Economic Update 18 September 2016

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1 Economic Update September Macroeconomic outlook Kuwait: Non-oil growth resilient on investment, as fiscal measures reassure > Nemr Kanafani Senior Economist +, Overview and outlook Non-oil growth is expected to accelerate to -.% in and, boosted by government driven investment program. Fiscal deficit to narrow in as reforms are enacted and oil prices are expected to improve. Deficit remains manageable thanks to large financial buffers and ample borrowing capacity; strong credit rating maintained. Liquidity remains comfortable despite lower oil price. Dinar weakened slightly in following two years of strength. Kuwait s non-oil economy has maintained a relatively healthy pace of growth even as oil prices remained more than half their levels of two year ago. Indeed, we see non-oil growth improving in and, in contrast to cooling activity in some neighboring GCC countries. The driver is a government-led development plan, which is helping ramp up both public and private investment, boosting the private sector s share of the economy and addressing capacity constraints in a number of areas. The consumer sector is also expected to continue to support activity, though it is expected to see some healthy moderation. It has been two years now since oil prices began to decline in mid-. As oil prices fell from over $ per barrel, a sizeable fiscal surplus turned into a deficit. The government responded by proposing comprehensive economic reforms, including fiscal as well as structural reforms. The government moved ahead with spending cuts targeting non-essential areas in FY/; more recently, it has introduced measures to reduce the subsidy bill. Initiatives to increase non-oil government revenues are also pending, including a value-added tax (VAT) and a corporate earnings tax, both of which require legislation. The fiscal deficit is expected to narrow in as the price of oil gradually improves. We expect Brent to average around $ a barrel in before rising to $ in. Fiscal reforms will also help close the gap. However, the risk that oil prices will underperform our projection remains a significant downside risk for the outlook. Weaker prices would put further pressure on the fiscal and external positions and could push Table : Key economic indicators * * Chart : Real GDP growth (%) * * Source: Central Statistical Bureau, NBK estimates, *estimate/forecast Chart : Consumer price inflation Jul- Jul- Jul- Jul- Jul- Source: Central Statistical Bureau, NBK estimates; *estimated by NBK Total GDP Nonoil GDP Headline Core* Chart : Budget balance (fiscal year: April-March; after FGF; *estimate/forecast) KD bn (LHS) % of GDP (RHS) - - / / / / / /* /* Source: Ministry of Finance, Central Statistical Bureau, NBK estimates Nominal GDP KD bn.... Nominal GDP USD bn Real GDP growth % y/y.... Oil % y/y Non-oil % y/y.... Inflation (average) % y/y.... Budget balance** % of GDP Source: CBK, MOF, CSB, NBK estimates; *estimate/forecast; **after FGF NBK Economic Research, T: (), F: (), NBK

2 the government toward more significant expenditure cuts and possibly even some reductions or delays in capital spending. However, we deem such a scenario unlikely. Non-oil activity remains resilient, as capital spending is maintained Preliminary figures show overall GDP growth accelerating to.% in from.% in, boosted by record high investment. While the figures show non-oil GDP growth slowing to.% in, we think growth will likely be revised higher when final figures are published (Chart ). Data also show domestic demand growth improving in, with stronger investment growth making up for some weakness in government and private consumption. We estimate that non-oil GDP growth remained robust at.% in and expect it to improve further to -.% in and (Chart ). In our view, the pace of growth has been improving as the implementation of the government s capital projects picks up pace. Indeed, preliminary figures indicate that aggregate investment received a strong boost in. The improving pace of economic activity has been visible in private credit growth, which accelerated to.% year-on-year (y/y) through May (Chart ). Credit growth has been particularly strong in the productive business sectors, with lending excluding personal facilities and lending to the financial and real estate sectors growing by.% y/y, compared to growth of.% y/y a year before. Credit growth is likely to end at an average pace of.%, up from % in. Overall GDP growth should improve to.% in and to.% in. In addition to accelerating non-oil activity, the gradually improving outlook is driven by a resumption of growth in the oil sector; we expect oil production to grow by around % in and, following two years of contraction. This is mainly due to the gradual return of output from Wafra and Khafji, fields shared equally with Saudi Arabia in the Neutral Zone; production from these two fields, which amounts to around - thousand barrels a day of crude for Kuwait, was shuttered in and. Government capital spending key to growth outlook The outlook for economic growth is driven largely by an improving pace of implementation of government-led infrastructure projects. The government s development plan targets investment of KD billion through and includes significant private investment. Among the projects are a number being implemented as public-private partnership projects (PPP), including the Al-Zour North power and water projects. A clear pickup in the pace of project implementation has been visible since. In, more than KD. billion in projects was awarded with another KD billion signed in. Project awards in have kept up the pace, with KD. billion awarded through July. Recent awards included the new airport terminal, which hopes to more than triple capacity by at an estimated cost of KD. billion. The national accounts data also reflected the improvement in project implementation, with investment seeing a strong boost in. Aggregate investment spending grew by % during the year, rising to % of non-oil GDP, a level that has not been recorded for over years (Chart ). Consumer moderating as confidence is dampened The consumer sector has long been a robust and reliable source of Chart : Private credit growth May- May- May- May- May- Month end Annual average Chart : Aggregate investment (% of GDP, *estimate/forecast) * * Source: Central Statistical Bureau, NBK estimates Chart : Card transactions Point-of-sale only Including cash withdrawals Q Q Q Q Q Chart : Household debt growth May- May- May- May- May- NBK Economic Research, T: (), F: (), NBK

3 growth in Kuwait. This is expected to remain so in and, though we see the sector moderating somewhat. The sector is supported by steady growth in employment and salaries, particularly in the government sector and among Kuwaiti households. Cuts in government wages and salaries are unlikely and subsidy reforms are expected to be gradual and thus to have a relatively limited impact. Chart : Consumer confidence index (index) General index -month average Most consumer metrics continued to indicate a robust sector. Household income of civilian Kuwaiti employees remained resilient, growing by an estimated.% y/y during the months through March. Household debt growth maintained a strong pace, standing at.% y/y at the end of May (Chart ). This all supported continued strength in consumer spending, with credit and debit card point-of-sale outlays growing by.% y/y in Q (Chart ). Despite the relatively healthy consumer sector, confidence has revealed some signs of softness in the sector. The Ara Research & Consultancy consumer confidence index has retreated consistently over the last year. The -month average index reading was down by % y/y in July (Chart ). A weaker perception of current employment prospects weighed the most on the overall index. Expectations for durable goods purchases were also weaker compared to a year ago. Correction in real estate prices has been gradual Since, activity in the real estate market has been relatively weak. Real estate sales during the -months through July were off by % y/y (Chart ). Most of the weakness was in the residential and investment sectors, with both sectors seeing -month trailing sales down by % y/y in July. Commercial activity, which had seen sales down in, has done better in. Sales in that sector were up by.% y/y through July. The cooler real estate market has coincided with the decline in the price of oil and may reflect a more cautious investor. It has also coincided with a concerted effort by the government, since, to increase the distribution of subsidized housing plots and built homes. The government nearly tripled its annual housing distributions to over, units in from around, the year before. In, it plans to distribute more than,. Expectations of an imminent increase in supply in the market may have helped cool market activity. The drop in sales activity has helped precipitate an orderly correction in real estate prices. The sectoral price indices developed by NBK indicate that price growth has turned negative in the investment buildings and residential sectors. The -month trailing residential home price index was down by.% y/y in August (preliminary estimate) (Chart ). In the investment sector, prices retreated by.% y/y. (preliminary estimate) Meanwhile, residential land prices, which had seen declines last year, are now back in positive territory; they recorded mild positive growth of.% through mid-august. Inflation easing gradually as domestic pressures recede Inflation eased over the last year or so, as most components saw inflationary pressures diminish. Headline inflation stood at.% y/y in July, compared to.% a year before (Chart ). Services excluding housing have been a main source of reduced inflationary pressures, with inflation in this segment declining to.% y/y in May compared to % a year ago. Meanwhile, pressures from housing services have been on the rise, with prices there, mostly representing housing rents, rising by.% y/y. Rent inflation should abate soon. We expect average inflation to be mostly steady in at around.% before accelerating slightly Jul- Jul- Jul- Jul- Jul- Jul- Jul- Source: Ara Research & Consultancy Chart : Real estate sales (KD million) Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Source: Ministry of Justice - - Monthly -m average Chart : Real estate prices (% y/y, -month average) Residential land - - Aug- Feb- Aug- Feb- Aug- Feb- Aug- Source: Ministry of Justice, NBK estimates *Preliminary estimates for Aug,,,,, Chart : Oil price and government oil revenues Oil revenues (KD bn, LHS) Residential homes Investment buildings Kuwait oil price ($/bbl, RHS) Jul- Jul- Jul- Jul- Jul- Source: Ministry of Finance, Kuwait Petroleum Corporation - - NBK Economic Research, T: (), F: (), NBK

4 to % in as a result of steps to cut energy and water subsidies. Fiscal deficits will persist, but remain manageable Government finances are expected to maintain a deficit in the medium term, especially with the price of oil staying below Kuwait s estimated breakeven price of around $- per barrel. A deficit of % of GDP is likely in FY/, after the mandatory allocation to the Future Generations Fund (FGF). The deficit is seen narrowing to around % of GDP in FY/ as oil prices improve and further fiscal reforms begin to take effect. The government responded to lower oil prices with a number of fiscal reforms. Starting in FY/, the government sought to rationalize expenditures, cutting them by %. Most cuts were in non-essential items that had little impact on the domestic economy. More than half of the savings was automatic, the result of a drop in the cost of fuel and electricity subsidies. The rest came from transfers to independent public agencies and authorities. Meanwhile, expenditures on wages and salaries continued to grow, albeit at a more moderate pace. Capital spending was also left untouched. In March, the government approved a reform plan, which included a number of fiscal reforms. The plan included planned cuts in energy and water subsidies, and the introduction of a corporate income tax and a value added tax (VAT). In April, the National Assembly (NA) approved increases in electricity tariffs to take effect gradually from May. While the step was a historic move, the NA approved a watered down version of the proposed cuts which should still save the budget around.% of GDP. In August, the cabinet announced plans to reduce fuel subsidies, a move not requiring legislation. Gasoline prices are to be lifted at the start of September by -% for the various octane grades. The most popular octane fuel, accounting for % of consumption, will see the price rise to fils, a % increase. The annual savings to the state will be around KD million, or.% of GDP. The government is also looking to introduce new taxes to boost non-oil revenues, though not before. The government has proposed a % corporate income tax on local and foreign companies. The new tax is expected to replace several existing levies on corporate earnings in a measure that will broaden the tax base. Authorities are also preparing to introduce a % VAT in conjunction with other GCC countries. Both measures will require legislation. Kuwait s deficits remain relatively manageable given the state s substantial overseas financial assets and ample capacity to borrow. In FY/, the full KD billion deficit was financed out of the General Reserve Fund (GRF). Kuwait s sovereign wealth fund assets are thought to near % of GDP. The bulk of the assets are with the Future Generations Fund (FGF), though the GRF, whose holdings are mostly liquid, also holds substantial assets thought to be around KD - billion. Bond issuance is being ramped up in FY/ Despite Kuwait s substantial sovereign wealth fund assets, the government will rely on debt issuance to finance the bulk of the deficit in FY/. We estimate the government will need to finance around KD billion in FY/ after the mandatory payment into the FGF. According to the government, more than % of that will be financed with bonds and sukuk. It has indicated it will issue around KD billion in domestic and international debt in FY/ Chart : Crude oil production (million barrels per day).. Jul- Jul- Jul- Jul- Jul- Jul- Source: OPEC Monthly -month average Chart : Money supply growth (% y/y, M) - - May- May- May- May- May- Chart : Banks excess liquidity (bank reserves as % of bank assets) May- May- May- May- May- Month end Annual average Chart : Money supply to non-oil GDP (M as % non-oil GDP) May- May- May- May- May-, Central Statistical Bureau, NBK estimates NBK Economic Research, T: (), F: (), NBK

5 The MOF is set to issue around KD billion in new domestic debt in FY/. Gross issuance of local currency bonds and Shariah-compliant tawarruq during the first five months of the fiscal year, through the end of August, amounted to KD. billion; as a result, the MOF raised KD million in net new debt; the debt level rose to KD. billion or an estimated.% of GDP. The issued paper varied in maturities between one and seven years. The MOF has been seeking to increase the average tenor of the debt; maturities of - years now account for % of outstanding MOF debt, up from % at the end of March. There are also preparations to tap the international debt market. The MOF has stated it plans to issue around $ billion (KD billion) in foreign currency debt in FY/. Such a step will allow Kuwait to capitalize on its solid credit rating (Moody s: Aa, S&P: AA, Fitch: AA) and low international rates. Reports indicate that $. billion in conventional bonds could be issued in Q, while a $ billion issue of Islamic sukuk is slated for Q. The latter awaits the adoption of a sukuk law, which is expected to be ready before the end of. Liquidity remains comfortable despite some tightening International debt issuance will also help relieve the pressure on domestic liquidity. With the government running a deficit and the current account seeing its surplus narrow considerably, system liquidity has come under some pressure. Money supply (M) growth slowed considerably since, from % y/y to.% y/y in and just.% y/y in. Still, liquidity levels remain relatively healthy. Money supply (M) to nonoil GDP was estimated at % in May, which is just above the average recorded since the financial crisis (Chart ). Interest rates have moved up over the last year in the wake of a hike in the policy rate late in. The Central Bank of Kuwait hiked its discount rate by basis points in December to.% immediately following the rate hike by the US Federal Reserve. The -month domestic interbank rate had risen to.% shortly after the rate hike but retreated since to stabilize at.% by August (Chart ). Dinar weakened slightly in following two years of strength The Kuwaiti dinar (KWD) retreated slightly thus far in, following two years of moderate appreciation driven by a stronger US dollar. The dinar index, which reflects the trade-weighted value of the currency, declined by.% year-to-date (ytd), after having registered gains of.% in each of and. The dinar, which is pegged to a basket of major currencies with the US dollar having the largest weight, was up by.% ytd in July against the US currency (Chart ). Stocks down year-to-date in, as market lags region Kuwaiti stocks continued to lag the region thus far in, with the year looking to be the third consecutive lackluster year. The Kuwait Stock Exchange s value-weighted index (IXW) recorded monthly declines in every month since April and was down by.% ytd through August (Chart ). The MSCI total return index was down by.% for the same period. Chart : Current account balance (*estimate/forecast) * * Source: Central Statistical Bureau, NBK estimates Chart : Interbank rates (%, -month).. Aug- Aug- Aug- Aug- Aug-, Thomson Reuters Datastream Chart : Exchange rate KD bn (LHS) % of GDP (RHS) Trade-weighted exch. rate (RHS). Aug- Feb- Aug- Feb- Aug- Feb- Aug- Source: JP Morgan, Thomson Reuters Datastream Kibor (KD) Libor (USD) Spread USD/KWD (LHS) Chart : Stock market indices KSE price index (LHS) KSE weighted index (RHS) Aug- Feb- Aug- Feb- Aug- Feb- Aug- Source: Kuwait Stock Exchange, Thomson Reuters Datastream NBK Economic Research, T: (), F: (), NBK

6 NBK Economic Research, T: (), F: (), NBK

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