Kuwait’s revenue has long been underpinned by oil which makes up approximately 95% of its exports, in similar fashion to its GCC neighbors. After a decade of high oil prices, Kuwait’s revenue generation took a hit owing to the volatility of global and Kuwaiti crude oil prices, which peaked at US$117 per barrel in June 2014, and subsequently precipitously falling to US$31 per barrel in February 2016. Thus, Kuwait is facing a vastly different fiscal position in 2016 as the country is expected to post its first fiscal deficit following two decades of budget surpluses. This has led to the government sanctioning new initiatives to adjust to the current low oil price environment which is expected to persist in the coming years.
Review of 2016
The prevailing economic environment will place added pressure on the government’s pervasive national welfare benefits extended to its citizens which include access to free healthcare and education, public sector jobs and housing. While the elimination or reduction of subsidies in utilities and energy remain very sensitive and fragile issues, the government has acknowledged that cuts are imperative for the overall benefit of the economy over the long term especially if the low oil price environment perseveres. Nevertheless, the economy of Kuwait remains stable largely due to the lack of government expenditure over the last decade despite enjoying a bonanza of revenue stemming from high oil prices – in stark contrast to other GCC countries who increased their public spending accordingly. However, the vast surpluses accumulated over the past decade, which the state can tap into should it be required, is not a sustainable fiscal solution to the country’s budgetary challenges throughout prolonged periods of low oil prices.
Consequently, the government is adopting several fiscal policies to maintain its historically robust fiscal position which include a reduction of fuel subsidies and the adoption of taxes such as value-added tax. More importantly, in view of invigorating private sector activity as a parallel strategy to maintaining future fiscal positions, the government has implemented changes within the country’s regulatory and legal framework which have encouraged private sector participation in the funding of large public infrastructure projects and the privatization of certain service-based government activities. Examples include the ratification of laws pertaining to public-private partnerships (PPPs) and the creation of the Kuwait Authority for Partnership Projects and new Sukuk bylaws through the Capital Markets Authority (CMA), all of which were carried out in mid-to-late 2015.
With the advent of the new PPP regulations, large projects such as the Al Zour Independent Water and Power Project and the Kabd Municipal Solid Waste Project, which will implement the latest technological advancements to treat waste and generate alternative power for the Ministry of Electricity and Water, have quickly attracted both private local and foreign investors and project operators. The development of PPPs in Kuwait cannot be understated as it extends to the government the ability to lessen its capital expenditure and reallocate upfront costs onto the private sector.
On the other hand, hinged by continued government spending on new projects and significant capital expenditures which it perceives fundamental to sustaining the country’s economic growth in the short term, multi-billion fiscal reserves from past years and low debt levels have fueled non-oil GDP growth in 2016 which is expected to reach 3%. The government’s spending on infrastructure and utility projects, in line with Kuwait’s development plan, has gained strong traction in the current year which should produce greater business opportunities and bolster economic diversification in 2017 and beyond.
2016 was also a major milestone for the development of Kuwait’s capital market. Boursa Kuwait Securities Company (BKSE), which was incorporated in 2014 to essentially privatize the Kuwait Stock Exchange (KSE), officially took over the management of the KSE. This, indeed, marks the commencement of a new age for Kuwait’s capital market as BKSE intends to list the KSE publicly through an IPO to Kuwaiti nationals in the forthcoming years with the aim of enhancing the capital market’s performance and value.
Preview of 2017
The outlook for Kuwait’s banking system in 2017 remains healthy due to the continued expectation of government spending as subdued oil prices linger. Supported by an increasing demand for Shariah compliant financial products and facilities from wholesale and retail customers, the Islamic financial sector in Kuwait is regarded as an integral constituent of the country’s path to development. Islamic banks in Kuwait hold approximately 45% of banking sector assets, according to data from the Central Bank of Kuwait (CBK).
From a regulatory vantage point, the CBK has plans to enhance the local retail banking competitive environment by eliminating branch expansion restrictions on foreign banks which would grant them the ability to open branches in numerous locations, positioning them to compete directly against local institutions for a share of the retail banking market, especially considering that Kuwaiti banks are in parallel reducing their branch network to reduce costs.
Notwithstanding the subdued levels of Islamic debt capital market issuances (Sukuk) by Kuwaiti issuers since the global financial crisis of 2008, steps undertaken by the CMA through the adoption of new Sukuk bylaws which became effective in November 2015 have created tangible results in 2016. Islamic commercial banks like Boubyan Bank and Ahli United Bank have taken advantage of the long overdue regulatory developments and successfully issued the first publicly listed Sukuk by Kuwaiti corporates since 2007.
Sukuk issuance by the aforementioned Islamic banks are part of their efforts to reinforce their Tier 1 capital base in compliance with Basel III standards. The outbreak in Kuwaiti Sukuk issuances, especially by local commercial banks, is believed to have a wide-ranging effect on Kuwait’s Islamic financial sector and the economy at large. Similarly, Kuwait’s government will look toward the Islamic debt capital market for funding to bridge forecasted budget deficits should low oil prices persist as expected. Consequently, Kuwait will be well positioned to compete for a piece of the global Sukuk market in the future.
Conclusion
Kuwait’s Islamic finance sector is expected to continue its growth trajectory and support bank operating conditions over the next 12 to 24 months as unremitting levels of government expenditure, assisted by considerable accumulated reserves estimated to be in the range US$600 billion, and low debt levels endure to push growth in the non-oil economy. Record amounts of government capital spending tied to planned or ongoing infrastructure, healthcare, oil, power and housing projects will provide new business opportunities for Islamic banks. By contrast, fiscal reforms such as the adoption and implementation of corporate and value-added tax and the decrease in fuel subsidies will have minimal impact in the short term as such policies will be enforced steadily over a protracted period, which means that government job opportunities will remain abundant for Kuwaiti nationals, supporting consumption and boosting credit growth for Islamic banks in the short term.
Thuwaini Al Thuwaini is the acting chief investment banking officer of the Investment Banking Group of Warba Bank. He can be contacted at [email protected].