Kuwait Economy at the Crossroads

 

In the past two years i.e. 2003-04, the Kuwaiti economy surged by an annual average of 8.5 percent, raising expectations of perpetuation of strong growth

Abstract

[In the past two years i.e. 2003-04, the Kuwaiti economy surged by an annual average of 8.5 percent, raising expectations of perpetuation of strong growth. This performance is significant in many respects. It is preceded by a period of low and negative growth, averaging 0.3 percent in the earlier four years (1999-2002). Though mainly contributed by higher domestic production and export of oil and its products propelled by sharp increase in world petroleum prices, the non-oil economy has also done well. The economic and social conditions have improved – fiscal and external surpluses rose sharply, inflation remained low, Kuwaiti Dinar remained stable, stock market boomed, non-oil exports increased, and social and welfare public expenditures went up. This paper discusses the prospects of continuation of this trend and the possible steps that may be considered to transform this short-term gain into long-term economic sustainability. Following discussions on the background and recent developments, policies and reforms, the paper identifies the critical areas that need to be addressed for ensuring sustainable growth. – Author]

 

Background

Kuwait¨ is one of the countries (area: 17,818 sq. Km, population: about 2.4 million) whose prosperity hinges on oil income. It is strategically located at the North-west extreme of the (Arab/Persian) Gulf, bordering Iraq on the West, Saudi Arabia on the South and Iran across the Gulf in the North (other neighbouring countries being Bahrain, Qatar and UAE).With a per capita income of over 20,000 US dollars (2004), it is categorised among the high income countries. Petroleum, the main source of prosperity, was first discovered in 1938 but exploration was disrupted during the World War (1939-44) and drilling resumed in 1945. In the pre-oil era trade, traditional crafts, fishing, pearl fishing, boat making and pasturing were the main economic activities and means of livelihood. The country prospered since ‘50s with the exploration, production and export of oil. The oil revenues were utilised for building industries, physical and social infrastructure and on economic and social welfare of the people. The construction boom (‘60s – ‘80s) attracted large number of workers, mainly from Arab countries, Iran and South Asia; over half of the inhabitants are non-Kuwaitis. The geographical location and improved port and communication facilities helped in expansion of trade, re-exports and other commercial activities.

 

Prior to becoming fully independent in June 1961, the Kuwaiti Shaikhdom remained a self-governing British protectorate for over sixty years. After independence, the ruler assumed full executive powers and took the title of Amir. A new constitution was adopted in 1962. The Amir is chosen by and from the members of the ruling Saba family, who exercises his executive power through the council of ministers headed by a prime minister appointed by him. Legislative power rests with the National Assembly having 50 members who are elected by literate adult male (recently women are also allowed) Kuwaiti nationals for a four year term. The National Assembly has a reputation of being independent, which often leads to confrontation with the government and, at times, resulted in dissolution of Assembly by Amir.

 

Kuwait is vulnerable to regional disruptions, mainly owing to oft-repeated territorial claims of Iraq. It was subjected to aggression by Iraq in 1973 when the Iraqi troops occupied its border post. It came under attack by Iran during Iran-Iraq War (1981-8) for siding with Iraq. The most serious and damaging incidence was the Iraqi invasion and occupation in August 1990, resulting in massive destruction of life and property, in particular oil fields, installations and refineries, buildings, infrastructure and private property. Thousands of people were killed or taken prisoner and majority of the citizens fled from the country. Losses in oil sector alone are estimated at more than one billion US dollars. The vulnerability was once again demonstrated during the recent Iraq War as Kuwait was also subjected to Iraqi incursions. This concern for state security seems to be responsible for the rulers seeking out-side protection (i.e., Britain – 1899-61, Arab League forces – 1961-3, and USA – since 1990).

 

Recent Developments and Critical Issues

Since liberation from Iraqi occupation in February 1991, Kuwait has passed through various phases of reconstruction and development. The earlier post liberation period was devoted to restoration and rehabilitation of oil facilities and production, rebuilding infrastructure, rehabilitation of people, and restoration of essential supplies including foodstuffs, utilities and industrial raw materials, etc. With the efforts of the government and people supported by other nations, the conditions were normalised rather quickly; with the economy recording an annual average growth of 12 percent in 1991-5. The growth rate slowed down thereafter; re-bouncing once again in 2003-4. In these two years the economy grew by 9.7 and 7.2 percent respectively, in sharp contrast to the dismal growth averaging 0.3 percent during 1999-2002. Besides oil, other sectors also shared this positive performance.

 

Despite this revival of high growth, the economy faces many challenges, especially connected with one-commodity dominance (namely, oil). About one-half of the national output is contributed by oil and oil related activities. Over 90 percent of export earnings are from oil and oil based products. Income from oil and oil-funds invested abroad are the main source of government revenues (i.e., over 93 percent). Government is the main source of employment with two-third of current budget expenditure incurred on salaries, wages and transfer payments. Over 88 percent of budget is incurred on current expenditure leaving a meagre amount of 12 percent for capital expenditure. National savings are high but a major part of them is invested out side the country. In addition, the country is faced with the problem of providing jobs to the nationals, especially in private sector, and revitalising the private enterprise. The economic sustainability thus warrants actions on many fronts, including broad-basing the economy, substantial increase in domestic investment, reshaping public finance, expanding non-oil exports, and creating job opportunities for the Kuwaitis.

 

Broad basing the Economy

The behaviour of the economy heavily depends on the performance of the oil sector and world petroleum situation. In general, when world demand and prices of oil go up, domestic oil production rises and economic growth, revenues and export earnings pushed up. Fall in world oil prices and demand has reverse effects. The oil sector also has contagious effect on other areas like manufacturing, trade, communications and public finance. The relationship between growth rates of real GDP and oil-GDP may be seen in table 1. For instance 6.5 percent decline in oil-GDP in 1999, pulled down the overall GDP growth to a negative level of -1.8 percent, despite a positive growth of 2.1 percent in non-oil GDP. Conversely, high growth of 19.8 percent in oil sector in 2003 pushed up the overall growth to 9.7 percent, besides help improving the growth of non-oil sector.

 

Table 1

GDP Growth (1999-2004)

Year	GDP	Oil GDP	Non-oil GDP
1999	– 1.8	– 6.5	2.1
2000	1.9	2.2	1.9
2001	0.7	– 3.3	3.6
2002	– 0.5	– 7.9	4.3
2003	9.7	19.8	4.6
2004	7.2	9.5	5.5

Source: Kuwait Authorities, IMF.

 

This heavy dependence on oil has made the economy vulnerable. The sustainability of growth is therefore linked either with the continuation of favourable world oil situation (which presumably is unlikely), or with developing the non-oil sector rapidly. Given the position of natural endowment and other factors, developing the non-oil sector is a big challenge. Most of the country being desert, with no perennial source of water and little rainfall, the scope of developing agriculture is remote. So is the position of minerals, other than oil. Manufacturing sector, which accounts for about 11 percent of GDP, seems to be an area of promise. Even this sector is dominated by oil as petroleum-refining industry accounts for 90 percent of the value added of the manufacturing sector. The base of non-oil industry remains low and geared to meeting domestic needs. Services sector is another possible area that needs to be explored. Sustained efforts and huge investment are required to exploit fully the potential of these sectors.

 

The need for transforming the oil-dominated economy into a broad based and more balanced one is widely recognised in Kuwait, as reflected in a number of recently taken initiatives. A new ‘vision’ has been conceived which aims at making the economy advanced and globally competitive by 2015, with manufacturing sector serving as engine of growth. The vision is complemented by the industrial development strategy and the export promotion strategy. The industrial strategy aims at increasing the share of manufacturing (particularly non-oil) in national output, creating jobs for nationals and enhancing competitiveness of products in world market. The strategy has identified the following six axes:

 

• Restructuring industrial sector with emphasis on strategic, resource based and high tech. industries.

 

• Developing a market-oriented incentive package

 

• Enhancing competitive ability

 

• Encouraging initiatives of individuals and firms

 

• Increasing share of national manpower in industrial sector

 

• Promoting regional and international integration

 

The export development strategy and programme have been launched and Export Development Centre set up to implement them. Kuwait has introduced structural reforms in many areas in recent years, with focus on broad-basing the economy and invigorating the private sector and foreign investment. A comprehensive law (Industrial Law 56) was adopted in 1996 which established the Public Authority for Industry (PAI) as an independent public body with wide-ranging responsibilities to promote industrial development. Laws have been enacted on Foreign Direct Investment (2001), Labour Market (2000), Intellectual Property Rights (1999), and Standardisation-amendment (2000). Reforms have been introduced in financial and fiscal sectors. The progress in implementation of reforms and policies is however slow.

 

Diverting National Savings to Domestic Investment

Kuwait is faced with a peculiar situation of high national savings with low domestic investment; which dependent on oil income are also volatile. During 1999-2004, out of average national savings of 31 percent of GDP, only 10 percent was invested domestically, the balance two-third invested abroad (Reference table 2). Over the years, the investments made outside the country have become a major source of government and private incomes. The nation has, however, paid a high cost as economic growth suffered due to low domestic investment. Acceleration of economic growth, particularly in the industrial sector requires that major part (at least two-third) of national savings should be utilised for the development of domestic economy. Investment abroad should also be diversified both in terms of countries and instruments. Heavy concentration of these investments in USA and other Western countries has increased the economic and political vulnerability. The emerging markets in developing world, especially Muslim countries, provide safe and profitable avenues for these investments.

 

National Savings and Investment As % of GDP

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Kuwait Authorities

 

 

Reshaping Public Finance

The overall fiscal position is strong with revenues exceeding expenditure, leading to persistent budget surpluses (Ref. Table 3). Financial and economic sustainability however, demands restructuring of the public finance. Firstly, over 90 percent of the revenues are generated by oil (about 80 percent in 2004) and investment income (mostly from abroad). These revenues are vulnerable to external factors, such as changes in world oil prices and financial market. Other sources of revenues should therefore be developed to reduce vulnerability. Secondly, major part of the budget is consumed by current expenditure and very little (about 10-12 percent) is left for development purposes. Allocations for capital expenditure should be raised substantially to ensure development and improvement of physical and social infrastructure necessary for accelerating growth of manufacturing and services sectors and creating favourable climate for private enterprise. Thirdly, a major part of current expenditure (e.g. two-third in 2004) is incurred on salaries and wages and subsidies and transfers; reflecting the policy of the government to distribute the oil wealth to the people through jobs and subsidies and transfers. The extended use of this policy is creating distortions. The government departments are reportedly over staffed (as government jobs are preferred due to better emoluments) while the employment of Kuwaiti nationals in the private sector remains low. This disproportionately high expenditure on salaries and wages should be restrained and used for other purposes like human resource development.

 

 

Table 3

Public Finance (% of GDP)

 

	1999	2000	2001	2202	2003	2004
Revenues	68.7	80.2	63.1	65.2	60.6	61.9
Of which oil	46.7	55.5	43.1	49.4	46.8	49.0
Investment income	11.0	18.2	15.0	14.1	19.0	26.0
Expenditure	39.5	39.4	45.6	43.9	41.5	39.8
Current	36.0	36.2	40.8	38.8	36.3	34.4
Capital	3.5	3.2	4.0	4.7	4.8	4.5
Fiscal Surplus	29.3	40.8	17.5	21.3	19.1	22.1

Source: Kuwait Authorities and IMF

 

A positive feature of public finance is the setting 10 percent of all government revenues aside for the Reserve Fund for Future Generation and placing the fiscal surpluses in the General Reserve Fund. Thus large assets have been generated for use by the future generation which are mostly placed in financial assets outside the country. These funds could be used for raising domestic production capacity and productivity. The management of these assets should be improved with a view to ensuring their safety and profitability. The emerging financial markets in the developing countries, particularly Muslin countries, should be explored for investment of these funds.

 

Another notable feature is Kuwait’s development assistance to the developing countries in Asia and Africa. In 2002-3, the Kuwait Fund for Arab Economic Development made loan commitments of KD 126.3 million (1.15 of GDP) for 15 projects in 14 countries. Pakistan is one of the recipients of Kuwaiti assistance. It has so far received about $66 million for development of water resource, health, education and other sectors. A Kuwait Pakistan Investment Company has been established to promote joint projects. Pakistan and Kuwait should develop a long term strategy for fostering bilateral economic relations, including infrastructure, joint ventures, trade, human resource and technology.

 

 

 

Expanding Non-oil Exports

The overall position of the external sector remains strong. As in other areas, this strength emanates from export earnings of oil and oil products (Ref. Table 4). The area needing attention therefore is the development of non-oil exports, particularly manufactures. This warrants transforming the present structure of the manufacturing sector from import substitution and domestic demand orientation to high value added and competitive industries. The industrial and export development strategies mentioned earlier should be effectively implemented to expand and diversify exports. Re-export is another promising area in which Kuwait had occupied an important position in the region in ‘70s and ‘80s. Some progress in this area has been made recently with resumption of re-exports to Iraq. This should be expanded by improving the transiting facilities and simplifying rules and procedures.

 

Table 4

External Balance

(in billion US $)

	1999	2000	2001	2002	2003	2004
Exports	12.2	21.3	17.9	17.0	22.6	30.4
Of  which oil	11.0	18.2	15.0	14.1	19.0	26.0
others	1.2	3.1	2.9	3.1	3.6	4.4
Imports	6.7	11.4	12.4	14.0	16.2	17.3
Current  Balance	5.0	14.7	8.3	4.3	7.3	15.1
International Reserves	4.9	7.2	10.0	9.3	7.7	8.4

Source: Kuwait Authorities and IMF

 

Improving Human Dimension

In a population of over 2.4 million, less than 40 percent are Kuwaitis. Similarly, in a labour force of 1.4 million, their share is less than 20 percent. The number of Kuwaitis joining the labour force, however, is rising at a rapid pace (i.e. 6 percent per annum as compared to 2.3 percent of total labour force during 1997-2002); and their participation in the labour market is going up. Most of the Kuwaitis (i.e. 80 percent in 2003) are employed in the public sector, which offers better emoluments and facilities. Kuwait is currently faced with a situation in which public sector employment is to be restrained while private sector job opportunities are not expanding fast. Kuwaitis labour prefers government jobs and the private sector prefer low paid expatriates. A Labour Market Law has been enacted to encourage employment of Kuwaitis by the private sector. The Law focuses on training, skill development and compensation to unemployed Kuwaitis and sector specific quotas for employment of Kuwaitis in the private sector.

 

The objective of rapid industrialisation and efficient services sector not only need massive investment in machinery and infrastructure but also the induction of technical and managerial skills and knowledge among the Kuwaitis with speed. For this purpose, a crash programme of education and training may be initiated in consultation with the private sector and other stakeholders. Immediate needs of trained manpower may be met by inflow of expatriate with the provision that, wherever possible, these be replaced by locals over time.

 

Strengthening Regional Links

Being a member of the Gulf Cooperation Council (GCC), Kuwait has adopted the common tariff of 5 percent since 2003 and abolished all import duties on imports from GCC members. Negotiations are being held to prepare a common list of items for prohibition on security and religious grounds. Discussions are continuing on technical details for the proposed GCC monetary union.

 

Opening up of GCC market offers challenges and opportunities for Kuwait. Compared to other regional members, in recent years the Kuwaiti industry has not progressed fast enough to compete in the domestic and regional markets. The domestic market is also faced with influx of subsidised regional goods (e.g. from Saudi Arabia). The industrial development should be speeded to cover up for the lost ground. With the opening of the regional market the prospects for undertaking mutually beneficial joint ventures, sectoral linkages have expanded. Similarly, the opportunities for strengthening trade and industrial relations with other regional countries, including Pakistan and Iran, both at regional and bilateral levels, should be explored.

 

Conclusion

The sustainability of the growth path is largely conditioned on how fast Kuwait is able to diversify and enlarge the economic base and implement the industrial and export strategies and structural reforms. The new ‘vision’ of turning the economy advanced and globally competitive by 2015 requires sustained efforts for which a plan and roadmap is already in place. The progress however remains slow and should be accelerated.

 

It should be realised that despite conscious efforts to diversify the economy, oil sector will continue to have a lead position. Being a non-renewable endowment, oil exploration activities should be geared up to add to the existing reserves. Plans are in hand to rehabilitate the existing oil refineries and add new ones for increasing the oil production from 2.5 million barrels per day to 3 million barrels per day in 2009 and 4 million barrels per day by 2020. The oil sector itself should be diversified by undertaking mega projects to produce inputs for petrochemicals and other down-stream products. This sector should also be integrated closely with the manufacturing sector. The gains from oil are being shared with the people primarily through government jobs, business opportunities, social benefits like education, health and other facilities, consumption subsidies and welfare donations. While these are important, there is a need to give enterprise, skill, knowledge and innovation related incentives to Kuwaitis.

 

The critical element in diversifying the economy and accelerating growth is rapid increase in domestic investment (almost doubling the present level of 8-11 percent of GDP). This is not a difficult task; high national savings can accommodate it with ease. The domestic investment should be geared to building modern and efficient physical and human infrastructure, raising productivity and productive capacity, harnessing private initiative and improving competitiveness. One of the objectives of this investment should be to build an advanced and competitive base for manufacturing and services sector. The dismal level of government capital expenditure should be raised substantially and used for infrastructure building and creating conducive environment for private sector investment and development. The new industrial incentives scheme, which focuses on global competitiveness, high value addition, productivity and quality, and innovation by firms and industries, should be effectively implemented. The policy framework and regulations should be improved to encourage technology-based foreign investment. The services sector, in particular finance, telecommunications and information technology, also provides prospects for diversifying the economy and providing jobs for the nationals. A strategy may be developed to attract private investment in this area.

 

The macroeconomic policy should be directed towards stability, balanced and sustained growth, reduction on oil dependence, opening up the economy and encouragement to private enterprise. The restructuring of public finance (as suggested earlier) and financial sector reforms are important steps in this direction. So are the reforms to update and revise the out-dated laws and regulations and strengthen institutions and systems to promote market friendly business environment.

 

Some two decades back Kuwait was a regional trading hub with substantial re-exports. This has been revived partially with re-exports to Iraq. Given the geographical location Kuwait still has good prospects to play that role provided communication and service facilities are upgraded and regulations and procedures are simplified and improved.

 

The economy of Kuwait suffered due to Iraqi invasion in early ‘90s whereas other GCC members progressed rapidly. Thus Kuwait is not yet fully prepared to face the challenges of regional integration and benefit from the enlarged open market. It has to accelerate the progress. The industrial development strategy (and the Industrial Master Plan and Industrial Roadmap – 2005-15 which are being prepared) provide a solid basis for development of competitive industries. These should be implemented effectively. Industrial and business linkages should also be promoted among GCC members.

 

Being a member of WTO, Kuwait cannot take such export and industrial promotion measures that are inconsistent with its commitments. Some other GCC members, like Saudi Arabia, which are not members of WTO, do not have such restraints, and are indulging in subsidising their industries. Kuwaiti products are faced with unfair competition from subsidised regional products. GCC should develop a code of fair business conduct to promote healthy competition among its members. Taking advantage of the unified market, the business community of GCC and other friendly Muslin countries should explore establishing joint ventures and sectoral linkages.

 

The Kuwaiti assistance programme for developing countries provides a useful basis for enhancing economic cooperation and linkage with recipient countries in many ways. The assistance may be linked with supply of products and services available in Kuwait. It may be used for encouraging joint ventures and multipurpose arrangements. It may be utilised for building such technology and human capital as is required by Kuwait. It may help in developing such infrastructure in recipient counties, which would induce Kuwaiti private investment.

 

Pakistan and Kuwait enjoy good economic and political relations. A large number of Pakistanis are working in Kuwait; Pakistan being an important market for Kuwaiti lubricants and oil products. At government level a joint economic commission and Kuwait-Pakistan Investment have been established. These should be reactivated. Collaboration between the business communities of the two sides should be expanded to for promoting mutually beneficial relations.

 

Kuwait is faced with the challenge of providing employment to its nationals for whom the Kuwaitisation policy has been initiated. The policy should be effectively implemented with emphasis on training and skill development of unemployed and observation of sector specific employment quotas for Kuwaitis in the private sector. In an advancing economy with limited manpower, the need for expatriate workers will continue. A strategy may be devised for smooth replacement of expatriates by locals, wherever desirable. One mechanism is to place Kuwaitis as under-trainees of expatriates who should replace the later in due course of time. Another way is to identify positions of high skills in which Kuwaiti are given intensive training under a crash programme.

 

The persistent external threat to its territory (primarily) from Iraq in the past was partly responsible for the flight of capital and lack of business confidence, particularly in making long-term investment in domestic industries. The conclusion of Kuwait-Iraq border arrangement and downfall of Saddam Hussein seems to have eased the situation. The business confidence seems to have revived, though still there is a lurking fear. Political stability in the region, permanent resolution of border dispute between Kuwait and Iraq and creation of atmosphere of mutual trust and respect will go a long way in ensuring sustained growth of the country. Iraq is a major beneficiary of Kuwaiti assistance with an estimated outstanding debt of $8.2 billion. Kuwait has in principle agreed to cut this debt by 80 percent and provide $560 million in 2004 for infrastructure, health and education projects. Such jesters on the part of Kuwaiti towards Iraq as increased economic and humanitarian assistance, debt relief, facilitating supply of essential goods, and support in nation building efforts should impact favourably in developing harmonious relations between the two sides. This policy should be persuaded with patience, perseverance and tact. Given the present situation of Iraq, the immediate prospects of regional calm are remote.

 

The prospects of sustaining Kuwait’s growth may also be seen in the context US presence in the region. Events since early ‘90s have led to expansion in presence and involvement of US and other Western powers in the region. This presence is not only for security and political reasons, but importantly for safeguarding the economic interests, oil being a high priority. It has a financial, economic cost, political cost and social cost. As the region holds a major chunk of global oil reserves with oil industry in the hands of respective governments, the stakes of big powers in dominating it are high. Many factors including conflicts among regional countries, weak and corrupt regimes, outside prompted intrigues and lack of foresight and tolerance, are abating this presence. These factors will no doubt cast a shadow on sustainability of growth.

---

¨ The article mainly uses the data and other information from the following sources: Kuwait, government: Ministry of Planning (2002): Annual Statistical Abstracts, The State of Kuwait: Industrial Investment Guide (p 9-17), Public Authority for Industry (1996): Industrial Law of State of Kuwait, No. 56. Central bank of Kuwait www.cbk.gov.kw, Public Authority of industries www.pai.gov.kw and IMF Country Report No. 05/231 July 2005, pp. 4-17 and 22-25.