Borrowing Time: Structural Challenges to Kuwait’s Economy after COVID-19
Kuwait continues to deal with the consequences of low oil prices, an ongoing pandemic, and a political stalemate. The country also finds itself at the dawn of a new era under Emir Sheikh Nawaf Al-Ahmad Al-Sabah and a potential opposition parliament after elections on December 5th. The battle of whether to protect the health of its citizens and residents or the economy has largely been won by business interests, with health procedures largely ignored and the economy verging on a full reopening as per its five–phase plan. Yet government support to the private sector has been minimal. A $1.6 billion fiscal support package in March predominately overlooked Kuwait’s private sector. Aside from postponing company and individual loan payments, pension contributions for Kuwaiti nationals, and a few fee reductions on import sectors, no real help was given to businesses. In July, a delayed $780 million salary package targeted the roughly 70,000 Kuwaitis employed in the private sector but did little to alleviate rent or loan requirements that accrued over the preceding months. While the Central Bank of Kuwait (CBK) reduced interest rates 3 times to assist borrowing for large companies and banks, government stimulus never provided substantial loans to SMEs as had originally been announced because loans simply had too steep of terms.
The Most Affected Sectors in the Economy
All of this did little to stem the tide of bankruptcy with estimates that 45% of companies were closing in May. Reports are slowly starting to come out about continuing losses in the market. News reports indicated that 30% of restaurants have closed since March 2020 and that by March 2021, without government support, the number will rise to 40%. The manufacturing sector has also been hit hard, as over 66.5% of its activities focus on the refinement of petroleum and chemical products, which have virtually stopped during the pandemic. Real estate companies continue their decline with 60% of listed companies in the stock market recording losses in the first half of 2020. The sector is expected to face significant pressures for one or two years and many companies won’t survive. The economic downturn is exacerbated by the mass exodus of expatriates, which is just beginning. Since March, the population is estimated to have decreased by at least 650,000, from 3.3 to 2.65 million. A new law evicting residents based on their age and education will lead to an estimated 70,000 residents being forced to leave in 2021 and it is unknown if the hundreds of thousands of people stuck outside the country with expired work permits will be allowed back.
The government non-response and the demographic changes will have a very negative impact on the country’s consumer spending, real estate, private healthcare and education and will make recovery a decade-long task. While the big banks like National Bank of Kuwait (NBK) or Kuwait Finance House (KFH) are able to weather the storm, medium term fiscal impact is likely to find its way through the rest of the banking system in the second quarter of 2021, since asset quality will “inevitably deteriorate” as companies unable to consolidate debt repayments dissolve. Perhaps the most important signal of government plans is the swift change to the Bankruptcy Law No. 71 of 2020 in the last session of the 2016 parliament, which fundamentally revises Kuwait’s bankruptcy framework, allowing for the orderly dissolution of companies–similar to voluntary arrangements that exist in English or French Law and financial restructuring schemes comparable to Chapter 11 of the United States Bankruptcy Code. Previously, the declaration of bankruptcy assumed that debtors were criminals, not taking into account misfortune. The simplified process for insolvency provides a way for thousands of failed businesses to close quickly and quietly.
Empty Pockets in Hindsight
Looking back, the continuing poor fiscal situation and lack of liquidity in the country was inevitable, far beyond the oil price crash in March 2020. Kuwait has had a 41% decline in oil revenues from 2014 to 2018 and the pandemic merely exacerbated and accelerated a trend it was not prepared for; a global shift to cleaner energy, an oversupply of oil, and a depletion of Kuwait’s oil capacity. Capacity fell 190,000 barrels per day (b/d) in 2017-18, another 300,000 b/d in 2018-19, and a 50,000 b/d drop for 2019-20. The main reasons for continued declines are long delayed projects to increase Kuwait’s heavy oil capacity at its northern Ratqa field, the Jurassic gas field project, and Wafra’s offshore development. Kuwait Oil Company missed its 2020 targets of 3.10 million b/d when production went to a 10-year low of just 2.81mn b/d.
The government has burned through 16 billion dinars from the General Reserve Fund since March to cover deficits and lost revenues. Kuwait’s State Audit Bureau said the government has no choice but to borrow 20 billion dinar to cover current costs and will need to pass a public debt law quickly after the new parliament convenes on December 15th. Unfortunately, this loan only buys the government a year at current spending rates and does nothing to resolve Kuwait’s runaway spending. Moody’s, which downgraded Kuwait’s credit rating twice since March, projects that Kuwait would need $90 billion between now and 2024 to meet funding needs. The IMF estimates debt will rise to over 74 % of GDP by 2025.
Increasing oil revenues in the short to medium term will be difficult with OPEC partners at odds to agree on long term unified responses to the historic fall in oil consumption. While there has been an uptick in oil prices recently, new restrictions in Europe and high death reports in the US dampen short-term optimism of a quick economic rebound. Regardless, there is a broad consensus that oil prices will be anywhere from $37 to $55 per barrel for the next few years; Kuwait needs $86 per barrel to balance the budget. Kuwait’s Future Generations Fund (FGF) also will not be able to plug the hole as it neither has the mandate or policy framework to divest its funds in the ad hoc manner suggested by commentators or parliamentarians.
The FGF often makes a 3-5% profit in a good year, which 2020 is not, and is tasked with saving and reinvesting wealth back into the FGF. Furthermore, not all assets are created equal, and as a conservative fund, the FGF’s resources are predominantly tied up in assets that are not liquid, such as oil, mining, infrastructure, real estate, equities, and hedge funds. The FGF has only been tapped once after the first Gulf War for reconstruction efforts, but the economy of the world was booming at the time and the sale of investments was done in concert with compliant international investors and banks. To liquidate assets in the current global environment would be the equivalent of a fire-sale and would damage investor confidence. Instead, the FGF is on a major buying spree, as this is the time to buy, not sell.
Kuwait’s central bank is similarly ill-equipped to deal with the crisis through monetary instruments. The CBK is more concerned about the stability of the KD and the sustainability of the local banks, not in fostering a conducive environment for investment or business. There is a very real risk that not planning a devaluation over the next several years will lead to a banking crisis and capital flight. Since 2014, Kuwait faced the longest period ever recorded of monthly consecutive losses in foreign exchange reserves, and during April and May, Kuwait lost $38.6 billion, maintaining the peg. Foreign exchange markets in Kuwait remain under considerable pressure, especially in spot markets. A dangerous situation is emerging where neighboring Oman and Bahrain’s fiscal deficits may lead to devaluation, which due to the interlinked nature of GCC banking systems, may lead to a contagion effect. The longer oil prices remain low, the higher the likelihood that pressure would increase on Kuwait’s exchange rate pegs.
Creating Liquidity
For now, there need to be significant cuts to spending. The Kuwait Port Authority’s decision to shelve the $6.5 billion Mubarak Al-Kabeer port project on Boubiyan Island, a centerpiece of Kuwait’s Vision 2035, highlights the severity of the fiscal crisis. The Kuwait Petroleum Corporation (KPC) has already planned cuts of 25% ($7 billion dinar) to its five-year capital spending budget, including projects to develop heavy crude oil facilities in the North, and accepted a $3.27 billion dinar loan with NBK and KFH to cover costs. Luckily, Kuwait’s oil and gas sector was already heading for a game-changing year in 2021, with several downstream megaprojects due to come online that will help with liquidity and energy market share in the medium term. Both Kuwait’s Clean Fuels Project and Al Zour Refinery project meet better environmental standards and will lead to higher exports to US, Asian, and European markets that have stricter environmental criteria for fuels. The largest import terminal in the MENA for liquefied natural gas (LNG) is opening at Al Zour in March 2021. This will make Kuwait an LNG exporter, instead of the region’s largest importer reducing government costs.
Alongside spending cuts, the government needs to develop a broader financial sector, and drive private sector participation and growth as quickly as possible. Much of this must be done in opposition to Kuwait’s banking sector, which is resistant to facilitating bond and equity markets as it creates competition for their deposits and loans and means that they will lose their commercial lending advantages. Yet there is little real choice as the lack of investor confidence in the current system is illustrated in the Boursa stock exchange’s lackluster performance in its opening week and “the broad decline in the Kuwaiti indices” in general. Middle Eastern fund managers plan to decrease investments in Kuwait in the current quarter on economic and valuation concerns, according to one Reuters poll. According to investors, many companies on the exchange have overvalued assets and unclear long term viability. Also the general difficulties investors find in initiating standard due diligence procedures, such as audits and asset traces to assess governance in many companies makes them less likely to invest in the emerging market. To develop more confidence, the government needs to move quickly with already-planned Initial Public Offerings (IPOs) for government projects. A recent successful IPO, the Shamal Az-Zour Al-Oula Power and Water Company was a great success and a new IPO for the public private partnership for Health Assurance Hospitals Company in 2021 will bring in much needed confidence in the market.
The government also should be focusing on sovereign debt investors as investor appetite regionally has been “very strong”, and Kuwait has a stable currency and credit profile it can still take advantage of now. One viable option would be to raise sovereign “sukuk” bonds, a very effective option in financial crises since sukuk bonds de-prioritize interest rate-based derivatives and focus on asset quality and mutual risk. This type of bond has been used extensively in Bahrain, UAE, and Malaysia to finance major government projects and the Kuwaiti government needs to set a benchmark yield curve to encourage lenders and borrowers both within and outside Kuwait. The government can do this by issuing sukuk for some of its most profitable or troubled assets, the former including Kuwait Petroleum Corporation and its subsidiaries, while the latter could be Kuwait Public Transport Company; the struggling local government bus company. Sukuk bonds would have a formative positive impact on Kuwait’s liquidity issue, lowering government finance costs and reducing competition between different line items in the state budget.
Denialist Economics
All of these measures only buy some time and are in lieu of the patently obvious: cutting much of the salaries, allowances, and subsidies that consume over 70% of the total budget and changing the constitutional mandated employment system to relieve government burdens. While every Kuwaiti government cabinet since 2014 has alluded to this necessary change, there is much opposition to this idea, stemming largely from living in denial and expect nothing other than the status quo and criticizing those pushing for reform. This criticism is often steeped in hyperbolic rhetoric, xenophobia, and half-baked proposals for a “Kuwait for Kuwaitis only.” While some chose to bury their heads in the sand, the government needs to take a bold step and cut public sector employee salaries by 20% in 2021 to stave off national disaster in the next ten years. As a result of indiscriminate hiring over decades, the public sector is overloaded with unqualified civil servants who do not work for the salary they have and many have ghost positions that require no work at all. Kuwait’s national labor market sits at a precipice. One hundred thousand young Kuwaiti nationals—22% of the current Kuwaiti labor force—will enter the job market in the next five years and within ten years there will be another 200,000 nationals entering the market.
There is also little hope for a quick private sector fix. Kuwaitization has been a failure since the government established the Manpower and Government Restructuring Program (MGRP) in 2001. Kuwait is not alone with this issue as the localization policies developed by the Gulf States have all produced marginal results. In most cases “phantom employment”, where employees are paid salaries to fulfill quotas, mirrors the “masked unemployment” in the government sector. A former Secretary General of the MGRP admitted in one report that “out of the 12,000 people who joined the private sector in 2007, I would say around 4,000 of them are phantom employees.” The simple unpalatable truth is many in the workforce do not work at all and are more of a hindrance to private sector businesses than a boon. Work is simply a two-hour daily hobby for them, not a real livelihood. To expedite a real wage economy the dama el amala salary subsidy needs to be removed for Kuwaiti nationals, and companies need to pay the full wages in the context of the merit of the job.
This will ensure there is competition among peers with the same qualifications and employment background and focus on human resource development. Employment must be based on merits and qualification. People need to be responsible for paying their own loans, expenses, and paying the consequence of not managing their finances based on their livelihoods. It is the only real hope for the country’s post-oil future.
Geoffrey Martin is a Ph.D. student in Political Science at the University of Toronto, entrepreneur, and economic analyst based in Kuwait. His focus is on political economy, food logistics, and labor law in Kuwait and the wider GCC. He tweets @bartybartin
