Mission Concluding Statement 

Kuwait: Staff Concluding Statement of the 2023 Article IV Mission

June 5, 2023

Washington, DC: Benefiting from high oil production and prices, Kuwait’s economic recovery continues. Inflation has been contained, while the fiscal and external balances have strengthened, and financial stability has been maintained. The dominance of oil in the economy, coupled with global decarbonization trends, necessitates fiscal reforms to reinforce sustainability, and structural reforms to boost non-oil private sector-led growth. Political gridlock between the government and Parliament has hindered reform progress, which could be made now from a position of strength.

Recent Developments, Outlook, and Risks

1.The economy has largely recovered from the pandemic. Growth is estimated to have surged to 8.2 percent in 2022, up from 1.3 percent in 2021, primarily driven by high oil production and prices. Non-oil growth is estimated to have risen to a brisk 4.0 percent in 2022, up from 3.4 percent in 2021, reflecting strong domestic demand. Inflation has been contained, given limited pass-through from higher global food and energy prices due to administered prices and subsidies, as well as monetary policy tightening broadly following major central banks. Since peaking at 4.7 percent in April 2022, annual headline CPI inflation has been on a downwards trend, reaching 3.7 percent in April 2023.

2.The fiscal and external balances have strengthened on the back of higher oil revenues. The overall fiscal surplus is estimated by Fund staff to have surged to 22.5 percent of GDP in 2022, up from 6.4 percent of GDP in 2021. In parallel, the current account surplus is estimated to have risen to 33.0 percent of GDP in 2022, up from 26.6 percent of GDP in 2021. Moreover, official reserve assets increased to US$48.2 billion (10.3 months of prospective imports) at end-2022, and adequately cover balance of payments financing risks. Nevertheless, the external position in 2022 is assessed as weaker than the level implied by fundamentals and desirable policies, largely due to insufficient public saving of the oil revenue windfall.

3.Financial stability has been maintained. Banks continue to be well capitalized and liquid—comfortably exceeding prudential regulatory requirements—while non-performing loans remain low. Growth in credit to the private sector continues to be strong, despite measured policy rate hikes by the Central Bank of Kuwait (CBK) totaling 250 basis points since the global monetary policy tightening cycle began last year. The impact of global banking sector turbulence on Kuwait’s banks has been limited, reflecting their domestically or regionally oriented business models and strong prudential oversight by the CBK.

4.The political gridlock between the government and Parliament continued. On January 23, the government resigned due to its power struggle with Parliament. On March 5, the Crown Prince reappointed the Prime Minister and tasked him to form a new Cabinet. On April 9, a new Cabinet was formed. On May 1, the Amir dissolved Parliament by royal decree and called for a general election. On June 6, a general election will be held.

5.Real GDP growth is moderating. In 2023, growth is projected to fall to 0.1 percent, reflecting agreed OPEC+ oil production cuts and slower external demand growth. Nevertheless, non-oil growth is projected to remain robust at 3.8 percent, due to fiscal stimulus and a partial rebound in expatriate employment, despite slower real credit growth. Inflation will remain contained as the economic recovery slows down, reinforced by lower global food and energy prices. The overall fiscal and current account surpluses will fall in 2023, reflecting the fiscal expansion and lower oil revenues.

6.Elevated risks surround the economic outlook. Volatility in oil prices and production arising from global factors poses two-sided risks to growth and inflation, as well as to the fiscal and external balances. A deeper global growth slowdown—possibly caused by further monetary policy tightening or banking sector stress in major advanced economies—would adversely impact Kuwait’s economy. As for domestic risks, delays in needed fiscal and structural reforms could give rise to procyclical fiscal policy and undermine investor confidence, while hindering progress towards diversifying the economy and enhancing its competitiveness. On the upside, a resolution to the political gridlock could accelerate needed fiscal and structural reforms, boosting investor confidence and stimulating private investment.

Fiscal Policy—Supporting the Recovery and Reinforcing Sustainability

7.Fiscal stimulus will support the recovery, but fiscal consolidation is needed soon. The draft FY2023/24 Budget envisages a large fiscal expansion, concentrated in higher current spending on the public sector wage bill, as well as subsidies and social benefits. The associated fiscal stimulus will help close the non-oil output gap (deviation of non-oil output from its potential), which is estimated at -1.7 percent in 2023. Indeed, the overall fiscal surplus is projected by Fund staff to drop to 6.9 percent of GDP in 2023, and to fall steadily thereafter into deficit over the medium term. Beyond FY2023/24, fiscal consolidation is needed to reverse this projected trend, thereby reinforcing long-run fiscal sustainability and supporting intergenerational equity.

8.Substantial fiscal consolidation based on both expenditure and non-oil revenue measures will be needed. To reduce current spending, it is critical to rationalize the public sector wage bill, as well as to gradually phase out large energy subsidies while replacing them with targeted income support to vulnerable households. To raise non-oil revenue, a 5 percent value-added tax should be introduced, while excises on tobacco and sugary drinks should be levied, as agreed with other GCC countries in 2015-16. In addition, the 15 percent corporate income tax should be expanded to cover domestic firms, which would bring Kuwait into conformity with the OECD-led global minimum corporate tax agreement for multinationals. Part of the resultant fiscal savings could be allocated towards needed investments in transport and renewable energy infrastructure. This infrastructure investment could be frontloaded in the event of a substantial fall in non-oil growth.

9.Developing a robust medium-term fiscal framework would support fiscal consolidation. Underpinned by a medium-term macroeconomic framework, this would strengthen the government’s capacity to undertake fiscal policy analysis and forecasting, supporting the rigorous evaluation of reform options. Under this medium-term fiscal framework, a fiscal rule based on the non-oil structural primary balance could provide discipline to fiscal policy, appropriately calibrated to achieve its countercyclical stabilization and intergenerational equity objectives. The government should also strengthen its sovereign asset and liability management framework. This would support the identification and management of risks to the consolidated public sector balance sheet. Finally, the government should reinstate monthly fiscal reporting while expanding its coverage to SOEs, which would enhance fiscal transparency and governance.

10.Expeditiously passing the new Public Debt Law is paramount. In the absence of a law to permit borrowing, or legal authority to draw from the large Future Generations Fund, fiscal financing has relied on drawing from the much smaller General Reserve Fund. Passage of the new Public Debt Law is desirable to facilitate orderly fiscal financing through sovereign bond issuance, while supporting the development of the domestic bond market. Ideally, this new law should not impose restrictions on sovereign bond maturities or have a predetermined expiration date.

Monetary and Financial Sector Policies—Safeguarding Financial Stability

11.The exchange rate peg to an undisclosed basket of currencies remains an appropriate nominal anchor for monetary policy. It has delivered low and stable inflation for many years, while providing the CBK with some monetary policy autonomy. Continuing to maintain central bank independence is critical to achieve the objectives of monetary policy. Fiscal consolidation to support intergenerational equity and structural reforms to diversify the economy are desirable to strengthen the external position and support the peg.

12.Prudent regulation and supervision by the CBK have helped maintain a resilient banking system. Global monetary policy tightening has exposed pockets of vulnerability in some advanced economy banking systems. In the event of global systemic financial instability, internationally active banks in Kuwait could face higher interbank dollar funding costs, constraining their credit supply. At the same time, the domestic credit cycle is maturing as interest rates rise. To proactively manage these emerging financial stability risks, the CBK should continue to closely monitor banks’ dollar funding liquidity and credit quality. Now that all pandemic-related financial regulatory support measures have been unwound, the CBK could consider activating the countercyclical capital buffer.

13.Financial sector policies should continue to adapt to structural change. Commendably, the CBK plans to regularly review the adequacy of its financial regulatory perimeter and macroprudential policy toolkit. It also plans to continue to regularly stress test the resilience of the banking system to emerging financial stability risks. The existing blanket guarantee on bank deposits should be gradually replaced with a limited deposit insurance framework to address moral hazard, while the interest rate cap on commercial loans should be phased out to support efficient risk pricing and credit supply to SMEs.

Structural Reforms—Strengthening Non-Oil Growth and Employment

14.Strengthening non-oil private sector growth and employment is imperative. Over the next five years, roughly 100,000 young Kuwaitis will join the labor force, as implied by demographics. Given fiscal consolidation needs and global decarbonization trends, most of these labor force entrants should join the non-oil private sector.

15.A structural reform package is needed to boost labor productivity and non-oil private sector-led growth. A comprehensive package of well-sequenced structural reforms should be implemented to promote strong and sustainable growth while enhancing labor productivity and diversifying the economy away from oil. To efficiently utilize the well-educated Kuwaiti labor force, labor market reforms are needed to incentive nationals to seek private sector employment. Towards this end, compensation and working conditions should be gradually aligned across the public and private sectors, while labor market policies should be steadily harmonized across nationals versus expatriates, and job search assistance and training programs should be enhanced. Commendably, Kuwait has made progress with encouraging female labor force participation by improving the working environment for women, and with digitalizing public services. To make the business environment more conducive to private sector development, reforms are needed to strengthen competition and promote investment, including by relaxing foreign ownership restrictions on firms. Enhancing public land allocation for commercial development with longer lease terms would also be desirable.

16.Climate change adaptation and mitigation plans should be further developed and implemented. The 2019-30 National Adaptation Plan laid out measures to address the impacts of extreme heat events on health and productivity. This adaptation plan still needs to be translated into investment projects, which in turn should be implemented following parliamentary approval. To mitigate global climate change, Kuwait committed under the Paris Agreement to cut its greenhouse gas emissions by 7.4 percent relative to business-as-usual by 2035. Looking further ahead, it also plans to reach net zero greenhouse gas emissions in the oil sector by 2050, and economy-wide by 2060. To achieve these emissions targets, Kuwait needs to finish developing its mitigation plan, which should include phasing out fossil fuel subsidies (while replacing them with targeted income support to vulnerable households) and promoting investment in renewables-based electricity generation infrastructure.

17.Governance reforms are needed to tackle corruption risks. Given the delays caused by the pandemic, the remaining elements of the 2019-24 Integrity and Anti-Corruption Strategy should be expeditiously implemented, including its measures to enhance compliance with the asset declaration system, as well as to strengthen the integrity and efficiency of public procurement. The government should also continue to strengthen the AML/CFT framework in line with FATF recommendations, including its beneficial ownership elements.