Kuwait pursues major reform following record budget deficit

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Economic reform is under way in Kuwait, after the Ministry of Finance unveiled a new six-point strategy last month aimed at restructuring the economy amid the slump in global oil prices.

Changes ranging from fuel subsidy cuts to the imposition of value-added tax (VAT) and road tolls have been floated in recent months as the country’s budget deficit expands.

Although implementation may be delayed until Kuwaiti authorities determine which model will best serve the economy, the proposed measures offer the potential for significant long-term benefits.

Policy reforms

In late February Anas Al Saleh, deputy prime minister, minister of finance and acting minister of oil, revealed a new strategy emphasising six critical priorities for economic reform.

The announcement came after the government and the National Assembly’s financial and economic affairs committee failed to come to an agreement on how best to roll out planned increases in fuel and electricity prices.

According to Al Saleh, Kuwait’s new strategy will focus on implementing financial reforms, redrawing the state’s role in the national economy, strengthening private sector participation, boosting project ownership by citizens, and various other labour market and public sector reforms.

The week before the plan was announced, the financial and economic affairs committee had recommended a round of subsidy cuts that would raise the cost of low-grade petrol by 42% from KD0.60 ($1.99) to KD0.85 ($2.82) per litre.

Prices of both high-grade and ultra-grade petrol would also be increased, from KD0.65 ($2.16) to KD1.05 ($3.45) per litre for high-grade; and KD0.90 ($2.99) to KD1.65 ($5.48) per litre for ultra-grade – an 83% increase.

The move mirrors steps taken by four other GCC members – Saudi Arabia, Bahrain, Qatar and Oman – who have each raised their respective retail fuel prices by as much 67% over the past two months.

Fiscal reforms a top priority

Fiscal reforms rank high on the state’s agenda, particularly after the government revealed record deficit levels in its draft budget for FY 2016/17, announced in late January.

While proposed spending was down 1.6% at KD18.9bn ($62.8bn), given expected revenues of KD7.4bn ($24.6bn) the government forecast a KD12.2bn ($40.5bn) deficit – nearly 50% higher than the previous year.

The gap is almost entirely attributable to falling oil prices, which have traditionally contributed more than 94% to government revenues; this share is expected to fall to 78% in FY 2016/17, according to the budget.

The draft budget assumes a crude oil price of $25 per barrel, roughly half the $45 estimate used in FY 2015/16. Although Kuwaiti crude was trading above $30 per barrel in mid-March, the IMF previously estimated that the country’s breakeven oil price stood closer to $49 per barrel.

Subsidies versus taxes

Earlier this year Al Saleh called for a host of potential reforms to maintain fiscal stability, including the introduction of corporate, income and sales taxes. He told media the government should also consider raising the cost of public services, in addition to the spending cuts outlined in the draft budget.

While fuel subsidy reforms are a step in the right direction, the introduction of new taxes may offer better long-term benefits.

In February ratings agency Moody’s announced that although fuel subsidy cuts could help ease some of the fiscal pressure on oil-dependent GCC nations, the overall economic benefits are relatively limited, averaging around 0.5% of GDP in savings in 2016, compared to an average regional deficit of 12.4% of GDP.

Indeed, based on the draft budget, Kuwait’s deficit in FY 2016/17 will amount to 30% of GDP, the Ministry of Finance reported, making non-oil diversification and enhanced private sector participation vital long-term priorities.

Tax measures like a VAT may prove more beneficial in the long term. In late February Christine Lagarde, managing director of the IMF, reported that the introduction of such a tax could help GCC members raise revenues by as much as 2% of GDP.

Speaking alongside Lagard, Obaid Humaid Al Tayer, the UAE’s minister of state for financial affairs, announced the broader GCC’s plans to implement a 5% VAT from January 1, 2018.

 

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