Public Information Notice No. 00/27

Public Information Notice: IMF Concludes Article IV Consultation with Kuwait

April 4, 2000

On March 13, 2000, the Executive Board concluded the Article IV consultation with Kuwait.¹

Background

Following several years of favorable economic performance, Kuwait's external conditions deteriorated in 1998 as a result of the adverse impact of the sharp decline in oil prices. The fiscal balance moved into a deficit of 1 percent of GDP in 1998/99, and the external current account surplus was reduced by half. Real GDP growth decelerated to 2 percent in 1998, reflecting mainly the contraction or sluggish growth in various non-oil sector activities in connection with the drop in oil prices. Monetary developments were marked by a moderate expansion in credit to the private sector mainly reflecting the general slowdown in economic activity. The stock market turnover and prices declined significantly following three years of buoyant activity. Inflation remained low, averaging about 1 percent, in part due to subdued import prices.

In 1999, the overall financial situation improved substantially reflecting the recovery of international oil prices following the OPEC agreement to cut crude oil production. Export earnings are estimated to have increased by about 24 percent and the current account to have risen to 17 percent of GDP. With higher oil revenue, the fiscal position is expected to improve markedly, with the surplus estimated to reach 15 percent of GDP in 1999/2000. Real GDP is estimated to have declined by 2.4 percent due to the cut in crude oil production under the above-mentioned agreement and the sluggish growth in the non-oil sector. While credit growth to the private sector continued to outstrip that of broad money, the local banks drew down their net foreign assets to meet credit demand. By end-1999, gross official reserves increased to US$4.4 billion, equivalent to 4.0 months of imports of goods and services.

The government has submitted to the National Assembly a package of structural reforms aimed at addressing the economy's structural imbalances, enhancing growth and fostering employment of Kuwaiti nationals. The reform package includes draft legislation on privatization (utilities, telecommunications, airline, transportation), foreign investment, opening up oil activities to foreign participation under services contract agreements, labor market reform, the company and agency laws, the corporate income tax law, and the copyright and the patent laws. A consensus between the government and the National Assembly on most of the draft bills has still to be reached, particularly with regard to implications of some of the reforms for employment, utility tariffs, and the risk of emergence of private monopolies.

Executive Board Assessment

Executive Directors noted with satisfaction the improvement in Kuwait's overall macroeconomic situation in 1999, particularly the strengthening of the fiscal and external balances which reflected the improvement in oil export revenues and the authorities' prudent fiscal management. They commended the authorities for maintaining prudent fiscal and monetary policies and tightening bank prudential regulations. They noted that these policies had also paved the way for consolidating Kuwait's financial situation and allowed the authorities to resume the building of assets for future generations.

Directors noted that the traditional policy of accumulating financial assets had paid off in 1998-99 when oil prices had been depressed by affording the authorities greater room for maneuver in maintaining financial stability and preserving the credibility of the exchange rate arrangement. They observed that such policy needed to be continued, especially now that oil prices have increased significantly.

Notwithstanding the improvement in the overall financial position, Directors observed, however, that Kuwait faces the medium-term challenge of raising economic growth and providing increased employment opportunities for its nationals. They underscored that the package of structural reform measures that was formulated last year aimed at better utilizing Kuwait's economic potential and laying the foundations for higher private sector-led growth and employment creation. The package was rightly focused on disengaging the government from commercial activities, privatization, promotion of foreign investment, reform of the company law, fiscal restructuring, and labor market reform. Directors agreed that such reforms will be key to improving business climate and promoting investment and efficiency in the economy by fostering private sector participation and attracting foreign investment. Noting that little progress had been made in approving these reforms, Directors stressed the importance of building a broad public consensus in favor of these reforms: They encouraged the authorities and the National Assembly to work toward securing the legislative approval of these measures.

Directors welcomed the fiscal measures introduced in 1999, including the increase in retail petroleum prices, which fully eliminated the subsidy on petroleum prices, the introduction of health care charges, and the increase in customs duties on tobacco. Directors encouraged the authorities to further diversify the revenue base, including by eliminating exemptions from import duties, introducing fees on government-provided services, increasing fees and charges on utilities, and levying excises on luxury items. On the expenditure side, consideration should be given to streamlining government employment, reducing subsidies and transfers, and further rationalizing government expenditure. A steadfast implementation of these measures would improve the structure of the budget and enhance the resiliency of the fiscal situation to fluctuations in oil prices. Directors agreed that the improved revenue prospects provided additional room for increased capital expenditure, which would help stimulate economic activity. In this regard, a few Directors would see some merit in considering establishing a more formal oil revenue stabilization mechanism that could link more closely the budget process and fluctuations in oil prices.

Directors noted with satisfaction that, despite the fall in oil prices in 1998-99, Kuwait's banking system remained strong and well supervised. They commended the authorities for their continued efforts to bring prudential regulation and bank supervision to the highest internationally accepted standards. They recommended to strengthen the regulatory infrastructure and the supervision of the stock exchange, particularly by enhancing transparency and combating insider trading. Also, passage of the foreign investment bill and acceleration of privatization would help deepen the market and enhance its liquidity.

Directors commended the authorities for pursuing an open exchange and trade system. The pegged exchange rate arrangement, backed by sizable official foreign assets and prudent fiscal and monetary policies, has continued to serve Kuwait well. They welcomed Kuwait's continued role in fostering regional economic cooeration among GCC countries.

Directors welcomed the progress that has been made in improving the quality, currentness, and coverage of economic data, and were encouraged by the continuing efforts to enhance the dissemination of economic and financial information. They encouraged the authorities to make further efforts aimed at strengthening data on national accounts, prices, public finances, and capital flows. Directors commended the authorities for their decision to participate in the General Data Dissemination System, and encouraged them to improve the presentation of fiscal accounts to enhance fiscal transparency.

Directors welcomed Kuwait's generous external financial assistance to developing countries, and the authorities' commitment to continue such assistance.