Financial sector reforms should focus on bolstering resilience and deepening inclusion – IMF
KUWAIT CITY, March 30, (KUNA): Executive Board of the International Monetary Fund (IMF) concluded Article IV consultation with Kuwait and considered and supported the staff appraisal without a meeting. According to the consultation, non-oil growth strengthened to estimated three percent in 2019, propelled by government and consumer spending.
With oil output contracting by one percent, broadly in line with the OPEC+ agreement, overall growth slowed to estimated 0.7 percent in 2019 from 1.2 percent in 2018. Fiscal and current account surpluses narrowed on account of lower oil prices and output. Meanwhile, inflation rebounded to 1.1 percent as food and transport prices recovered. Credit growth accelerated to 4.4 percent in 2019, spurred by relaxation of macroprudential ceilings on personal loans and supportive monetary conditions.
The underlying fiscal stance loosened in FY2018/19, with non-oil balance excluding investment income in percent of non-oil GDP deteriorated as government spending continued to rise. Fiscal financing needs – the overall balance after compulsory transfers to the Future Generations Fund (FGF) and excluding investment income – remained large at 7.7 percent of GDP.
Lacking borrowing authorization since October 2017, the Kuwaiti government had to continue drawing solely on General Reserve Fund (GRF) assets for financing, which brought its total and liquid balances down to 56 and 24 percent of GDP by June 2019. Combined, FGF and GRF assets continued to grow however, as the FGF generated strong returns and received mandatory transfers from the government, said the IMF. The banking system remains sound, it remarked, adding that the systemwide capital adequacy ratio reached 17.6 percent in September 2019, and banks have plentiful short-term liquidity.
Nonperforming loans net of specific provisions remain low, while loan-loss provisioning is high. Net interest income declined due to a narrowing spread between bank lending rates and cost of funds. The real estate market has stabilized, and equity markets outperformed in 2019, in part thanks to the inclusion in emerging market indices.
However, the challenge to reduce dependence on oil and boost savings has become more urgent. The subdued forecast for oil revenues is weighing on near-term growth and fiscal and external balances. This has heightened the need for reforms to create a vibrant private sector and ensure adequate savings of the exhaustible oil wealth for future generations. Kuwait has large financial buffers and low debt, but the window of opportunity to tackle its challenges from the position of strength is narrowing.
Without a course correction, fiscal and financing challenges will intensify. The recent runup in hard-to-reverse spending weakened the underlying fiscal position. At current policies, the overall fiscal balance would turn into a growing deficit, which, after mandatory savings in the FGF, would give rise to large financing needs over the medium term. Borrowing should be viewed as a temporary solution while slowing the depletion of liquid financial assets, it would lead to a rapid debt buildup.
Kuwait needs ambitious, growth friendly, and socially equitable fiscal adjustment, noted the IMF, saying that staff’s proposed adjustment would cut current expenditure, by tackling spending rigidities, boost nonoil revenue, and create space for growth enhancing investment.
The large public wage bill should be reformed, and generalized subsidies and transfers phased out in favor of targeted compensation schemes. As for revenue, the government should initiate broad consultations, redouble efforts to engage parliament, and continue the technical work on the GCC-wide excises and VAT.
Taxes on corporate income, luxury items, and personal income of the wealthy could be also considered for a more socially-balanced adjustment mix. The IMF report carried on to say that embedding fiscal measures in a comprehensive reform package that promotes private sector growth, strengthens governance and accountability, and improves public services would help build broad support for reforms. A rules-based fiscal framework would improve management of oil revenues. It would also help anchor fiscal policy on a long-term objective of intergenerational equity. It should include a well-calibrated operational rule that helps reconcile long-term savings and near-term economic stabilization objectives. Such a rule would further help establish policy predictability, prevent procyclicality, and ensure durable gains from adjustment.
To be effective, a fiscal rule would need to be enshrined in a sound institutional framework. Until a properly calibrated fiscal rule is in place, the current arrangement with respect to the FGF should be maintained. As for fiscal governance reforms, they should be an integral part of the overall fiscal strategy. Reforms should aim to enhance fiscal transparency, modernize public procurement, and boost spending efficiency. These steps would reduce vulnerabilities to corruption and strengthen support for fiscal adjustment. The exchange rate regime remains appropriate. The peg has provided an effective nominal anchor.
The proposed fiscal adjustment would close the current account gap over the medium term. As the economy becomes diversified, the arrangement should be periodically reviewed to ensure that it continues to serve Kuwait well. Financial sector reforms should focus on bolstering resilience and deepening inclusion. To reduce moral hazard, the authorities should enhance the corrective action framework, establish a special resolution regime for banks, and unwind the blanket deposit guarantee.
CBK’s continued efforts to recalibrate macroprudential tools to balance stability and growth considerations are welcome. Gradually relaxing the interest rate ceiling on commercial loans would expand lending to new market segments, including SMEs. Market forces should be allowed to play a greater role in the allocation and pricing of liquidity to promote interbank market development. Sustaining reforms to foster private sector-led and diversified growth will be critical.
With limited scope for public employment going forward, a vibrant private sector must emerge to absorb the large number of Kuwaitis entering the labor market in coming years. Enabling the private sector to thrive requires reducing the economic footprint of the state, promoting market competition, and improving the business environment. To that end, further efforts are needed to revamp insolvency framework, reduce excessive regulations, and ease trading across borders. To incentivize Kuwaitis to seek private sector opportunities, public sector wages should be aligned with those in the private sector, accompanied with improvements in education and training programs to nurture entrepreneurship and equip graduates with skills for in-demand jobs.