IMF Executive Board Concludes 2017 Article IV Consultation with Kuwait
the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kuwait.
Non-oil growth has picked up modestly over the past two years, and inflation has moderated. After coming to a standstill in 2015, real non-hydrocarbon growth has recovered and is set to reach 2.5 percent this year, driven by improved confidence. However, a cut in hydrocarbon output by close to 6 percent, reflecting implementation of the OPEC+ deal, will bring overall real GDP down by about 2.5 percent in 2017. Notwithstanding the impact of higher energy and water prices, inflation is on track to reach a multiyear low of 1.75 percent in 2017, due to a decline in housing rents and favorable food price developments.
The government’s underlying fiscal position has improved on the back of spending restraint, but financing needs have remained large. While overall fiscal accounts remained broadly balanced in 2016/17, the fiscal balance which excludes mandatory transfers to the Future Generations Fund (FGF) and investment income posted a large deficit (17.5 percent of GDP) for a second year in a row. The corresponding financing needs were covered through a drawdown in readily available General Reserve Fund (GRF) assets, domestic borrowing at various maturities, and a successful debut international sovereign bond sale. The external current account recorded its first deficit in many years in 2016.
The banking sector has remained sound, and deposit and credit growth have slowed somewhat. As of Q2 2017, banks featured high capitalization (CAR of 18.3 percent), steady profitability (ROA of 1.1 percent), low non-performing loans (ratio of 2.4 percent), and high loan-loss provisioning (over 200 percent coverage). Moreover, banks have maintained strong liquidity buffers. Private sector deposit growth has declined in recent years, but this has partly been offset by an increase in public sector deposits. While the growth of credit to the private sector has also slowed mildly on a year-on-year basis since July 2016, the underlying trend (i.e. after adjusting for a large one-off loan repayment) has remained above 5.5 percent.
Executive Board Assessment
Executive Directors concurred that Kuwait is facing “lower-for-longer” oil prices from a position of strength given large financial buffers, low debt, and sound financial sector. Directors noted that non-oil growth is expected to continue to recover gradually over the medium term, with the fiscal and external positions remaining broadly balanced. While acknowledging short-term upside risks from the recent recovery in oil prices, they saw a further drop in oil prices over the medium term, tighter global financial conditions, heightened regional security and geopolitical risks, and delays in project and reform implementation as the main risks to the outlook.
Directors noted that the sharp decline in oil prices had adversely affected fiscal and current account balances. They commended the government’s recent efforts to streamline current spending, diversify revenue, and improve the business climate, and stressed that the new environment calls for deep and sustained reforms.
Directors encouraged the authorities to proceed with the planned introduction of excises and the VAT and to further curtail current expenditure. Highlighting the need for deeper reforms to reduce financing requirements more rapidly, create space for growth-enhancing capital outlays, and achieve intergenerational equity, they recommended further steps to contain the wage bill. They stressed that better aligning public and private sector compensation would enhance nationals’ incentive to consider private sector jobs and support competitiveness, and recommended limiting public sector employment growth as more private sector jobs are created. They saw reducing the large subsidy and transfer bills while protecting the most vulnerable as important.
Directors commended the introduction of medium-term expenditure ceilings and encouraged the authorities to further strengthen the medium-term fiscal framework to help underpin consolidation. They welcomed the government’s balanced financing approach and noted that further strengthening of the related institutional and legal frameworks would make debt management more effective and support the development of capital markets.
Directors welcomed the banking system’s sound position and the authorities’ prudent regulation and supervision. Given the downside risks to asset quality, high loan concentrations, common exposures, and interconnectedness of the financial sector, they welcomed ongoing initiatives to identify and address emerging pressures. To further enhance financial sector resilience, Directors saw scope to strengthen the crisis management and preparedness and the liquidity forecasting frameworks.
Directors stressed that moving from a public sector-led growth model to one driven by the private sector requires creating incentives for risk-taking and entrepreneurship. They emphasized the importance of education reform to equip new graduates with the relevant skills for private sector jobs and saw merit in greater use of privatization and partnerships with the private sector to boost productivity, investment and job creation. They agreed that this should be complemented by further steps to improve the business environment, including reforms to facilitate access to land, reduce the burden of administrative procedures and excessive regulations, and foster competition. Given their potential for job creation, they welcomed the authorities’ focus on SMEs.
Directors concurred that the peg to a basket remains appropriate for the Kuwaiti economy, as it continues to provide an effective nominal anchor. They noted that the recommended fiscal adjustment would largely close the moderate current account gap over the medium term.