Public Information Notice No. 03/02

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Kuwait

January 2, 2003

On December 13, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kuwait.¹

Background

In 2001, overall real growth fell slightly as oil output dropped following OPEC-mandated production cuts. The real non-oil GDP growth decelerated to 0.5 percent from 1 percent in 2000 as private sector investment remained broadly unchanged. Inflation remained low at less than 2 percent, reflecting little increase in import prices and a modest nominal effective appreciation of the dinar.

The macroeconomic position continued to be strong despite a decline in oil exports receipts. The overall government budget surplus moderated to about 23 percent of GDP from about 40 percent of GDP in 2000. The reduced fiscal surplus reflected, primarily, the lower oil revenue and an increase in total expenditure, mainly on current outlays. The external position also remained solid. Though smaller than in 2000, the external current account registered a large surplus equivalent to about 26 percent of GDP. There was a sharp drop in portfolio capital outflows, and the Central Bank of Kuwait's (CBK) international reserves increased to the equivalent of about 10 months of prospective imports of goods and services from 7 months in 2000.

Growth of domestic liquidity accelerated to 13 percent in 2001 from 6 percent in 2000, as credit to the private sector picked up strongly in response to low interest rates. The financial sector continued to perform well and the stock market registered sharp gains. Following trends in global financial markets, the CBK reduced its discount rate seven times in 2001 and another time in 2002, bringing the discount rate down to the present 3.75 percent with the differential of the Kuwaiti dinar deposit rate over the U.S. dollar rate remaining at the broadly historical 75 basis points. Reflecting the appreciation of the U.S. dollar, the Kuwaiti dinar appreciated in real effective terms by 5 percent in 2001.

Some progress was made during 2001 on creating the necessary institutional framework for the implementation of the structural reform package. The reform package includes measures to increase private sector investment, privatize state enterprises and utilities, allow foreigners to own 100 percent equity, open up the upstream oil sector to foreign investment under operating service agreements, reduce implicit subsidies through increases in fees and charges on government-provided services, and reform the labor market. The Kuwait Investment Authority also continued to divest government's equity holdings in telecommunications and the banking sector. Steps have been taken to encourage Kuwaiti nationals to seek employment in the private sector, through extending the social allowance available to government employees to Kuwaitis in the private sector, providing vocational training, and matching jobs with jobseekers.

The macroeconomic position is expected to remain comfortable in 2002 despite reduced oil export receipts and real non-oil GDP growth would pick up somewhat under low inflation. The fiscal and external current account surpluses are estimated to moderate further, and the CBK's net foreign assets are estimated to increase to the equivalent of 11 months of prospective imports. With the expected continued strong credit expansion to the private sector, domestic liquidity is projected to grow at about the same rate in 2002 as in 2001.

Executive Board Assessment

Executive Directors commended the Kuwaiti authorities for their continued pursuit of prudent fiscal monetary policies in an open and free and exchange and trade system. These policies have resulted in a strong macroeconomic position, and characterized by large fiscal and external current account surpluses, a stable financial system, and low inflation, despite wide fluctuations in global oil prices and a difficult external environment. While the medium-term outlook remains favorable, Directors noted that, under current policies, the Kuwaiti economy also faces a number of challenges. The fiscal and current account surpluses, while still sizeable, would likely decline over time and remain vulnerable to oil price fluctuations. The rapidly growing population may generate unemployment pressures, if non-oil growth would remain subdued. And, looking further ahead, sustaining intergenerational equity may become more difficult.

Directors commended the authorities for addressing these emerging challenges by promoting non-oil growth through structural reforms to increase the role of the private sector and foreign direct investment, further deepen and widen the financial sector, and improve labor market performance. Efforts to further strengthen the budget structure will provide welcome support to these reforms, while allowing continued growth in per capita wealth.

Directors noted the progress achieved to date in implementing the reform agenda. They encouraged the authorities to continue their efforts to broaden the consensus in favor of a sustained implementation of reforms that will send a clear signal of their commitment to accelerate the growth of the private non-oil sector. In this context, they looked forward to the early enactment of the Privatization Law and implementation of the Foreign Investment Law. Steps that would facilitate private investment include: measures to streamline rules and regulations and shift away from sector-specific interventions; and the determined implementation of the privatization program under market-based prices and effective regulatory systems. The authorities were also encouraged to consider the introduction of a nondiscriminatory, broad-based income tax on both domestic and foreign corporations.

Directors commended the authorities for their effective supervision of the financial sector, the continued strong progress toward conformity with the Basel Core Principles, and the improvements in stock market regulation. They encouraged further steps to deepen and widen the financial sector. In this regard, Directors looked forward to the early implementation of the amended Banking Law, which will allow adapting regulations to ensure continued financial stability as the economy continues to open up, as well as to the implementation of the planned, more limited deposit insurance scheme. Steps to further strengthen the capital market and improve the investment climate would include transforming the Stock Market Commission into an independent regulatory body, liberalizing the rules governing nonresident participation in the capital market, and introducing bond trading and other similar products to complement stock market operations. Directors welcomed the authorities' decision to undertake an Financial Sector Assessment Program exercise. They commended the authorities for further strengthening the comprehensive framework to combat money laundering and the financing of terrorism.

Directors supported the authorities' strategy to address emerging unemployment pressures through the development of skills that will be needed by the private sector in the period ahead. They called for a flexible application of quotas under the Kuwaitization policy to ensure competitiveness of the private sector. Looking ahead, it will be important to work toward integration of the labor market through a reduction in cost differentials between public and private sector employment, possibly in the context of comprehensive civil service reform.

Directors noted the authorities' determination to restrain government expenditure in 2002/03 and to further strengthen fiscal policy over the medium term. They encouraged continued efforts to reduce current expenditure, especially on wages and subsidies, better target social benefits, and redirect expenditure toward capital outlays. On the revenue side, consideration should be given to strengthening non-oil revenue generation, including through new tax measures such as VAT. Directors endorsed the planned shift toward a three-year rolling budget to formulate fiscal policy in a medium-term framework, and highlighted, in this context, the importance of using prudent oil price assumptions. They supported continued Fund technical assistance to facilitate the strengthening of expenditure management and revenue mobilization in Kuwait.

Directors endorsed the authorities' intention to continue to pursue a cautious monetary policy to keep inflation low and ensure the stability of the pegged exchange rate arrangement. The use of direct deposits with the CBK has helped ensure effective liquidity management, and Directors encouraged continued timely adjustments in the Central Bank's discount rates in line with changes in international rates. Directors also noted that the elimination of lending rate ceilings could facilitate lending to small- and medium-scale private enterprises. Directors generally supported the authorities' decision to peg the Kuwaiti dinar to the U.S. dollar, effective 2003, as a first step toward the Gulf Cooperation Council monetary integration, and as part of a far-reaching regional economic integration effort. They encouraged further analysis of the monetary integration process.

Directors welcomed the significant progress achieved by Kuwait on statistical issues, and encouraged the authorities to continue their efforts to improve the quality, collection, and dissemination of comprehensive data.

It is expected that the next Article IV consultation with Kuwait will take place on the standard 12-month cycle.