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Kuwait starting to cut subsidies: IMF
October 1, 2014, 8:31 am
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Planning advanced for kerosene, electricity cuts

Kuwait’s government has started reducing some state subsidy payments and is an advanced stage of preparing a plan to cut subsidies for kerosene and electricity, the International Monetary Fund said. Subsidy cuts are an important economic reform for Kuwait because lavish subsidies, mostly on energy, swallow about 5.1 billion dinars ($17.7 billion) annually, or roughly a quarter of the government’s projected spending this fiscal year, according to government figures. Despite Kuwait’s vast oil wealth, such spending threatens to push the state budget into deficit later this decade, the IMF has warned. So far, the government — like other governments in the Gulf Arab region — has shied away from major reform of its subsidy system because of political sensitivities.

But in a report released this week after regular consultations with Kuwaiti authorities, the IMF said some reforms had now started. “Subsidies have been eliminated for diesel (with potential saving of 0.5 percent of GDP), and the government is in advanced stages of sending a proposal to the cabinet for reducing subsidies for kerosene and electricity,” the report said. “Moreover, the government recently rationalised some allowances for Kuwaitis traveling for healthcare abroad,” it added. The IMF did not give details of the reforms and government officials were not available for comment. Plans for subsidy cuts have received little publicity in the Kuwaiti media, perhaps because of their political sensitivity. The IMF has been urging Kuwait to restrain spending on public wages and subsidies to make its finances more sustainable in the long term.

The government said in June that it had decided in principle to remove subsidies on diesel fuel, pending a study on how to deal with the negative impact on consumers, according to state news agency KUNA. That measure was expected to save around $1 billion a year. Kuwait has posted budget surpluses since 1995 but rising government spending is projected to slash the surplus to around 12.1 percent of gross domestic product in 2019, the IMF estimated in April. It expects a surplus of 26.3 percent of GDP in 2014, the report showed. “Staff’s analysis shows that a $20 decline in oil prices relative to the baseline would result in reversing of the fiscal position — excluding investment income — from a surplus to a deficit in the medium term,” the IMF said in its latest report. “Fiscal restraint in the medium term is...needed to help reduce fiscal vulnerabilities and bring the fiscal stance closer to benchmark sustainability level.” The budget surplus edged up to 12.9 billion dinars in the last fiscal year to March as government spending fell, largely because of a drop in capital expenditure.

In its latest report, the IMF slashed its GDP growth forecasts for Kuwait to 1.3 percent this year and 1.7 percent next year, from 2.6 percent and 3.0 percent predicted in April. It also estimated that Kuwait’s economy shrank 0.2 percent in 2013, its first contraction since 2010, compared with its previous estimate of 0.8 percent growth. The downturn was mainly due to a 1.8 percent drop in oil-related GDP as growth in the non-hydrocarbon sector accelerated to 2.8 percent, the report showed. The figures suggest Kuwait underperformed other Gulf Arab oil exporters by a large margin last year; businessmen blame red tape, slow progress in building infrastructure and domestic political tensions for the economy’s weakness.

On ways to foster sustainable growth, the mission says that efforts by the government to diversify the economy are paramount to reduce Kuwait’s dependence on oil and to generate jobs for nationals. Although removing impediments in physical, legal, and business infrastructure is important, aligning incentives of firms, workers, and nationals is the missing link in the diversification strategy.

Improvements in the quality of education, and skill development, and changes to the balance of incentives for tradable/non-tradable production and public/private sector employment are essential to change the incentive structure. Developing SMEs, with the support of the KD 2 billion National Fund for SME Development, is important as a source of job creation for nationals, economic diversification including promoting non-oil exports-, and sustainable growth. Banks are amply capitalized and liquid with stable profits, reflecting prudent regulations by the Central Bank of Kuwait (CBK). Banks have a combined capital adequacy ratio of 18.3 percent, falling gross non-performing loans (NPLs) of 3.5 percent, and a growing provisioning ratio (general plus specific provisions) of 139 percent at end-June 2014.

The CBK has been proactive in introducing regulations to mitigate potential risks. It has introduced Basel III capital regulations for conventional and the growing Islamic bank segments, including a framework for domestic systemically important banks, which will increase the regulatory capital of banks significantly. Regulations on leverage and short term liquidity are in advanced stages of preparation. In line with international practices, the central bank introduced a loan-to-value ratio for residential real estate for investment purposes of individuals in November 2013, to limit financial stability risks, which the mission welcomes.

(The IMF) Staff observed that activity has been recently increasing in investment properties and commercial real estate segments of the real estate market, which the central bank is closely watching and ready to use macroprudential tools when appropriate, to limit potential stability risks to the banking system arising from this sector.

The systemic risk from ICs is contained, but the sector is vulnerable to swings in real estate and financial markets. Stronger regulatory oversight by the Capital Markets Authority is needed to strengthen this sector and engender consolidation.

The completion of the new draft corporate bankruptcy law could help expedite the restructuring of some loss making ICs, and implementation of the corporate governance code by June 2016 would help strengthen the sector. Continued coordination between the regulatory and supervisory bodies will facilitate effective monitoring and management of potential systemic risks.

Such a framework should include; strengthening the institutional arrangements for policy making and coordination through a formal mandate; further strengthening the Early Warning System for identifying and monitoring systemic risks, with macro stress testing becoming an integral part of systemic surveillance; continued enhancement of the existing macro-prudential toolkit; and implementing structural measures over the medium term, including further developing domestic interbank money and debt markets to support liquidity management, modernizing the insolvency regimes and supporting judiciary framework, and strengthening crisis management and resolution systems. The CBK should be provided with enhanced powers in this regard.

- Agencies

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