Statement by A. Shakour Shaalan, Executive Director for Kuwait
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International Monetary Fund
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The strong economic and financial position of Kuwait has improved further, but inflation has risen. The nation has made significant progress on the issues raised in the 2007 consultation. Kuwait’s integration into the global economy has been increasing in recent years. Global integration is underpinned by active membership in global and regional trade initiatives and an ongoing push to liberalize domestic regulations. Both the external current account and fiscal positions are projected to remain in large surplus, albeit at declining levels owing to the high import intensity of the planned investment projects.

Abstract

The strong economic and financial position of Kuwait has improved further, but inflation has risen. The nation has made significant progress on the issues raised in the 2007 consultation. Kuwait’s integration into the global economy has been increasing in recent years. Global integration is underpinned by active membership in global and regional trade initiatives and an ongoing push to liberalize domestic regulations. Both the external current account and fiscal positions are projected to remain in large surplus, albeit at declining levels owing to the high import intensity of the planned investment projects.

1. On behalf of the Kuwaiti authorities, I thank staff for their continued engagement with Kuwait and a helpful and constructive Article IV consultation report. The Kuwaiti authorities attach particular importance to the views of the Executive Board, Management, and the staff regarding the economic policies and prospects of Kuwait.

Recent Developments

2. Underpinned by sustained prudent macroeconomic policies and structural reforms, a pick-up in investment, as well as higher oil prices, Kuwait’s macroeconomic performance strengthened further in 2007. This is reflected in buoyant growth in the non-oil economy, increasing private sector employment for Kuwaiti and non-Kuwaiti nationals, and substantial fiscal and external current account surpluses. Price pressures has however picked up somewhat, driven by domestic demand pressures and higher import prices, notably food. This appears to be a general worldwide phenomenon.

3. These developments were accompanied by a continuation of fiscal reforms and measures aimed at enhancing the environment for private sector activity. A schedule to close the actuarial deficit of the Kuwait Public Institute for Social Security (KPISS) by 2009 was announced. The fiscal framework was further strengthened by consolidating the budget preparation process in the Ministry of Finance. Moreover, measures to facilitate the flow of foreign investment into the country, including reducing taxes on foreign investors, were introduced. The national assembly approved the Sale of State Properties Law, enabling the government to provide state land to local or foreign investors, and providing a legal basis for projects based on public-private partnerships. It also expanded the privatization program. These efforts to further diversify the economy, together with increased spending on infrastructure, education and public services, as well as plans to expand oil production and refining capacity, bode well for sustainable high growth over the medium term.

4. Kuwait is fully aware of its responsibilities as a major oil producer, and remains committed to supporting global oil market stability. To this end, it has launched an ambitious $50 billion investment program to expand both its upstream and downstream production capacity. The plan aims at raising production capacity to 4 million barrels per day (mbpd) by 2020 and doubling refining capacity to about 1.4 mbpd by 2012-13. It would be essentially financed by the Kuwait Petroleum Corporation's own resources, with strong private participation in the downstream sector.

Fiscal Policy and Reforms

5. Higher oil revenues have contributed to a significant improvement in the fiscal position last year, with the overall fiscal surplus estimated at about 40 percent of GDP in FY2007/08, despite a substantial increase in capital spending. In spite of increasing pressure on the budget engendered by the favorable fiscal position, the authorities remain committed to fiscal prudence. In addition to containing recurrent spending by limiting increases in public sector salaries and benefits, the authorities are cognizant that further increases in subsidies will add to price distortions and the misallocation of resources.

6. The focus on enhancing the structure of public finances will be maintained. To this end, the authorities plan sizable transfers from the budget to close the remaining KPISS actuarial deficit over the next two years and are considering reforming the contribution and benefits rules to ensure the viability of the system. In addition to progress achieved in the consolidation of the budgetary process, future reforms include better anchoring of one-year budgets in rolling medium-term fiscal frameworks and introducing GFSM 2001 accounting. Efforts are also ongoing to coordinate with other GCC members the introduction of a value-added tax and the harmonization of tax laws.

7. The authorities however remain unconvinced that greater transparency in the financial operations of the Kuwait Investment Authority (KIA) and KPISS would support their fiscal strategy or help avert protectionist measures in countries where the growing role of sovereign wealth funds (SWFs) has raised concerns. They wish to emphasize that KIA currently manages two highly efficient saving funds. Adequate safeguard arrangements are in place with regard to the management of these resources, which are overseen by the KIA Board of Directors, internal and external auditors and the Public Audit Office. Moreover, rigorous biannual parliament oversight ensures proper accountability. Furthermore, although legal constraints prohibit the publication of KIA’s balance sheet and income statements, the data is widely reported in the media as noted by staff.

8. The authorities share staff’s assessment in the April 2008 Global Financial Stability Report regarding the stabilizing role of SWFs in global financial markets, particularly in strengthening bank balance sheets through sizable injections of capital. They wish to emphasize that KIA's investment policy is purely commercially driven and respects regulations in the financial markets it invests in. While the authorities hope that the Fund would play a constructive role in ensuring a positive dialogue between SWFs and recipient countries, they remain to be convinced of the need for a code of "best practices." In the authorities' view, this would risk disrupting the flow of sizeable long-term capital from SWFs to institutions in the U.S. and elsewhere that face both liquidity and capital needs.

Monetary and Exchange Rate Policies

9. In the context of the pegged exchange regime, and against the background of demand and import-driven inflationary pressures, the Central Bank of Kuwait (CBK) aimed at dampening capital inflows by reducing the Kuwaiti dinar interbank rate below LIBOR, while relying on prudential measures to contain the expansion of private credit. In the period ahead, the authorities recognize the importance of pursuing efforts to enhance the supply response in the nontradable sector, further strengthening the fiscal policy framework, and containing credit growth, to reduce inflationary pressures.

10. The authorities share staff’s assessment regarding the adequacy of the pegged exchange rate regime, given Kuwait's openness, structure of financial markets, and the plans for regional monetary union. The recent move to a basket peg should, in their view, create some room for maneuver in relation to U.S. monetary policy, in view of the differences in the two countries’ cyclical positions, while better aligning the peg with Kuwait’s trading and investment patterns. The authorities reiterate their intention to join the planned GCC monetary union by 2010.

External Developments and Policies

11. The authorities consider that the current and planned policy mix will lead to domestic and external stability over the medium term. Indeed, while substantial external account surpluses have been recorded over the past years due to higher oil prices, surpluses are expected to decline over the medium term as domestic demand and imports rise further. It should also be stressed that surpluses in oil-exporting countries are different in nature from those of other countries as they are a result of exports of non-renewable resources to meet global demand. It is therefore critical to use these surpluses effectively to (i) raise the growth potential of the economy through high levels of public investments in infrastructure and social areas; and (ii) accumulate savings through large fiscal and current account surpluses to help ensure intergenerational equity, reduce dependence on oil revenues, and smooth out fluctuations in revenue in the coming years. All these factors should be reflected in equilibrium exchange rate calculations, which currently present serious methodological weaknesses. These are further compounded in the case of oil-exporting countries by the high degree of volatility in oil prices. Moreover, the standard notion of currency undervaluation should not apply since Kuwait is not gaining market share at the expense of other countries. Finally, current account balances are determined mostly by fiscal policy with little role for the exchange rate. Accordingly, reducing Kuwait’s current account surplus would involve either greater fiscal expansion at the risk of creating higher inflation, or reduced oil production, which is not a desirable solution for both oil producers and consumers.

Financial Sector Issues

12. Benefiting from the rapid expansion in the economy, Kuwait’s banking sector continues to enjoy comfortable levels of profits and capitalization. It remains well supervised and appears to be weathering the current financial turmoil well. Good progress has been made in implementing the 2003 FSAP recommendations, as all measures pertaining to the central bank have been implemented, except for the removal of the ceiling on lending rates which would require parliamentary approval. Further refinement in the periodic stress-testing of banks attests to the commitment to strengthen the banking sector's resilience to the rapid increase in credit and the direct and indirect exposure to domestic and international stock and real estate markets. The authorities appreciate the focus in Box 2 on investment companies whose number, size, and activities have significantly grown over the last few years, making that sector systemically important. While the CBK is comfortable with the overall current regulatory framework, which covers disclosure, credit concentration and provisioning, anti-money laundering, and consumer/installment loans limits, it will continue to carefully watch individual banks' exposures to investment companies.

Statistical and Other Issues

13. Notwithstanding progress achieved in improving the quality and dissemination of economic data, the Kuwaiti authorities remain strongly committed to further improvements. They fully recognize the need to improve the production of the CPI, especially given the importance of current inflationary developments for economic policy.

14. Kuwait continues to provide substantial assistance to developing countries. Its development assistance, estimated at about 2 percent of GDP on average over the past 20 years, significantly exceeds the U.N. target. Kuwait is a strong supporter of the HIPC Initiative and is currently considering ways to extend HIPC debt relief to claims held by KIA.

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Kuwait: 2008 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Kuwait
Author:
International Monetary Fund