Kuwait
2010 Article IV Consultation: Staff Report and Public Information Notice on the Executive Board Discussion

Kuwait’s economy was affected significantly by the global crisis. The financial sector experienced funding pressures and deterioration in asset quality. The economic outcome depends largely on government spending and the associated private investment. Stress tests indicate that the banking system can withstand shocks. The macroeconomic policy mix is adequate, but growth of current expenditures should be contained. Successful implementation of the growth agenda requires progress in structural reforms. The financial system’s oversight framework should be strengthened. The household debt relief law can undermine the financial culture.

Abstract

Kuwait’s economy was affected significantly by the global crisis. The financial sector experienced funding pressures and deterioration in asset quality. The economic outcome depends largely on government spending and the associated private investment. Stress tests indicate that the banking system can withstand shocks. The macroeconomic policy mix is adequate, but growth of current expenditures should be contained. Successful implementation of the growth agenda requires progress in structural reforms. The financial system’s oversight framework should be strengthened. The household debt relief law can undermine the financial culture.

I. Context

1. Kuwait’s economy was affected significantly by the global crisis. The impact hit Kuwait in the second half of 2008, through the decline in oil prices and production, and was further exacerbated by the intensification of liquidity shortages in global financial markets post-Lehman’s collapse. Oil market developments had a direct impact on government finances and external positions, but they also had an indirect impact on financial and corporate sector liquidity as the speculative capital inflows experienced in 2007 and early 2008 reversed in the second half of 2008 and investor confidence declined. These developments triggered a steep fall in real estate and equity prices and weakened the financial system’s balance sheet.1

2. Real GDP is estimated to have contracted by about 4½ percent in 2009—the weakest performance among GCC countries. Real oil GDP declined by more than 11 percent, and real non-oil GDP is estimated to have remained flat, mainly reflecting weaker activity in the financial and construction sectors. Lower domestic demand and a 12 percent drop in import prices reduced average consumer price inflation to 4 percent. Equity prices continued to decline, money growth slowed, and credit growth plunged on account of lower demand and higher risk aversion by banks. Fiscal and external surpluses narrowed as oil revenues and investment income declined. The Kuwaiti dinar (KD) depreciated by about 4 percent against the U.S. dollar (Figures 1 and 2).

Figure 1.
Figure 1.

Kuwait: Economic Context

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Sources: Kuwait authorities; and Fund staff estimates.
Figure 2.
Figure 2.

Macro and Financial Developments in the GCC Countries

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Sources: Bloomberg; Zawya; country authorities; and Fund staff estimates.

3. The financial sector, particularly investment companies (ICs), experienced funding pressures and deterioration in asset quality. ICs—with significant dependence on external financing, maturity mismatches, and large exposures to equity and real estate markets—suffered considerable valuation losses in 2008–09 and faced difficulties rolling over their debts. Five ICs are known to have defaulted in 2009–10. Banks’ nonperforming loan (NPL) ratio doubled to 9.7 percent in 2009 and profitability declined significantly in 2008–09 reflecting higher provisioning and the large loss incurred by one bank in 2008. Profitability in the nonfinancial corporate sector also declined substantially (Text Table 1 and Figure 3).

Text Table 1.

Kuwait: Financial and Corporate Sector Performance, 2006–09 1/

(In billions of U.S. dollars)

article image
Source: Fund staff estimates based on published statements from Zawya.

Data reflects companies listed on the Kuwait Stock Exchange.

Food, industrial, insurance, real estate, and services.

Figure 3.
Figure 3.

Kuwait: Financial Sector Conditions

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Source: Central Bank of Kuwait.

4. A forceful early response by the authorities contributed to financial sector stability. Measures were extensive, ranging from liquidity support to the introduction of a financial stability law (Figure 4 and Annex 1). The CBK required banks to take precautionary provisioning and encouraged some to increase capital. Only one bank needed public funds for recapitalization. As of end-2009, the banking sector’s capital adequacy ratio (CAR) was at 18 percent and all banks maintained CARs well above the regulatory minimum of 12 percent. Similarly, the leverage ratio stood at a comfortable level of 12 percent. Banking system liquidity was adequate, with liquid assets covering 35 percent of short-term liabilities, supported by public sector deposits. The overall open net foreign currency position was marginal. Nevertheless, the impact of government support measures on credit growth and non-oil activity was limited in light of the absence of fiscal stimulus and the limited utilization by borrowers and banks of guarantees provided for under the financial stability law.2

Figure 4.
Figure 4.

Kuwait: Government Reponse to the Economic and Financial Developments

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Source: Central Bank of Kuwait.

5. The relationship between the government and the National Assembly has improved but remains tense. In particular, the Assembly’s approval of a debt relief law—opposed by the government—could reignite tensions.

II. Economic Outlook

6. The economic outlook is broadly positive. Real GDP is projected to increase by around 2 percent, with non-oil GDP growth of about 2½ percent—spurred by government spending in the context of the recently approved development plan (DP)—and oil GDP growth of about 1 percent. Inflation will remain at around 4 percent in 2010, primarily due to a moderation in rental rates, which is expected to offset the increase in imported inflation. The economy is projected to grow steadily over the medium term as the global recovery boosts the demand for oil and the government continues the DP’s implementation. The fiscal and current account balances are expected to remain stable in 2010–11 and improve in subsequent years, as oil receipts and investment income recover (Figure 5 and Table 5).

Figure 5.
Figure 5.

Kuwait: Macroeconomic Outlook, 2009–11

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Sources: Country authorities; and Fund staff estimates

7. The financial sector is expected to continue to face challenges in the immediate term. Bank loan concentration in the weak real estate sector, equities, and ICs are likely to result in higher NPLs in 2010 (Figure 6). Nevertheless, high CARs—which were supported by capital increases in some large banks in 2009—and planned capital injections by five banks in 2010 should help maintain the sector’s stability. In light of their vulnerabilities, challenges for ICs will be more extensive. The progress achieved so far on the restructuring of two large ICs is welcome, but it is necessary to speed up the restructuring of the sector more generally (Box 1).

Figure 6.
Figure 6.

Kuwait: Allocation of Banks’ Credit Portfolio, 2009

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Source: Central Bank of Kuwait.

Kuwait: Investment Companies—A Tale of Two Restructurings

Corporate debt restructuring has taken various forms in different countries. During the Asian crisis, key elements included government financial intervention, the establishment of state restructuring agencies, the implementation of legal and regulatory reforms, and out-of-court settlements. The current global financial crisis necessitated significant government support to the financial sector, particularly in light of substantial systemic cross-sectoral linkages.1

The crisis management strategy in Kuwait included immediate measures to ensure macroeconomic and financial stability, followed by measures to support the corporate debt restructuring phase and economic growth. Macroeconomic and financial stability facilitated market-based debt restructuring of investment companies (ICs). The March 2009 Financial Stability Law (FSL) established an orderly and efficient mechanism for facilitating the timely restructuring of debt of solvent companies through legal protection, and facilitated access to sufficient financing to support an economic recovery.

As of June 2010, five ICs had defaulted on their debt. Global Investment House (GIH), the largest IC, defaulted on the majority of its $3 billion debt; Investment Dar (ID) on its $100 million sukuk; Gulfinvest International on a U.A.E. dirham 200 million loan from the Abu Dhabi Commercial Bank; International Investment Group, on a payment for its $200 million Islamic bond; and Kuwait Finance and Investment Company (KFIC) restructured $495 million in debts owed to local and foreign lenders.

The conclusion in late 2009 of a market-based debt restructuring agreement by GIH with 54 lending banks demonstrated a speedy and orderly debt restructuring process, with constructive facilitation by the CBK. The key terms of the GIH market-based restructuring included the full repayment of outstanding debt and an overhaul of the business model to ensure long-term viability. The specific terms of GIH restructuring encompassed the exchange of existing debt with secured new multi-currency, conventional, Islamic and bilateral facilities; a reduction in operational costs; orderly deleveraging of principal investment positions through transfers to a global macro fund and a domestic real estate fund; a strengthened focus on asset management and brokerage business; and enhanced corporate governance.

ID has reached a debt standstill agreement with more than two-thirds of its creditor banks and investors pending a final agreement, which envisages the repayment of its obligations with an enforceable security package over a five-year period. ID has sought protection under the FSL to ensure a stay against litigation and execution of judgments against it from minority creditors until its restructuring plan is approved.

As of May 2010, the restructuring of ICs involved no fiscal cost to the government, avoided contagion to the banking system, and ring-fenced fiduciary assets from the restructuring process. In light of the protracted insolvency procedures in Kuwait, creditors are likely to prefer restructuring rather than pressing for dissolution of ICs.

1 See Approaches to Corporate Debt Restructuring in the Wake of the Financial Crisis, IMF Staff Position Note, SPN/10/02, January 26, 2010.

8. The authorities agreed that 2009 had been challenging and highlighted recent positive developments. They noted progress achieved in the restructuring of the two largest ICs, the increase in precautionary provisions by banks, and the large degree of liquidity in the banking system. Furthermore, they argued that the increase in the banking system’s NPLs was skewed by the results in two banks and that banks’ asset quality could improve with the envisaged economic recovery. There were some positive signs regarding credit expansion, with credit allocation going largely to households for installment loans rather than for equity purchases. They viewed the pace of ICs’ restructuring as reasonable and argued that problems were concentrated in only a few large companies.

III. Risks to the Outlook and Vulnerabilities

9. The economic outlook largely depends on the pace of global recovery. Although Kuwait has the financial strength to smooth out the impact of short-term oil price fluctuations on its fiscal position, a weaker than expected global recovery and a decline in oil prices could impact regional and domestic asset markets, investor confidence, and government spending, leading to a worsening of the balance sheet of financial institutions. Additionally, deterioration in the regional economic or political environment might have an impact on investor confidence and Kuwaiti entities’ access to and pricing of international funding.3

10. The outlook is also subject to domestic downside risks. The overarching risks would be associated with the inability of the government to meet the DP’s spending targets, particularly in light of capacity constraints and the under-spending of the capital budget in previous years. Notwithstanding the improvement in relations between the government and the National Assembly, as evident from the recent progress made on the legislative front, political gridlock could delay necessary reforms and impact implementation, and red tape and bureaucratic hurdles could discourage private sector participation. A slow recovery of the nonfinancial corporate sector could stretch their debt-service capacity and limit their ability to finance new investments. A further deterioration in the balance sheet of financial institutions or delays in the restructuring of ICs would protract banks’ risk aversion to lending, limit private sector financing for new projects, and constrain non-oil GDP growth.

11. In the longer term, slow progress in the implementation of oil projects could constrain fiscal revenues. Kuwait has adequate excess oil production capacity in the medium term. Nevertheless, unless progress is made toward oil sector project implementation, protracted capacity constraints could have a significant impact on revenues in the long term.

12. The authorities concurred with staff on downside risks to the outlook. In addition to high oil price volatility and oil dependency, they were concerned about geopolitical risks affecting confidence in the region. They also highlighted some domestic political risks—such as the passage of the debt relief law and the tensions related to the privatization law—that could affect the credit culture and the pace of structural reforms.

Stress Tests

13. Banking system stress tests conducted by the Financial Sector Assessment Program (FSAP) update indicate that the system could broadly withstand significant shocks, although some banks could be vulnerable to a severe shock.4 Two adverse scenarios (intermediate and severe) were constructed involving a slowdown in the global economy that would lower oil revenues, reduce investor and consumer confidence, constrain access to credit, increase domestic interest rates, and depress asset prices. In turn, these would increase NPLs—up to 19 percent of total loans under the severe scenario—and result in bank losses. Recapitalization needed to restore banks’ regulatory CAR to 12 percent would be around 1.0 percent of GDP under the intermediate scenario, and 3.8 percent of GDP under the severe scenario. Vulnerability to interest rate and foreign exchange risks was limited.

14. Stress tests of ICs point to their limited capacity to withstand adverse shocks. Under an assumption of 15–33 percent asset loss rates, three ICs (out of eleven) would lose all of their capital and seven ICs would have a capital-to-assets ratio below 10 percent. Under a more severe scenario, which assumes 20–66 percent loss rates, eight ICs would lose all their capital and only one IC would have a leverage ratio above 10 percent. Stress tests of nonfinancial corporations also point to some fragility in the real estate and industry sectors, particularly to increases in domestic interest rates and a revenue shock (Box 2).

15. Spillovers from the Dubai debt developments have been limited so far. The banking sector has minimal direct exposure to Dubai real estate and entities. However, indirect exposure could arise through the exposure of ICs and real estate companies to Dubai. Single factor stress tests indicate that banks could be vulnerable to a deterioration in their real estate portfolios (including loans to real estate companies), but losses related to a deterioration in loans to ICs would be manageable.

16. The authorities reiterated that the financial system was resilient. Additionally, four banks were in the process of increasing their capital further in 2010 and one bank has already increased its capital in early 2010. These will further enhance the resilience of the banking sector.

IV. Policy Issues

A. Strategy for Sustained Economic Growth

17. Swift financial sector measures have helped support financial and macroeconomic stability. Early action in the financial sector and continued vigilance by the authorities should also help restore healthy credit conditions and support non-oil economic activity. Nevertheless, in light of weak private sector balance sheets, fiscal stimulus will also be needed to support financial sector measures and revive non-oil economic growth.

Kuwait: Vulnerabilities of the Nonfinancial Corporate Sector

This analysis focuses on the balance sheet of the 109 non-financial companies listed on the Kuwait Stock Exchange. The total assets of these firms were $75 billion (147 percent of non-oil GDP) as of the end of 2009 and their total debt was $22 billion (43 percent of non-oil GDP). Net corporate profits increased to $1.8 billion in 2009, compared to $0.8 billion in 2008, while the combined cash holdings of nonfinancial firms stood at $5 billion (down marginally from $5.8 billion in 2008). The average debt-to-equity ratio at end-2009 was 1.1 and short-term debt constituted 35 percent of the total debt stock. Nevertheless, the unprecedented pace of debt accumulation in the boom years—for example, the debt-toequity ratio doubled between 2006 and 2008—raises questions about the vulnerability of the nonfinancial corporate sector to financing constraints and a prolonged economic slowdown.

Listed non-financial corporations as a whole appear to have adequate debt servicing capacity, with the ratio of total liabilities to total assets at 49.6 percent as of end 2009. Similarly, the interest coverage ratio (ICR)—defined as earnings before interest and taxes over interest payments—stood at 2.6 on an asset-weighted basis, well above the threshold of 1 for debt distress. Nevertheless, out of 109 listed nonfinancial companies, 49 already had either operating losses or an ICR below 1 in 2009. Including cash balances, the ICR increases to 6.2, with only 25 non-financial companies with an ICR below 1.

Interest Servicing Capacity of Corporates, 2009

(In billions of U.S. dollars)

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Source: Fund staff calculations based on company balance sheets.

If short-term interest rates increase by 300 basis points, or if there is a negative income shock of 25 percent, 31 listed non-financial firms could end up with an ICR below 1 (17 companies, if cash balances were included). Furthermore, in testing the tail risk, if monetary tightening leads to an increase of short-term interest rates by 500 basis points, 36 firms would have an ICR below 1 (18 companies, if cash balances were included). Some sectors, such as industrial and real estate, have more leveraged balance sheets and are therefore more sensitive to interest rate and income shocks. Overall, although cash reserves of companies provide a reasonable cushion for the time being, it would diminish if economic slowdown persists.

18. Staff welcomes the thrust of the DP and the planned role of the private sector in its implementation. The DP provides the needed fiscal expansion to support recovery in the immediate term. It seeks to boost investment expenditures across the board, enhance the role of the private sector in the economy, and have positive spillover effects through higher healthcare and education spending. The government’s cost of the plan is estimated at $55 billion (about 56 percent of 2009 GDP), which is expected to be matched by the private sector through public-private-participation and the establishment of joint stock companies. Approximately $17 billion is budgeted to be spent by the general government in 2010/11, half of which has been allocated in the central government’s budget. As a result, the adjusted non-oil fiscal deficit is projected to widen by 10 percentage points of non-oil GDP.5

19. Implementation of the DP needs to be managed carefully. Implementation should take into account absorptive capacity and supply constraints. Spending should focus on social and key physical infrastructure projects, keeping in mind project viability, and excessive private sector leverage should be avoided. Successful implementation would require progress in structural reforms to create an enabling environment for private investment and financing. In this connection, initiatives to diversify financing channels, including corporate debt market development, should be pursued.

20. Progress achieved in structural reforms is welcome, but significant challenges remain. The new Capital Markets (CMA) Law paves the way for the establishment of an independent capital market authority that will regulate the Kuwait Stock Exchange, supervise public and private subscriptions, and regulate and supervise acquisitions and mergers. The Law also grants broad regulatory and supervisory authority over ICs to the CMA. The new private sector labor law introduces sweeping changes to labor regulation, including allowing for the portability of expatriates’ work permits, and the recently approved privatization law opens up most activities to the private sector with the exclusion of the oil, gas, health, and education sectors. Amendments to the companies and tender laws are expected to be considered by parliament in the second half of 2010. Staff encourages an expeditious implementation of the new laws and cautions that a reversion to political gridlock could cause significant delays to additional necessary legislative reforms.

21. The authorities acknowledged the need for further progress in structural reforms. They emphasized their commitment to enhance the environment for private sector investment and noted their intentions to initiate reforms in the education and health sectors to prepare Kuwaiti nationals for private sector employment. While they were aware of the need to diversify financing channels to corporates, they highlighted the failure of earlier efforts to stimulate private sector bond activity and noted that supportive market fundamentals are needed to complement initiatives by the authorities.

B. Macroeconomic Policy Mix

22. Expansionary capital expenditures are welcome. Planned expenditures in the context of the DP are essential to resume non-oil sector growth and are consistent with the government’s long-term economic diversification objectives. They should help strengthen investor confidence and private sector balance sheets, and revive non-oil economic growth.

23. The growth of current expenditures should be contained. Past conservative fiscal policies have allowed the accumulation of a sizeable stock of financial wealth and placed Kuwait in a good position to meet the challenges of economic diversification and intergenerational equity in the distribution of oil wealth. Nevertheless, government current expenditures have expanded rapidly in recent years, largely on account of increases in wages, subsidies, and transfers. In addition to contributing to an inefficient allocation of resources,6 this trend could undermine long-term fiscal sustainability (Box 3). While an assessment of long-term sustainability of fiscal policy is highly sensitive to the parameters involved in the calculation, staff estimates suggest that the government’s non-oil deficit is somewhat above its long-term sustainable value, and this gap is projected to widen over time.7

24. Monetary policy remains subject to the constraints associated with the exchange rate regime. In this context, the responsibility for ensuring adequate credit growth and maintaining financial stability if demand pressures were to reemerge will fall on macroprudential policies.8 A reemergence of inflationary pressures in the immediate term is not expected in the baseline scenario. During the past year, the CBK adjusted downward its policy rates on several occasions, in line with domestic credit conditions and U.S. interest rate reductions.

25. The basket peg has served Kuwait well and remains an appropriate exchange rate regime in the run up to the GCC monetary union. Staff calculations using CGER-type analyses suggest that the real exchange rate is broadly in line with its fundamentals (Box 4). The regime provided some flexibility to the nominal and real exchange rate during 2007–09 (Figure 7), which witnessed high volatility in oil prices.

26. The authorities agreed with staff about the need to control current expenditures. They noted that the privatization program would contribute to this objective and the introduction of a personal income tax and a VAT system would also help reduce the non-oil deficit. They also emphasized that the pace of implementations of these measures would likely be gradual. On the macroeconomic policy mix, while monetary policy had played a key stabilizing role during the crisis, the authorities emphasized that fiscal policy was now needed to stimulate growth. They also argued that the basket peg provided sufficient monetary policy flexibility, as indicated by a sustained deviation of domestic interest rates from U.S. monetary cycle, including during 2008–10, both with respect to timing and the extent of interest rate reductions.

Kuwait: Fiscal Sustainability Analysis

The fiscal sustainability analysis suggests that Kuwait’s government expenditure path should be reduced in the medium-term to ensure long-term sustainability. In this exercise, long-term sustainability assumes intergenerational equity by assuming a constant real per capita government expenditure path that delivers a constant real per capita annuity after oil revenues are exhausted. In the baseline scenario, the non-oil fiscal balance for FY 2010/2011 is estimated to be approximately 3½ percentage points higher than its equilibrium value, and the gap is projected to reach approximately 7 percent by 2014/15.

While the results are sensitive to the assumptions, they provide useful guidance.1 For instance, under an alternative set of assumptions, the gap in 2010/11 would switch signs, indicating a non-oil deficit below its equilibrium value. Nevertheless, even under this scenario, fiscal sustainability would face challenges, as the non-oil deficit would have approximately reached its equilibrium value by 2014/15.

A01bx03fig01

Government Non-oil Deficit to GDP

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Sources: Ministry of Finance of Kuwait; and Fund staff estimates.
1 The baseline calculations assume long-term values of the real rate of return of assets, inflation, and population growth of Kuwaiti nationals of 4 percent, 2 percent, and 2 percent, respectively. Oil reserves are assumed to be depleted in 73 years and the oil price to reach 83 dollars per barrel in 2015 and remain constant in real terms thereafter. The alternative calculation assumes long-term population growth of 1.4 percent (as forecasted for the whole population [i.e., nationals and expatriates] by the 2008 United Nations World Population Prospects for the period 2010-50).

C. Ensuring Financial Sector Stability

27. Progress made so far on strengthening the financial system’s oversight framework is welcome. The CBK has issued comprehensive regulatory guidance addressing several weaknesses in banks’ risk management processes that came to light during the crisis and has begun moving towards a risk-based supervisory process. It has also begun the process of improving the oversight framework for ICs and has issued new regulations pertaining to leverage, liquidity, and foreign exposure.9 The intended establishment of a Financial Stability Department with an appropropriate mix of supervisory, financial market, and macroeconomic expertise would help address financial stability issues in a systematic manner.

Kuwait: Exchange Rate Assessment

A CGER-type analysis indicates that the Kuwaiti Dinar is in line with fundamentals, with all the misalignment values being very close to zero.

The macrobalance (MB) approach suggests a slight overvaluation (less than ½ percent). Cross-country work (see below) suggests an equilibrium current account for Kuwait of 40.1 percent of GDP, which is slightly higher than the projected medium-term current account.

The equilibrium real exchange rate (ERER) approach suggests an undervaluation of approximately 3 percent. This approach indicates that the depreciation in the equilibrium real exchange rate resulting from recent developments (i.e., worsening in the terms of trade, decline in investment income, and increase in government expenditure) has been fully offset by the actual depreciation of the real exchange rate.

The external sustainability (ES) approach suggests an undervaluation of around 2½ percent, as the current account surplus is slightly higher than what would be needed to guarantee intergenerational equity in the consumption of oil resources. This result is very sensitive to the assumed parameters as small declines in the assumed rate of return or increases in the projected population growth would result in an indication of some overvaluation (e.g., the equilibrium current account would decline to 30¼ percent of GDP if—similarly to the stress tests in the fiscal sustainability analysis—population growth were 1.4 percent). Furthermore, the external sustainability approach does not take oil price uncertainty fully into account. For instance, Bems and de Carvalho Filho (2009, IMF WP/09/33) calculate that precautionary savings associated with oil price uncertainty could increase Kuwait’s equilibrium current account by about 5.6 percent of GDP.

Kuwait: Exchange Rate Assessment 1/

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Current account figures are in percent of GDP. Overvaluation calculations are in percent.

Macro balance approach. Uses the CGER coefficients as reestimated for oil exporters by Bems and de Carvalho Filho (2009b IMF WP/09/281).

External sustainability approach. The equilibrium current account delivers a constant real per capita annuity after oil exports are exhausted. These calculations assume: (i) a 64 percent recovery rate for oil reserves; (ii) price of Kuwait’s oil reaching USD 83 per barrel and staying constant in real terms after that; (ii) a 2 percent rate of population growth; (iv) a riskless real rate of return of 4 percent [as in Bems and de Carvalho Filho (2009a, IMF WP/09/33)] (v) a constant extraction rate at the projected 2015 level (2.84 mbd); and an initial financial wealth of $ 0.3 trillion.

Equilibrium real exchange rate approach. Based on a cointegration relationship between the real exchange rate and key fundamentals (terms of trade, investment income, and government expenditure). Assessment is for end-point WEO projection.

End-point (2015) WEO projection.

Figure 7.
Figure 7.

Kuwait: REER and NEER

(April 2007=100)

Citation: IMF Staff Country Reports 2010, 236; 10.5089/9781455204861.002.A001

Sources: Country authorities; and Fund staff estimates.

28. Nevertheless, the financial system’s prudential and systemic oversight framework needs to be strengthened further. The recent introduction of a set of new regulations for ICs is welcome. Nevertheless, the oversight framework of ICs needs to be strengthened. In particular, while the implementation of the Capital Market Authority (CMA) Law would enhance securities regulation and supervision, there is a need for proper coordination between the three regulatory agencies—the CBK, CMA, and the Ministry of Commerce and Industry (MOCI). Regulatory overlaps and gaps should be closed to avoid regulatory arbitrage (Box 5).

29. The household debt relief law is counterproductive to building an efficient financial culture. If promulgated, the proposed write-off of interest payments and debt restructuring for Kuwaiti nationals (Annex 1) would create moral hazard that would undermine the creation of a sound credit culture. It might also encourage banks to take riskier positions and households to assume higher debt. Targeted household debt relief could be implemented instead through the already existing Insolvency Fund. Fund size and terms of access could be modified, if needed.10 The authorities have stated their strong opposition to the household debt relief legislation.

30. The crisis management and contingency planning system should be enhanced further. As part of an exit strategy from all support measures provided in the context of the crisis, the blanket guarantee introduced during the crisis should be replaced by an explicit deposit insurance system once conditions allow. The resolution framework should be upgraded by adopting a special resolution regime for failing financial institutions.

31. The authorities are engaged to make their anti-money laundering and combating financing of terrorism (AML/CFT) legislation conform to international standards. A draft law is expected to be considered by the National Assembly before the AML/CFT assessment scheduled to be conducted by the IMF in October 2010.

Kuwait: Priority Recommendations of the FSAP Update

General. The CBK, the CMA, and Ministry of Commerce and Industry should (i) clarify at the outset their respective supervisory responsibilities and initiate a coordination process to ensure efficient oversight architecture; (ii) establish a financial stability unit responsible for macroprudential supervision; and (iii) develop an exit strategy from support measures to the financial system to be implemented once conditions allow.

Banking supervision. The CBK should (i) perform periodic stress tests including for real estate and other sectors with credit concentration risk and review the supervisory assessment of banks’ treatment of risk concentrations in their Internal Capital Adequacy Assessment Process (ICAAP); (ii) lower the maximum exposure limits on related parties; (iii) enhance the legal framework to prohibit conflict of interest concerning related party transactions; (iv) complete the migration from compliance-based supervision to risk-based supervision; (v) continue strengthening the supervision capacity through further hiring and training; (vi) shorten the on-site supervision cycle; and (vii) organize a comprehensive ICAAP on-site examination.

Investment companies. There is a strong case for strengthening regulations on (i) licensing (in particular “fit and proper” criteria); (ii) permissible activities; (iii) corporate governance, including requirements on internal organization, internal control, risk management, external auditors, and accountancy rules; and (iv) prudential limits on leverage and liquidity/maturity mismatch. Consideration could also be given to varying the minimum capital depending on the activities and risks assumed by supervised entities.

Financial Safety Net Framework. Consideration should be given toward (i) putting in place a deposit insurance system that promotes market discipline; and (ii) improving the emergency liquidity assistance framework.

Resolution Framework. Overhaul the bankruptcy framework for financial institutions to adequately handle bankruptcies of banks or other financial institutions.

32. The authorities argued that financial sector stability was due to the strong oversight framework that was already in place. The authorities highlighted the resilience of the banking system and believed that the oversight framework for ICs was adequate. Nevertheless, they intended to strengthen the latter further by (i) delineating the responsibilities of the CBK and the CMA regarding ICs’ supervision; and (ii) developing a five-pronged regulatory prudential structure over ICs covering leverage, liquidity, foreign funding risks, risk management, and corporate governance. The authorities also noted that whereas the CBK continuously sought to enhance staffing quality, both qualitatively and quantitatively, existing staffing capacity was fully adequate to ensure the discharge of CBK responsibilities.

D. Statistical Issues

33. The authorities should continue their efforts to improve their statistical system. Staff welcomes recent progress to improve the timeliness of the CPI and the accuracy of external debt, foreign assets, and workers’ remittances data. Nevertheless, statistical data quality and timeliness continues to suffer from weaknesses, particularly with respect to national accounts and trade.

V. Staff Appraisal

34. The global financial crisis had a significant impact on Kuwait given its international trade and financial linkages. The impact was felt strongly in 2009 as real GDP contracted, asset prices declined, and fiscal and external surpluses narrowed. The financial and nonfinancial sectors witnessed a substantial fall in profitability, and five ICs defaulted in 2009–10. Credit growth slowed significantly. The financial system remained stable, underpinned by swift policy actions by the authorities, but credit growth and non-oil activity were subdued in light of the absence of fiscal stimulus and the limited utilization of guarantees provided for in the financial stability law.

35. The economic outlook is broadly positive. The economy is expected to rebound in 2010, and to grow steadily over the medium term as the global recovery boosts the demand for oil and the government implements the planned fiscal stimulus in the context of its four-year DP, starting with an expansionary budget in 2010/11. The fiscal and current account balances are expected to remain stable in 2010–11 and improve in subsequent years, as oil receipts and investment income recover.

36. The financial sector is expected to continue to face challenges in the immediate term. Rising NPLs and large concentrations in banks’ loan portfolio—particularly in real estate, ICs, and equities—are a source of concern. Nevertheless, aggregate financial soundness indicators show that the banking sector is well capitalized and highly liquid, which should help the system to remain stable. On the other hand, challenges facing ICs will be more extensive.

37. The economic outcome for 2010 depends largely on government spending and the associated private investment. External risks to the outlook include a weaker than expected global recovery and a deterioration in the regional economic or political environment. The overarching domestic risks would be associated with the inability of the government to meet the spending targets set out in the DP. Political gridlock could delay necessary reforms and impact implementation, and bureaucratic hurdles could discourage private sector participation.

38. Stress tests indicate that the banking system could reasonably withstand significant shocks, although some banks are vulnerable to a severe macroeconomic shock. Stress tests for ICs point to their limited capacity to withstand adverse shocks. Stress tests of listed nonfinancial corporations suggest vulnerability in real estate and industrial sector companies to a prolonged economic slowdown and financing constraints.

39. The macro policy mix is adequate but growth of current expenditures should be contained. Increases in recent years in wages, subsidies, and transfers could undermine long-term fiscal sustainability and should be moderated. As monetary policy remains constrained by the exchange rate regime, macroprudential policies should ensure financial stability if a credit boom were to reemerge. The real exchange rate is broadly in line with fundamentals, and the current exchange rate regime remains appropriate in the run up to the GCC monetary union.

40. Successful implementation of the authorities’ growth agenda would require progress in structural reforms. In this context, the passage of recent key laws, namely the Capital Markets Law, the Labor Law, and the Privatization Law is welcome. The authorities should move ahead with an efficient implementation of these laws and the amendment of other key legislation, particularly the Companies and Tender Laws. DP implementation should take into account project viability, absorptive capacity, and supply constraints.

41. The financial system’s oversight framework should be strengthened. Proper coordination should be ensured between the three regulatory agencies—the CBK, the CMA, and the MOCI, particulalry with regards to ICs; and the crisis management, contingency planning, and resolution frameworks should be enhanced. The authorities’ plans to introduce an enhanced regulatory prudential structure over ICs are welcome.

42. If promulgated, the household debt relief law would undermine the financial culture. The law was passed by the National Assembly but rejected by the Amir. Targeted household debt relief could be implemented instead through the already existing Insolvency Fund.

43. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Table 1.

Kuwait: Selected Economic Indicators, 2004–11

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Sources: Data provided by the authorities; and Fund staff estimates and projections.

Also includes government entities.

Kuwaiti fiscal year ending March 31, e.g. 2007 refers to fiscal year 2007/08.

In 2006/07 KD 2 billion was transferred to partly cover the actuarial deficit of the Public Pension Fund. In 2008/09, KD 5.5 were transferred. KD 1.1 billions are budgeted for each year from 2010/11 to 2014/15.

Excludes investment income and pension recapitalization, but includes transfers for FGF.

Excludes debt of Kuwait’s SWF related to asset management operations.

Excludes SDRs and IMF reserve position.

Change in the KSE as of May 24, 2010 for 2010.

Table 2.

Kuwait: Summary of Government Finance, 2004/05–2011/12 1/

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Sources: Ministry of Finance; Central Bank of Kuwait; and Fund staff estimates and projections.

Coverage of budgetary operations includes the operation of the KIA. Data are on an accrual basis.

Excluded from the national budget presentation. Estimated by Fund staff.

Excludes revenues from utility tariffs (which are included in the national budget presentation), but includes UN (Iraq) compensations.

Includes other miscellaneous expenditures in FY 07/08 and 08/09.

Covers interest payments on the treasury bills and bonds, and on the DCP bonds. Only the latter is included in the national budget presentation.

In 2006/07 KD 2 billion was transferred to partly cover the actuarial deficit of the social security fund. In 2008/09, KD 5.5 were transferred. KD 1.1 billions are budgeted for each year from 2010/11 to 2014/15.

The 2006/07 budget reflects KD195 million on account of a KD 200 one off grant transfer to each Kuwaiti citizen.

By law 10 percent of all state revenues are transferred to the Future Generations Fund (FGF) on an annual basis and all reinvested. No assets can be withdrawn from the FGF unless sanctioned by law.

Equals overall balance minus oil revenues, investment income, and 10 percent of other current revenues and capital revenues.

The Future Generations Fund (FGF) and the General Reserve Fund (GRF).

Table 3.

Kuwait: Summary Balance of Payments, 2004–11

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Sources: Central Bank of Kuwait; and Fund staff estimates.

Also includes unrecorded oil exports.

Kuwait Investment Authority, Kuwait Petroleum Corporation, Kuwait Fund for Arab Economic Development, Public Institute for Social Security, Kuwait Airways Corporation, and Bank of Savings and Credit.

CBK, local banks, investment companies, exchange companies, insurance companies, and the nonfinancial private sector.

From 2007, based on a new, more comprehensive methodology to estimate outward workers’ remittances.

Includes UN war compensation.

For 2010, includes a projection of the net inflow from the sale for $10.6 billion of a foreign asset owned by a Kuwaiti company.

Includes other unclassified private sector flows.

Includes SDRs and IMF reserve position.

Table 4.

Kuwait: Monetary Survey, 2004–11

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Sources: Central Bank of Kuwait; and Fund staff estimates.

Excludes SDRs and IMF reserve position.

Excludes deposits with financial institutions which are marginal.