(MENAFN- Arab Times) Economic activity has picked up over the last two years, supported by the accelerated implementation of the government's development plan and a robust consumer sector. Ambitious capital spending targets have boosted aggregate investment and should continue to do so in 2015 and 2016. The National Assembly's recent approval of the government's 2015-2020 investment agenda and the FY15/16 capital spending budget indicates the government is staying the course on plans to boost infrastructure spending in the economy, as indeed it has stated it intends to do.
However, Kuwait's fiscal position has been squeezed over the last three quarters as the price of oil plummeted. As a result, Kuwait is likely to register its first deficit in years during FY15/16. Still, we think the government has sufficient buffers to weather a period of lower oil revenues.
The country entered the period of lower oil prices following several years of substantial fiscal and external surpluses. Also, the state has one of the largest sovereign wealth funds in the region, estimated at over 300% of GDP, which should allow it to easily finance a deficit. The government is also taking steps to reduce unnecessary spending without touching strategic capital spending.
Risks remain however, especially in addressing the medium to long term fiscal sustainability concerns. A key challenge is limiting current government spending growth and addressing the large subsidy bill.
Recent experience has highlighted the large political obstacles facing efforts to reduce general fuel subsidies in Kuwait, for example. Nonetheless, we think the government's gradual approach should ensure Kuwait addresses the concerns in due course.
Kuwait's nonoil economy has been seeing an increase in activity, reflecting the improved economic conditions. The most recent available data on GDP growth show Kuwait's nonoil economy growing by 5.6% in 2013. We think that pace of growth was maintained in 2014. Growth is likely to edge towards 6% in 2015 and 2016, as investment spending increases.
There have been some concerns that nonoil growth may be faltering though we do not think the data support these concerns.
In particular, private credit growth has been easing following several years of acceleration. Private credit grew by 6.2% y/y in December 2014, down from growth of 8.1% in 2013.
Business credit (excluding personal facilities and the nonbank financial sector) alone slowed to 5% y/y from 7.9%. However, we think that these figures are down largely due to the write-off of Family Fund loans by banks and the pay down of legacy debt by some corporates in 2014. Adjusting for these factors, we think growth accelerated to near 9% in 2014.
Investment spending has been on the rise, driven largely by improved implementation of the government development plan. The plan, which calls for both government and private investment in a host of large infrastructure projects, has seen a number of significant awards over the last year.
Further progress should be seen in the coming period after the National Assembly passed the broad investment plan for the next five years (2015-2020) as well as the FY15/16 capital spending budget.
The recently approved 2015-2020 development plan envisions spending around KD 34 billion on new projects in various sectors including the oil sector, power generation, transportation and housing. Most of the projects in the plan have already been approved individually and have been on the government's drawing board for several years.
The plan's broader vision is to improve Kuwait's investment environment and to boost private sector participation in the economy.
This is to be done largely through the public-private partnership (PPP) investment model. Legislation passed in 2014 should lead to better regulation of the PPP initiatives.
The new law replaced the Partnerships Technical Bureau (PTB) with the Kuwait Authority for Partnership Projects (KAPP).It is hoped that the new body, with greater independence and executive powers, will more effectively manage PPP initiatives.
The consumer sector has been resilient despite expectations of slowing growth. Instead, the sector remains a key driver of the nonoil economy. Household income growth has remained robust, thanks to steady hiring among both Kuwaitis and skilled expats. As a result, we have seen strong growth in consumer spending and household borrowing, both in the double-digits. Card spending grew by a steady 14.7% y/y in 2014, pointing to solid retail activity, while personal loan growth topped 12.7% y/y in December 2014.
Real estate sales maintained healthy growth throughout 2014, led by strong growth in the investment and commercial sectors. Total sales rose to a record KD 4.3 billion in 2014, up 19% on the year before. Sales of investment properties rose by nearly 30%, supported by the attractiveness of rental properties in an environment of low interest rates. The commercial sector also saw robust growth in 2014, rising by over 40% from the previous year.
Following 16 years of fiscal surpluses, Kuwait is expected to record its first deficit in years during FY15/16 as a result of the decline in the price of oil. Government spending is also expected to decrease in FY15/16 as the government seeks to reduce the deficit, though most of the cuts will come in areas that should leave the outlook for the domestic economy unchanged. In particular, investment spending plans will be largely unchanged.
In oil markets, Brent declined by over 60% from its highs in June 2014 to its lowest level in January 2015. The average oil price for FY14/15, which ends in March 2015, is expected to come in at $85 per barrel, 47% lower than the year before. As a result, oil revenues are expected to drop by 24% to KD 22.3 billion. Despite a narrowing surplus, the fiscal balance in FY14/15 will remain positive and large at around 8.8% of GDP.
In response to lower oil prices, the government has proposed a more austere budget for FY15/16, which starts in April 2015. The proposed spending figure, which still awaits legislative approval, is 18% lower than the prior year's budget, at KD 19.1 billion. The draft budget projects a deficit 18% of GDP. We think it will be closer to 6% of GDP, due to a slightly higher price of oil and the usual under spending.
Half of the spending cuts in the FY15/16 budget are due to the change in the nominal price of oil (from $75 per barrel to $45); this, in addition to reducing projected revenues, lowered the estimated cost of subsidies by 35%. However, this cut only affects transfers between state entities and does not imply a reduction in subsidies provided to the public. Other proposed cuts were in "wages and related items" and "other expenditures".
Inflation in Kuwait has remained moderate running at around 3.0% y/y in 2014. Inflation excluding the more volatile food component (or "core inflation"),was slightly higher at 3.2% y/y. Consumer price growth has been on a moderate uptrend over the last two years but has remained subdued thanks to low international inflation and benign domestic pressures. We expect inflation to continue to increase towards 3.5% in 2015on accelerating domestic activity.
The Kuwaiti dinar (KD) strengthened in 2014, in large part due to the stronger US dollar. The KD, which is pegged to a basket of major currencies, declined by 4.8% against the USD between June 2014and February 2015; but, due to the central bank's peg mechanism, the KD moved up against all other major currencies, rising by 15% against the euro, 12% against the yen and over 5% against the British pound during the same period. Overall, the KD has strengthened as measured by the JP Morgan trade-weighted index of the dinar, which has risen by around 8.5% since May2014.
Following a large correction during the last quarter of 2014, Kuwait equities bounced back in early 2015. The Kuwait Stock Exchange's value-weighted index (IXW) rose by 1.6% since the start of 2015. The MSCI total return index shows a more robust 5% gain year-to-date compared to a small decline in 2014.
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