The health of the Kuwaiti economy in the current scenario is underlined by the controlled inflation even at such high liquidity levels

Global Investment House – Kuwait Economic & Strategic Outlook VIII- MacroEconomic Profile - The benefits of high oil prices have been omnipotent in Kuwait, helped by the adequate reserves and the relative small size of the country. It is one of richer countries in the world with a per capita GDP of US$21,260. Abundance of oil reserves as well as the various steps to increase oil production and export capacity has set the economy for high growth at least in the short to medium term. Growth would further be aided by the petro-dollar generated liquidity and the resultant investments in construction projects. However, sustaining this growth in the longer term remains the challenge and is contingent upon a number of structural changes in the economy, imperative to reduce the dependence on oil. This revolves around a shift towards market oriented system so as to improve the efficiency on all fronts. The current boom period, though opportunistic to bring about such changes, has not resulted in many, owing to the lack of incentive to try something new in the best of times. Nominal GDP for 2004 increased to KD16.4bn, 19.3% higher than the previous year, while the real GDP grew by 8.5% to KD10.4bn.
The best of times are here to remain for at least some more years as portended by the global oil demand forecasts. Oil price anywhere above US$40 is bound to ensure adequate liquidity in a small country like Kuwait. Besides the buoyant oil scenario, what enhances our expectations for the medium term are the multiplier effects of projects, which attract huge investments. While transport and utility related projects are set to ensure steady investments for years, other construction and tourism related projects would abet the optimum utilization of liquidity in the shorter term. Another offshoot of the current excess liquidity is the increase in earnings from investments for some years to come. Funds managed by agencies such as Kuwait Investment Authority (KIA), Kuwait Petroleum Corporation (KPC) and Public Institute for Social Security have almost multiplied in the last three years, with the Reserve Fund for Future Generations (RFFG) already estimated to hold around US$80bn.
While the liquidity powered by oil prices and steady production led to high growth of the Kuwait economy, heavy dependence on oil continues to loom large when considering the sustainability of this growth in the longer term.  The fact that Kuwait has not met with the same measure of success as that of a few neighboring countries in executing diversification accentuates this fear. Progress on implementation of an official strategy is hampered by squabbles between the government and parliament, administrative constraints and regional uncertainties, according to the latest IMF Article 4 consultation on Kuwait.
To the credit of the authorities in Kuwait, there has always been a roadmap framed to make structural changes in the country and thus to render the growth more broad based. Salient among these structural changes were privatization, removal of procedural delays, liberalizing the route of foreign investments and lowering of the corporate tax rate for foreign firms.  However, for various reasons, some of them have not fructified to the desired extent, while some of them did not take off at all. The state of affairs saw little change in the last two years, more so as political imbalances and divisive forces hampered any kind of progress.
Though the political and geopolitical scenario does not present the picture perfect, there have been a few marked changes in Kuwait’s policy towards liberalization in the last few years. These could in turn trigger structural changes, if the few supportive factors fall in place. Forefront among the policy changes has been that towards privatization, what with a slew of build operate and transfer (BOT) projects leading the way in the region. Prominent among these are the estimated US$3.3bn tourist development in Failaka and US$6bn development in Bubiyan, which involves the construction of a new port, container terminal and residential and commercial infrastructure on the island. The potential size of tourism industry in Kuwait pales in comparison with some of the other GCC countries. But projects like that in Failaka would result in a huge improvement from the prevailing situation of negligible tourism revenues. Though both the projects have been delayed due to various reasons, the frameworks involving them itself is in the right direction-that of diversifying the economy.
Another applaudable step on the same lines is the easing of state control on strategic sectors like airlines and petrol retail sector. Inception of low budget carriers like Al Jazeera Airways is definitely in the right direction. The government also has a two-pronged strategy which includes selling some of the shares held by KIA in local companies including banks, insurance firms and light industries, while also fully or partially privatizing entities currently in state hands like the loss-making Kuwait Airways. Privatization can go a long way in giving a facelift to the investment scenario in an otherwise closed economy like Kuwait.
Apart from privatization, another policy change that can have far reaching positive implications is the providing of a more supportive environment for foreign capital inflow. At present there are 11 specified sectors in which foreign direct investment (FDI) is allowed. The most significant among these is the financial sector, a recent addition to this list.  This is a bold step considering the size of the sector and its potential, as it would bring in the much needed organized competition in some of the yet to mature segments like consumer financing and a few other fee-based services. Foreign banks such as HSBC and BNP Paribas have already made their entry into this prospective market, while others like National Bank of Abu Dhabi and Citibank are waiting in the wings.
Liberalization of a few sectors as mentioned above this hides the real picture presenting a number of discouraging factors that limits FDI. Procedural delays are the bane of Kuwait, as elucidated by the World Bank data which shows that it takes 13 procedures to start a business in the country. Also, there are a number of caveats associated with most of the approvals given to the foreign promoters, including the mandatory number of Kuwaiti employees to be kept. Most importantly, key areas such as upstream oil and gas sector have been insulated from foreign equity participation so far.
An excellent example of an endeavor that got bogged down by policy and legislative bottlenecks is the ‘Project Kuwait’. Envisioned in 1995, the project is yet to take off on account of the inability to bridge the gap between the demands of foreign partners and the Kuwaiti authorities. While the refusal to agree on a product sharing agreement reflects on the policies adopted by the authorities, the refusal by the foreign partners to abide by the promised returns to some extent shows the rigidity adopted for short term good, obviating the long term opportunities in the country. However, with the compulsion to procure raw materials from Kuwait along with disparate tax treatment more than vindicates the reluctance of foreign companies to put in their stakes.
We believe that the ‘Project Kuwait’, if and when it actualizes into something substantial would go a long way in boosting the growth of the Kuwait economy. This along with the planned increase in refining capacity and the oil export capabilities at Al-Ahmadi port are of utmost importance looking at the sustainability of growth even in the longer term. It is important for capital formation to play a more prominent role in the economic growth to give it the reassuring sustainable feel. The value created by such long term capital investments are extremely important to hedge against the unfavorable movements of the commodity or stock markets in the future.
Expectations from the aforementioned value creating initiatives and the overall feel good brought about by the oil prices have had an unprecedented effect on the Kuwait stock markets in 2005. The overall Kuwait market as measured by the market capitalization weighted Global General Index appreciated by 62.7% during the period Jan-Oct 2005 to reach 286.7. This came on the back of an excellent corporate performance, which saw the aggregate profits of all the listed companies in Kuwait growing by 92% in the first nine months of 2005. Huge increase in the net profitability, though aided by high returns from investments, has rendered the stock market in Kuwait one of the cheapest in GCC at a market price to earnings multiple of 13 times (for 2005) despite the run up. Considering the even steeper stock market rallies in other GCC countries and an equally good or better performance by companies in Kuwait, domestic stocks seem to have further room for growth, a scenario which would add to the already high liquidity. The health of the economy in the current scenario is further underlined by the controlled inflation even at such high liquidity levels.