Kuwait: Crisis Complicates Reform

A robust financial sector is helping Kuwait weather the Covid storm. But the emirate’s economic future will depend on some difficult reforms.

Last month, Ahmad Nasser Al Mohammad Al Sabah, Kuwait’s minister of foreign affairs, announced the reopening of borders between Qatar and Saudi Arabia, effectively putting an end to the three-year-long embargo of Doha by many of its regional neighbors. The historic deal gave tiny Kuwait a regional diplomatic triumph—offset, however, by a troubling economic situation at home.

Like most Middle Eastern countries, Kuwait is still recovering from the dual shock of the Covid-19 pandemic and crashing energy prices. Data from the Ministry of Finance show that total revenues dropped by 48% in the first half of fiscal 2020-21 (April through September). Oil revenues—by far the country’s biggest source of income—declined by 51% over the same period, due largely to the global price drop and OPEC+ production cuts; while non-oil revenues fell 12% owing to slow economic activity. Kuwaiti authorities predict a budget deficit increase of 19% to $30 billion for the upcoming fiscal year.

Real GDP growth, as a result, is expected to contract by 7.9% in 2020, according to the World Bank. The numbers should pick up again in 2021, thanks in part to the emirate’s strong financial buffers, but Kuwait’s long-term economic outlook remains uncertain.

Widening Deficit

Kuwait’s soft spot is its heavy dependence on oil. Hydrocarbon sales account for nearly 90% of state income; and Vision 2035, the state’s economic diversification blueprint, is taking time to materialize.

Since 2014, however, falling oil prices have brought on a steady decline in state revenues. Many other countries would respond to such a difficulty by turning on the debt spigot, but Kuwait instead has carried on business as usual and covered its widening deficit with money from the General Reserve Fund (GRF), one of two funds run by the Kuwait Investment Authority sovereign wealth fund.

There are rising concerns that the GRF might soon dry up. Recent press reports suggest that its remaining liquid assets cover only a few more months of the government’s financing needs. Last August, then Finance Minister Barak Ali Al-Sheetan warned that the state could soon find it impossible to pay salaries. Last year, Moody’s and Standard & Poor’s downgraded Kuwait for the first time.

“In the continued absence of legal authorization to issue debt” Moody’s said, “available liquid resources are nearing depletion, introducing liquidity risk despite Kuwait’s extraordinary fiscal strength.”

Kuwait isn’t borrowing on local and international markets, because it lacks the legal framework to do so. Unusually for the region, Kuwait has an elected National Assembly that doesn’t shy from accusing the government of mismanaging public funds. In recent years, multiple corruption scandals have rocked the emirate, sparking popular fears that additional public resources could fall into the wrong hands. The National Assembly has therefore refused to pass a new debt law until the government can explain how it would institute reforms.

That may change as the country experiences a turnover of executive and legislative leadership. In September, Crown Prince Sheikh Nawaf Al Ahmad Al Sabah came to power as emir following the death of his brother; and in December, parliamentary elections saw two-thirds of the members lose their seat. The debt bill is likely going to be the first item on the new National Assembly’s agenda. Further complicating the situation, however, the Cabinet in January handed its resignations to Prime Minister Sheikh Sabah Al Khalid Al Sabah, raising the possibility of a second election.

Banks Provide Buffer

Even with a few more bumps in the road, Kuwait isn’t likely to go bankrupt anytime soon. It remains one of the world’s richest states thanks to the Future Generations Fund, Kuwait’s other sovereign wealth fund, estimated at close to $600 billion; prolific oil reserves; and a strong financial sector.

Banks were particularly well prepared for the Covid crisis last year, thanks to careful planning. The Central Bank of Kuwait (CBK) had been cleaning up assets; raising capital, liquidity and reserve levels; and working with major lenders to game out various stress scenarios.

“We entered the storm from a strong standpoint,” says Sulaiman Al-Marzouq, deputy CEO of National Bank of Kuwait (NBK), the country’s largest lender. “The CBK is a conservative regulator, and we’d been preparing for a crisis for the past six or seven years. Banks took on their shoulders the majority of the financial burden.”

“Kuwaiti banks are in a better position than most peers in the [GCC] to weather pressures in the current crisis,” Fitch Ratings said in a report last March.

When the first cases of coronavirus broke out in Kuwait, the CBK quickly cut its discount rate to 1.5%. In April, it rolled out a $16.5 billion stimulus package and encouraged local lenders to defer loan payments, to support key sectors of the economy. The regulator also reduced capital adequacy requirements by 2.5% and cut its credit-risk weighting requirement from 75% to 25%, allowing banks to increase their lending to small and midsize enterprises (SMEs).

“From a government standpoint, Kuwait was not in good shape to help the affected sectors; and actually—unlike in other GCC countries—I believe the banks took on that role,” says Al-Marzouq.

“Local lenders allowed a moratorium period of six months on all financing installments including waiver of profits and charges,” says Abdulwahab Al-Roshood, acting group CEO at Kuwait Finance House (KFH). “Banks were largely able to accommodate the unprecedented situation, thanks to the higher level of capital and liquidity they accumulated.”

As the dust settles, Kuwaiti banks appear relatively unharmed and ready to tackle future challenges. Most have already leveraged the pandemic to fast-track investments in digital transformation and innovation. Some are seeking international expansion through mergers and acquisitions.

“We managed to continue offering the highest levels of service to all customers while continuing with our projects and plans” says Adel Al Majed, Boubyan Bank’s vice-chairman and CEO.

Early 2020, Boubyan increased its ownership of Bank of London and Middle East (BLME), Europe’s largest Islamic bank, to 71% of ordinary issued shares.

KFH is expected to finalize its acquisition of Bahrain’s Ahli United Bank early this year; together, they will form one of the world’s biggest Islamic banks, with over $100 billion of assets.

Slow Path to Reform

The current crisis remains a serious one, however.

“The inevitable fiscal deficit increase from declining oil revenue and crisis mitigation spending and funding needs for the Future Generations Fund are exacerbating pressure on fiscal buffers, in the absence of a debt law,” the World Bank warns. “While less exposed to internationally hard-hit sectors than its GCC neighbors, long-standing rigidities will impede adjustment to the protracted Covid-19 shock.”

With little hope that oil prices will regain their pre-2014 levels, sustainable recovery implies structural reforms and some level of austerity. One of Kuwait’s biggest challenges will be to better target public sector wages and subsidies, which currently account for over 70% of public spending. New taxes, such as a value-added tax on transactions, are also under discussion.

“Continuing dependency on hydrocarbons as the main source of income has bound Kuwait to market forces beyond its control,” Bader Al-Saif, a professor at Kuwait University, says in a recent blog post from the Carnegie Middle East Center. “This reality, coupled with the constitution’s Article 41, which grants all Kuwaitis a right of work, has turned the state into the single largest employer, straining public finances.”

Kuwait’s best hope to address these issues successfully may be in the hands of a young, entrepreneurial generation and a rejuvenated small-business sector.

“Kuwait focuses on the SME sector, which is critical to promoting long-term economic diversification” says KFH’s Al-Roshood. “The latest figures reveal that this sector comprises 90% of registered companies in Kuwait.”

Kuwaiti banks “have gone a long way in supporting small projects in collaboration with competent governmental authorities, says Al Majed at Boubyan. “Currently, almost every bank has a dedicated department to offer all kinds of support to SMEs.”

In 2013, the government established a $3.5 billion fund targeting SMEs, raised to $7 billion the following year. While it remains a niche in the country’s financial establishment, accounting for less than 5% of bank lending, Kuwait already boasts a burgeoning startup scene supported by local corporates (see sidebar on ZAIN / ZINC). In 2020, Kuwait ranked fourth in the Middle East and North Africa (MENA) region in startup funding after the United Arab Emirates, Egypt and Saudi Arabia, according to Magnitt, a Dubai-based entrepreneurs’ network.

But while Kuwait’s large financial buffers give it a “window of opportunity to tackle its challenges from the position of strength,” that window is narrowing, says the International Monetary Fund. To move forward, Kuwait needs reform; and while the 2020 crisis has put pressure on all stakeholders to enact change, it remains to be seen how strong this commitment will remain as the Covid-19 crisis abates.