Public Information Notice No. 01/60

Public Information Notice: IMF Concludes Article IV Consultation with Kuwait

June 29, 2001

On June 27, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kuwait.¹

Background

The recovery in oil export prices since mid-1999 and the authorities' fiscal and monetary policies have resulted in substantial improvement in Kuwait's financial situation in 2000. Kuwait's average export price of crude oil rose by 66 percent and its crude oil output, which had declined by 8.7 percent in 1999, also increased by about 6 percent. As a result, the overall fiscal balance (including investment income), which had slipped into a small deficit of 1.3 percent of GDP in 1998/99, moved into surpluses of about 29 percent of GDP in 1999/2000, and an estimated 37 percent of GDP in 2000/01 for the full 12 months.² Similarly, the external current account surplus, which had increased to 17 percent of GDP in 1999, surged to the equivalent of 39 percent of GDP in 2000. Kuwait continued to accumulate assets abroad while the holdings of international reserves by the Central Bank of Kuwait (CBK) increased to US$7.5 billion in 2000, or the equivalent of over seven months of imports of goods and services. Domestic liquidity, as measured by broad money, picked up by 6.3 percent in 2000 from only 1.6 percent in 1999 in connection with the disbursement of the United Nations' compensation from Iraq of about US$2 billion. Claims on the private sector also grew by 5.4 percent, with lending for construction being the strongest, while the growth of credit to industry, trade, and real estate decelerated from its sharp increase in 1999. Activity in the stock market, however, weakened further in 2000 with the volume declining by 29 percent and the average share price on the Kuwait Stock Exchange falling by 6.5 percent.

Growth performance in 2000 remained weak with real GDP rising 1.7 percent, reflecting the cuts in government capital expenditure and initial uncertainty regarding the legislative approval of structural reform measures. Despite a rise in crude oil production, the growth of oil GDP (including refining) was dampened by a reduction in refinery output due to fire damage. Inflation, as measured by the consumer price index, eased to 1.7 percent in 2000, reflecting lower import prices and the appreciation of the nominal effective exchange rate of the Kuwaiti dinar.

The structural reform process has advanced since late 2000. The National Assembly has passed elements of the reform package, including key components of the labor market reform (May 2000), the laws on foreign portfolio investment (September 2000), and foreign direct investment (March 2001). Additional measures that do not require legislative approval were introduced, such as increases in fees and charges on government-provided services. Other important initiatives such as the privatization law, the reform of the corporate income tax law, and the company law were expected to be approved by the National Assembly by year-end. A Committee for Economic Reform has been recently formed to help expedite the preparatory work and build broader support for the proposed reforms.

Executive Board Assessment

Directors noted that the improved terms of trade and sound macroeconomic policies had helped strengthen Kuwait's financial situation in 1999 and 2000. The fiscal and external positions recorded large surpluses in both years, inflation was low, the banking system remained strong and well supervised, and Kuwait continued to accumulate foreign assets that generated a steady stream of investment income. However, at the same time directors noted that growth in the non-oil sector remained low and stock market prices were depressed, reflecting uncertainty regarding the approval of key economic reforms. Directors felt that with the progress achieved on the latter front in recent months, a renewed optimism was expected to help revive private sector activity and the stock market in 2001. Nonetheless, they believed that continued structural reforms were needed to allow Kuwait to achieve and sustain higher growth rates over the medium term.

Directors encouraged the authorities to capitalize on the improved dialogue between the government, the National Assembly, and the private sector to move forcefully to implement the structural reform program. They noted the recent approval of the laws on foreign direct and portfolio investments and key elements of labor market reform. The recently formed Committee for Economic Reform should also expedite the preparatory work and build broader support for the proposed reform package. Directors called on the authorities to approve other important laws, including the privatization law, the company law, and the income tax reform. They also encouraged the authorities to put in place the implementing regulations and the needed technical support and recommended an early implementation of the proposals (developed in collaboration with the World Bank) aimed at energizing the private sector.

Directors called on the authorities to restrain fiscal spending in the face of higher oil revenue under the current 2001/02 budget. While recognizing that the increase in capital expenditure might be warranted following cutbacks in recent years, directors underscored the need for the authorities to resist pressure to raise current expenditures and to persevere with their medium-term objectives of restructuring the budget, in conjunction with other structural reforms, including in particular, containing the growth of the wage bill, streamlining the civil service, and reducing expenditure on subsidies and transfers. Directors also suggested that the rise in capital expenditures should be limited to economically sound projects, and that authorities should take into account the need to reduce the size of the public sector. They also welcomed the authorities' intentions to achieve savings on various current expenditure items, and to improve the collection of non-oil revenue. Directors called for further efforts to diversify the revenue base, including the elimination of import duty exemptions on a wide range of products, the introduction of a broad based consumption tax, and the levying of excises on luxury items.

Directors noted that monetary policy was correctly focused on maintaining the credibility of the pegged exchange rate arrangement and achieving price stability. The CBK's actions to keep the interest rate differential with U.S. dollar deposits within a narrow margin and its efforts to maintain stability in the interbank money market and mop up excess liquidity have been commendable. Directors strongly supported efforts to complete compliance with the Basel Committee's Core Principles for Effective Banking Supervision. Directors noted that the recent recovery of the stock market attests to the general improvement in business climate, including the opening of the stock exchange to foreign investors and the strengthening of regulations regarding disclosure and insider trading. They encouraged the authorities to further facilitate the participation of foreign investors by expediting the revision of the income tax law, reforming the company law, and further strengthening supervision and the enforcement of regulations pertaining to the stock exchange.

Directors also observed that the pegged exchange arrangement, open capital account, and prudent fiscal and monetary policies had served Kuwait well, keeping inflation low and reinforcing confidence in the economy. While sharing the authorities' views that the recent appreciation of the real effective exchange rate has not affected the competitiveness of non-oil activities, directors encouraged the authorities to closely monitor indicators of competitiveness and step up structural reforms, which would raise private sector productivity.

Directors also noted that the quality and timeliness of data provision for the conduct of the surveillance was adequate and commended the authorities for maintaining a generous foreign assistance program.

Directors also commended the authorities' on their participation in the Fund's General Data Dissemination System (GDDS) and their intention to continue to upgrade their database. Directors supported the Central Statistical Office (CSO) efforts to improve the national accounts and price data, which should be sustained, including through provision of adequate resources. They encouraged the central bank to persevere with its efforts to improve balance of payments data on private capital flows. Directors stressed that, to enhance the transparency of fiscal data, the fiscal accounts should be consolidated and the time lag in reporting data to the Fund be shortened. Directors backed the authorities' intention to modernize and improve the budget presentation in an effort to enhance the economic assessment of fiscal policy.