Abstract
This 2002 Article IV Consultation highlights that in 2001, overall real growth for Kuwait fell slightly as oil output dropped following OPEC-mandated production cuts. The real non-oil GDP growth decelerated to 0.5 percent from 1 percent in 2000 as the private sector investment remained broadly unchanged. Inflation remained low at less than 2 percent, reflecting little increase in import prices and a modest nominal effective appreciation of the dinar. The macroeconomic position continued to be strong despite a decline in oil exports receipts.
In the context of a strong macroeconomic position and a comfortable medium–term outlook, the Kuwaiti authorities are focusing their attention on the key long–term challenges facing the economy. While it is recognized that, realistically, the oil sector will continue to be the mainstay of the Kuwaiti economy for some time to come, the authorities attach high importance to accelerating the growth of productive activities in the private non–oil sector. Accordingly, increasing employment opportunities for the growing population and reducing the economy’s vulnerability to oil price fluctuations, while preserving the country’s wealth for future generations, are key concerns. A comprehensive structural reform strategy to address these long–term challenges has been developed, and implementation is proceeding at a steady pace with emphasis being placed initially on building the institutional and legal framework necessary for the promotion of private sector activity and investment.
Recent developments
The macroeconomic position remained strong in 2001, notwithstanding a slight decline in oil output and subdued non–oil economic growth that was in line with the global slowdown. The fiscal and external current accounts continued to enjoy large surpluses, reaching 23 percent of GDP and 26 percent of GDP, respectively. Central bank international reserves and the stock of foreign assets in the Reserve Fund for Future Generations (RFFG) also rose substantially. Monetary conditions remained stable and inflation remained low. The financial sector also continued to perform well and prudential regulation remained strong, keeping pace with international standards and practices.
Progress has been made in institutional and structural reforms aimed at a number of interrelated goals:
opening up the economy to foreign investment;
reducing the role of government in the economy;
promoting private sector activity; and
increasing employment opportunities for Kuwaiti nationals.
Building on the reforms initiated in 2000, a new Higher Committee for Development and Economic Reform was appointed in 2001 and a Five–Year Development Plan has been drafted to coordinate and facilitate the reform process. The draft plan emerged from a candid assessment of the ramifications of maintaining the economic strategy pursued since the early 1970s, which focused on the distribution of the country’s oil wealth through the provision by the state of a wide array of services and subsidies to the population. The plan emphasizes the need for a fundamental shift to a growth–oriented strategy that relies primarily on the private sector and limits the economic role of the state to one of regulator, as it should be in a free–market economy.
Given the far–reaching nature of the plan and the expected short–term socio–economic consequences of some of its proposed reforms, the authorities are proceeding to build the broad political consensus required to ensure its acceptability and its successful implementation. Even though the plan is still being discussed nationally and has not been finalized, the Higher Committee has already taken steps to implement several of its main themes. Thus various reforms are underway that seek to redefine the roles of the public and private sectors and to create an environment conducive to both foreign and private investment, while promoting the economically justified diversification of the economy. A key element of this effort is the initiation of reforms in education and training to facilitate the absorption of Kuwaiti citizens into the private sector, and building the necessary institutional and legal infrastructure that would promote private sector investment.
Prominent among the steps taken recently in this direction is the passage of the Foreign Direct Investment Law, allowing foreigners to own 100 percent of Kuwaiti companies. The new law grants companies a tax holiday of 10 years, exempts them from customs duties on imports of capital and raw materials, and allows them to bring in necessary foreign labor. A new tax law reducing corporate tax rates is being drafted.
The Manpower and Government Restructuring Program (MGRP) was also established in 2001 to implement the Labor Market Law that was passed in the previous year to encourage Kuwaitis to seek employment in the private sector. The MGRP facilitates the employment of Kuwaiti nationals by providing them with social allowances and training opportunities accorded to government employees and unemployment benefits. The government also promotes Kuwaiti employment by requiring private companies to maintain a certain proportion of nationals in their labor force.
Other steps have been taken recently to promote private sector participation in economic activity. The Privatization Law was recently approved by the Finance Committee of the National Assembly and is awaiting the Assembly’s approval. The law would establish a comprehensive framework for large–scale privatization, while identifying the areas and modes of privatization. It would also establish a transparent pricing mechanism and institute safeguards against job losses. Procedures for the use of “build–operate–transfer” (BOT) mode have also been approved for use in the electricity, water desalination, and sewerage sectors. The establishment of a regulatory authority to oversee the public road transportation system to ensure appropriate pricing and private sector participation is under study. The Copyrights and the Patent Laws have also been amended, in line with WTO requirements. A number of other laws aimed at facilitating private sector investment are also currently under consideration.
Looking ahead
On fiscal policy, as part of their comprehensive reform plan, the authorities are determined to contain the growth of government expenditure. This will be done gradually and in conjunction with the planned acceleration of private sector growth and the generation of increased employment opportunities.
For 2002/03, the authorities have initiated a restrained fiscal policy supported by tighter budget management, despite the 2002 rebound in oil revenues. Thus, the 2002/03 budget is based on a very conservative oil price assumption of USS15 per barrel and does not include investment income. However, if account is taken of the relevant WEO oil price estimates and investment income is included, total revenue is projected to reach almost twice the budgeted amount. Nevertheless, the increase in total expenditures will be limited to about 2 percent of GDP as compared with 6 percent of GDP in 2001/02. To this end, expenditures on subsidies and transfers will be contained to about 95 percent of the budgeted amount and capital projects will be implemented at a pace that is slower than planned. Expenditure restraint will be facilitated by a number of steps that have been taken to strengthen budget management. These include the introduction of fees for certain government services, engaging private companies to collect outstanding utility charges and fees, stricter enforcement of controls on maintenance and procurement and the privatization of government maintenance services.
In the medium term, the intention is to set fiscal policy in a medium–term framework by instituting a system of a three–year rolling budget. This will be facilitated by the ongoing technical assistance being provided by the Fund, which aims at establishing a macro–fiscal coordination unit and a new system of budget classification.
Monetary policy in Kuwait has been prudent and continues to be aimed at the stability of the exchange rate under an open and free exchange and trade system. Open market operations and direct bank deposits with the Central Bank of Kuwait (CBK) are being used effectively for liquidity management, and the CBK discount rate is being adjusted in line with developments in interest rates. The authorities intend to move to a full U.S. dollar peg of the Kuwaiti dinar with margins from the beginning of 2003, in line with the GCC decision on this matter, pending the establishment of the planned GCC monetary union by 2010.
Monetary policy has been supported by strong bank supervisory policies that have helped maintain confidence in the exchange rate in an environment of low inflation, while facilitating private sector activity. Banking supervision has kept pace with international standards and practices. To date, 21 of the 25 Basel Core Principles have been implemented, including most recently, the addition of market risk analysis to the computation of capital adequacy as a step toward the adoption of the proposed new Basel capital standards. A credit bureau will also be operational by end–2002 or early 2003.
An amended banking law is also expected to be approved by the National Assembly during its current session. Implementation of the provisions of this law would bring Kuwait to observance of all the Basel Core Principles. Among other provisions, the law would open the market to foreign banks, and bring Islamic banks fully under the CBK’s supervision. A limited deposit insurance scheme is also being considered to protect small depositors. The authorities are also looking forward to the conduct of an FSAP in the first half of 2003.
Statistical issues
The Kuwaiti authorities were pleased to note staff’s recognition that there had been significant improvement in Kuwait’s economic database since the last Article TV consultation. The authorities are committed to continuing to improve their statistical database and are appreciative of the Fund’s technical assistance in this area.
With regard to the provision of information to the Fund on the country’s International Investment Position (IIP), the authorities intend to remain fully compliant with Article VIII, Section 5, by orally providing to the Board, through their Executive Director, the financial position of the Fund for Future Generations. This information should be considered confidential and should not be made public.
As to the nonfinancial private sector’s IIP, the authorities would like to draw the Board’s attention to the unavailability of such information in the context of Kuwait’s open economy. Information on private capital movements is not available, either directly or indirectly. The authorities, therefore, have serious reservations on the Fund’s request for this information. Such information is not available in an open economy with no form of exchange controls. In my view, the Fund would be well advised to exercise more caution in requesting members to provide the International Investment Position of the private sector. Collecting such information would require intensive resources and, in fact, is not doable to any useful degree. In my view, and that of the authorities, there are other more pressing priorities in the area of data provision. I do not support the undue emphasis that has been recently placed on this area.