Economic Update

Whilst the economy is surging on the back of higher-than-forecast oil prices that are swelling the state coffers, concerns remain over the state’s long-term prospects.

The pace of investment in major capital works projects needed to sustain development, as well as the high cost of state services and wages, could mean that current budget surpluses might become deficits before the end of the decade. In early August, for example, the government released the details of the 2011/12 financial year, revealing that the budget posted a record surplus of $47bn from total revenue of $107.5bn, double the forecast earnings when the provisional budget was handed down in early 2011. It is estimated that the surplus came to around 27.1% of GDP in 2011, nearly twice the 14.8% of GDP for the 2010/11 budget surplus.

The government had initially forecast a deficit for the financial year – the first in more than a decade – based on projected higher expenditures and on a $60 per-barrel price for oil, giving an estimated budgetary shortfall of $21bn. However, due to increased production, with Kuwait pumping an average of 3m barrels per day (bpd) – well up on the 2.2m bpd it had estimated − and the price for a barrel of oil hovering around the $100 mark for the 12-month budget period, the deficit soon became a hefty surplus.

However, the record highs posted also underscore the emirate’s continued dependence on oil. Of total revenue, all but $6bn, or 5.5%, came from the oil fields, leaving the state not only almost wholly reliant on its hydrocarbons wealth but also extremely susceptible to market fluctuations.

Another contributor to the budget surplus was underspending, which, unlike revenue, was well down on expectations. Outlays for 2011 came in at $60.5bn, 12.5% below projections − the lowest in a decade − according to a study conducted by the National Bank of Kuwait (NBK). Daniel Kaye, a senior economist at NBK, said the surplus is a double-edged sword.

“While the surplus is comforting in financial terms, the low spending rate reduced the degree of fiscal expansion and was one reason why economic growth remained sluggish last year,” Kaye told The Financial Times in an interview in mid-August.

Government underspending was largely the result of slow implementation of major development projects and schemes designed to provide employment and boost economic growth, many of which focus on the utilities, industry and transport sectors.

In May, the IMF warned that Kuwait’s economy faced fiscal difficulties unless the government moved to reduce state expenditures, and in particular rein in the burgeoning public service wages and pension bill, which account for up to half of all state spending. Failure to do so would mean the country’s fiscal reserves would be whittled away and the budget would slip into deficit by 2017.

It was essential that Kuwait diversify its economy, improve its infrastructure and take steps to promote investment, the IMF report said. A call from the IMF for Kuwait to broaden the state’s revenue base, with one option being a goods and services tax, was roundly rejected by parliamentary deputies at the time, and has not won much support from the government.

According to most estimates, Kuwait’s GDP will grow by around 5.5% in 2012, though expansion of the non-oil sector will be around 4%, another indicator of the slower rate of activity in the private sector and the difficulties the state is having in maintaining the flow of investments.

In part, disputes in the political arena have hampered the introduction of new projects, and, as parliament has yet to convene, this year’s fiscal budget, which was due to come into force on April 1, remains unratified. This means the government is operating under the same revenue and expenditure targets set for the 2011/12 budget, rather than the draft for this year, which included much higher spending on capital works, the very thing the IMF said was essential for the economy’s development.

Despite the warnings of the IMF, Kuwait does have the tools needed to create a diversified economy, having set out a programme of investment aimed at broadening the national revenue base, meeting future infrastructure needs and reducing its reliance on oil. As long as the government can clear approval bottlenecks, direct more spending to development and keep its wages bill in check, the economy will be well placed to grow.