 for a barrel of oil, we spend $30. If we earn $80, we still spend $30. The only people who will suffer are the Kuwait Investment Authority [Kuwait’s sovereign wealth fund], because there will be less of a surplus.”

“Fundamentally, the economy is strong as long as oil prices are strong,” says Azar-Khoury. “Kuwait will continue to generate surpluses as long as the oil price stays above $55 a barrel.”

But expectations of continued strong growth do not make inflation any less of an issue. Indeed, the country’s conspicuous oil wealth gives Kuwaitis a feeling that they are entitled to a share of it themselves.

As a result, when problems arise, demands for government action are greater. “It would be socially unacceptable for a country with all that surplus to let its people suffer from the burden of high inflation,” says Azar-Khoury.

External factors

The impact of inflation is accentuated by its novelty. Average inflation between 2000 and 2004 was just 1.1 per cent.

In the three years since, it has reached 4.1 per cent, 3.1 per cent and 5.5 per cent respectively. The administration says the recent surge in inflation has much to do with external factors.

“The huge increases in non-oil primary commodity prices are external factors that pushed up the domestic inflation rates,” said central bank governor Salem Abdulaziz al-Sabah in a statement to the press on 7 May.

This is true to a degree. The cost of food has increased worldwide, and the GCC countries, which have a shared dearth of cultivatable land, have been hit particularly hard.

“Food inflation is a global issue,” says Bikash Rout, senior financial analyst at Kuwait-based investment company Global Investment House (GIH). “Kuwait’s geography means that it cannot be self-sufficient in food.”

As well as providing a boon to government revenue, high oil prices have contributed to inflation.

Increased energy costs have pushed up the cost of raw materials, extraction of which is energy intensive, and have led to higher project costs, as an increasing number of major construction projects compete for an increasingly limited pool of contracting labour and expertise.

Housing market

But there is also a substantial domestic element to the inflation problem. Most striking is the level of real estate inflation. In 2007, housing services inflation accounted for 37 per cent of reported inflation, averaging 7.6 per cent, according to NBK.

In December 2007, housing inflation was 16.1 per cent, and it has con-tinued to play a dominant role in price inflation in 2008.

In May, real estate inflation was 13-14 per cent, compared with headline inflation of 11.2 per cent, according to GIH.

“About 60 per cent of inflation so far in 2008 is due to inflation in the housing market,” says Azar-Khoury.

The government has introduced a series of measures to combat inflation. In May 2007, it depegged the Kuwaiti dinar from the dollar to dampen the impact of imported food inflation.

It has worked to a degree: food inflation in Kuwait is now lower than in neighbouring economies such as Saudi Arabia.

But the depegging has been limited. The Kuwaiti dinar is now tied to a basket of currencies, and although the government has not published details of the currency mix, the dollar is believed to account for about 80 per cent of the basket.

In the 12 months after depegging, the dinar appreciated less than 10 per cent against the dollar.

“It would be better to diversify the basket further, but somehow it has to be related to trade, and most of Kuwait’s exports are in dollar-denominated oil,” says the senior banker.

Embryonic plans for a single GCC currency are another incentive not to diverge too far from the dollar, as all other GCC members have maintained their dollar peg.

In March, the Kuwaiti government introduced consumer lending restrictions that reduce the maximum monthly repayment on loans, including interest, from 50 per cent of a debtor’s monthly salary to 40 per cent.

The measure also lowers the margin chargeable by banks over and above the central bank’s standard interest rate on lending, known as the discount rate, from 4 per cent to 3 per cent.

In a measure that will be applied retrospectively, it also stipulates that interest must be fixed for the first five years of the loan to prevent the 40 per cent barrier being breached because of the rising cost of borrowing.

Although some have criticised the measure for contributing to the falls in the Kuwait Stock Exchange, it has been welcomed by many in the financial sector for its dampening effect on inflation.

“The central bank is managing the inflation issue well, and the control of money supply and credit is helping,” says the senior banker.

The measure has been credited for easing rapid growth in money supply, a broad measure of which, M2, contracted from KD21.3bn in May to KD 20.7bn in June, according to the latest figures from the central bank.

The measure has also helped to prevent the development of the type of credit problems that sparked the global financial crisis.

“The central bank was right to restrict consumer borrowing, otherwise it would have had a mini sub-prime problem,” says the senior banker.

In August, the central bank withdrew a facility guaranteeing the availability of Kuwaiti dinars at a fixed exchange rate in the interbank lending market.

Although it was designed to make the sale of dinars more expensive, and thereby quell speculation on the dinar/dollar exchange rate, the measure has also pushed up interest rates, another monetary tool for controlling inflation.

Interest rates fell to 4.65 per cent in June, against the central bank’s benchmark discount rate of 5.75 per cent.

Quelling speculation

In an effort to stamp out the speculative element in house price inflation, the administration has also introduced legislation forbidding private companies from buying or selling residential units.

“The central bank saw rental prices rising despite there being no real influx of expatriates, which is responsible for housing inflation in Dubai and Doha,” says GIH’s Rout. “It was the result of trading in land.”

Although housing inflation was still 13 per cent in June, property sales fell 28 per cent in the first six months of the year, suggesting the market is cooling.

The new government measures should cut overall inflation in Kuwait to about 9 per cent, according to GIH.

But other government policies are themselves contributing to the inflation problem. Facilitated by increased oil earnings, government spending on both infrastructure and social benefits is increasing rapidly.

The 2008-09 budget envisages government spending of KD18.97bn, a 68 per cent increase on the KD11.30bn budgeted for 2007-08.

Much of this spending is designed to alleviate the impact of inflation on the local population.

In April, the government introduced a cost-of-living allowance for Kuwaitis, entitling them to an extra KD120 a month, while non-Kuwaitis employed by the government were given an extra KD50 a month.

The increase amounted to a 13-15 per cent raise for Kuwaitis and 10 per cent for expatriates, according to NBK.

The government has also increased the level and coverage of subsidies on products it deems to be necessities.

Although such benefits are in line with Kuwait’s unwritten social contract, under which the government is expected to distribute the benefits of its oil wealth to the broader population, they exacerbate the inflation problem.

The large expatriate population in Kuwait means the measure will affect only an estimated 550,000 people out of a total population of 3.3 million, so such a blanket approach will inevitably push up prices.

“A cost of living increase helps a consumer cover a rise in his or her expenses,” says Azar-Khoury. “But when you give it to everybody, you are increasing disposable income.”

Proposals to free up government land for property development are understood to be under consideration by the government.

When the central bank releases its next set of figures, they are likely to show an easing of inflation back into single digits.

“We think that even without the problems on Wall Street, inflation will ease back to about 7 per cent by the end of the year,” says Azar-Khoury.

The anticipated global recession, and the downward pressure it will exert on oil prices, materials costs and demand for international contracting expertise, is likely to accelerate this cooling of prices.

It may even enable the government to relax some of its lending restrictions, in turn stimulating investment on the KSE.