Waking from slumber?

After nearly two years of half-hearted fiscal response to the global financial crisis, early this year Kuwait put together a spending plan to boost its economy that is expected to place it firmly back on the growth path.

In February the Kuwaiti parliament decided to pass a multi-year $105 billion (Dh385.6 billion) spending programme. It has raised hopes of a strong economic revival in this primarily hydrocarbon-driven economy.

While its Gulf neighbours fought hard with limited success to keep the financial crisis at bay, the Kuwaiti government's response to the crisis was at best muted.

In one sense the tiny nation of four million can't be blamed for a lethargic response, given the massive financial underpinning accumulated from oil revenues. Any meaningful threat arising from the international economic crisis was probably the last thing on the minds of Kuwait's policymakers, while governments around the world were racked by concern about sustaining growth.

"Unlike its Gulf neighbours, Kuwait's fiscal response to the global recession has been timid. The Kuwaiti economy weathered the global financial crisis and economic downturn relatively well, thanks to its oil cushion," says Ann Wyman, managing director and head of research for Europe at Nomura.

Kuwait is the world's fifth-largest oil exporter, its reserves estimated at 100 billion barrels, or more than 100 years of production.

The combination of plentiful hydrocarbon reserves and a small population makes it one of the world's most affluent countries, with per capita GDP in excess of $50,000. The economy's limited absorption capacity means that it regularly runs large fiscal and current account surpluses and has built a substantial pool of foreign assets, held both publicly and privately.

Unemployment in Kuwait is low, substantially the result of state spending. According to recent government statistics more than80 per cent of the Kuwaiti workforce is employed by the public sector. But in the medium to long term the economy will need to create more employment opportunities, owing to demographic pressure. At theend of 2009, 41 per cent of the population was between the age of 20 and 34.

"The stage where the public sector can continue to absorb new entrants to the labour market is over, hence the thrust for private sector participation in national growth and employment. Employment in the public sector, though it may look appealing for the nationals, has reached a tipping-point," says M.R. Raghu, Senior Vice-President — Research at the Kuwait Financial Centre (Markaz).

Spending programmes

As oil investments cannot absorb all the aspiring newcomers, new positions in manufacturing and services have to be created to solve the emerging problem, necessarily procured through the private sector.

Economists and policymakers expect the new four-year spending programme to make an impact. The central bank expects the economy to recover quickly from the impact of the global financial crisis. "We think that for 2010, gross domestic product will expand by four to five per cent," Shaikh Salem Abdul Aziz Al Sabah, Central Bank Governor, said in Kuwait City on March 24.

The International Monetary Fund has said it expects the economy to grow 3.3 per cent this year.

In addition to the long-awaited support from the fiscal stimulus, Kuwait's heavy hydrocarbon-dependence means that in 2010 growth prospects should also benefit from higher oil prices and increasedproduction. "Kuwait's economy relies mainly on oil for growth. Oil prices have increased to about $80 a barrel after falling to a low of about $34 a barrel in December 2008.

Those monies are anticipated in prudent fashion. "Kuwait usually bases its budget on conservative oil price estimates that helped it to maintain surpluses during the global economic downturn," says Shailesh Dash, CEO, Al Masah Capital.

Kuwait posted a budget surplus (of six billion dinars, Dh76.1 billion) for the 11th consecutive time in the 2009-2010 fiscal year. Total state revenues hit 17.7 billion dinars, with 16.6 billion dinars coming from the oil sector. The average price of Kuwait's crude oil in the year was $68.60 per barrel, far higher than the $33.60 it had forecast.

Kuwait has built one of the most robust foreign asset positions (on a per capita basis) in the world. Although precise figures of the government's net foreign position are not regularly reported, assets are estimated at about $200 billion, or 160 per cent of GDP. With oil prices improving, analysts expect Kuwait's surpluses to bulge in the year ahead.

"We expect the current account to register a surplus of more than 30 per cent of GDP this year as hydrocarbon prices rise. Import demand is likely to remain relatively steady given the modest growth environment," said Nomura's Wyman.

Financial woes

Despite its strong fiscal position, huge spending plans and potentially higher oil revenues this year, another issue looms large — Kuwait's financial service sector remains its Achilles' heel.

While the banking sector has been secured through a Central Bank of Kuwait-led bailout programme, more than 90 domestic investment companies with haemorrhaging balance sheets remain a risk to financial system. The growing threat of non-performing loans (NPLs) deriving from exposure to these investment companies has limited the lending capacity of most banks.

The ratio of NPLs has nearly doubled since the crisis began. Nevertheless, despite decreased profits due to the provisions required to cover the related costs, seven of the country's nine domestic banks recorded positive earnings in 2009.

The rebound has been largely credited to the timely bailout by the central bank and the government. When in 2008 Gulf Bank, the country's second-largest lender, reported a $1 billion loss in derivatives trading, the central bank quickly stepped in by guaranteeing all deposits in the banking system. Meanwhile, the country's sovereign wealth fund, the Kuwait Investment Authority, provided a capital injection by purchasing ownership in the bank via a rights issue.

The entire banking sector continues to face deteriorating asset quality, leading to higher provisioning. The asset quality problem is mainly due to banks' exposure to real estate and investment companies. In spite of that, banks still enjoy a reasonably good capital adequacy ratio well above 12 per cent, which may provide the needed comfort for medium- to long-term stability.

"The impact on the domestic banking sector is already being felt through their earnings numbers so far. Aggregate earnings for banks expanded only by 11 per cent during 2009, and if we remove Gulf Bank (that had a one-off effect), aggregate earnings actually dipped by 55 per cent. The problem with banks is not only restricted to exposure to investment companies but with overall asset quality," says Raghu. Estimates about banking exposure to investment companies vary, he adds, with the Institute for International Finance putting it at 12 per cent (of total assets).

In the run-up to the global financial crisis, credit growth was extremely rapid, but has since fallen off sharply and been slow to recover. In the aftermath, Kuwait's banking sector appears to have weathered the worst. Yet, despite the liquidity injection by the central bank, banks are still reluctant to lend, citing a lack of perceived growth prospects. This has resulted in part from the banking sector's concerns about their exposure to investment companies that in turn are exposed to the domestic real estate sector. It's a circular conundrum.

By year-end 2009 outstanding debt to local investment firms was estimated at $18 billion, including $7.6 billion owed to foreign financial institutions. In an effort to break the impasse, the government in February announced a $5.2 billion package that guarantees 50 per cent of fresh loans to local firms throughout 2009-10.

But, despite numerous measures to jumpstart lending — including the discount rate having been cut six times between October 2008 and February 2010 — the banks have yet to open the lending tap to local borrowers.

Central bank data show that credit to the domestic private sector grew by 6 per cent during 2009, the slowest in almost a decade. "The data showed no sign of an imminent recovery in either private sector demand for credit or commercial bank appetite for risk in the latter part of the year," says Ajay Garg, Senior Director, Al Masah Capital.

Deposit growth across the banking sector was weak, rising by just2 per cent over the year as a whole. As a consequence, the systemic loan-to-deposit ratio stood at the ceiling rate of 85 per cent in December 2009, suggesting that liquidity remains constrained.

Amidst the rising worry over lending growth, the central bank governor has advised that the banking system will be kept liquid enough by support. Apparently, the signs of upturn are already there. "We are approaching levels that are more in tune with reality. It is expected that in the next few months we will see more credit growth," the central bank governor said in mid-March.

Perhaps the newly-announced spending plan will bring sufficient relief. In an accompanying article, Majdi Gharzeddeene, Head of Investment Research, Kamco, points to that prospect, giving detail, and referring to the government's commitment to implementation in the face of the surrounding economic and financial pressures, although still subject to restraints.

Political process

Yet, some analysts say the political process in the country will still be the biggest roadblock. "Democracy in Kuwait has not helped the economy and its different constituents. The government-bashing and inexperience has not helped the parliament to drive policies which would be of benefit to the growth of the economy. As a result, we have seen the other, smaller Gulf economies surge," said an analyst. It's a verdict the authorities must wish to overturn.

The continuous conflict between the government and elected members of the parliament has been a feature of Kuwait's profile that has weighed on the economy for far too long. Tensions between the legislature and the cabinet eased after the prime minister, Shaikh Nasser Al Mohammad Al Sabah, survived a no-confidence motion in parliament last December, but disagreement remains over reforming the economy and weaning Kuwaitis from a decades-old welfare state.

The government is well aware of the country's economic challenges, so it is exerting intensive efforts to create the right atmosphere for meeting them.

If the situation does not improve, then all the big projects that have been announced — actually many of them not new — may not come adequately to fruition, and Kuwait may continue to lag behind its GCC peers in its development. It would seem unwise to rely too much on inherent resource-based wealth-production — which is why the agitation of policymakers is sure to persist.

- The writer is Deputy Business Editor, Gulf News.