Summary:
Kuwait witnessed major economical changes and
events during the past few years. Prior to the global financial crisis, most
sectors were registering strong growth, specially the real estate, banking and
investment sectors. The financial developments worldwide gave Kuwait sort of a
“push” to pursue new development plans that would enhance its position among
other countries and improve its infrastructure. The spill-over effect from
developments in other GCC countries is expected to result in boosting higher
demand for new projects in Kuwait, primarily in infrastructure.
The Central Bank of Kuwait (CBK) used both
the monetary and fiscal policies to contain the negative effects of the
financial crisis, and provide stability to the economy. The steps taken by the
CBK have improved the overall market conditions, brought in the much needed
stability and avoided further deteriorations.
Economic Highlights
·
Recent
developments in the region
·
Kuwait’s
first development plan since 1986
·
Capital
Market Authority Law
·
CBK to
lower the discount rate to 2.50%
·
Pegging
the Kuwaiti Dinar (KWD) currency to a basket of foreign currencies
·
CBK to
impose new regulations for banks and investment companies.
The Global Financial Crisis
In 2008, the global financial conditions
deteriorated sharply after the major crash in the worldwide markets. The GCC
region incurred huge amount of losses consequently. However, some countries in
the region were able to stabilize their economy using the accumulated surplus
generated during the oil price boom prior to the crash. The global financial
crisis caused many firms in Kuwait to default. Also, many companies in Kuwait
had outstanding debt with banks and financial institutions in Europe.
Accordingly, foreign financial institutions, especially European banks, were
reluctant to extend credit or restructure debt to defaulters. According to the
IMF, the recovery rates ranged in the GCC region from 47% in Kuwait to 72% in
Qatar and KSA after the 2008 markets crash.
The debt market in the GCC, which was
affected by the weak economic conditions, was a result of the 2008 financial
crisis. According to MEED, the GCC debts amounted to USD 39 bn, were due within
one year. Half of these debts came only from the UAE. However, in 2009, there
was a partial recovery due to some government interventions like decreasing
interest rates and issuing bonds.
Dubai debt crisis had a huge impact on the
GCC region and the world. Total debt, amounting to USD 109.3 bn, was used to
turn the city into a financial hub. Currently, Dubai is going through a debt
restructuring plan of USD 24.9 bn. Since the correlation is notably high
between the GCC countries, Dubai crisis negatively influenced the region and
impacted its financial stability.
The GCC Outlook
According to the IMF, the growth potential in
the GCC region will be relatively higher in 2010/2011. The improvements in the
GCC region are expected to be at approx. USD 50 bn from 2009 to 2011. This
growth could be a result of the different development projects taken by most
countries in the region. Using both fiscal and monetary policies, the private
sector will expand further, and new development projects should breathe life
into the region.
The current market conditions influenced many
countries in the GCC region to pursue new development plans. Qatar was recently
selected to host the 2022 world cup event, which will further boost up its
economy. According to Bloomberg, Qatar will spend approx. USD 57 bn on
infrastructure to support the event. This is part of the USD 100 bn allocated
to sustain the government development plan 2030.
Inflation rates dropped significantly after
the 2008 meltdown in the GCC region, and are expected to slightly rise by 2010
and 2011. As for the Gross Domestic Product (GDP), Qatar is projected to have
the highest growth rate (16%) in 2010, followed by Oman (4.7%) then Bahrain
(4%). On the other hand, Kuwait, KSA and UAE have lower levels of GDP growth.
Recent Developments in the Region
The political situation in the MENA region
has been very volatile since the beginning of 2011. Many countries have already
faced shocking events, such as the ousting of the Tunisian President in January
2011. Moreover, up to the time of the writing, protestors in Egypt are still
demanding their President, Hosni Mubarak, to quit the presidency. The amount of
losses attributed to these events is huge. The GCC stock markets declined
sharply at the start of the events. Yet, they rose again few days later, eliminating
most of these losses. It is worth noting that Kuwait, UAE and Saudi Arabia have
significant direct investments in Egypt, whether through telecom, real estate
or other sectors. It is predicted that other countries such as, Syria, Yemen,
Algeria and Jordan, are likely to face similar political disputes. The
instability in the region may affect the demand of foreign investments and the
cost of insuring debt. The IMF cut the growth in the Arab World by one
percentage point due to the political instability in the region.
Kuwait Economy Overview
Kuwait Development
Plan
The demand for new plans and projects has
increased since the global financial crisis. In 2010, Kuwait’s parliament
approved a new development plan, and upon the implementation, Kuwait’s economy
would have a positive growth especially in infrastructure projects. As promised
by the government, the development plan will help to transform Kuwait into a
major financial hub and trade center by 2035. The government plans to expand
project development through local and foreign companies, and to diversify and
boost the economy.
The initial plan is estimated to be completed
by 2013/2014. The total cost is estimated to reach KWD 37 bn (USD 129 bn). The
government and the private sector must put huge efforts into implementation of
projects such as;
·
The new
“Silk City”, estimated to cost USD 77 bn
·
Enhancing
oil production and facilities, estimated to cost USD 25 bn
·
Easing
regulations for new business establishments, and give access to lands for
development and infrastructure purposes
·
A
railway metro system
·
Improving
the educational system in Kuwait
·
Developing
a modern healthcare system, in which new hospitals will be built across the
country
·
Adapting
and investing in the green environment concept
·
Al Sabiya
high way
The most important goal of the plan is to
revive Kuwait’s economy in an attempt to increase the GDP. The plan is expected
to result in:
·
Increasing
the individual welfare
·
Accentuating
the role of the private sector
·
Solving
the housing problems, as the new plan includes developing new residential
cities
·
Boosting
up the banking sector, more credit lines to companies engaged in the new
projects
·
Enhancing
all types of investments in Kuwait
·
Diversify
the economy and decrease its dependence on oil & gas
Companies will develop new projects mainly
through “Build, Operate and Transfer” (BOTs) or Public Private Partnerships
(PPPs). The government will establish five companies, of which three will not
need funding; these three will be health care, electricity and warehousing.
Although the plan has been approved, its
implementation and execution remains a major concern. Doubts regarding the
government’s actions exist, as this is the first plan since 1986. The political
situation in Kuwait has been unstable given the continuous tension between the
government and the national assembly. The parliament members promised to
monitor the government and its progress in this plan very closely. The plan
constitutes a very strong element for accountability as well.
The growth volatility
Kuwait’s GDP has declined in 2009 as a
reaction to the crisis. Real GDP growth rate had declined by 4.8% in 2009,
against a 5.5% increase in 2008. It is projected to rise again to 2.3% in 2010
and to 4.4% in 2011, according to the IMF projections. CSR believes that this
rate may increase if the government will succeed in executing the new projects
as per the plan.
The deterioration in oil prices has dragged
down the total GDP in 2009. Oil GDP growth in 2009 dropped by 11.4%, while it
increased by 3.3% in 2008. Oil GDP growth should climb back by 1.9% in 2010
according to the IMF projections. On the other hand, the non-oil GDP growth in
2009 dropped by 0.7%, and it’s expected to increase by 2.6% in 2010 and 4.5% in
2011. The growth in the non-oil sector could also be driven by the government’s
diversification strategy addressed by the new development plan in Kuwait.
Oil & Gas contribute the largest amount
of the total GDP at producer’s price in Kuwait (43.3%), followed by community,
social & personal services (17.1%), and then financial institutions
(13.4%), as shown in chart 1. On the other hand, the least contributing
components to the GDP are insurance (0.39%), agriculture (0.22%), and mining
(0.14%). The insurance sector is expected to rise significantly in Kuwait, as
the concept of insurance is now spreading in the market, and more individuals
and entities are adapting it.
Oil & Gas Sector
Oil & Gas are the main income sources in
the GCC region. With the fall of oil prices, countries in the GCC – Oil
Exporters – incurred significant declines in revenue. Oil prices in 2010 are
still lower than the average price of 2008, ranging from USD 70 to USD 85 per
barrel. On the other hand, gas prices were stable during the period, but also
resulted in a lower average than 2008. The huge uncertainty in the market
played an important role in this drop as well as the crisis in Europe and USA.
The OPEC oil production incurred the largest decline in 2009 of 7.3%, according
to BP’s statistics. The Suez Canal was closed due to the recent events in
Egypt. Accordingly, oil prices increased and they’re expected to further rise
in the future.
Other energy resources have witnessed a rapid
growth worldwide. Governments of many countries supported adapting other forms
of renewable energy. Global wind and solar generation capacity had increased by
31% and 47% respectively, according to BP’s 2009 statistics. Moreover, it is
predicted that the demand on non gasoline cars – hybrid/electric – will further
increase in the future. This shift will decrease the demand of oil & gas,
which may subsequently result in lower prices, and thus lower income for the
oil exporting countries.
Kuwait mainly relies on oil exports as the
core revenue source. According to CBK, oil revenue in 2010/2011 is projected to
represent approx. 88.6% of total revenue; while it was 93.7% in 2009 as shown
in chart 2. Oil production had also decreased by approx. 14.8% in 2009, and oil
exports decreased subsequently by approx. 22.2%. The new development plan
reflects this decrease as it aims to focus more on promoting non-oil income
resources to diversify the revenue.
Inflation Rates
Kuwait’s Consumer Price Index (CPI) and the
Inflation rate were stable in 2009 and 2010. The inflation rate increased remarkably
in 4Q2009 and 1Q2010, and then decreased in 2Q2010. Average inflation rate
during 9M2010 was 1.3%, which is higher than the average rate during 9M2009
(0.44%).
Based on the IMF projections, the inflation
rate for 2010 is estimated to be at 4.1%, and 3.6% in 2011. There is an overall
upward trend in both the CPI and Inflation rate, which can be justified by the
financial improvements and stability.
The two main items of the basket that
impacted the inflation rate are food and clothing. Food inflation rate
increased remarkably from approx. 0.20% in 3Q2009 to approx. 3.30% in 3Q2010.
Food prices are affected by the increase in commodity prices worldwide. Also,
clothing inflation rate increased from approx. 1.4% in 3Q2009 to 3% in 3Q2010,
based on CSR analysis.
External and internal factors are affecting
the inflation rate in Kuwait. The government is consistently monitoring prices
of goods, and detecting all violations like selling spoilt or expired food
products, and price manipulations. 744 violations were detected during the
period (January 2010 to April 2010). The government recently decided to grant
an amount of KWD 1,000 to all Kuwaiti citizens on the occasion of the 50th
Independence Day. The grant will be distributed to 1.150 mn Kuwaitis as of Feb.
01, 2011, and will cost KWD 1.150 bn according to Al Shall Economic Report.
Moreover, the government offered free food supply for 14 months as of the same
date, which is estimated to cost KWD 2.3 bn. CSR believes that sudden changes
in the household spending could result in a short term hyper inflation. As
money supply increases, inflation rates will increase consequently. However,
the free food supplies may limit the increase in the prices of food, as demand
on retailers’ food products will decrease.
Interest Rates & Exchange Rates
The financial sector in Kuwait was in need of
strong support from the Central Bank during the crisis. CBK had to intervene to
minimize the losses and stabilize the economy. In 2009, the CBK cut down the
discount rate three times to result in a total drop of 125 basis points. The
discount rate therefore decreased from 3.75% in 2008 to 2.50% in 2009.
The KWD currency has been stable over the
past years. The purchasing power of the KWD is the strongest among all
currencies. However, a strong currency does not necessarily indicate a strong
economy. All of the GCC currencies are pegged to the US Dollar (USD), except
for the KWD. The KWD currency is pegged with a basket of major currencies
worldwide. This decision came in 2007 by the CBK, after a 5 years peg with the
USD (2003-2007). Therefore, the correlation between the rates in Kuwait and
other countries decreased. It is worth noting that the KWD was not affected by
the euro movements in 2010 as it was offset by the movements of currencies in
the basket. CBK however did not disclose which currencies the basket consists
of, thus the existence and the amount of associated risks cannot be determined.
The GCC unified monetary system plan was
formed to establish a unified currency and a central bank for the GCC region.
However, the plan is currently on hold due to the recent economic events. The
launch date of the unified currency is not yet determined as well. UAE and Oman
have already withdrawn from this project. UAE withdrawal came as a result of
the decision to locate the GCC Central Bank in Saudi Arabia. It is apparent
that the execution of this plan will not take place in the near future, as the
situation remains unstable. Additionally, the governor of Saudi Arabia’s
Central Bank stated, back in 2009, that the currency may be pegged to the USD
initially, and then it will be allowed to float. Also, the depreciation of the
USD against most currencies further resulted in the delay of the unified
monetary system in the region.
Kuwait Stock Market
The Kuwait Stock Exchange (KSE) experienced
significant declines during 2008 in line with the GCC and global markets.
Almost all the sectors faced large sell-offs, and the index touched all time
lows. KSE lost around 52.17% (approx. KWD 27 bn) of its market capitalization
by the end of 2008. Companies suffered huge losses during the period, and many
were on the edge on bankruptcy.
On the other hand, the market had witnessed
some improvements in 2009. Average volatility for the period (Oct-2009 to
Nov-2010) was approx. 8%. This is attributed to the low trading volume when
many investors lost faith in the market. The volume of trading had increased
significantly in 4Q2009 and 1Q2010. In contrast, it dropped sharply in 2Q2010,
followed by a slight increase in the subsequent quarter.
The index resumed to decline in 2010, closed
at 6891 points on November 2010, while it closed at 6933 in November 2009. The
index increased in 4Q2009 and 1Q2010, and then declined in 2Q2010. Services was
the best performing sector during the period, it closed at approx. 14920 in
November 2010. It is essential to note that the index did not reach the 8000
points during the period.
Transparency is one of the key elements in
the market. The overall disclosure & transparency standards in Kuwait are
weak in comparison to international standards. However, after the crisis, the
regulators have started focusing on enforcing higher level of transparency.
Some companies also started voluntarily to apply better corporate governance standards
to build strong relations with their shareholders and to increase performance.
However, it is worth noting that some companies, specifically in the investment
sector, stopped publishing their financial results after the collapse, which
increased the amount of associated risks to shareholders and investors.
CBK enforced the third part of the Basel II
Capital Adequacy standards “Disclosures and Transparency”, which focuses on
banks and financial institutions. Additionally, CBK issued more instructions to
banks and investment companies regarding disclosing information on financial
obligations and other financial data.
Capital Market Law
KSE, the second largest stock market in the
GCC after Saudi Arabia, until 2010 May, is the only market in the GCC without a
Capital Market Authority (CMA). In 2010, the parliament approved setting a CMA
to supervise the stock market. According to the new law, KSE will turn into a
private shareholding company in which 50% of the shares will be available to
Kuwaiti citizens, 24% will be owned by the government and 26% will be sold to a
strategic private investor.
CMA’s main purpose is to increase
transparency levels and to eliminate the insider trading activities. Fines and
jail terms will be enforced on those who practice such activities. Companies
will be forced to disclose their financial results, and timely disclose all
quarterly earnings reports & financials to the public. The presence of the
CMA should minimize the amount of insider trading and market manipulations when
it’s fully implemented. This will boost investors’ confidence in the market and
therefore both trading volume and efficiency will increase.
The Banking Sector
The banking sector was one of the most
affected sectors by the crisis. However, banks have focused on cleaning up
their balance sheets to reduce their risk exposure. A number of banks have
registered high provisions to cover bad loans. The aggregate balance sheet of
local banks increased by almost 2.7% in the financial year 2009/10 amounting to
KWD 40,584.7 mn from KWD 39,518.1 mn in 2008/09. The capital adequacy ratio of
local banks was more than 17%, which is higher than the 12% minimum ratio
required by the central bank and the 8% ratio recommended by the Basel
committee.
The sector’s index has been on an increasing
trend in 2010, closing at 11,647 by the end of November 2010, against 8307 in
November 2009.
Personal facilities loans represent 33% out
of the total loan portfolio in 2009, followed by real estate and trade &
industry. The percentage of non-performing loans increased from 5.3% in 2008 to
9.7% in 2009, which is the highest among the GCC countries according to the
IMF. This affected the banking sector negatively, as many companies, in
addition to individuals, were not able to pay back their outstanding loans. On
the other hand, the government has initiated a “Defaulters Fund” to assist
residents with financial difficulties. The fund will provide zero interest
loans to consumers, in which the loan’s amount should not exceed 15 times the monthly
salary after deductions. The limit of the loan is KD 15,000 and the
accumulative loans of each applicant must not exceed KD 70,000.
The Real Estate Sector
The real estate sector in Kuwait contracted
significantly as a result of the global markets crisis. Prices were extremely
inflated prior to the crash which caused a real estate “bubble”. It is worth
mentioning that the real estate sector is positively correlated with the
banking sector in Kuwait. The huge amounts of debt impacted the sector negatively.
Many real estate investors were in default, and therefore they were not able to
commit to their debt obligations with the financial institutions. According to
the IMF, real estate contributed 26% of the bank loans portfolio in 2009. Also,
the poor performance of investment companies affected the real estate investors
as well.
The real estate index continued to decline
where it closed at 2368 in November 2010, against 2748 in November 2009.
Trading volume in the sector dropped as well. There is a large amount of risks
associated with the real estate sector. The real estate market in Kuwait, which
is very unstable, could evolve if the government successfully implements the
development plan. Moreover, external events are affecting the sector too.
According to Bloomberg, Dubai property prices may continue to fall during the
next two years. As a result, real estate companies in Kuwait that have
investments in Dubai will suffer from associated losses.
The Investment Sector
Most investment companies in Kuwait are
financed by large amounts of debt. The crisis resulted in a number of issues
related to liquidity and insolvency. A number of companies defaulted in paying
back their debts to local banks, thus they started shifting to foreign
financial institutions for more funding. The aggregate balance sheet of local
investment companies dropped by almost 10.7% in the financial year 2009/10 to
KWD 14,778 mn (100 companies), against KWD 16,468 mn in 2008/09 (101
companies).
The investment sector index fluctuated throughout
2010, where it witnessed a sharp decline in 2Q2010. The index closed at 4906
points in November 2010, against 5634 in November 2009. The sector recorded
losses amounting to KWD 105 mn during the 1H 2010, which represents almost a
46% decline. However, the amount of losses in 2009 was KWD 200 mn.
The central bank imposed new regulations on
the investment companies in June 2010. These regulations should enhance both
liquidity and leverage. All investment companies must comply with these
requirements by June 2012.
The company’s leverage ratio (total
liabilities/equity) must not exceed 2:1
·
Quick
ratio calculation must only include “cash and equivalents” and “Government and
other sovereign debt” in the numerator. The minimum acceptable ratio is 10%
·
Maximum
foreign debt is 50% of total equity or 25% of total liabilities
·
Debt
restructuring may assist investment companies to minimize risks. Yet, the new
regulations imposed by the CBK regarding foreign funding may not be in the
favor of the companies. It is worth noting that the disclosure of the type of
debt (local/foreign) is optional in the companies’ financial statements.
CBK had already announced that about 82 of
the 100 investment companies meet two of the three criteria according to the
2009 results. Nonetheless, many investment companies stated that they will not
be able to meet the new requirements by 2012.
Further Actions by the Central Bank
The central bank is enhancing the supervision
of the banks and other financial institutions to improve the overall financial
markets in Kuwait. This will be done by the continuous checks on the standards
and policies of all banks, the frequent monitoring of cash positions, and the
implementation of new rules and regulations that correspond with the recent
changes in the economy which are in line with international standards.
In the financial year 2009/10, the central
bank adjusted the Basel II Capital Adequacy Standard to evaluate banks based on
their internal capital adequacy (ICAAP). The first part of the Basel II focuses
on the banks’ credit, market and operating risks. The central bank requires
banks to comply with the second part of the Basel II, which ensures that the
capital adequacy is enough to face all types of risks. Also, in 2009 the CBK
issued instructions regarding the Basel II Capital Adequacy Ratio for Islamic
banks that suits their risk profile.
CBK enforced more regulations on the banking
sector, by which banks should provide auditors’ reports on financial
derivative. Also they should present periodic work progress reports that
include their strategic plans and the difficulties they are facing.
New regulations are in favor of shareholders
and investors in Kuwait. Companies that comply with these regulations will be
exposed to lower amounts of risk. Nonetheless, companies may need a longer
period of time to comply with these new rules. Accordingly, CBK may impose
penalties on companies that fail to fulfill all the targets.
Conclusion
Kuwait is in need of major changes to boost
up the economy. Given the recent developments in other GCC countries, such as
UAE and Qatar, Kuwait must put huge efforts to keep up with the large growth in
the region. The most important factor is the implementation and execution of
the development plan as the whole economy will shift from one point to another.
Kuwait is still fully dependent on oil & gas resources that will eventually
dry up over time. The development plan should solve this issue by providing
other valuable sources of income. Furthermore, the formation of the CMA will
enhance the performance of the KSE, and the overall transparency standards in
the market. Nevertheless, Political disputes are delaying all growth potentials
in Kuwait. There must be an end to the conflicts between the government and the
parliament for a stabilized economy.
