IMF Executive Board Concludes 2008 Article IV Consultation with KuwaitPublic Information Notice (PIN) No. 08/67
June 12, 2008
Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.
On April 18, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kuwait.1
Kuwait's macroeconomic performance has been strong in 2007 with prudent macroeconomic management supporting high growth especially in the non-oil economy. The large increase in oil revenue generated substantial fiscal and external current account surpluses, enabling the country to build up its foreign assets. Structural reforms continued, aimed at promoting a dynamic private sector driven economy and enhance incentives for bringing in foreign know-how. Inflation has been gradually picking up, reaching 7.3 percent year-on-year in October 2007, driven both by domestic demand pressures (especially rents) and higher import prices (mostly food).
Real GDP growth in 2007 is estimated at 4.6 percent. Kuwait's oil production has declined by 2.6 percent in 2007, in line with the OPEC decisions, while non-oil activity—particularly in financial, transportation, and communication services—grew by almost 9 percent per annum, benefiting from a surge in investment and expansionary macroeconomic policies.
The fiscal surplus is estimated to have increased to 40 percent of GDP in FY2007/08 (ended March 31), but is projected to narrow in FY2008/09 due to a large transfer to the Kuwait Public Institution for Social Security (KPISS) to strengthen the financial position of the public pension system, and large increases in public wages, transfers and subsidies, and capital expenditure.
Kuwait abandoned the peg to the U.S. dollar in May 2007, and has since pegged the Kuwaiti dinar (KD) to an undisclosed basket of currencies in order to dampen imported inflation related to rising world food prices and the depreciation of the U.S. dollar. The real effective exchange rate (REER) of the Kuwaiti dinar appreciated by about 2 percent in 2007, largely due to a 6 percent appreciation against the U.S. dollar and relatively higher inflation.
Broad money and credit to the private sector expanded rapidly in 2007. Within the constraints of the peg, the central bank of Kuwait sought to contain the expansion of monetary aggregates by tightening the loan-to-deposit ceiling, and to dampen capital inflows by driving down the KD interbank rate (KIBOR) below LIBOR. After a moderate correction in 2006 (12 percent), the Kuwait stock exchange (KSE) recovered strongly in 2007 with the KSE index gaining 25 percent; it fell again in early 2008 as global turbulences intensified.
Structural reforms to promote a dynamic private sector driven open economy gained momentum. The profit tax on foreign investors has been reduced from 55 percent to 15 percent and capital gains from stock investment have become exempt from tax, removing an important obstacle for the flow of foreign investment into the country. The national assembly also approved the Sale of State Properties Law. The law sets guidelines for the government to provide state land to local or foreign investors, and provides a legal basis for projects based on public-private partnerships. Parliament also approved a bill authorizing the privatization of Kuwait Airways, the first major privatization in Kuwait. The government granted licenses to three private airlines and four new private universities, and privatized a number of gas stations. Budget preparation (including the wage bill and the capital budget) has been consolidated in the ministry of finance, strengthening further the fiscal framework.
Kuwait's macroeconomic vulnerabilities remain low. As a large international creditor, Kuwait is not vulnerable to capital flow reversals, and could maintain macro-stability even if faced with a sizable drop in oil prices. To date Kuwait's financial system has weathered the recent turbulences in global financial markets rather well. Kuwait banking system is sound and available financial soundness indicators through September 2007 point to strong capitalization, asset quality, and profitability.
Executive Board Assessment
Executive Directors commended the Kuwaiti authorities' prudent macroeconomic policies and structural reform efforts which, in combination with higher oil prices, have contributed to strong growth, especially in the labor-intensive non-oil sector. Directors agreed that dealing with inflation pressures will be a priority for the near term. Vigorous implementation of the government's reform plans should help support the favorable medium-term growth prospects for both the oil and non-oil sectors.
Directors commended the Kuwaiti authorities' intention to continue to play a constructive role in the global oil market. They welcomed plans to increase oil production and refinery capacity, which would help support global oil market stability.
Directors highlighted Kuwait's strong fiscal position, which enhances the economy's resilience against shocks. Going forward, they agreed that fiscal policies must strike a delicate balance between moderating demand pressures, addressing domestic supply bottlenecks, and building up financial assets for future generations and to reduce dependence on volatile oil revenue. The wage bill and subsidies should be contained through merit-based wage increases and better-targeted social spending. Directors welcomed plans to close the actuarial deficit of the Pension Fund and recommended to build on recent improvements in budget planning and execution by adopting a medium-term budget preparation framework.
Directors welcomed the stabilizing role being played by the Kuwait Investment Authority (KIA), both domestically and in global financial markets. Some Directors saw scope for greater transparency regarding the KIA's financial position. They also encouraged the authorities to participate in the initiative to formulate a set of best practices for sovereign wealth funds. A few other Directors, however, shared the authorities' reservations regarding participation in the development of such best practices.
Most Directors agreed that the pegged exchange rate regime remains appropriate for Kuwait, and that the recent move to a basket peg may have been helpful in containing imported inflation. However, the peg limits the active use of interest rate policy, and some Directors suggested that there may be a case for reviewing the nature of the exchange rate arrangement. Directors considered that, to counter rising domestic inflationary pressures, the supply response in the nontradables sector—in particular in housing and land—will need to be enhanced, in the context of maintaining fiscal policy prudence. Containing domestic credit growth through continued supervisory vigilance will also be needed.
Regarding the real exchange rate of the Kuwaiti dinar, most Directors concurred that, while the surge in oil prices in recent years may have contributed to some undervaluation, the recent moderate currency appreciation and rising inflation are moving the real exchange rate closer to its equilibrium level. At the same time, Directors recognized the methodological difficulties surrounding the assessment of exchange rate equilibrium for oil exporting countries, and looked forward to further work on these issues.
Directors welcomed Kuwait's commitment to Gulf Cooperation Council (GCC) monetary union, but noted that its implementation by 2010 will require speeding up the building of an appropriate institutional framework. In line with the GCC common market agreement, they encouraged the authorities to work toward removing remaining obstacles to the flow of labor and capital among GCC countries. Several Directors looked forward to the forthcoming staff paper on the options for the exchange rate arrangement under the planned monetary union.
Directors noted the sound position of the banking sector, while cautioning that the rapid growth of financial investment companies calls for continued vigilance. They encouraged the authorities to complete the implementation of outstanding Financial Sector Assessment Program (FSAP) recommendations, including establishing a unified and independent capital market regulatory authority applying best international practices, and to continue and broaden regular stress testing of the overall financial sector.
Directors stressed that further structural reforms will be critical to sustain growth over the medium term, and welcomed in this context the authorities' ongoing efforts to promote private sector growth and improve the investment climate. Focusing public expenditure primarily on infrastructure and education, rather than on subsidies and transfers, would help develop human capital and create private sector employment opportunities for Kuwaiti nationals. The establishment of a strong capital market regulator, along with legal reforms to encourage competition and facilitate doing business, will help promote the private sector as the main engine of growth and employment.
Directors welcomed the authorities' intention to improve economic statistics, and encouraged them to adopt a program aimed at subscribing to the Fund's Special Data Dissemination Standard (SDDS).
Directors commended the authorities for their substantial development assistance and their active support for the Highly Indebted Poor Countries (HIPC) Initiative. They encouraged the authorities to extend HIPC debt relief to claims held by the Kuwait Investment Authority.