Kuwait's Bitter Pill

Despite its significant fiscal reserves, falling oil prices highlight the need to reform the Gulf nation’s economy to achieve long-term sustainability.

Published in Bloomberg Businessweek, 17 February 2015

Low oil prices tend to make people in the Gulf rather nervous, given how central the black gold is to the health of its economies. With the price of crude falling by over 50 percent between June and January—below the threshold at which each of the region’s governments can balance their budgets—the spending plans of the Gulf states have been thrown into doubt. Luckily, Kuwait has less to fret about than its neighbours.

“Kuwait is the most oil-dependent economy in the GCC, but is likely to be one of the least affected [by the slump in oil prices]. This is because it has the lowest fiscal breakeven oil price in the region,” says Paul Gamble, director of the sovereign ratings group at Fitch Ratings.

Kuwait depends on oil for around 90 per cent of its income, the highest among GCC countries, but it can also balance its budget when oil is around $49 a barrel, far lower than most of its neighbours. It may seem counterintuitive that an economy so dominated by oil should be in a relatively strong position in the current environment; but that strength comes, at least in part, from a fundamental weakness. Governments have historically found it hard to spend oil revenues because uncooperative parliaments have so regularly blocked large projects.

According to National Bank of Kuwait (NBK), the government has on average spent less than 75 per cent of planned capital expenditure since 2006/07. In the most recent financial year, which ended in March 2014, capital spending was KD1.7 billion ($5.8 billion), 3.9 per cent less than the year before. This means Kuwait has had a budget surplus every year for the 15 years through 2013/14, and another is projected for the fiscal year ending 31 March.

While current spending is far higher— last year it was $58.2 billion, although that was also lower than budgeted because of reduced fuel costs—the persistent underspending means that Kuwait has accumulated an enviable investment portfolio. The country also has very low debt levels, with gross public debt at around 4.4 per cent of gross domestic product (GDP), according to the IMF.

“Since 2003, elevated oil prices have allowed GCC oil exporters in general and Kuwait in particular to generate significant trade surplus and accumulate robust reserves,” says Raghu Mandagolathur, head of research at local investment firm Kuwait Financial Centre (Markaz). “With current reserves totalling more than $580 billion, this should provide sufficient comfort and cushion to future government expenditure programmes.”

Despite its fiscal strength, the low oil price environment is a concern for an economy in which the state relies so heavily on oil income and in which private sector activity is so limited. The oil sector accounts for 64 per cent of overall GDP, around 92.4 per cent of government revenues and 95 per cent of exports, according to Saudi investment bank Al-Khabeer Capital.

The need to diversify government income and the economy as a whole has long been recognised and low oil prices may just stiffen the resolve of the authorities to do so. They will be helped by a more constructive domestic political environment. Many opposition politicians boycotted the most recent parliamentary elections, held in July 2013, which meant a more conciliatory chamber was returned. While tensions remain, there is now a less confrontational relationship between the executive and legislature. “Kuwait’s government has taken several attempts to diversify and develop the economy, but implementation of economic plans was often hampered by parliamentary interference,” says Steffen Dyck, a senior analyst at ratings agency Moody’s Investor Services. “With a more supportive parliament in place, the implementation of projects is likely to improve.”

That means the prospects for the new five-year development plan, which runs from April 2015 to March 2020 and which was approved by a parliamentary committee in February, are relatively promising. The plan includes $115 billion worth of spending on 521 projects across a wide range of sectors including water, power, transport, education and the oil industry. “The prospects for capital spending are the best they have been for some time given the improved relations between the government and parliament,” says Gamble.

Higher levels of government spending, particularly on capital projects, should help boost economic growth. The IMF is predicting overall GDP growth of 1.7 per cent this year, followed by 1.8 per cent next year. Most of that will come from the non-oil sector, which is expected to grow by 3.5 per cent in 2015 and 5 per cent next year.

However, things could yet get blown off course. “Although a number of projects have been announced in the 2015-2020 plan, it would be interesting to see if how many go ahead,” says Mandagolathur. “A sustained drop in the oil prices might result in delays or even cancellations.”

Alongside changes to government spending patterns, the economy would also benefit from some other reforms. Global league tables tend to show Kuwait in a rather poor light in terms of its business environment. According to the World Economic Forum’s Global Competitiveness Report, for example, Kuwait ranks worst in the GCC in terms of its infrastructure. Meanwhile, the World Bank’s Doing Business report places Kuwait at 150 out of 189 countries when it comes to the ease of starting a business.

Clearly reforms are badly needed. As well as cutting back on red tape to make it easier to set up a business, observers suggest that the country would benefit from improvements to the education system and labour market reforms to incentivise locals to take private sector jobs.

Economic reforms have proved as hard to push through parliament in the past as project spending, but some significant moves have been made recently, including a cut in subsidies for diesel and kerosene on 1 January, which pushed up the cost from 55 fils a litre to 170 fils a litre (there are 1,000 fils in a dinar).

Such measures are not easy to introduce in a country where the government and the head of state are unelected and so lack a clear popular mandate. Further change is likely to take time. “Subsidy reforms are generally done in a very gradual way, especially in somewhere like Kuwait,” says Giyas Gokkent, senior economist at the Institute of International Finance in Washington DC. “The hike in diesel prices is, I think, the correct approach to rationalising spending. If they can tilt the balance of spending away from current spending and towards capital spending that would be positive for the economy.”

What is certain is that the need to do something will not go away. Wages and salaries alone made up half of all spending in the 2014/15 budget, says the IMF, and the cost of providing subsidies will inevitably keep on rising as the population grows. Despite the sensitive nature of subsidy reforms, the government is expected to review water and electricity tariffs, and the public sector wage bill.

Low oil prices highlight the need to put the country’s economy on a sustainable long-term footing. Whether the government has the will or the ability to take advantage of the current climate to address the issue, remains to be seen.