Kuwait expands investment with prudent fiscal management

As one of the world’s largest oil producers, Kuwait’s energy sector has supported a rapid pace of economic growth since the discovery of oil in the country in the early 1930s. Revenues from these resources have helped Kuwait to become one of the wealthiest countries in the world in terms of GDP per capita. Despite a significant increase in government spending, high oil prices until 2014 and a steady level of production have enabled the country to generate significant budget surpluses over the last decade. The government redistributes a significant portion of the country’s wealth to its citizens through a generous welfare system that provides free or subsidised electricity, water and fuel; free education and health care; and support for housing.

While the decline in global oil prices will likely have a real impact on Kuwait’s economy, the country benefits from a very low fiscal break-even price on the production of its oil, which will help protect the economy if current oil prices are maintained. Furthermore, the government has reaffirmed its commitments to maintain capital expenditures and deliver the project pipeline outlined under the Kuwait Development Plan (KDP) 2015-20 (see analysis).

Background

Similar to many other resource-rich countries, Kuwait has faced a number of challenges in developing its economic base. While a few non-oil sectors, including retail and real estate, have grown in recent years, this can generally be linked to higher salaries and benefits that ultimately tie back to the country’s oil revenues. Political disputes have further inhibited economic diversification by hindering vital public expenditures on infrastructure and other development projects. Increasing consumption of the country’s subsidised energy and water resources have also strained Kuwait’s power and water desalination plants, while the stalled investment programme has meant that the country has not been able to add new capacity. Domestic and international stakeholders including the IMF have highlighted that government spending and subsidies in their current form are unsustainable.

In response, the government has initiated a number of reforms to ease political hurdles and to focus spending on strategic projects to spur growth. The government has also introduced a new law to promote public-private partnerships and has taken some steps towards reducing subsidies. The projects market in 2014 has demonstrated the impact of these reforms, with the value of infrastructure contracts awarded by the government in the year exceeding the previous three years combined.

Oil Economy

Kuwait’s economic strength is directly linked to its status as the world’s fourth-largest exporter of oil and the 10th-largest producer of oil. The country, which spans an area of some 17,820 sq km and holds less than 0.3% of the world’s population, sits on 101bn barrels of oil, representing more than 8.4% of the total reserves in OPEC countries and about 6% of global reserves. Oil and gas revenues, which account for more than 60% of the country’s GDP and more than 95% of exports, have remained relatively steady over the last decade.

Kuwait has no individual income tax but it subjects foreign-owned companies to a 15% tax. Government revenues are thus almost entirely dependent on income from the oil and gas sector, which makes the budget susceptible to external price shocks, as was seen in late 2014 as the price of oil dropped over 40%. IMF projections estimated oil revenues were approximately $57bn in 2014, but this figure is likely to be lowered significantly into 2015 after taking into account recent trends in global oil markets.

The country’s total economic output at constant prices over the last 10 years has grown steadily from an estimated KD31.22bn ($107.56bn) in 2005 to KD39.75bn ($136.95bn) in 2014, according to estimates by the IMF. This translated into a GDP per capita of more than $43,100 in 2014 for the country’s population of around 4m people, as per IMF figures. Meanwhile, total oil and gas exports reached KD26.83bn ($92.43bn) in 2014, accounting for an estimated 95% of the country’s export revenues.

Despite the heavy reliance on the oil and gas sector, the government has had the luxury of dealing with record budget surpluses in recent years, enabling the country to invest in major infrastructure projects and to divert significant resources into national sovereign wealth funds. Looking ahead, Kuwait has indicated plans to increase oil production to 4m barrels per day (bpd) by 2020.

While this will not affect oil exports over the short term, it will provide a significant boost for the government’s budget, which has operated at a surplus of around 30% of GDP in recent years. The healthier revenues have led to higher budget expenditures, though these have generally been on wages for the country’s public sector employees.

In January 2015, the government endorsed a draft economic development plan, with a pledge to spend up to $116bn from 2015 to 2020 to build infrastructure, diversify the economy, attract investment and boost private sector participation in the economy. While the details of the plan are yet to be approved, there are indications that the government will build on the momentum of 2014 to revive plans of building a metro and railway network, and to initiate several projects to strengthen the country’s downstream capacity within the oil sector.

Economic Indicators

The performance of the banking sector has been steady despite concerns about the broader economic impact of recent oil prices (see Banking chapter). According to the Central Bank of Kuwait (CBK), local banks held total assets of KD55.46bn ($191.07bn) as of December 31, 2014. The sector consists of 16 commercial banks and six Islamic banks. The National Bank of Kuwait (NBK) and Kuwait Finance House (KFH) are the biggest in terms of asset shares, holding 39% and 31%, respectively. The CBK, which regulates all banks within the country, has maintained supportive fiscal policies for the non-oil sector that support commercial investment and lending. According to NBK, growth in lending to consumers grew by an estimated 12.7% year-on-year (y-o-y) in December 2014, while credit to non-bank financial companies grew by KD10m ($34.45m). Loans to the private sector still account for a small portion of all loans in Kuwait. The potential of growth in construction and infrastructure development activity will thus provide a boost for local banks as they step in to finance the projects (see Construction and Transport chapters).

According to NBK, inflation in the consumer price index was higher in 2014 than in 2013, averaging 2.9% over the year, which was slightly above the 2.7% posted in 2013 but lower than the 3.3% for 2012. NBK points to higher prices for housing as the main factor behind 2014 inflation, though the rise in housing costs was offset by a slowdown in other components of the CPI, particularly in food prices.

Foreign Direct Investment

Despite having access to significant reserves accumulated due to revenues from the country’s oil and gas production, the government has actively set forth policies and instruments to encourage greater foreign investment into the local economy. One major reason is to diversify the sources of investment within Kuwait to prepare the country against potential economic shocks. The recent drop in oil prices illustrates why this could be vital for stable economic growth.

Another reason behind the government’s strategy is to diversify how its own funds are invested, rather than taking on sole responsibility for financing the local economy. Finally, foreign direct investment (FDI) also serves as a transfer mechanism to draw international knowledge, expertise and best practices into Kuwait. Attracting foreign investment, however, has become more challenging, particularly in the aftermath of the 2007-08 financial crisis, which made investors cautious about investing in emerging markets, and the political discord that shifted many investments away from the Middle East and North Africa region.

FDI flows into Kuwait decreased 66.1% y-o-y in 2014, touching $486m, according to the “World Investment Report 2015” from the UN Conference on Trade and Development (UNCTAD). The UN agency also notes that FDI into the GCC region as a whole fell for the five years up to 2014. While in 2009 FDI into the GCC totalled $51.4bn, it had dropped to $27bn in 2012 and declined again in 2014 to $21.7bn. This decline did not reflect the global trend between 2012 and 2013, when worldwide FDI actually increased by 9.1% reaching $1.5trn in 2013. However, in 2014 global FDI also fell, decreasing to $1.2trn. Over the past few years the GCC has lost out to other regions, as its share of global FDI has fallen from a high of 4.3% in 2009 to 1.8% in 2014.

Although FDI has been declining, strong and stable economic growth supported by various government initiatives has helped stem the flight of foreign investment. Furthermore, there is a significant amount of liquidity within GCC countries that is starting to flow into Kuwait. Major mergers and acquisitions, such as Qatar Telecom’s 2012 purchase of Wataniya Telecom for $1.8bn, point to Kuwait’s potential as a leading investment destination.

Investment Authority

The government has also initiated a number of investment-focused programmes. In a boost for the economy, Kuwait established a public authority dedicated to promoting direct investment into the country under the new FDI Law in 2013. The law repealed the previous law, which was issued in 2001, and shifted the Kuwait Foreign Investment Bureau’s existing assets and functions to the newly established Kuwait Direct Investment Promotion Authority (KDIPA). KDIPA comes under the purview of the Ministry of Commerce and Industry. It has a comprehensive mandate that places the authority in charge of “promoting direct investment by both local and foreign investors, streamlining the investment environment to improve Kuwait’s position in competitiveness and doing business international indices, licensing direct investments in accordance with set criteria, raising awareness regarding the importance of direct investment, and the promotion of the Kuwait investment environment and the available direct investment opportunities”. KDIPA will serve as the first stop for investors in Kuwait. The organisation is currently in the process of establishing its operations and is drafting a strategic plan to implement its vision. According to KDIPA, the aim is to identify priority sectors and outline how the authority will integrate its operations with other public agencies in the country. In line with the KDP, small and medium-sized enterprises (SMEs) are likely to be a major focus for the authority. KDIPA is assessing opportunities to collaborate with the National Fund for SME Development to establish business incubators and accelerators.

Outflows

While Kuwait and its GCC counterparts are competing to attract FDI, the six countries are also among the world’s largest investors abroad. According to data from the UNCTAD, FDI flows from GCC countries as a whole rose by 102% between 2012 and 2013, reaching a total of $35bn, and then fell by 16% to $29.4bn in 2014.

Foreign exchange reserves accumulated on the back of oil and gas revenues have been invested in various mergers and acquisitions abroad. Out of the GCC total, Kuwait was the largest overseas investor in 2014, bringing its investments for the year to more than $13bn. Qatar and Saudi Arabia rounded off the top-three overseas investors, with $6.7bn and $5.4bn in FDI outflows, respectively.

Furthermore, Kuwait’s cumulative FDI stock abroad is one of the highest among GCC countries. UNCTAD estimates that the country holds more than $36bn in assets abroad, while the FDI stock within the Gulf country sits at approximately $15.3bn. As of 2014 the UAE and Saudi Arabia were the only nations in the region with greater FDI stocks outside their borders with $66.3bn and $44.7bn, respectively.

Sovereign Wealth Fund

The Kuwait Investment Authority (KIA), the world’s oldest sovereign wealth fund, is one of the biggest sources of these funds flowing abroad. The country’s sovereign wealth fund has its roots as a single account established at the Bank of England to manage the country’s oil revenues. In 1953, the government inaugurated the Kuwait Investment Board to manage these funds with the broad purpose of investing the country’s wealth. The board was eventually replaced with KIA, set up under Law No. 47 in 1982. As part of the transition, KIA was given a broader and more formal mandate to serve as the main investment agency managing the country’s wealth.

Kuwait’s revenues, which are primarily generated from the oil and gas sector, currently flow into the General Reserve Fund (GRF). KIA oversees the GRF, serves as the country’s state asset manager and acts as treasurer for all government expenditures that are paid out of the GRF. Withdrawals from the GRF are determined and authorised by the country’s National Assembly.

In addition to state expenditures, the GRF also currently transfers 25% of the country’s revenues into the Future Generations Fund (FGF). The FGF was created with a direct transfer of 50% of the GRF’s assets in 1976. The fund, which serves as Kuwait’s savings account, was established with the goal of investing the state’s assets outside the country. The fund originally received 10% of all state revenues each year, though the government raised this to 25% in 2013. The FGF is managed by KIA and is strictly protected under Law No. 106, which prohibits withdrawals of the fund’s investment income. Any withdrawals from the FGF require the National Assembly to pass a specific authorisation law. While KIA’s investment strategy is not made public, the authority does follow a few specific principles, such as diversifying its portfolio globally in a way that is consistent with each country’s share of the world’s GDP.

In addition to playing a long-term savings role for Kuwait, the FGF serves as a critical instrument to help stabilise the economy. The FGF, which holds most of its assets outside Kuwait, was the main source of funding for the government in exile in the aftermath of the First Gulf War in 1990 and was used to underwrite the cost of the country’s reconstruction in the aftermath of the conflict. KIA also stepped in to bolster the local economy during the global financial crisis by establishing a KD1.5bn ($5.17bn) fund to provide guarantees on investments into the country to reassure investors. More recently, KIA has also increased its investments into the domestic economy. KIA does not publish its investment figures but is estimated to hold combined assets worth more than $548bn as of 2015, according to the Sovereign Wealth Fund Initiative (SWFI). Major holdings estimated by the SWFI include a $5bn stake in the multinational automotive group Daimler AG, $2.8bn in British Petroleum, $127m in the Arab Insurance Group and $800m in Gulf Bank. KIA recently also sold its 4.9% stake in Citigroup for $4.1bn, netting the fund a 37% return on its $3bn investment.

Redirecting Petro-Revenues

In addition to the national sovereign wealth fund, Kuwait’s oil company is rolling out a strategy of expanding operations by investing the country’s oil and gas revenues abroad. In 2009, Kuwait Petroleum Corporation (KPC) announced plans to spend half of its investment budget on petrochemical and refinery projects abroad. One project that emerged under the strategy was a $6bn refinery in Vietnam. The Nghi Son Refinery and Petrochemical Project, which is located 200 km south of Hanoi, is structured as a joint-venture with Japanese companies Idemitsu Kosan and Mitsui Chemicals, and the Vietnamese group PetroVietnam. KPC has committed to supplying crude oil to the refinery, which will eventually boost Vietnam’s refining capacity by more than 200,000 bpd. More recently, KPC has eyed a major deal to buy a 50% stake in the state-owned Indian Oil Corporation’s Paradip refinery. The deal would allow Kuwait, which is India’s fourth largest supplier of crude oil, to expand its operations within South Asia.

Outlook

While the recent drop in oil prices has been a major concern for all OPEC countries, the GCC states, and Kuwait in particular, appear largely well prepared to absorb lower revenues without increasing production. The government’s 2015/16 budget, which covers expenditures starting on the first day of the fiscal year, April 1, outlines spending plans of $60.8bn, which is almost 17% lower than the $74bn allocated for 2014/15.

Despite the cutback on spending, the budget is anticipated to incur a deficit of $27.9bn under the new assumptions of oil prices hovering at around $45 per barrel, although by May 2015 the price of oil had recovered to around $60 per barrel.

The government has reaffirmed that it will not cut capital investments or wages in its budget for 2015/16 and has indicated that it will cover the deficit by borrowing from the GRF or by turning to local and foreign capital markets.

A number of major projects outlined under the KDP 2015-20 are already being awarded (see analysis), which is a strong indicator for economic growth going forward. The government is also using the budget cutbacks as an opportunity to identify and trim unnecessary expenditures, while contributions to the FGF will be reduced to 10% of national income in light of lower oil revenues.

Based on these indicators, the IMF anticipates that Kuwait’s non-oil economic growth will be in the range of 3.5% and may even pick up to almost 5%, driven by a combination of higher domestic consumption and increased government investment.

While the risk of a further drop in oil prices still looms large over all oil-producing countries, Kuwait’s ambitious capital expenditure plans coupled with a number of positive policy reforms to diversify economic growth and to strengthen private sector participation within the economy are likely to continue providing support for steady growth going forward.

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The Report: Kuwait 2015

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