NBK, outlook bright despite Iraq worries

High oil prices kept budget and export revenues buoyant and UN Compensations Committee (UNCC) payments flowing. Added liquidity has contributed in part to making the Kuwaiti stock market one of the best performing markets worldwide in 2001 and 2002. NBK expects the economic recovery to stay on track, precluding a prolonged conflagration in Iraq physically impacting Kuwait or derailing the anticipated global economic recovery.

However, factors lending strength to oil prices and contributing to fiscal and external surpluses in the short term are likely to weaken the prospects for Kuwait's future in the long run notes NBK.

Firstly, OPEC's success in maintaining oil prices in the desired range is likely to be at the expense of market share in the long-run, mainly lost to Russia. Secondly, easy fiscal conditions make it more difficult for the government to push through its economic reform program on the grounds of economic necessity. The more such reforms are delayed, the harder the process becomes.

Kuwait's budget surplus of KD 0.6 billion in fiscal year (FY) 2001/2002 was substantially better than the official projected deficit of KD 1.8 billion before the 10% allocation to the Reserve Fund for Future Generations. Nevertheless, the surplus was significantly lower than the previous year's, representing only 6% of 2001 GDP versus 22% a year earlier. NBK expects another moderate surplus in the current FY.

The current account can also be expected to record a similar surplus to last year's KD 2.6 billion, while GDP growth recovers to positive territory. GDP contracted by 9% to KD 10 billion in 2001 on the back of a 15% drop in oil prices. In real terms, GDP is reported to have contracted by only 1%. A higher oil price is one factor behind NBK's projections, with KEC likely to remain above the year to date average of $23.

Another factor is the complete restoration of refining capacity by end September at Mina Al Ahmadi refinery following the June 2000 explosion.

Outside the oil sector, economic activity held little surprises in 2001. Non-oil GDP grew at 2.8% in line with its average for the previous 2 years. Most of the growth was in community, social and personal services. Private sector activities showing higher growth were communications and trade.

The pattern should continue in 2002 with a pick-up in government spending and hiring boosting domestic demand and economic activity.

Government spending in FY 2001/2002 grew by 12% to roughly 4.7 billion, though remained 10% below budget. The wage bill stood at KD 1.5 billion, up by 4%, though all employment-related spending accounted for approximately half of total government expenditures. Wage increases in the current fiscal year are budgeted at 3% in line with total spending growth.

For the first time in 4 years, capital expenditures registered positive growth. While two thirds of the 42% increase was in land purchases that have limited impact on economic activity, spending on development and maintenance projects received a long-awaited boost. Still, spending remained 30% below budget. NBK expects growth to continue with next year's budget increase by 15%.

Growth in consumer spending rose in 2001 to 3.6%, after slowing down slightly in the previous 3 years largely a result of a drop in the size of the expatriate population. NBK expects consumer spending to be more robust in 2002 following accelerating growth in the size of the expatriate population and in public sector employment of nationals during the 12 months ending June 2002, in addition to the rapid increase in consumer and housing loans.

NBK estimates that the relaxation of the central bank's regulatory limits on consumer loans raised their annual growth rates to the tune of 20%-25% in 2001 and 1H02. Loans disbursed by the SCB were up 22% in 1H02 relative to 2H01, and almost double the amount disbursed during the same period last year. The value of approved loans saw a much bigger increase.

Residential real estate sales and prices mirrored the increase in housing loans. Sales were up 10% in value during 2001 and an annualized 20% in 1H02. Meanwhile, abundant liquidity and low interest rates made the near 10% return on property investments in Kuwait look quite attractive lifting sales activity dramatically.

In contrast, low interest rates and poorly performing global equity markets are expected to have a negative impact on Kuwait's vast foreign reserves and investment income from abroad, though they should remain sizeable. Investment income was KD 1.5 billion in 2001, while the net increase in the government's foreign investments was around KD 3 billion.

In recognition of Kuwait's continued strong financial position major international rating agencies including Moody's, Standard & Poor's and FitchRatings all moved to raise their sovereign credit ratings for Kuwait. Ratings of most Kuwaiti banks were also raised benefiting from strong liquidity and profits with NBK attaining the position of highest rated bank in all emerging markets.

Consolidated profits of local banks had risen by a cumulative 50% over the last 3 years, albeit at varying rates. Expectedly, profitability had been impacted by the declines in interest rates. Profit growth dropped from 21% in 2000 to 10% in 2001 and to an annualized 4% in 1H02.

Growth in private deposits is likely to moderate from last year's 14% that was triggered by a combination of accelerating credit growth and bigger injections of new liquidity from higher government spending and UNCC payments. Demand for credit saw a boost from the surge in trading activity on the Kuwait Stock Exchange (KSE) during the first seven months of the year that surpassed turnover during 2001 as a whole. But the recent sell-off and lower turnover in the stock market should cool down this demand.

During 1H02 the KSE index rallied to a four year high peaking at 2309 in July, 35% ahead of last year's close, following a 27% increase in 2001. The market benefited from increased optimism and liquidity but has retreated sharply on heightened war fears and slower earnings growth.

Earnings for 1H02 were only 3.1% ahead of last year. Growth was a spectacular 42% in 1H01 and 21% for 2001 as a whole. Slower growth reveals in part the completion of the recovery in earnings from their 1998 lows. Reduced UNCC payments this year have also put pressure on corporate results.

The performance of local equities as well as the private sector as a whole remains constrained by the dominance of the public sector that limits investment opportunities. Privatization remains elusive in the near term, with the exception of BOT projects, as political issues are likely to delay key legislation concerning reforms, privatization and opening up the oil sector. However, for the reform program to go ahead, the public must become convinced that sacrifices need to be made today to ensure a more promising future.