The NBK Economic Review

Luckily for Kuwait, the Mina Al-Ahmadi refinery accident that shuttered half of the country's refining capacity for three months during 2000 happened when oil prices were exceptionally high. Nevertheless, the accident is a reminder that worst case scenarios can happen and stresses the need for Kuwait to diversify its income sources.
Hopefully, this message is not lost on policy makers when debating economic reforms this coming year. The risk of continued complacency in pushing for reforms remains high, especially since high oil prices promise another budget surplus next fiscal year and the country's reserves are perceived to be fast approaching their pre-invasion level.
In the long run, oil remains a commodity subject to severe price fluctuations that can go into a steep decline just as fast as it can climb. The risk of overlooking this reality is high given the current strength of oil markets and OPEC's success in favourably managing oil prices through adjusting production to prevent large inventory build-ups.
Indeed, compliance with quotas was remarkably good this past year, but that's easy when few have excess capacity. Eventually, high prices will provide an incentive for the industry to build additional capacity, which could undermine current efforts to stabilise prices within a higher range.
Meanwhile, the upswing in oil prices during 2000 continued to improve the medium-term prospects for the Kuwaiti economy though the immediate impact on domestic economic activity was less pronounced.
Less than two years after dropping below $10 per barrel, Kuwait export crude (KEC) traded over $25 for most of the year. As a result, Kuwait generated the largest budget surplus and current account surplus in more than two decades, in addition to the highest rate of nominal GDP growth barring the reconstruction period following the Iraqi invasion.
GDP rose 28% to KD 11.6 billion in 2000. Growth was uneven in the various sectors of the economy. Despite a spectacular 57% rise in oil sector GDP on the back of higher oil production, prices and refinery margins, growth in the non-oil sector slowed down to its lowest rate since liberation. Financial services remained the fastest growing sector, albeit at a slower rate than last year. The trade sector was practically stagnant. Construction meanwhile, showed an unexpected mild recovery.
Overall, the non-oil sector reflected weakening domestic demand due in larger part to a big drop in investment spending and slower growth in private consumption. This meant that growth in net national savings was even more pronounced, rising to 45% of GDP, thanks to strong gains in net investment income from abroad.
Higher oil prices and refinery margins contributed to the record balance of payments surplus in more than one way. They raised oil exports by 66%. They increased the country's income from refining and marketing activities abroad, thereby boosting investment income. Indirectly, they contributed to the jump in compensations received through the United Nations for losses due to the Iraqi invasion. The compensations are collected by the United Nations Compensation Committee (UNCC) from Iraqi oil export revenues under the oil-for-food program. Higher oil prices implied higher appropriations to the UNCC fund.
The current account surplus more than doubled to top KD 4.5 billion, or 39% of GDP. This helped various government entities add KD 4 billion to their foreign investments. Most of this was in the form of portfolio investments. Portfolio outflows by investment companies, though small by comparison, also reached a record. No doubt the KD 686 million received from the UNCC during the year contributed to these outflows by increasing liquidity in the market.
Kuwait's fiscal policy, normally insulating the non-oil sector from the impact of oil price volatility, saw little change with government spending seeing only modest increases. Government final consumption rose moderately during 2000 according to national income accounts.
However, interim budget figures show that the much-awaited increase in government spending on development projects did not materialise, as most planned projects were moving slowly through the administrative process for approval and tendering. But moving forward they were, and next year promises to see the initiation of a host of new large public and oil sector projects. Given the dominance of the public sector, the increase in capital spending should be a boon for the private sector.
The last three years demonstrated how little the private sector can do to lift itself from a slump induced by decreased fiscal expenditures. Constrained government outlays have lowered activity in the construction and contracting sector, reduced imports of capital and intermediate goods, and depressed growth in the service and trade sectors. It also had a direct impact on the size of the expatriate population and labor force, causing their numbers to drop for the second year in a row, in turn hurting providers of consumer goods and services including the apartment property market.
The shrinking expatriate population, combined with slower growth in salaries and government hiring, had a dampening effect on consumer spending. However, UNCC payments helped offset the slower growth in average household income. Overall, consumer spending is estimated to have grown upwards of 4.2% in 2000 versus 5.1% a year earlier.
One area that did not see a similar slowdown in consumer demand was private homes. As the waiting period for government built houses continued to get longer, and concerns over continued availability of interest free housing loans from the government-sponsored Savings and Credit Bank (SCB) mounted, the demand for privately developed homes increased.
This triggered a boom in housing development as evidenced by the 29% increase in building permits granted during 1999, the last period for which data is available. However, activity slowed down in the second half of 2000 due to a hiatus in new loan approvals by the SCB pending a decision to increase the bank's capital.
Housing construction by private developers received a further boost in 2000 as consumer lending limits on individual banks were raised by at least 20%. The cap on a bank's consumer loan portfolio (inclusive of housing loans) was raised from 10% of private deposits to 12%, plus an additional 30% of any bonds issued by the bank.
Housing and consumer loans were a contributor to credit growth during 2000, though not necessarily the most significant. Domestic bank credit rose by 4.7%, slightly higher than last year. The largest increase in KD terms was in personal facilities used mainly for financing the last two installments of the Debt Settlement Program (DSP).
With these instalments, the DSP came to a conclusion seven years after Law 41 of 1993 was passed to resolve the difficult debts issue resulting from the 1982 stock market crash and the Iraqi invasion in 1990. All remaining unresolved debt will be referred to the courts, with the possibility of putting debtors in bankruptcy or allowing the use of non-monetary assets as payment in kind. The government has also been using UNCC payments to claimants with bad debts to settle their outstandings. Other debtors appear to have used their claim awards to pay down debt as well.
Proceeds from the DSP instalments were used to redeem part of the government's outstanding Debt Purchase Bonds (DPBs) held by banks, thereby improving the liquidity of banks and releasing bank assets for other more profitable uses. Another boost to liquidity came from UNCC payments. These payments caused growth in private sector deposits and consolidated assets of local banks to accelerate. Though much of the added liquidity was deployed in time deposits at the central bank, banks still managed to improve their profitability.
Monetary policy continued to focus on maintaining stability in the value of the Kuwaiti dinar against a basket of major currencies. Changes in the exchange rate of the dinar were dominated by the continued depreciation of the euro against the US dollar and the Japanese yen, with the dinar depreciating slightly relative to the dollar during 2000, and appreciating against the euro and the yen. This meant raising the discount rate in May 2000 by half a point as the spread against dollar rates had narrowed significantly. However, this was reversed by three separate half point cuts in 1Q01 following similar moves by the US Fed.
Despite an overall brighter macroeconomic picture the liquidity infusion from the UNCC payments, and a new law permitting foreign portfolio investment in local listed equities, the Kuwait Stock Exchange (KSE) index continued to crawl slowly downwards during 2000, losing over 6.5% for the year. Activity weakened still more dramatically with turnover falling by 29% from its level the previous year.
Strong earnings announcements helped the market turnaround in 1Q01. The price index shot-up close to 8% and average turnover more than doubled. Consolidated profits of the 74 Kuwaiti listed companies releasing figures for the full year rose 14% in 2000 to surpass their previous peak in 1997. Growth was again dominated by three corporates, led by NBK, together accounting for 43% of total earnings.
A positive development that could provide a boost for the local stock market is the progress with economic reforms. During the year, the government moved forward with some long-awaited measures, most notable of which were a national labor law and the law allowing foreign portfolio investment. The ratification of these laws paves the way for addressing the more serious issues of privatization, foreign direct investment (FDI) and taxation in the coming year.
The FDI law will have important implications for the proposed opening of the upstream sector to international oil companies to invest in some of Kuwait's more technically challenging oil fields under operating service agreements. This initiative, dubbed 'Project Kuwait', moved ahead in 2000, with the government introducing a draft law concerning foreign investment in the oil sector to ensure such investments do not compromise the State ownership of the country's oil reserves.
The law has not been approved by parliament yet. Meanwhile, the government has invited a number of companies to submit proposals for developing Kuwait's northern fields. These companies would be expected to operate as part of a consortium that would invest some $7 billion over 20 to 30 years.
If such reforms see the light in 2001, they would set the stage for the private sector to become less dependent on public sector expenditures.