Challenges for Kuwait's policy makers

Kuwait is learning to breathe freely again. After decades of living uncomfortably in the shadow of its vast and menacing neighbor - not to mention the trauma of the Iraqi invasion in 1990 - the emirate at the northern end of the Gulf is beginning a new era in its history.

The initial signs are that the new era will be a very fruitful and profitable one. The accident of history that put Kuwait in the sights of Saddam Hussein's Iraq is today working in the emirate's favor. Kuwait looks set to profit in a major way from the long and expensive task of rebuilding Iraq.

But real economic growth will require a major change in the country's decision-making process: until the executive and legislative branches of government figure out how to overcome their differences, Kuwaiti politics will remain paralyzed - and a major drag on the economy.
Even after the reopening of regular air links between Iraq and the world at large, much of the equipment needed for the country's renaissance will need to be transported through Kuwait.

The emirate is wasting no time in making preparations for the expected boom in transit business. Last January, the Council of Ministers approved a proposal to construct a port at Bubiyan, an island off the northern coast of the country. In August last year, it was reported that the cabinet would be studying a feasibility study on the proposed $850 million project.

The decision to press ahead with studies on the scheme was taken in the light of the change of regime in Iraq and the subsequent expectation of a big increase in the volume of container shipping in the northern Gulf region - with estimates of a 45 percent rise by 2020.

At present, the dry goods handling capacity at Kuwait's ports is 12 million tons per year. With the new facility, this is expected to rise to 20 million tons per year by 2020. It is estimated that by 2005, demand at current ports in Kuwait and Iraq will have outstripped capacity.

The development of the new port at Ras al-Qaid will be carried out in five stages over a period of 16 years, beginning with capacity of 5 million tons per year in 2006. The new port will comprise roll on-roll off container handling facilities, along with infrastructure development and road and rail connections to Kuwait City and the Iraqi border.

The impression that Kuwait is in for a business boom is confirmed by a number of assessments of its economic health by international organizations. According the International Monetary Fund (IMF), Kuwait's economy remained in a comfortable position in 2003, with real non-oil gross domestic product (GDP) growth picking up briskly to about 6.5 percent due to the spillover effects of developments in Iraq and improved domestic confidence.

Today, the Kuwaiti economy is "buzzing with activity," according to one analyst who recently visited the emirate, with hotel occupancy high and busy trading. Kuwait is well-placed (and has the infrastructure and capabilities) to act as a base for international companies bidding for and managing projects in Iraq's reconstruction, particularly while the current lack of security in many parts of Iraq persists.

The financial sector is also benefiting, he says, from the opportunities in trade and project financing. Moreover, says the IMF, the macroeconomic position is projected to remain manageable over the medium term in 2004-08.

The IMF also gave Kuwait's stock market positive marks, saying that it continued to rise sharply in 2003 following increases of 39 percent in 2002 and 27 percent in 2001. Credit expansion has been brisk and broad money is estimated to have risen by about 13 percent, said the IMF.

The external current account surplus is estimated to have improved further to 19 percent of GDP due, in part, to an increase in oil export receipts. However, the Central Bank of Kuwait's net foreign assets are estimated to have declined to the equivalent of about six months of prospective imports. The fiscal and external current account surpluses are projected to contract on the basis of the expectation for declining oil prices, official foreign asset position and the authorities' intention to follow a cautious fiscal policy.

As for Kuwait's banking system, ratings agency Standard & Poor's (S&P) has it as "one of the strongest in the Gulf region and among emerging markets." The sector benefits from "a solid financial profile and limited competition," said S&P. This situation is expected to continue in the medium term, although increasing competition and foreign expansion could pressure banks' profitability, it added.

According to S&P analyst Anouar Hassoune, "The strengths stemming from a supportive government policy - together with the solid capitalization, strong profitability and adequate liquidity of Kuwaiti banks - largely offset the risks related to operating in a cyclical economy, the country's narrow customer base and limited business opportunities."

The Kuwaiti banking system will remain protected despite the recent approval of the foreign direct investment law, which allows foreign banks to operate in Kuwait.

"The Central Bank of Kuwait will remain very cautious in granting banking licenses, and the narrowness of the market offers limited prospects for foreign entrants," says Hassoune. Furthermore, the end of the war in Iraq and the capture of Saddam Hussein have boosted confidence in the Kuwaiti economy, creating momentum in trade, manufacturing and infrastructure, says S&P.

Retail banking will remain the driver of growth and profits for Kuwaiti banks. However, Iraq represents a promising opportunity for Kuwaiti banks, as does the prospect of large industrial projects (mostly in the hydrocarbon sector) driving business on the corporate banking side, provided legislation for the projects is passed.

S&P sounds one note of caution: the booming capital and real estate markets, which have been buoyed by the more stable geopolitical situation in the region, as well as increasing liquidity and some structural economic improvements, pose the risk that a financial bubble could be created if this trend continues.

At the same time, another ratings agency, Capital Intelligence (CI), has raised Kuwait's long-term foreign currency rating to A+ from A and affirmed its short-term foreign currency rating at A1. It also assigned a long-term local currency rating of A+ and a short-term local currency rating of A1 to the sovereign.

The upgrade reflects CI's expectation that the budget and external current account will remain in surplus in the foreseeable future, enabling the government to continue accumulating assets for future generations and bolstering the country's net external creditor position. The upgrade also takes account of the reduction in geopolitical risk following the change of regime in Iraq.

While the business boom will be welcome news for Kuwait's trading community, the economy as a whole will continue to be underpinned by oil. And in this sector, too, the news has been positive. A long period of sustained high oil prices - substantially higher than the most recent budget estimate - has helped to fill the government's coffers.

But efforts on the part of state-owned Kuwait Oil Company (KOC) to enable the necessary work to be carried to expand production in the future continue to face political obstacles.
Indeed, despite the current economic boom, Kuwait's political malaise shows no signs of lifting anytime soon.

On the question of expanding oil production, the issues are simple: the oil establishment insists that international firms are the only ones equipped to carry out the work, while most members of the National Assembly, for a wide variety of reasons, are firmly opposed in principle to foreign companies getting involved in long-term oil exploration deals.

KOC's arguments were presented recently by its chairman, Ahmad al-Arbeed. He said that maximum production from the giant Burgan oilfield would not be sufficient for the country to achieve and sustain production capacity of 3 million barrels a day. (Current capacity is 2.4 million barrels a day.)

Nor could Kuwait rely on Burgan to achieve its longer-term goal of reaching production capacity of 4 million barrels a day by 2020. As a result, Arbeed insisted, it was clearly necessary to develop the northern fields, which have enormous reserves, when compared with their current output.

"Most of the production from these fields close to the northern border," the KOC chairman said, "comes from easy crude reserves. Whereas the plan to increase production necessitates the expansion of output from the difficult reserves - once they have been developed.

"There is a major risk in the development of these difficult reserves - especially with regard to assessing the volumes of associated water and the subsequent effect of corrosion on facilities," said the KOC chairman. "This increases the cost and requires the introduction of advanced production management techniques because of the change in the nature of production required." Only the world's major oil firms, he continued, have the technology and expertise to carry out this difficult work.

KOC is pushing ahead with the preparatory work and says it will keep the country's parliament up to date on any new developments. What is required now is the political determination of the government and the oil minister to follow it up. But, as has been the case over most of the past decade, the political climate in Kuwait is anything but conducive to swift and decisive action being taken.

The relationship between the executive and legislative branches of government is as abrasive and distrustful as ever. Furthermore, splits have developed within parliament itself between Islamic groups and liberal and secular ones. This has found expression in demands by each side to question ministers associated with the other over allegations of corruption and inefficiency. The upshot is that most normal government and parliamentary business has been put on hold, leaving Kuwait's decision-making apparatus paralyzed.

Even when KOC brings the economic model for the scheme - labeled Project Kuwait - to parliament, the government is likely to encounter problems. The view of the oil establishment is that foreign companies selected for the scheme will merely be contractors (albeit for a period of some 25 years). And because none of the oil produced under the plan will be owned by the foreign firms, they argue, there is no need for special legislation to govern it. But parliamentarians show no signs of being convinced by this line of persuasion.

Some members of parliament argue that there is no need for foreign companies to become involved, while others say that their involvement breaches the country's constitution. But, above all, there are doubts about the transparency of the government's relationships with the international energy firms: parliament's highlighting this issue is a clear indicator of the level of mutual distrust between it and the cabinet.

So while Kuwait's hotels are full of businessmen looking for lucrative contracts in Iraq, and Kuwaiti agents and traders are happily cashing in on the boom, the shadow of country's political malaise cannot be ignored.