## 1. Addressing Risks from Real Estate Exposures Through Macroprudential Policies

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### Context and policy priorities
- Financial buffers estimated by staff at about "320 percent of GDP at end-2014."
- Government intentions and actions:
  - Smooth fiscal adjustment while supporting growth through large investment spending.
  - Reduced current expenditure in 2015, including partially abolishing diesel subsidies.
  - Committed to continuing subsidy reforms, and introducing corporate tax and wage reforms in a phased manner over the medium term.
- Status of specific staff recommendations (highlights):
  - Contain fiscal spending and reallocate toward capital; public wage reform under study; reductions in allowances; 2015/16 budget envisages increased capital expenditure; public expenditure management reform with World Bank TA.
  - Phased removal of energy and electricity subsidies: diesel and kerosene subsidies eliminated effective January 2015; gasoline subsidy reform under impact study.
  - Introducing corporate tax: government considering a proposal for business profits tax designed with Fund TA.
  - Strengthen budget framework: modernization of tax administration continues; macro-fiscal unit operational with Fund resident advisor; TA recommended a fiscal rule framework under study.
  - Establish a more formal macroprudential framework: CBK and other agencies working on crisis management framework.
  - Expand macroprudential toolkit and systemic risk monitoring: Fund TA focused on expanding toolkit; further TA envisaged; CBK undertaking periodic macro stress tests.
  - Investment companies (ICs): coordination exists between CBK and CMA but no formal committee; corporate governance guidelines to take effect June 2016.
  - Liquidity management and debt markets: CBK issuing Treasury Bills; government considering issuing domestic debt to finance the fiscal deficit.
  - Non-oil tradable sector and employment: bye-laws for foreign investment and SMEs issued; National Fund for SMEs Development established.
  - Bankruptcy law under preparation.
  - AML/CFT: Kuwait removed from FATF list of countries with strategic AML/CFT deficiencies in February 2015.

### Recent economic and financial developments
- Growth and production:
  - Non-oil growth estimated at "3.2 percent in 2014 and 3 percent in 2015 (4.2 percent in 2013)."
  - Oil production declined by "1.9 percent and 1.4 percent, respectively in 2014 and 2015."
  - Overall real GDP growth around zero in 2014–15; staff project recovery from "0.3 percent in 2015 to about 2.8 percent over the medium term."
- Inflation and prices:
  - Average inflation "increased slightly to 3 percent in 2014, and edged up to 3.8 percent in August 2015," driven mainly by housing rents.
  - As of July 2015, average residential and investment property prices fell "by 6 and 7 percent, respectively," while commercial segment prices increased "by 5 percent."
- Financial markets and banking:
  - Stock prices declined by "about 24 percent y-o-y at end-September 2015."
  - CBK discount rate unchanged at "2.0 percent."
  - Growth in banks’ deposits and credit to the private sector "edged down to 6.5 percent and 5.5 percent, respectively, in July 2015 (y-o-y)."
  - One half of banks’ local credit is to real estate; installment loans grew at "15 percent y-o-y in July 2015."
- Banking sector soundness (consolidated, end-June 2015 unless noted):
  - Capital adequacy ratio "16.9 percent (Basel III definition)."
  - Nonperforming loans ratio "2.8 percent."
  - Provisioning ratio "172 percent."
  - Banks’ return on assets and equity at end-March 2015: "1.1 percent and 8.9 percent" (comparatives: "1.0 percent and 7.4 percent in 2013").
  - Investment companies’ exposure diminished to "2.8 percent of banks’ total lending."

### Fiscal and external developments
- Fiscal balances:
  - Authorities’ presentation (after transfers to FGF of "25 percent of total revenues" and excluding investment income): fiscal balance declined to "a deficit of 4.4 percent of GDP in 2014/15 from a surplus of 11.7 percent in 2013/14."
  - IMF presentation (does not take transfers to FGF into account and includes staff estimate of investment income): overall fiscal balance narrowed to a "surplus of 17.4 percent, compared to a surplus of 34.8 percent in 2013/14."
  - Government savings from reforms: diesel and kerosene reforms and aviation fuel price increases yield estimated savings of "0.3 percent of GDP annually."
- Current account:
  - Current account surplus fell to "31.2 percent of GDP in 2014 from 39.5 percent in 2013."
- Fiscal outlook and financing:
  - Authorities’ presentation projects cumulative accounting deficit reaching "KD26.2 billion (US$94 billion)" creating financing needs of similar amount during 2015–20.
  - Government expected to continue accumulating fiscal buffers of "$35 billion during 2015-20" by adhering to fiscal rule of transferring "10 percent of total revenue to the FGF" and retaining investment income in the fund.
  - Baseline assumes spending growth contained to "about 5 percent annually" and capital spending budgeted to increase "over 20 percent this year" and projected to grow by "4 percent annually over the medium term."
  - Considered financing options: drawdown from General Reserve Fund (GRF), issuance of domestic debt, issuance of foreign currency debt abroad. Staff favored a mix of drawdown, domestic, and foreign debt and support TA on public debt management.

### Macro-financial outlook and risks
- Growth drivers and projections:
  - Investment in infrastructure and oil-sector upstream/downstream projects support non-oil growth; staff project non-oil GDP growth to be "slightly lower in 2015–16 and thereafter increase to 4 percent over the medium term."
  - Average oil production projected to increase by "2 percent a year in the medium term."
  - Average inflation projected to increase to "3.4 percent in 2015" and remain broadly stable at that level over the medium term.
  - Overall GDP recovery from "0.3 percent in 2015 to about 2.8 percent over the medium term."
- Risks and conditionalities:
  - Growth prospects hinge on efficient implementation of Development Plan 2015–19 and project execution; DP implementation under monthly cabinet monitoring and periodic parliamentary review.
  - Risks to oil upstream/downstream expansion noted, including recent loss of market share and global developments; authorities initiated an investment program to increase crude oil production capacity from "3 mbd to 4 mbd by 2020" and an oil sector investment program amounting to "about KD27 billion during 2015–20 in upstream and downstream projects."
  - Staff external assessment suggests current account is weaker than level consistent with fundamentals by "about 11 percent of GDP" under current policies; closing the gap requires achieving larger fiscal surpluses.

### Real estate, banks’ exposures, and macroprudential measures
- Banking system exposures (at end-June 2015, KD billions and shares):
  - Major exposures include direct real estate loans ("17.8"), total assets "68.6", shareholders equity "8.6", regulatory capital "7.6".
- Regulatory measures and limits:
  - Loan-To-Value (LTV) Ratio for residential property only: "50 percent for undeveloped land purchase, 60 percent for existing property purchase, 70 percent for construction use only."
  - Maximum Installment loan value (all residential properties) is "KWD 70,000" and these loans subject to a DSTI of "40% (and DSTI of 30% for retired persons)."
  - Lending to KSE Trading shares should not exceed "10% of total credit facilities portfolio extended to the resident customers, or 25% of the bank’s capital in its comprehensive concept, whichever is lower."
  - Consumer loans subject to maximum amount of "KWD 15,000" and a DSTI of "40% (and DSTI of 30% for retired persons)."
- Stress tests and resilience:
  - Banking system shows resilience with high capital and provisioning buffers; stress tests indicate limited but non-trivial aggregate risks to corporate profitability from interest rate shocks.
  - Household investments in local equity market are vulnerable to wealth effects from stock price declines; ICs face valuation losses from local equity investments.
- Macroprudential policy actions:
  - CBK is proactively monitoring and mitigating risks with macroprudential tools, expanding the macroprudential toolkit with Fund TA, and undertaking periodic macro stress tests of banks.
  - Authorities are working on establishing a framework to deal with crisis management and enhancing systemic risk monitoring; further TA envisaged to assist CBK in developing a deposit insurance mechanism.

### Banking sector resilience and stress-test findings
- Staff stress tests indicate "continued overall banking sector resilience," but "a few banks" are more sensitive and "could require additional capital under severe stress scenarios."
- Bank exposures and regulation:
  - Banks have significant real estate and equity market exposures.
  - Banks’ loans to the real estate sector were "25 percent of total loans at end-July 2015."
  - Banks’ installment loans to households for purchase of homes constituted "28 percent of total loans."
  - "40 percent of the total collateral of banks is tied to real estate."
- Macroprudential measures in place:
  - DSTI limit of "40 percent" for installment loans for residential purchases.
  - Ceiling on loan amount of "KD70,000" with maximum tenor of "15 years."
  - Capital risk weight of "100 percent" applies to installment loans.
  - LTV limits introduced in November 2013:
    - "50 percent" for purchase of undeveloped land.
    - "60 percent" for purchase of existing property.
    - "70 percent" for housing construction in residential areas.
  - Regulation not applicable to unsecured installment loans used to buy or renovate first homes.
  - Effective December 2014, phasing out of credit mitigation for real estate collateral "by 10 percent annually yearly over 5 years."
- Staff recommendation:
  - Strengthen resolution framework, macroprudential policy framework, and refine early warning system and toolkit; focus on collation of real estate indicators to monitor property market risks.

### Macro-financial downside risk from oil price decline
- A sustained decline in oil prices is a major downside risk to the medium-term outlook; financial buffers could decline under adverse oil price scenarios.
- Scenario: "A lower oil price over the medium term ($10 below WEO projections)" would:
  - "shift the overall fiscal surplus into deficit starting in 2015 (under the IMF presentation), reaching 4.2 percent by 2020."
- Combined scenario: if the $10 lower oil price shock is combined with an unchanged fiscal stance from 2014:
  - The deficit would reach "about 16 percent of GDP by 2020."
  - Resulting in a decline in financial buffers of "around KD46 billion by 2020."
- Authorities’ policy intent:
  - Maintain capital spending in the budget and reduce inefficient current expenditure to prevent stagnation of growth.
  - If oil prices decline further, focus cuts on current spending.

### Stress-testing methodology and quantitative results (Box 2)
- Sample and model:
  - Analysis based on "7 Kuwaiti banks (5 conventional and 2 Islamic)" accounting for "92 percent of total banking system assets."
  - System GMM dynamic panel approach using data from 2000 to 2014.
  - Key determinants of NPL ratios: strong autocorrelation of NPLs; statistically significant drivers include "Real Non-Oil private Sector Growth," "Real Equity Prices Growth," and "Real Estate Prices Growth (investment)."
- Stress scenarios: two scenarios (moderate and severe) for 2015–2017 combining real and financial shocks based on historical lows.
- Results (moderate scenario):
  - NPL ratio rises to "about 9.3 percent" two years after the shock.
  - Capital adequacy ratio at "16.7 percent" two years after the shock.
  - Aggregate combined capital remains above the central bank’s regulatory prescribed minimum.
- Results (severe scenario):
  - "5 out of 7 banks would fall below the prescribed regulatory minimum."
  - Additional capital requirements of the 5 banks would amount to "KD1.26 billion in 2016."
  - At aggregate level, capital adequacy ratio would fall to "9.7 percent," below the regulatory minimum standard.
- Stress-test coefficients (determinants of NPLs):
  - NPL t-1: "0.961"
  - Real Non-Oil private Sector Growth t-1 (%): "-0.027"
  - Real Equity Prices Growth t-1 (%): "-0.019"
  - Real Estate Prices Growth - Investment t-1 (%): "-0.011"
- Selected scenario table excerpts (preserved exactly from source):
  - Moderate Scenario assumptions and impacts:
    - Real non-oil private sector growth (%): "4.1-4.7"
    - Real equity price growth (%): "-15.7-22.6"
    - Real estate prices (investment) growth (%): "11.4-20.0"
    - Impact: Nonperforming loans (% of total loans): "2.9 3.6 8.5 9.3 3.6 18.1 17.7"
    - Capital adequacy ratio: "16.2 17.4 16.5 16.7 17.2 9.7 10.4"
    - Recapitalization to achieve 12.5% CAR Mn KWD: "000001,2601,044"
    - % of total assets: "000002.31.9"
    - % of 2014 GDP: "000002.62.1"

### Fiscal consolidation, composition and policy recommendations
- Urgency and fiscal gap:
  - "Gradual and sustained fiscal adjustment should commence without delay."
  - At current policies in baseline projections, fiscal balance will diverge from intergenerational equity level by "4 percent of GDP in 2015" and "about 11 percent by 2020."
  - If long-term oil prices decrease by "$10 below current levels in the medium term," the gap would rise to "over 16 percent of GDP by 2020."
- Suggested pace and sequencing:
  - An adjustment of "1 percent of GDP annually relative to the baseline over the medium term" is recommended to close the fiscal gap over a cycle of 10 years under current oil price assumptions.
  - Staff recommended starting adjustment in "2016" and emphasized sequencing to minimize impact on growth.
- Recommended measures and quantified savings:
  - Reforms combining subsidy and wage reforms, VAT and business profits tax could yield:
    - "about 1 percent of GDP in 2016" and rise "to over 7 percent of GDP by 2020."
  - Specific projected savings (Percent of GDP) from table "Kuwait: Expected Fiscal Saving from Proposed Fiscal Measures, 2015–2020":
    - Corporate tax 1/: "2015 0.0 2016 0.0 2017 1.5 2018 0.4 2019 0.8 2020 1.2"
    - VAT 2/: "2015 0.0 2016 0.0 2017 0.0 2018 1.5 2019 1.5 2020 1.5"
    - Subsidies 3/: "2015 0.0 2016 0.1 2017 0.1 2018 0.1 2019 3.7 2020 3.6"
    - Wage 4/: "2015 0.0 2016 -0.1 2017 0.2 2018 0.5 2019 0.8 2020 1.0"
    - Transfers 5/: "2015 0.0 2016 -0.5 2017 -0.4 2018 -0.4 2019 -0.4 2020 -0.3"
    - Total net saving: "2015 0.0 2016 0.4 2017 2.3 2018 3.0 2019 6.4 2020 7.0"
    - Overall balance (baseline scenario): "2015 2.8 2016 2.1 2017 4.3 2018 5.3 2019 5.1 2020 4.2"
    - Overall fiscal balance (reform scenario): "2015 2.8 2016 2.5 2017 6.6 2018 8.3 2019 11.5 2020 11.1"
    - Distance from PIH (baseline): "4.3 5.8 7.3 8.6 9.8 10.9"
    - Distance from PIH (reform): "4.3 5.4 5.0 5.6 3.4 3.9"
- Growth impact of consolidation:
  - Staff projects potential impact by 2020:
    - Revenue reform could reduce non-oil growth by "about 0.2 percent in 2020."
    - Current spending reform will reduce growth by "about 1 percent."
    - Combined impact "around 1.2 percent by 2020" and fades thereafter.
  - Fiscal stance: non-oil balance relative to non-oil GDP would improve "by about 4.7 percentage points annually during 2016-20."
- Energy price reform:
  - Estimated fiscal/quasi-fiscal cost of energy pricing at current levels: "7.2 percent of GDP in 2015."
  - Gradual reform of energy pricing, with a social safety net and communication strategy, would generate substantial savings and benefit long-term growth.
  - Planned timing mentioned by authorities:
    - Gasoline subsidy reforms "by the end of this year."
    - Electricity and water subsidy reforms expected to require legal changes; government expects to introduce to parliament "by end-2015."
- Public wage reform:
  - Proposed capping of annual salary increases at the inflation rate and containing wage bill expansion.
  - Initial cost of salary alignments: "about KD350 million (0.9 percent of 2016-GDP)," with savings backloaded and initial cost spread over two years.
  - Reform expected effective "FY 2016/17" and government plans to approve new civil service law "before end-2015."
  - Staff suggested including clauses to limit public employment growth and an escape clause to hold wage growth below inflation when warranted.
- Revenue measures:
  - Introducing a business profit tax (BPT) could increase revenues by "KD500–800 million (1.3 to 2.1 percent of 2016-GDP)."
  - Implementation of VAT could yield "an additional 1–2 percent of non-oil GDP."
  - Authorities expect to introduce a draft BPT law in the next session of the parliament; they prefer to coordinate VAT implementation with the rest of the GCC but would move alone if coordination is excessively prolonged.
- Public financial management reforms:
  - Move to top-down budgeting beginning "FY 2016/17" and to a medium-term budgeting framework starting "fiscal year 2017/18."
  - Full roll-out and implementation of the Government Financial Management Information System during "FY 2016/17."
  - Establishment of an overall Public Financial Management Committee chaired by the Minister of Finance.

### Box 3 — Subsidy Reform: fiscal and growth implications
- Short-term fiscal and opportunity costs of low energy prices:
  - On-budget costs of low energy prices (including water) were about KD3.7 billion ("7.6 percent of GDP") in 2014; 35 percent corresponds to petroleum products subsidies.
  - Opportunity cost for selling energy products at prices below international prices estimated at $12.7 billion ("7.4 percent of GDP") in 2014.
  - Lower energy prices in 2015 reduce estimated opportunity cost to $9.3 billion ("7.2 percent of GDP").
- Observed inflation pass-through in Kuwait:
  - The 100 percent diesel price increase in January 2015 does not appear to have impacted headline inflation as of May 2015 based on available data.
  - Transport prices: did not increase in January 2015, fell in March 2015, and increased slightly in May 2015 ("0.16 percent").
  - Empirical evidence indicates pass-through from shocks to CPI sub-indices to headline inflation appears moderate.
- Estimated long-term fiscal savings and GDP effects:
  - Preliminary estimates suggest net permanent savings in the range of "1.6–2.2 percent of GDP" even if consumers are fully compensated for price increases.
  - If net savings from the reform were invested, Kuwait GDP could further increase between "0.06 percent of GDP and 0.08 percent of GDP."
- Interaction with financial stability, labor market, and broader policy context:
  - CBK strengthened Basel III regulations for capital, including framework for DSIBs, liquidity, and leverage.
  - Staff recommended constant review of macroprudential measures; suggested compiling real estate indices and indicators (average and distribution of LTV and DSTI ratios).
  - Recommended reforms for nonbank sector: close monitoring, strengthened regulatory oversight, further consolidation, and a formal macroprudential coordination mechanism.
  - Structural reform needs: educational and training reforms, active labor policies, improvements in business environment and governance, foreign investment and SMEs by-laws, and fostering FDI via the Kuwait Direct Investment Promotion Authority.
- Policy implications:
  - High financial buffers provide cushion to support medium-term growth through public investment.
  - Gradual fiscal consolidation in the medium term is needed to reduce vulnerabilities and align fiscal stance with intergenerational equity while preserving growth.
  - Exchange rate policy: the peg to a basket remains appropriate as a nominal anchor; fiscal consolidation is needed to bring external balance to a level consistent with fundamentals.

### Risk Assessment Matrix — Main threats, likelihood, expected impact, and recommended policy responses
- Persistently low energy prices (Likelihood: Medium)
  - Expected impact: fiscal and external revenues fall further; private sector confidence likely to decline; government needs medium-term fiscal consolidation.
  - Recommended policy response:
    - Develop a medium-term fiscal policy framework underpinned by a medium-term macroeconomic and expenditure framework.
    - Strengthen diversification and increase private-sector employment opportunities for nationals.
    - CBK should ensure adequate liquidity in the banking system in case of an unanticipated liquidity shock.
- Sharp asset price adjustment and decompression of credit spreads (Likelihood: High)
  - Expected impact: funding, market and credit risks for ICs and banks; negative wealth effects on households; substantial bank exposure to real estate and equity markets.
  - Recommended policy response:
    - Monitor health of ICs and complete restructuring of loss-making ICs.
- Banks’ limited wholesale funding and ICs’ exposure to global/regional markets
  - Recommended policy response:
    - Establish a macroprudential framework and coordinating mechanism; further develop domestic bond market; improve investment climate; strengthen corporate governance; establish bankruptcy procedures.
- Heightened regional security risks (Likelihood: Medium)
  - Expected impact: oil price volatility; potential temporary liquidity tightening in banks; deleveraging of ICs.
  - Recommended policy response:
    - Complete IC restructuring; establish macroprudential coordination mechanism.
- Slow and inefficient implementation of Development Plan 2015–19 (Likelihood: Medium)
  - Expected impact: public expenditure misallocation and weaker productivity and growth.
  - Recommended policy response:
    - Integrate DP into medium-term fiscal framework; monitor implementation of capital expenditure; improve budget performance through public expenditure review.
- Severe property price correction (Likelihood: Low)
  - Expected impact: banks have high exposure but are highly capitalized and provisioned; macroprudential tools can mitigate risks.
  - Recommended policy response:
    - Construct real estate indices to help calibrate measures.

### Appendix I — Public Sector Debt Sustainability Analysis (selected indicators)
- Baseline Scenario — Key Indicators (in percent of GDP unless otherwise indicated):
  - Nominal gross public debt: "10.0 (2013); 3.6 (2014); 3.1 (2015); 3.2 (2016); 4.2 (2017); 3.9 (2018); 3.6 (2019); 3.3 (2020); 3.1 (2020)."
  - Public gross financing needs: "-28.1 (2013); -34.3 (2014); -34.7 (2015); -27.2 (2016); -5.3 (2017); -7.2 (2018); -8.2 (2019); -8.8 (2020); -8.3 (2020)."
  - Real GDP growth (in percent): "6.1 (2013); 7.7 (2014); 0.8 (2015); 0.1 (2016); 1.2 (2017); 2.5 (2018); 2.7 (2019); 2.7 (2020); 2.9 (2020)."
  - Inflation (GDP deflator, in percent): "9.7 (2013); 6.4 (2014); 1.5 (2015); -1.7 (2016); -24.4 (2017); 5.6 (2018); 5.7 (2019); 5.6 (2020); 4.0 (2020)."
  - Effective interest rate (in percent): "3.4 (2013); 2.2 (2014); 2.0 (2015); 2.1 (2016); 2.1 (2017); 2.8 (2018); 3.5 (2019); 3.7 (2020); 3.6 (2020)."
  - Credit ratings (Foreign / Local): "Moody's Aa2 / Aa2; S&P's AAAA / AAAA; Fitch AAAA / AAAA."
- Contribution to Changes in Public Debt (percent of GDP; selected):
  - Change in gross public sector debt: "-2.8 (2013); -1.0 (2014); -0.5 (2015); 0.2 (2016); 1.0 (2017); -0.3 (2018); -0.3 (2019); -0.3 (2020); -0.2 (2020); cumulative 0.0."
  - Identified debt-creating flows: "-2.1 (2013); -0.6 (2014); -0.1 (2015); 0.0 (2016); 1.0 (2017); -0.3 (2018); -0.3 (2019); -0.3 (2020); -0.2 (2020); cumulative -0.1."
  - Primary deficit: "-29.0 (2013); -34.7 (2014); -35.0 (2015); -27.4 (2016); -5.6 (2017); -7.6 (2018); -8.6 (2019); -9.1 (2020); -8.6 (2020); cumulative -67.0."
  - Asset accumulation: "28.6 (2013); 34.6 (2014); 34.9 (2015); 27.4 (2016); 5.5 (2017); 7.5 (2018); 7.5 (2019); 8.5 (2020); 8.5 (2020); cumulative 66.4."
- Baseline scenario assumptions (2015–2020) (selected):
  - Real GDP growth: "0.1 (2015); 1.2 (2016); 2.5 (2017); 2.7 (2018); 2.7 (2019); 2.9 (2020)."
  - Inflation (GDP deflator): "-1.7 (2015); -24.4 (2016); 5.6 (2017); 5.7 (2018); 5.6 (2019); 4.0 (2020)."
  - Primary Balance: "27.4 (2015); 5.6 (2016); 7.6 (2017); 8.6 (2018); 9.1 (2019); 8.6 (2020)."

### Appendix III — Summary of FSAP Recommendations (status as of 6/30/2015)
- Key status updates (selected):
  - Clarify regulatory and supervisory responsibilities between CBK, CMA and MOCI: "Completed" (MOU signed with Capital Markets Authority).
  - Perform periodic stress tests of real estate and other major sectoral credit risk concentrations: "Completed" (Financial Stability Office performs regular stress tests and ICAAP).
  - Extend viability assessment to all systemically important ICs: "Completed" (supervisory responsibility shifted to CMA).
  - Establish funding and operational arrangements for deposit insurance and cap coverage: "In Progress" (IMF TA provided).
  - Establish an MOU on financial crisis management between CBK, MOF, CMA, and KIA: "In Progress" (work team formed).
  - Formulate long-term plan for debt/sukuk market development: "Excluded" (within functions of CMA).
- Key financial sector findings and reforms:
  - Banking sector described as well-capitalized, well-regulated, and with high provisioning buffers.
  - Financial Stability Office established; Macroprudential Toolkit discussed with IMF includes Countercyclical buffers, Real estate index, Liquidity monitoring tools, D-SIBs.
  - Deposit insurance and resolution framework remain in progress with IMF technical assistance.
  - Stress testing and ICAAP: Financial Stability Office performs regular stress tests and ICAAP; On-site Supervision integrated ICAAP into manuals and initiated pilot examinations.
- Selected exact figures and dates:
  - Update date for FSAP recommendations: "6/30/2015."
  - CBK Circular on Supervisory Standards on Financing Companies: dated "26/01/2012."
  - CBK "Instructions concerning Rules and Standards of Corporate Governance in Banks": "20/6/2012."
  - CBK Board Resolution No. (91/377/2011), session held on "18/12/2011."
  - IMF technical assistance mission dates referenced: "from 29/4 to 11/05/2015."
  - Development Plan investment: around "KD 34 billion (2015–19 Development Plan)."
  - Staff estimated savings from reforms: "1 percent of GDP in 2016 and increase to 7 percent in 2020."
  - Stock market decline: "about 24 percent y-o-y at end-September 2015."

*Source: _cr15327 - 1. Addressing Risks from Real Estate Exposures Through Macroprudential Policies*

### 1. Addressing Risks from Real Estate Exposures Through Macroprudential Policies ______________ 11

### 1. Addressing Risks from Real Estate Exposures Through Macroprudential Policies

### Context and policy priorities
- Kuwait entered the oil price shock from a position of strength with financial buffers "estimated by staff at about 320 percent of GDP at end-2014."
- Government intentions and actions:
  - Smooth fiscal adjustment while supporting growth through large investment spending.
  - Reduced current expenditure in 2015, including partially abolishing diesel subsidies.
  - Committed to continuing subsidy reforms, and introducing corporate tax and wage reforms in a phased manner over the medium term.
- Status of specific staff recommendations (highlights):
  - Contain fiscal spending and reallocate toward capital; public wage reform under study; reductions in allowances; 2015/16 budget envisages increased capital expenditure; public expenditure management reform with World Bank TA.
  - Phased removal of energy and electricity subsidies: diesel and kerosene subsidies eliminated effective January 2015; gasoline subsidy reform under impact study.
  - Introducing corporate tax: government considering a proposal for business profits tax designed with Fund TA.
  - Strengthen budget framework: modernization of tax administration continues; macro-fiscal unit operational with Fund resident advisor; TA recommended a fiscal rule framework under study.
  - Establish a more formal macroprudential framework: CBK and other agencies working on crisis management framework.
  - Expand macroprudential toolkit and systemic risk monitoring: Fund TA focused on expanding toolkit; further TA envisaged; CBK undertaking periodic macro stress tests.
  - Investment companies (ICs): coordination exists between CBK and CMA but no formal committee; corporate governance guidelines to take effect June 2016.
  - Liquidity management and debt markets: CBK issuing Treasury Bills; government considering issuing domestic debt to finance the fiscal deficit.
  - Non-oil tradable sector and employment: bye-laws for foreign investment and SMEs issued; National Fund for SMEs Development established.
  - Bankruptcy law under preparation.
  - AML/CFT: Kuwait removed from FATF list of countries with strategic AML/CFT deficiencies in February 2015.

### Recent economic and financial developments
- Growth and production:
  - Non-oil growth estimated at "3.2 percent in 2014 and 3 percent in 2015 (4.2 percent in 2013)."
  - Oil production declined by "1.9 percent and 1.4 percent, respectively in 2014 and 2015."
  - Overall real GDP growth around zero in 2014–15; staff project recovery from "0.3 percent in 2015 to about 2.8 percent over the medium term."
- Inflation and prices:
  - Average inflation "increased slightly to 3 percent in 2014, and edged up to 3.8 percent in August 2015," driven mainly by housing rents.
  - As of July 2015, average residential and investment property prices fell "by 6 and 7 percent, respectively," while commercial segment prices increased "by 5 percent."
- Financial markets and banking:
  - Stock prices declined by "about 24 percent y-o-y at end-September 2015."
  - CBK discount rate unchanged at "2.0 percent."
  - Growth in banks’ deposits and credit to the private sector "edged down to 6.5 percent and 5.5 percent, respectively, in July 2015 (y-o-y)."
  - One half of banks’ local credit is to real estate; installment loans grew at "15 percent y-o-y in July 2015."
- Banking sector soundness (consolidated, end-June 2015 unless noted):
  - Capital adequacy ratio "16.9 percent (Basel III definition)."
  - Nonperforming loans ratio "2.8 percent."
  - Provisioning ratio "172 percent."
  - Banks’ return on assets and equity at end-March 2015: "1.1 percent and 8.9 percent" (comparatives: "1.0 percent and 7.4 percent in 2013").
  - Investment companies’ exposure diminished to "2.8 percent of banks’ total lending."

### Fiscal and external developments
- Fiscal balances:
  - Under authorities’ presentation (after transfers to Future Generations Fund (FGF) of "25 percent of total revenues" and excluding investment income): fiscal balance declined to "a deficit of 4.4 percent of GDP in 2014/15 from a surplus of 11.7 percent in 2013/14."
  - Under IMF presentation (does not take transfers to FGF into account and includes staff estimate of investment income): overall fiscal balance narrowed to a "surplus of 17.4 percent, compared to a surplus of 34.8 percent in 2013/14."
  - Government savings from reforms: diesel and kerosene reforms and aviation fuel price increases yield estimated savings of "0.3 percent of GDP annually."
- Current account:
  - Current account surplus fell to "31.2 percent of GDP in 2014 from 39.5 percent in 2013."
- Fiscal outlook and financing:
  - Authorities’ presentation projects cumulative accounting deficit reaching "KD26.2 billion (US$94 billion)" creating financing needs of similar amount during 2015–20.
  - Government expected to continue accumulating fiscal buffers of "$35 billion during 2015-20" by adhering to fiscal rule of transferring "10 percent of total revenue to the FGF" and retaining investment income in the fund.
  - Baseline assumes spending growth contained to "about 5 percent annually" and capital spending budgeted to increase "over 20 percent this year" and projected to grow by "4 percent annually over the medium term."
  - Considered financing options: drawdown from General Reserve Fund (GRF), issuance of domestic debt, issuance of foreign currency debt abroad. Staff favored a mix of drawdown, domestic, and foreign debt and support TA on public debt management.

### Macro-financial outlook and risks
- Growth drivers and projections:
  - Investment in infrastructure and oil-sector upstream/downstream projects support non-oil growth; staff project non-oil GDP growth to be "slightly lower in 2015–16 and thereafter increase to 4 percent over the medium term."
  - Average oil production projected to increase by "2 percent a year in the medium term."
  - Average inflation projected to increase to "3.4 percent in 2015" and remain broadly stable at that level over the medium term.
  - Overall GDP recovery from "0.3 percent in 2015 to about 2.8 percent over the medium term."
- Risks and conditionalities:
  - Growth prospects hinge on efficient implementation of Development Plan 2015–19 and project execution; DP implementation under monthly cabinet monitoring and periodic parliamentary review.
  - Risks to oil upstream/downstream expansion noted, including recent loss of market share and global developments; authorities initiated an investment program to increase crude oil production capacity from "3 mbd to 4 mbd by 2020" and an oil sector investment program amounting to "about KD27 billion during 2015–20 in upstream and downstream projects."
  - Staff external assessment suggests current account is weaker than level consistent with fundamentals by "about 11 percent of GDP" under current policies; closing the gap requires achieving larger fiscal surpluses.

### Real estate, banks’ exposures, and macroprudential measures
- Banking system exposures (at end-June 2015, KD billions and shares):
  - Major exposures include direct real estate loans, installment loans, equity purchase loans, and investments; total direct exposure "17.8" (real estate loans) plus other components; total assets "68.6"; shareholders equity "8.6"; regulatory capital "7.6".
  - Regulatory measures and limits:
    - Loan-To-Value (LTV) Ratio for residential property only: "50 percent for undeveloped land purchase, 60 percent for existing property purchase, 70 percent for construction use only."
    - Maximum Installment loan value (all residential properties) is "KWD 70,000" and these loans subject to a DSTI of "40% (and DSTI of 30% for retired persons)."
    - Lending to KSE Trading shares should not exceed "10% of total credit facilities portfolio extended to the resident customers, or 25% of the bank’s capital in its comprehensive concept, whichever is lower."
    - Consumer loans subject to maximum amount of "KWD 15,000" and a DSTI of "40% (and DSTI of 30% for retired persons)."
- Stress tests and resilience:
  - Banking system shows resilience with high capital and provisioning buffers; stress tests indicate limited but non-trivial aggregate risks to corporate profitability from interest rate shocks.
  - Household investments in local equity market are vulnerable to wealth effects from stock price declines; ICs face valuation losses from local equity investments.
- Macroprudential policy actions:
  - CBK is proactively monitoring and mitigating risks with macroprudential tools, expanding the macroprudential toolkit with Fund TA, and undertaking periodic macro stress tests of banks.
  - Authorities are working on establishing a framework to deal with crisis management and enhancing systemic risk monitoring; further TA envisaged to assist CBK in developing a deposit insurance mechanism.

*Source: _cr15327 - 1. Addressing Risks from Real Estate Exposures Through Macroprudential Policies*

### 12.      Stress tests conducted by staff suggest continued overall banking sector resilience. A

### _cr15327 - 12.      Stress tests conducted by staff suggest continued overall banking sector resilience. A

### Banking sector resilience and stress-test findings
- Staff stress tests indicate "continued overall banking sector resilience," but "a few banks" are more sensitive and "could require additional capital under severe stress scenarios."
- Bank exposures and regulation:
  - Banks have significant real estate and equity market exposures.
  - Banks’ loans to the real estate sector were "25 percent of total loans at end-July 2015."
  - Banks’ installment loans to households for purchase of homes constituted "28 percent of total loans."
  - "40 percent of the total collateral of banks is tied to real estate."
- Macroprudential measures in place:
  - Debt-service to income ratio (DSTI) limit of "40 percent" for installment loans for residential purchases.
  - Ceiling on loan amount of "KD70,000" with maximum tenor of "15 years."
  - Capital risk weight of "100 percent" applies to installment loans.
  - Loan-to-value (LTV) limits introduced in November 2013:
    - "50 percent" for purchase of undeveloped land.
    - "60 percent" for purchase of existing property.
    - "70 percent" for housing construction in residential areas.
  - Regulation not applicable to unsecured installment loans used to buy or renovate first homes.
  - Effective December 2014, phasing out of credit mitigation for real estate collateral "by 10 percent annually yearly over 5 years."
- Staff recommendation: strengthen resolution framework, macroprudential policy framework, and refine early warning system and toolkit; focus on collation of real estate indicators to monitor property market risks.

### Macro-financial downside risk from oil price decline
- A sustained decline in oil prices is a major downside risk to the medium-term outlook; financial buffers could decline under adverse oil price scenarios.
- Scenario: "A lower oil price over the medium term ($10 below WEO projections)" would:
  - "shift the overall fiscal surplus into deficit starting in 2015 (under the IMF presentation), reaching 4.2 percent by 2020."
- Combined scenario: if the $10 lower oil price shock is combined with an unchanged fiscal stance from 2014 (government does not tighten spending):
  - The deficit would reach "about 16 percent of GDP by 2020."
  - Resulting in a decline in financial buffers of "around KD46 billion by 2020."
- Authorities’ policy intent:
  - Maintain capital spending in the budget and reduce inefficient current expenditure to prevent stagnation of growth.
  - If oil prices decline further, focus cuts on current spending.

### Stress-testing methodology and quantitative results (Box 2)
- Sample and model:
  - Analysis based on "7 Kuwaiti banks (5 conventional and 2 Islamic)" accounting for "92 percent of total banking system assets."
  - System GMM dynamic panel approach using data from 2000 to 2014.
  - Key determinants of NPL ratios: strong autocorrelation of NPLs; statistically significant drivers include "Real Non-Oil private Sector Growth," "Real Equity Prices Growth," and "Real Estate Prices Growth (investment)."
- Stress scenarios: two scenarios (moderate and severe) for 2015–2017 combining real and financial shocks based on historical lows.
- Results (moderate scenario):
  - NPL ratio rises to "about 9.3 percent" two years after the shock.
  - Capital adequacy ratio at "16.7 percent" two years after the shock.
  - Aggregate combined capital remains above the central bank’s regulatory prescribed minimum.
- Results (severe scenario):
  - "5 out of 7 banks would fall below the prescribed regulatory minimum."
  - Additional capital requirements of the 5 banks would amount to "KD1.26 billion in 2016."
  - At aggregate level, capital adequacy ratio would fall to "9.7 percent," below the regulatory minimum standard.
- Stress-test coefficients (determinants of NPLs):
  - NPL t-1: "0.961"
  - Real Non-Oil private Sector Growth t-1 (%): "-0.027"
  - Real Equity Prices Growth t-1 (%): "-0.019"
  - Real Estate Prices Growth - Investment t-1 (%): "-0.011"
- Stress-test scenario table excerpts (selected entries preserved exactly):
  - Moderate Scenario assumptions and impacts:
    - Real non-oil private sector growth (%): "4.1-4.7"
    - Real equity price growth (%): "-15.7-22.6"
    - Real estate prices (investment) growth (%): "11.4-20.0"
    - Impact: Nonperforming loans (% of total loans): "2.9 3.6 8.5 9.3 3.6 18.1 17.7" (table layout preserved as presented).
    - Capital adequacy ratio: "16.2 17.4 16.5 16.7 17.2 9.7 10.4"
    - Recapitalization to achieve 12.5% CAR Mn KWD: "000001,2601,044"
    - % of total assets: "000002.31.9"
    - % of 2014 GDP: "000002.62.1"

### Fiscal consolidation, composition and policy recommendations
- Urgency and fiscal gap:
  - "Gradual and sustained fiscal adjustment should commence without delay."
  - At current policies in baseline projections, fiscal balance will diverge from intergenerational equity level by "4 percent of GDP in 2015" and "about 11 percent by 2020."
  - If long-term oil prices decrease by "$10 below current levels in the medium term," the gap would rise to "over 16 percent of GDP by 2020."
- Suggested pace and sequencing:
  - An adjustment of "1 percent of GDP annually relative to the baseline over the medium term" is recommended to close the fiscal gap over a cycle of 10 years under current oil price assumptions.
  - Staff recommended starting adjustment in "2016" and emphasized sequencing to minimize impact on growth.
- Recommended measures and quantified savings:
  - Reforms combining subsidy and wage reforms, VAT and business profits tax could yield:
    - "about 1 percent of GDP in 2016" and rise "to over 7 percent of GDP by 2020."
  - Specific projected savings (Percent of GDP) from table "Kuwait: Expected Fiscal Saving from Proposed Fiscal Measures, 2015–2020":
    - Corporate tax 1/: "2015 0.0 2016 0.0 2017 1.5 2018 0.4 2019 0.8 2020 1.2"
    - VAT 2/: "2015 0.0 2016 0.0 2017 0.0 2018 1.5 2019 1.5 2020 1.5"
    - Subsidies 3/: "2015 0.0 2016 0.1 2017 0.1 2018 0.1 2019 3.7 2020 3.6"
    - Wage 4/: "2015 0.0 2016 -0.1 2017 0.2 2018 0.5 2019 0.8 2020 1.0"
    - Transfers 5/: "2015 0.0 2016 -0.5 2017 -0.4 2018 -0.4 2019 -0.4 2020 -0.3"
    - Total net saving: "2015 0.0 2016 0.4 2017 2.3 2018 3.0 2019 6.4 2020 7.0"
    - Overall balance (baseline scenario): "2015 2.8 2016 2.1 2017 4.3 2018 5.3 2019 5.1 2020 4.2"
    - Overall fiscal balance (reform scenario): "2015 2.8 2016 2.5 2017 6.6 2018 8.3 2019 11.5 2020 11.1"
    - Distance from PIH (baseline): "4.3 5.8 7.3 8.6 9.8 10.9"
    - Distance from PIH (reform): "4.3 5.4 5.0 5.6 3.4 3.9"
- Growth impact of consolidation:
  - Staff projects potential impact by 2020:
    - Revenue reform could reduce non-oil growth by "about 0.2 percent in 2020."
    - Current spending reform will reduce growth by "about 1 percent."
    - Combined impact "around 1.2 percent by 2020" and fades thereafter.
  - Fiscal stance: non-oil balance relative to non-oil GDP would improve "by about 4.7 percentage points annually during 2016-20."
- Energy price reform:
  - Estimated fiscal/quasi-fiscal cost of energy pricing at current levels: "7.2 percent of GDP in 2015."
  - Gradual reform of energy pricing, with a social safety net and communication strategy, would generate substantial savings and benefit long-term growth.
  - Planned timing mentioned by authorities:
    - Gasoline subsidy reforms "by the end of this year."
    - Electricity and water subsidy reforms expected to require legal changes; government expects to introduce to parliament "by end-2015."
- Public wage reform:
  - Proposed capping of annual salary increases at the inflation rate and containing wage bill expansion.
  - Initial cost of salary alignments: "about KD350 million (0.9 percent of 2016-GDP)," with savings backloaded and initial cost spread over two years.
  - Reform expected effective "FY 2016/17" and government plans to approve new civil service law "before end-2015."
  - Staff suggested including clauses to limit public employment growth and an escape clause to hold wage growth below inflation when warranted.
- Revenue measures:
  - Introducing a business profit tax (BPT) could increase revenues by "KD500–800 million (1.3 to 2.1 percent of 2016-GDP)."
  - Implementation of VAT could yield "an additional 1–2 percent of non-oil GDP."
  - Authorities expect to introduce a draft BPT law in the next session of the parliament; they prefer to coordinate VAT implementation with the rest of the GCC but would move alone if coordination is excessively prolonged.
- Public financial management reforms:
  - Move to top-down budgeting beginning "FY 2016/17" and to a medium-term budgeting framework starting "fiscal year 2017/18."
  - Full roll-out and implementation of the Government Financial Management Information System during "FY 2016/17."
  - Establishment of an overall Public Financial Management Committee chaired by the Minister of Finance.

### Other risks and authorities’ view
- Regional geopolitical uncertainty is an additional downside risk that could impact growth and business confidence.
- Removal of sanctions on Iran’s oil exports could add downward pressure to world oil prices.
- Authorities optimistic that continued investments in mega projects will help maintain confidence, crowd in private investments and preserve growth.

*Source: IMF staff analysis from the provided content unit.*

### Box 3. Subsidy Reform in Kuwait: Long-Term Growth Benefits Outweigh

### Box 3. Subsidy Reform in Kuwait: Long-Term Growth Benefits Outweigh Short-Term Inflation Costs

### Short-term fiscal and opportunity costs of low energy prices
- On-budget costs of low energy prices (including water) were about KD3.7 billion (7.6 percent of GDP) in 2014; 35 percent corresponds to petroleum products subsidies.
- The opportunity cost for selling energy products (gasoline, diesel, natural gas, and electricity) at prices below international prices is estimated at $12.7 billion (7.4 percent of GDP) in 2014.
- Lower energy prices in 2015 reduce the estimated opportunity cost to $9.3 billion (7.2 percent of GDP).

### Regional and international reform experience
- MENA countries adopting energy price reforms include: Qatar (increased gasoline prices); Bahrain and Saudi Arabia (increased electricity tariffs for industries); Kuwait (increased diesel and kerosene prices; studying a proposal to increase electricity prices); Bahrain and Oman (increased natural gas prices for industrial users); UAE (introduced a pricing mechanism for setting fuel prices against an international benchmark).
- Non-GCC and other country examples initiating subsidy reforms include: Iran, Yemen, Egypt, Jordan, Mauritania, Morocco, Sudan, Tunisia, Malaysia, and Nigeria.

### Observed inflation pass-through in Kuwait
- The 100 percent diesel price increase in January 2015 does not appear to have impacted headline inflation as of May 2015 based on available data.
- Transport prices: did not increase in January 2015, fell in March 2015, and increased slightly in May 2015 (0.16 percent).
- Headline inflation during 2015 appears to follow the pattern observed during the second half of 2014.
- Empirical evidence indicates pass-through from shocks to the CPI sub-indices to headline inflation appears moderate; past domestic price shocks suggest a modest impact on domestic inflation if energy prices were raised in Kuwait.

### Estimated long-term fiscal savings and GDP effects
- Preliminary estimates suggest net permanent savings in the range of 1.6–2.2 percent of GDP even if consumers are fully compensated for price increases.
  - This estimate reflects:
    - Opportunity costs of 7.4 percent of GDP for subsidies on gasoline, diesel, electricity, and natural gas;
    - Price elasticity for energy consumption in the range of (-0.3, -0.5);
    - Assumption that energy prices are aligned with US pre-tax gasoline prices.
- If net savings from the reform were invested, Kuwait GDP could further increase between 0.06 percent of GDP and 0.08 percent of GDP.
- If consumers are less than fully compensated, fiscal gains from energy price reform could be larger.
- Footnotes and methodological notes:
  - The estimated opportunity cost uses as reference: gasoline and diesel US pre-tax prices published by the IEA, Henry Hub gas prices, and average electricity tariff for all sectors published by the US EIA.
  - Estimated net savings are equivalent to the deadweight loss — the loss for the society from selling products in the domestic market at prices lower than world prices, which lead to consumption levels that are higher than what would be at world prices in the context of a demand that responds negatively to prices.

### Interaction with financial stability, labor market, and broader policy context
- Financial stability and macroprudential context:
  - CBK strengthened regulations under Basel III for capital (including framework for DSIBs), liquidity, and leverage.
  - Real estate sector: loan-to-value (LTV) ratio applied since November 2013 to a segment of individuals purchasing or developing residential property; debt-service-to-income ratio (DSTI) already exists.
  - Staff recommended constant review of macroprudential measures to avoid exacerbating property price corrections while preempting buildup of real estate risks; suggested compiling real estate indices and indicators (average and distribution of LTV and DSTI ratios).
  - Recommendations for nonbank sector: close monitoring, strengthened regulatory oversight, further consolidation, and a formal macroprudential coordination mechanism encompassing nonbank financial institutions with: (i) assigned macroprudential mandate and delineation of powers; (ii) formal financial stability coordination committee headed by the central bank and comprising all financial system regulators; (iii) appropriate accountability mechanisms; (iv) legal requirement for exchange of information.
- Labor market and diversification context:
  - Staff projections: growth in the number of new labor market entrants rises every year; with less than a quarter of new entrants expected to find jobs in the private sector, the government faces a trade-off between absorbing entrants (raising the wage bill) or higher unemployment among nationals.
  - Empirical analyses suggest complementarities between expatriate and national labor and a low degree of substitutability due to major differences in skill composition, wage structures, and sectors of work; heavy reliance on expatriates should be reduced gradually alongside skills development of nationals.
  - Structural reform needs: educational and training reforms, active labor policies to improve skills, pay and productivity in the private sector, improvements in business environment and governance, foreign investment and SMEs by-laws, streamlining registration and licensing, and fostering FDI via the Kuwait Direct Investment Promotion Authority.
- Nonfinancial corporate sector:
  - Ex-post profitability (return on assets) has remained stable but at low levels compared with peers; lower price to earnings ratios may reflect weaker confidence in Kuwait’s business environment.
  - Recommended reforms: deepen asset markets, improve investment climate and reduce costs of doing business, increase privatization, strengthen corporate governance and anti-corruption, establish bankruptcy procedures, and improve data availability to investors.

### Implications for fiscal consolidation and macro policy
- High financial buffers provide cushion to support medium-term growth through public investment.
- Growth outlook: recovery from 0.3 percent in 2015 to about 2.8 percent over the medium term as oil production is projected to increase by 2 percent a year; non-oil sector growth projected to increase to 4 percent over the medium term.
- Gradual fiscal consolidation in the medium term is needed to reduce vulnerabilities and align the fiscal stance with intergenerational equity considerations while preserving growth; delays would worsen fiscal position and require larger future adjustments.
- Measures to achieve desirable fiscal position include:
  - Containing expenditure growth via wage reform and continued subsidy reform;
  - Prioritizing and improving efficiency of capital expenditure;
  - Expanding non-oil revenues via business profits tax and value added tax;
  - Establishing a medium-term budget framework integrated with the macroeconomic framework and improving public financial management.
- Exchange rate policy:
  - The peg to a basket remains appropriate as a nominal anchor.
  - Fiscal consolidation is needed to bring external balance to a level consistent with fundamentals and support the peg over the long-term.
  - As the economy diversifies, more exchange rate flexibility might become appropriate.

*Source: IMF staff analysis as presented in Box 3 of the Kuwait staff report.*

### 39.      It is recommended that the next Article IV consultation takes place on the standard 12-month

### It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

### Recommendation
- It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

### Risk Assessment Matrix — Main threats, likelihood, expected impact, and recommended policy responses
- Persistently low energy prices triggered by supply factors reversing only gradually, and weaker demand.
  - Likelihood of Risk: Medium
  - Expected impact on the economy if risk is realized:
    - Fiscal and external revenues would fall further, and private sector confidence is likely to decline.
    - Economic, credit, and asset price cycles move closely with oil price developments. The impact of oil prices on government revenues and expenditures could affect liquidity and credit growth in the banking system, but strong starting liquidity position of banks would help ensure a stable funding base.
    - The substantial fiscal and financial buffers built-up by Kuwait would allow the government to avoid knee-jerk cuts in government spending. However, with the decline in oil prices expected to persist, the government will need to commence implementing medium-term fiscal consolidation to bring spending into line with lower revenues. If prices decline further on a sustained basis, the consolidation will need to be faster and deeper.
  - Recommended Policy Response:
    - Develop a medium-term fiscal policy framework that is underpinned by a medium-term macroeconomic framework and a medium-term expenditure framework.
    - Strengthen efforts toward diversification to reduce oil dependence and increase employment opportunities for nationals in the private sector.
    - The CBK should ensure adequate liquidity in the banking system in case of an unanticipated liquidity shock.

- Sharp asset price adjustment and decompression of credit spreads.
  - Likelihood of Risk: High
  - Expected impact on the economy if risk is realized:
    - Surges in market volatility and increased financial market distortions could pose funding, market and credit risks for ICs and banks.
    - The local equity market can be affected by adverse movements in global financial conditions, imposing negative wealth effects on households’ investments in local stocks. The real estate market is driven mainly by local demand-supply conditions, including land availability.
    - Banks’ exposure to the real estate and local equity market remains considerable.
  - Recommended Policy Response:
    - Monitor the health of ICs and complete the restructuring of loss making ICs.

- (Continuation across RAM pages) Banks have limited, though increasing, wholesale funding, and foreign assets in the form of bank deposits and investments. ICs have large exposures to global and regional financial and real estate markets, and continue to be dependent on foreign financing. The Kuwait Investment Authority (KIA) also has substantial foreign investments, but the impact on KIA’s assets is expected to be manageable. The nonfinancial corporate sector would get affected to the extent bank credit slows down and consumers reduce demand.
  - Recommended Policy Response:
    - Establish a macroprudential framework and a coordinating mechanism to assess incipient systemic risks, and adjust macroprudential policies as needed to limit risks to the financial system.
    - Further develop the domestic bond market to provide corporates with alternate means of financing and investment, improve the domestic investment climate, reduce costs of doing business in Kuwait, strengthen corporate governance, and establish bankruptcy procedures, to strengthen the corporate sector.

- Heightened risk of fragmentation/state failure/security dislocation in the Middle East and some countries in Africa, leading to a sharp rise in oil price volatility and migrant flows, with negative global spillovers.
  - Likelihood of Risk: Medium
  - Expected impact on the economy if risk is realized:
    - Oil prices could increase as a result of heightened tensions and conflict in the Middle East and create a positive impact on fiscal and current account balances.
    - Disruptions in global financial markets could lead to temporary liquidity tightening in banks, force further deleveraging of ICs, and reduce credit growth of banks.
  - Recommended Policy Response:
    - Complete the restructuring process of loss-making ICs.
    - Establish a macroprudential framework and a coordinating mechanism to assess incipient risks and adjust macroprudential policies as needed to limit risks to the financial system.

- Slow and inefficient implementation of the Development Plan (DP) 2015–19.
  - Likelihood of Risk: Medium
  - Expected impact on the economy if risk is realized:
    - Public expenditure misallocation and inefficiency would affect incentives and overall productivity and growth.
  - Recommended Policy Response:
    - Integrate the DP into a medium-term fiscal framework to ensure continued implementation.
    - Monitor the implementation of capital expenditure.
    - Improve performance of the budget through a public expenditure review to support prioritization of public spending and strengthen anti-corruption efforts.

- Severe property price correction
  - Likelihood of Risk: Low
  - Expected impact on the economy if risk is realized:
    - Banks have high exposure to the real estate sector but are highly capitalized and provisioned to absorb severe shocks.
    - Macroprudential tools can help mitigate potential risks.
  - Recommended Policy Response:
    - Construct real estate indices to help calibrate measures.

### RAM explanatory note
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

*Source: IMF staff report text.*

### Appendix I. Public Sector Debt Sustainability Analysis

### Appendix I. Public Sector Debt Sustainability Analysis

### Baseline Scenario — Key Indicators (in percent of GDP unless otherwise indicated)
- Nominal gross public debt: 10.0 (2013); 3.6 (2014); 3.1 (2015); 3.2 (2016); 4.2 (2017); 3.9 (2018); 3.6 (2019); 3.3 (2020); 3.1 (2020)
- Public gross financing needs: -28.1 (2013); -34.3 (2014); -34.7 (2015); -27.2 (2016); -5.3 (2017); -7.2 (2018); -8.2 (2019); -8.8 (2020); -8.3 (2020)
- Real GDP growth (in percent): 6.1 (2013); 7.7 (2014); 0.8 (2015); 0.1 (2016); 1.2 (2017); 2.5 (2018); 2.7 (2019); 2.7 (2020); 2.9 (2020)
- Inflation (GDP deflator, in percent): 9.7 (2013); 6.4 (2014); 1.5 (2015); -1.7 (2016); -24.4 (2017); 5.6 (2018); 5.7 (2019); 5.6 (2020); 4.0 (2020)
- Nominal GDP growth (in percent): 16.8 (2013); 14.6 (2014); 2.3 (2015); -1.5 (2016); -23.5 (2017); 8.2 (2018); 8.6 (2019); 8.5 (2020); 7.0 (2020)
- Effective interest rate (in percent): 3.4 (2013); 2.2 (2014); 2.0 (2015); 2.1 (2016); 2.1 (2017); 2.8 (2018); 3.5 (2019); 3.7 (2020); 3.6 (2020)
- Sovereign spreads: EMBIG (bp) — na; 5Y CDS (bp) — na
- Credit ratings (Foreign / Local): Moody's Aa2 / Aa2; S&P's AAAA / AAAA; Fitch AAAA / AAAA

### Contribution to Changes in Public Debt (percent of GDP; selected years and cumulative)
- Change in gross public sector debt: -2.8 (2013); -1.0 (2014); -0.5 (2015); 0.2 (2016); 1.0 (2017); -0.3 (2018); -0.3 (2019); -0.3 (2020); -0.2 (2020); cumulative 0.0
- Identified debt-creating flows: -2.1 (2013); -0.6 (2014); -0.1 (2015); 0.0 (2016); 1.0 (2017); -0.3 (2018); -0.3 (2019); -0.3 (2020); -0.2 (2020); cumulative -0.1
  - Primary deficit: -29.0 (2013); -34.7 (2014); -35.0 (2015); -27.4 (2016); -5.6 (2017); -7.6 (2018); -8.6 (2019); -9.1 (2020); -8.6 (2020); cumulative -67.0
  - Primary (noninterest) revenue and grants: 65.1 (2013); 72.1 (2014); 71.8 (2015); 68.5 (2016); 57.4 (2017); 56.1 (2018); 55.8 (2019); 55.1 (2020); 54.0 (2020); cumulative 346.9
  - Primary (noninterest) expenditure: 36.2 (2013); 37.4 (2014); 36.8 (2015); 41.1 (2016); 51.8 (2017); 48.6 (2018); 47.2 (2019); 46.0 (2020); 45.3 (2020); cumulative 279.9
- Automatic debt dynamics (total): -1.8 (2013); -0.5 (2014); 0.0 (2015); 0.1 (2016); 1.1 (2017); -0.2 (2018); -0.2 (2019); -0.2 (2020); -0.1 (2020); cumulative 0.5
  - Interest rate/growth differential: -1.8 (2013); -0.5 (2014); 0.0 (2015); 0.1 (2016); 1.1 (2017); -0.2 (2018); -0.2 (2019); -0.2 (2020); -0.1 (2020); cumulative 0.5
    - Of which: real interest rate: -0.8 (2013); -0.2 (2014); 0.0 (2015); 0.1 (2016); 1.1 (2017); -0.1 (2018); -0.1 (2019); -0.1 (2020); 0.0 (2020); cumulative 1.0
    - Of which: real GDP growth: -1.0 (2013); -0.3 (2014); 0.0 (2015); 0.0 (2016); 0.0 (2017); -0.1 (2018); -0.1 (2019); -0.1 (2020); -0.1 (2020); cumulative -0.4
  - Exchange rate depreciation: 0.0 (2013); 0.0 (2014); 0.0 (2015)
- Other identified debt-creating flows: 28.6 (2013); 34.6 (2014); 34.9 (2015); 27.4 (2016); 5.5 (2017); 7.5 (2018); 7.5 (2019); 8.5 (2020); 8.5 (2020); cumulative 66.4
  - Privatization (negative): 0.0 (all years listed)
  - Contingent liabilities: 0.0 (all years listed)
  - Asset accumulation: 28.6 (2013); 34.6 (2014); 34.9 (2015); 27.4 (2016); 5.5 (2017); 7.5 (2018); 7.5 (2019); 8.5 (2020); 8.5 (2020); cumulative 66.4
- Residual, including asset changes: -0.7 (2013); -0.5 (2014); -0.5 (2015); 0.1 (2016); 0.0 (2017); 0.0 (2018); 0.0 (2019); 0.0 (2020); 0.0 (2020); cumulative 0.1

Notes from the table:
- Public sector is defined as general government.
- Effective interest rate is defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.
- Automatic debt dynamics derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation.
- Real interest rate contribution derived as r - π (1+g); real growth contribution derived as -g.
- Exchange rate contribution derived as ae(1+r).
- Residual includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.
- "Debt-stabilizing primary balance" assumes key variables remain at the level of the last projection year.

### Composition of Public Debt and Alternative Scenarios — Underlying Assumptions (selected)
- Baseline scenario assumptions (2015–2020):
  - Real GDP growth: 0.1 (2015); 1.2 (2016); 2.5 (2017); 2.7 (2018); 2.7 (2019); 2.9 (2020)
  - Inflation (GDP deflator): -1.7 (2015); -24.4 (2016); 5.6 (2017); 5.7 (2018); 5.6 (2019); 4.0 (2020)
  - Primary Balance: 27.4 (2015); 5.6 (2016); 7.6 (2017); 8.6 (2018); 9.1 (2019); 8.6 (2020)
  - Effective interest rate: 2.1 (2015); 2.1 (2016); 2.8 (2017); 3.5 (2018); 3.7 (2019); 3.6 (2020)
- Historical scenario assumptions (2015–2020):
  - Real GDP growth: 0.1 (2015); 4.6 (2016); 4.6 (2017); 4.6 (2018); 4.6 (2019); 4.6 (2020)
  - Inflation (GDP deflator): -1.7 (2015); -24.4 (2016); 5.6 (2017); 5.7 (2018); 5.6 (2019); 4.0 (2020)
  - Primary Balance: 27.4 (2015); 31.3 (2016); 31.3 (2017); 31.3 (2018); 31.3 (2019); 31.3 (2020)
  - Effective interest rate: same as baseline
- Constant Primary Balance scenario (2015–2020):
  - Real GDP growth: same as baseline
  - Inflation (GDP deflator): same as baseline
  - Primary Balance: 27.4 (each year)
  - Effective interest rate: same as baseline

### Projections and Graphical Indicators (summarized)
- Gross nominal public debt (in percent of GDP) plotted 2013–2020 under Baseline, Historical, and Constant Primary Balance scenarios (table/figure provided in source).
- Public gross financing needs (in percent of GDP) plotted 2013–2020 (figure provided).
- Debt maturity composition (By Maturity): medium and long-term vs short-term (plot 2004–2020).
- Debt currency composition (By Currency): local currency-denominated vs foreign currency-denominated (plot 2004–2020).

*Source: IMF staff.*

### Appendix III. Summary of FSAP Recommendations

### Appendix III. Summary of FSAP Recommendations

### Recommendation status updates (as of 6/30/2015)
- 1. Clarify regulatory and supervisory responsibilities for financial institutions between the CBK, CMA and MOCI and initiate coordination for transition process to new oversight architecture.
  - Status: Completed
  - Update: A Memorandum of Understanding (MOU) was signed with Capital Markets Authority. Amendments to be made to the MOU in respect of the joint issues between Ministry of Commerce and Industry and Central Bank of Kuwait, are under consideration.
- 2. Perform periodic stress tests of real estate and other major sectoral credit risk concentrations and review existing assessment of the way banks consider these risk concentrations in their ICAAP.
  - Status: Completed
  - Update: The Financial Stability Office performs regular stress tests and ICAAP on all Kuwaiti banks. The Supervision Sector revises stress tests and ICAAP prepared by banks.
- 3. Extend viability assessment to all systemically important ICs.
  - Status: Completed
  - Update: Supervisory responsibility on the investment companies was shifted to the Capital Markets Authority; CBK informed CMA to take necessary action. CBK issued Circular on Supervisory Standards on Financing Companies dated 26/01/2012.
- 4. Complete integration of ICAAP in an on-site manual and start on-site examination on ICAAP in one bank as a pilot project.
  - Status: Completed
  - Update: On-site Supervision Department prepared a manual including ICAAP. A professional team was formed to lay down an inspection program to examine local banks' ICAAP.
- 5. Finalized qualitative and quantitative staffing enhancement program for the banking supervision department.
  - Status: Completed
  - Update: The qualitative and quantitative capabilities of all staff working in the Supervision Sector shall be developed on regular basis.
- 6. Enhance framework for macroprudential surveillance by establishing the FSU and initiate integrated supervision of systematically important sectors.
  - Status: Completed
  - Update: Financial Stability Office was established. Macroprudential Toolkit was discussed with the IMF during technical assistance mission (from 29/4 to 11/05/2015). The toolkit included (1) Countercyclical buffers (2) Real estate index (3) Liquidity monitoring tools (4) D-SIBs.
- 7. Strengthen corporate governance rules by applying "fit and proper" test on board and management of new conventional banks.
  - Status: Completed
  - Update: Article (68) of Law NO. (32) of 1968 and a CBK Board resolution set conditions for Board Members and executive authority.
- 8. Issue directive on conflict of interest requiring board members and senior management and staff to abstain from participating in decisions on credit granting in their favor and reduce the individual and aggregate limit for credit to related parties.
  - Status: Completed
  - Update: CBK issued "Instructions concerning Rules and Standards of Corporate Governance in Banks" on 20/6/2012. Follow-up is coordinated between On-Site and Off-site Supervision.
- 9. Continue the migration process from compliance-based supervision to risk-based supervision.
  - Status: Completed
  - Update: Risk-based supervision system implemented in the Supervision Sector in both on-site inspections and Off-site Surveillance System (OSS).
- 10. Introduce quantitative and qualitative regulation to better monitor ICs' financial soundness and improve corporate governance. Develop new licensing regime for ICs.
  - Status: Completed
  - Update: A comprehensive study prepared evaluating and classifying investment companies by six qualitative factors (Stage One). Since investment companies are no longer supervised by CBK, (Stage Two) corporate governance instructions for Finance companies issued in September 2013.
- 11. Establish funding and operational arrangements for deposit insurance and cap coverage.
  - Status: In Progress
  - Update: IMF is providing Technical Assistance on this issue. (deposit insurance and resolution framework)
- 12. Establish an MOU on financial crisis management between key agencies such as the CBK, MOF, CMA, and KIA.
  - Status: In Progress
  - Update: A work team from CBK including the Financial Stability Office, Supervision Sector, Economic Research Department, Foreign Operations Department and the Legal Office was formed.
- 13. Consider widening collateral acceptance for ELA operations.
  - Status: Completed
  - Update: Collateral acceptance was widened for Emergency Lending Assistance operations under CBK Board Resolution No. (91/377/2011) in session held on 18/12/2011. The list of guarantees issued under CBK Board Resolution dated 17/02/1979 was annulled.
- 14. Establish a special resolution regime that sets out a set of distinct bankruptcy.
  - Status: In Progress
  - Update: IMF is providing Technical Assistance on this issue. (deposit insurance and resolution framework)
- 15. Formulate long-term plan for debt/sukuk market development, and start implementing it with a short-term market.
  - Status: Excluded
  - Update: Excluded because of being within the functions of Capital Markets Authority.

### Key financial sector findings and reforms (extracted from the staff report)
- Banking sector resilience and supervision
  - The banking sector is described as well-capitalized, well-regulated and with high provisioning buffers.
  - Banks are under Basel III regulations for capital, including a framework for domestic systemically important banks, liquidity, and leverage.
  - Banks are subject to loan-to-value and debt-service-to-income ratios in the real estate sector.
  - CBK is continuously strengthening regulations and macroprudential tools and stands ready to address risks.
- Macroprudential and supervisory institutions and tools
  - Financial Stability Office established; Macroprudential Toolkit discussed with IMF includes Countercyclical buffers, Real estate index, Liquidity monitoring tools, and D-SIBs.
  - Formal macroprudential coordination mechanism recommended to identify systemic risks from nonbank financial institutions.
- Resolution, deposit insurance, and nonbank supervision
  - Deposit insurance and resolution framework remain in progress with IMF technical assistance.
  - Investment companies now supervised by Capital Markets Authority; corporate governance instructions for finance companies issued September 2013.
- Governance, AML/CFT, and anti-corruption
  - Continued progress in strengthening AML/CFT; FATF removed Kuwait from monitoring list.
  - Anti Corruption Authority bylaws issued and Authority recently made operational.
- Stress testing and ICAAP
  - Financial Stability Office performs regular stress tests and ICAAP on all Kuwaiti banks; On-site Supervision integrates ICAAP in manuals and initiated pilot examinations.

### Fiscal and macroeconomic context (staff findings and authorities' overview)
- Oil and growth
  - Kuwait is an important oil producer negatively impacted by the sharp decline in oil prices during the second half of 2014.
  - Non-oil GDP grew at about 3 percent in 2014 and the trend expected to continue in 2015.
- Fiscal balances and reforms
  - The fiscal balance turned into a deficit of 4.4 percent of GDP in 2014/15 from a surplus of 11.7 percent in the previous year.
  - Government's 2015–19 Development Plan entails investments of around KD 34 billion.
  - Planned revenue and spending measures under consideration include subsidy and wage reforms and introducing VAT and a business profits tax, with associated savings estimated by staff to amount to 1 percent of GDP in 2016 and increase to 7 percent in 2020.
  - Implementation of planned measures expected to improve the non-oil primary balance by about 20 percentage points over the medium term.
  - Budget process reforms: move to top-down budgeting in FY 2016/17 and medium-term budgeting in FY 2017/18; planned establishment of a Public Financial Management Committee and implementation of the Government Financial Management Information System.
- Financial markets and external sector
  - Stock market index declined by about 24 percent y-o-y at end-September 2015.
  - The 2014/15 fiscal and external balances deteriorated after the collapse in oil prices.
- Labor market and diversification
  - Public sector is main employer of nationals with higher wages than private sector, creating a dual labor market.
  - 2015–19 Development Plan aims to: support private investment, establish National Fund for SMEs Development, raise mandatory national labor ratios, and advance privatization.
  - World Bank technical assistance: new Labor Market Information System to improve matching of supply and demand.

### Statistical and data issues
- General assessment
  - Data provision has shortcomings but is broadly adequate for surveillance; timeliness, particularly for national and fiscal accounts, is a concern.
- National accounts and prices
  - Base year changed to 2010; improvements in value added estimation for public utilities sector; priority to produce quarterly national accounts.
  - CPI weights based on 2007 household expenditure survey; improved monthly CPI published with about a one-month lag.
  - PPI development ongoing and expected to be published by end-2014.
- Government finance and public sector data
  - Annual GFS data reported for GFSY, but major components of extrabudgetary revenues/expenditures and operations of two reserve funds are not reported.
  - Data on operations of the Public Institute for Social Security are not made available.
  - Authorities moving toward a new chart of accounts and accrual reporting.
- Monetary and external statistics
  - CBK reports monetary data to STA on SRFs regularly and timely.
  - Investment companies that accept deposits need reclassification as depository corporations where appropriate.
  - CBK compiles and disseminates annual BOP data in BPM6; trade data monthly estimates and quarterly from 2013; some gaps in capital flows of the nonfinancial private sector and in coverage of general government external asset holdings.
- Data dissemination and standards
  - Kuwait is an early GDDS participant; most metadata not updated since October 2002 except real sector and socio-demographic metadata.
  - CBK, Ministry of Planning, and Ministry of Finance publish a range of statistics on their webpages.

### Selected exact figures and dates from the source
- Update date for FSAP recommendations: 6/30/2015
- CBK Circular on Supervisory Standards on Financing Companies: dated 26/01/2012
- CBK "Instructions concerning Rules and Standards of Corporate Governance in Banks": 20/6/2012
- CBK Board Resolution No. (91/377/2011), session held on 18/12/2011
- CBK Board Resolution dated 17/02/1979 (annulled list of guarantees)
- IMF technical assistance mission dates referenced: from 29/4 to 11/05/2015
- Fiscal balance: deficit of 4.4 percent of GDP in 2014/15; surplus of 11.7 percent in previous year
- Development Plan investment: around KD 34 billion (2015–19 Development Plan)
- Staff estimated savings from reforms: 1 percent of GDP in 2016 and increase to 7 percent in 2020
- Expected improvement in non-oil primary balance: about 20 percentage points over the medium term
- Non-oil GDP growth: about 3 percent in 2014
- Stock market decline: about 24 percent y-o-y at end-September 2015

*Appendix III. Summary of FSAP Recommendations — Updates as of 6/30/2015; extracted from the Kuwait staff report and informational annex (November 4, 2015).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15327.pdf_