Mission Concluding Statement 

Kuwait: Staff Concluding Statement of the 2024 Article IV Mission

October 10, 2024

Washington, DC: Kuwait has a window of opportunity to implement needed fiscal and structural reforms to boost private sector-led inclusive growth and diversify its economy away from oil:

• Gradual fiscal consolidation of about 12 percent of GDP is needed to reinforce intergenerational equity.
• Structural reforms should focus on improving the business environment, attracting FDI, and unifying the labor market.
• These reforms should be underpinned by continued prudent monetary and financial sector policies.
• Economic statistics should be strengthened to support well-informed policymaking.

Recent Developments, Outlook, and Risks

1. Kuwait has a window of opportunity to implement needed fiscal and structural reforms. Political turmoil has gripped Kuwait in recent years, stalling reforms. The political gridlock was broken in May 2024, when H.H. the Amir Sheikh Meshaal al‑Ahmad al‑Jaber al‑Sabah dissolved the Parliament and suspended parts of the Constitution for up to 4 years, allowing reforms to be expedited.
2. The economic recovery was disrupted in 2023, and inflation is moderating. Real GDP contracted by 3.6 percent in 2023. This economic downturn was concentrated in the oil sector, which contracted by 4.3 percent in 2023 due to an OPEC+ oil production cut. In addition, the non-oil sector is estimated to have contracted by 1.0 percent in 2023, primarily reflecting lower manufacturing activity in oil refining. Headline CPI inflation declined to 3.6 percent in 2023 reflecting lower core and food inflation. More recently, headline inflation moderated further to 2.9 percent (y-o-y) in August 2024, given lower housing and transport inflation.
3. The external position remained strong in 2023. The current account surplus moderated to 31.4 percent of GDP in 2023, with a 10.3 percent of GDP reduction in the trade surplus from lower oil prices and production largely offset by a 7.4 percent of GDP increase in the income surplus. Official reserve assets amounted to a comfortable 9.0 months of projected imports at end-2023. However, the external position was substantially weaker than the level implied by fundamentals and desirable policies in 2023, partly reflecting inadequate public saving of oil revenue.
4. The fiscal balance weakened in FY2023/24. The fiscal balance of the budgetary central government swung from a surplus of 11.7 percent of GDP in FY2022/23 to a deficit of 3.1 percent of GDP in FY2023/24. This mainly reflected a 5.8 percent of GDP reduction in oil revenue given lower oil prices and production, and a 9.7 percent of GDP increase in current spending, of which 5.7 percent of GDP went to the public sector wage bill while 3.4 percent of GDP went to subsidies. Nonetheless, the fiscal balance of the general government (which includes the income from SWF investments) was an estimated 26.0 percent of GDP in FY2023/24.
5. Financial stability has been maintained. Banks have sustained strong capital and liquidity buffers to satisfy the CBK’s prudent regulatory requirements, while NPLs remain low given judicious lending practices and are well provisioned for.
6. Under the baseline assuming current policies, the economy is projected to remain in recession in 2024, then to recover over the medium term:

• Real GDP will contract by a further 3.2 percent in 2024 due to an additional OPEC+ oil production cut, then will expand by 2.8 percent in 2025 as the cuts get unwound, and will grow broadly in line with potential thereafter.
• The incipient recovery of the non-oil sector will continue in 2024, with non-oil GDP expanding by 1.3 percent despite fiscal consolidation, after which it will gradually converge to its potential of 2.5 percent.
• Headline CPI inflation will continue to moderate to 3.0 percent in 2024 as excess demand pressure dissipates and imported food prices fall, then will gradually converge to 2.0 percent as the non-oil output gap closes.
• The current account surplus will moderate further to 28.4 percent of GDP in 2024 as lower oil prices and production reduce the trade surplus, then will gradually decline over the medium term alongside oil prices.
• The fiscal deficit of the budgetary central government will increase to 5.1 percent of GDP in FY2024/25 as lower oil revenue more than offsets expenditure rationalization, then will steadily rise by about 1 percent of GDP per year over the medium term under current policies.

7. The risks surrounding these baseline economic projections are skewed to the downside. The economy is highly exposed to a variety of global risks through its oil dependence, in particular to commodity price volatility, a global growth slowdown or acceleration, and the further intensification of regional conflicts. The materialization of these risks would be transmitted to Kuwait mainly via their impacts on oil prices and production. Domestic risks are primarily associated with the implementation of fiscal and structural reforms, which could get further delayed or accelerated. These reforms are needed to diversify the economy away from oil, which would enhance its resilience and stimulate private investment.

Economic Reforms—Transitioning to a Dynamic and Diversified Economy

8. The authorities aspire to implement reforms to support the transition to a dynamic and diversified economy. To achieve this goal, a well-sequenced package of fiscal and structural reforms is needed. Structural reforms to improve the business environment and attract foreign investment are needed to boost private sector-led inclusive growth. Meanwhile, fiscal reforms should be implemented to reinforce intergenerational equity while incentivizing Kuwaitis to pursue newly created job opportunities in the private sector, in particular gradual fiscal consolidation.

Fiscal Policy—Reinforcing Intergenerational Equity

9. The contractionary stance of fiscal policy is appropriate. Fiscal policy was strongly procyclical in FY2023/24, with a fiscal expansion of 6.9 percent of non-oil GDP contributing to excess demand pressure. Under the FY2024/25 Budget, the non-oil fiscal balance of the budgetary central government should increase by 4.7 percent of non-oil GDP relative to FY2023/24. This large fiscal consolidation will help close the non-oil output gap while reinforcing intergenerational equity. It is mainly driven by current expenditure rationalization, concentrated in planned subsidy cuts worth 4.3 percent of non-oil GDP.
10. Substantial further fiscal consolidation is needed to ensure intergenerational equity. Under the baseline, the projected fiscal balance of the general government is far below the level needed to maintain the living standards of Kuwaitis for generations to come. A prudent approach calls for gradual fiscal consolidation of about 12 percent of GDP to reinforce intergenerational equity, alongside structural reforms to diversify the economy away from oil. These reforms would also reinforce external sustainability.
11. Expenditure and tax policy reforms would be needed to support the transition to a dynamic and diversified economy:

• Fiscal consolidation should be implemented at a pace of 1 to 2 percent of GDP per year until the PIH fiscal balance target is achieved. This would offset or reverse the projected roughly 1 percent of GDP per year increase in the fiscal deficit of the budgetary central government over the medium term, without reducing growth much.
• Compensation of government employees surged over the past decade, to the top of the GCC. A public sector wage setting mechanism should be introduced to gradually reduce the 41 percent premium over the private sector, while a hiring cap should be used to steadily lower the public sector employment share, both towards high-income country levels.
• Hydrocarbon consumption subsidies are the highest in the GCC. They should be phased out by gradually raising retail fuel and electricity prices to their cost-recovery levels while providing targeted transfers to vulnerable groups.
• On-budget public investment plummeted over the past decade, to near the bottom of the GCC. It should be raised to build up the quantity and quality of infrastructure towards high-income country levels.
• The hydrocarbon share of government revenue remains the highest in the GCC. In the context of the global minimum corporate tax agreement, the government’s plan to extend the CIT to all large domestic companies is welcome. To boost non-oil revenue mobilization, Kuwait should introduce the GCC-wide VAT and excise tax.

12. The conduct of fiscal policy should be strengthened with Public Financial Management reforms. To align budget planning and execution with fiscal policy objectives, the Ministry of Finance should introduce a medium-term fiscal framework—including a fiscal rules framework with a public debt ceiling and non-oil fiscal balance target—underpinned by a medium-term macroeconomic framework. To inform fiscal policymaking and assess reform proposals, the capacity of the Macro-Fiscal Unit should be strengthened. To facilitate orderly fiscal financing, the Liquidity and Financing Law should be enacted expeditiously.

Monetary and Financial Sector Policies—Maintaining Macrofinancial Stability

13. The exchange rate peg to an undisclosed basket of currencies remains an appropriate nominal anchor for monetary policy. It has supported low and stable inflation for many years. Sustaining this successful monetary policy track record requires preserving the independence of the CBK. The monetary transmission mechanism should be strengthened by deepening the interbank and domestic sovereign debt markets, establishing an efficient capital market, and phasing out interest rate caps.
14. The restrictive stance of monetary policy is appropriate. The exchange rate regime gives the CBK relative flexibility to conduct monetary policy. The policy rate is currently in line with controlling inflation and stabilizing non-oil output while supporting the exchange rate peg, and is above neutral. Under the baseline, monetary normalization is warranted, as inflation further moderates and the non-oil output gap closes.
15. Systemic risk remains contained and prudently managed. The credit cycle downturn triggered by the pandemic has been gradually unwinding, with the credit gap estimated to be nearly closed. Under the CBK’s latest stress tests, the capitalization and liquidity of the banking system generally exceeded Basel III minimum requirements, while individual bank shortcomings were limited. The stance of macroprudential policy is appropriate given contained systemic risk and subdued credit growth. Given that capital requirements exceed Basel III minimum requirements, the CBK could consider reclassifying part of its country specific capital buffer as a positive neutral countercyclical capital buffer. It should also continue its practice of regularly reviewing the adequacy of its financial regulatory perimeter and macroprudential toolkit. Finally, the CBK should continue its risk-based supervisory approach to assessing banks and effectively addressing any vulnerabilities.
16. Structural financial sector reforms are needed to enhance financial intermediation efficiency. The unlimited guarantee on bank deposits should be gradually replaced with a limited deposit insurance framework to address moral hazard, while the interest rate caps on loans should be phased out to support efficient risk pricing.

Structural Reforms—Boosting Private Sector-Led Inclusive Growth

17. A comprehensive and well-sequenced structural reform package is needed to increase non-oil potential growth. The initial priorities are to improve the business environment by enhancing transparency, raising efficiency, and further opening up the economy. Meanwhile, labor market reforms should be gradually phased in to incentivize private sector-led inclusive growth.
18. The business environment should be further improved to raise economic competitiveness and promote private investment. To boost transparency, data disclosure on secondary market real estate transactions should be enhanced, while universal auditing standards for corporate balance sheets should be adopted. To raise efficiency, the government should improve public infrastructure, conduct regulatory impact assessments with public consultations, integrate digital public service delivery across ministries, and further streamline business establishment processes. To attract FDI, full foreign ownership of businesses should be permitted, while foreign ownership restrictions on land should be relaxed. Finally, public land sales for residential and commercial development should be scaled up.
19. Major labor market reforms are needed to promote economic diversification. To incentivize Kuwaitis to seek employment in the private sector, compensation and working conditions should be better harmonized across the public and private sectors. Enhancing the quality of education and aligning it with private sector needs would raise productivity and support economic diversification. Employment of highly-skilled expatriate workers should be supported by introducing targeted visa programs and reforming job sponsorship frameworks, promoting knowledge transfer. Higher female labor force participation should be encouraged by further improving the working environment for women, including by fully implementing the legal requirements for childcare in the private sector.
20. Reforms are needed to strengthen AML/CFT effectiveness. The AML/CFT framework should be strengthened expeditiously following a risk-based approach to protect its effectiveness.
21. Progress with climate change adaptation and mitigation should be accelerated. The government has made progress with implementing the 2019 National Adaptation Plan, but is delayed in developing its mitigation plan.
22. Data provision has some shortcomings that somewhat hamper surveillance, which the authorities should address within their legal constraints. An expenditure-side National Accounts decomposition remains unavailable for 2023, while multi-year delays in the publication of GDP data after the pandemic confounded surveillance and policymaking. The CSB urgently needs additional funding to boost its capacity and resume its annual Establishment Survey, which has not been conducted since 2019. The exclusion of government investment income and SOE profit transfers from the Government Finance statistics hampers fiscal policy analysis, while the omission of government foreign assets from the IIP statistics generates stock-flow inconsistencies with the BOP statistics.

The mission thanks the authorities for their warm hospitality and constructive engagement.