Kuwait: Missed opportunities

Kuwait's outlook continues to be pulled in opposite directions. On the positive side, the economy realised one of it strongest economic performances in 2005/06 and the outlook remains buoyant with the oil price forecast to remain strong. However, the government has not been able forge ahead with its economic reform program owing to parliamentary opposition. This is resulting in missed opportunities, especially at a time when other GCC countries are making progress on their plans. These include maximising the hydrocarbon potential (Qatar, Abu Dhabi), diversifying their economies (UAE, Qatar, Oman) or structurally reforming the economy (Saudi Arabia).

Positively, after 3 years of robust economic performance, we expect the economy to continue to perform strongly, owing to growing oil revenues. The substantial external current account and fiscal surpluses are resulting in the build-up of financial assets. Reserves of the central bank increased to USD 9.3bn in January 2006, up 18.1% y/y. However, reserves represent only a
small amount of total assets, with substantially higher levels of reserves are being held in government funds for future generations. By law, 10% of total oil revenues have to be placed in the Reserve Fund for Future Generations. Government revenues increased by 56% y/y to USD 42.6bn in the first 11 months of 2005/06; this is the largest in Kuwait's history and almost three
times the figure estimated in the budget, which was based on a conservative oil price of USD 21pb. The budget surplus is forecast to increase in 2006/07 43.0% of GDP in 2006/07. Meanwhile on the external front, the current account surplus is forecast to grow to an impressive 49.1% of GDP in 2006, up from 43.2% in the previous year.

Furthermore, we forecast real GDP growth of 6.2% for 2006. Net exports will again make a positive contribution to real GDP growth as the oil price increases. In Q1 2006, the average price for Kuwaiti crude is estimated to have increased by around 29% y/y. Furthermore, higher government spending will also support the economic expansion, along with boosting private consumption. Early indications from the government suggest spending is slated to grow by 15.0% in 2006/07, which would be one of the strongest increases in expenditure in recent years, although the pace of growth in public expenditure will be well below the rate of revenues growth.

Inflationary concerns have risen owing to the US dollar weakness and strong domestic demand. In order to curb imported inflation, the Kuwaiti central bank revalued its currency peg in line with our call against the USD on 11th May, raising the KWD by around 1% to KWD0.28914:USD. The central bank noted that both CPI and the WPI have accelerated on the back of the USD weakening against other major global currencies. Inflation increased to 3.9% in 2005 from 1.3% 2004. Furthermore, the strengthening of the KWD against the USD, will help to maintain the purchasing power of the KWD against the currencies of its major trading partners, as well as Kuwaiti assets, with the majority of Kuwait's imports originating from Europe and Asia.

The IMF noted in 2006 that although Kuwait's medium term outlook remains positive, GDP growth is expected to slow unless the pace of structural reforms accelerates. The country's longer-term development remains hampered by structural and social rigidities such as an overdependence on oil, little private sector dynamism and an expensive welfare system (with relatively high population growth). In the short-term, this employment burden can be maintained by the state, as oil prices are high. But over the longer-term, the already overstaffed government sector will not be able to absorb the growth of the labour force. Therefore, fiscal pressures from the generous welfare system would clearly increase in the event of weakening oil prices. Negatively, there has been very little progress on the reform front. Parliament has continued to block economic reform measures over the last decade. The National Assembly is seeking to gain the maximum benefit for their constituents and any attempts to reduce subsidies have been blocked. Furthermore, parliament remains deeply suspicious of the government's privatisation plan, fearing that it would eventually lead to job losses. Although the National Assembly's Financial and Economic Committee approved a privatisation plan in May, the draft law will face strong opposition and is unlikely to be approved.

Furthermore, parliamentary support for Project Kuwait - the government's plan to increase oil production from the northern fields to 900,000 bpd from 450,000 bpd by opening the upstream oil sector to foreign participation - is also not expected in the short- to medium-term. Indeed, there are indications that anti-Project Kuwait rhetoric has increased over the last few months.

Negatively, this impasse between the government and parliament is forecast to continue with the appointment of the prime minister. Kuwait's new emir, Sheikh Sabah al-Ahmed al-Jaber al-Sabah, has appointed his brother Interior Minister Sheikh Nawaf al-Ahmed (67) as the new crown prince and his nephew Sheikh Nasser Mohammad al-Ahmed (64) as prime minister in
February.

Sheikh Nasser has served more than 14 years as Emiri Diwan minister, a position that gave him unparalleled access to the late Sheikh Jaber, but kept him out of the combative parliamentary arena where he must now win support for the government's program. He will now have to prove he can operate on the public stage. However, the appointment of a courtier rather than a frontline
politician for the premiership signals that the key decisions will be taken by Sheikh Sabah, rather than being left to the government as was the case recently. Sheikh Sabah has been the de facto ruler for the past 5 years.

The appointment of the crown prince and the prime minister from the al-Jaber branch of the royal family breaks with the tradition of alternating power between two branches of the Sabah dynasty. A member of the al-Salem branch was widely expected to be appointed in one of these two positions to appease them after the controversial removal of Sheikh Saad after the death
of Emir Sheikh Jaber al-Ahmed in January. So far, Kuwait's political class appears to accept the decision to break with convention and keep the succession line in the al-Jaber branch.

Although the political upheaval has passed, challenges remain, including accommodating the al-Salem side of the family's demand for increased power and clarity over the next round of succession. Meanwhile, it is vital for the government and parliament to improve their working relationship, especially in the run-up the next general election due in July 2007. The continuation of this difficult relationship for another five years following the election would place downward pressure on Kuwait's outlook.