KUWAIT CITY, Jan 14: GCC states are expected to maintain strong growth in government expenditure through 2009, in order to support growth in region’s weakening economies. The following report evaluates the spending trend across GCC. Listed below are the main highlights of the report by National Bank of Kuwait
* The extent to which Kuwait’s economy slows down this year will depend on oil prices and production, but also on the direction of the government’s fiscal policy.
* Fiscal stimulus is needed at a time when the private sector will be held back by a weak economic outlook, stock market losses and by battered confidence.
* A fund of KD 5-6 billion is required to invest in local equities on a long-term strategic basis, injecting steady liquidity into the market.
* The time for action is now. There is little point in waiting another year, or in having to legislate special emergency changes during the fiscal year, when it may be too late and when a larger dose of medicine may be required.
When the now infamous economic crisis first started in America, back in 2007, conventional wisdom had it confined to the real estate market in the US. When other US dominoes started to fall, conventional wisdom in Europe, in Asia and in the GCC had it confined to the US economy while songs of “decoupling” and “insulation” filled the air. Annus horribilis 2008 changed all that. Economic data and stock markets worldwide hammered home the reality that the economies of the world were indeed very sick. Governments and central banks, the world over, were busy working overtime, putting off fires here and there and trying to shorten what looks like the worst and longest recession since WW II.
Kuwait, like others, has been affected, to a milder extent but affected nonetheless. Oil prices and stock prices took a tumble in 4Q08, commercial real estate slowed in 1H08, etc. We expect further slowdown in growth this year. How slow will depend on oil prices and production, but more importantly for the rest of the economy on the direction of the government’s fiscal policy. So far, Kuwait, like others, put out fires last year (supporting Gulf bank, helping investment companies). Kuwait, like others, insured bank deposit, cut interest rates, added liquidity to its banking system.
However, and unlike others, Kuwait has not publicly nor clearly endorsed the use of deficit spending to prop up its economy in 2009, notwithstanding years of large surpluses.
Money and Motive
In our view, fiscal stimulus is needed at a time when the oil sector and the private sectors are expected to retrench. The oil sector for obvious reasons: lower prices and production cuts. The private sector should be held back by a weak economic outlook, stock market losses and by battered confidence. The two sectors, oil and non-oil private, make up 75% of the Kuwaiti economy.
Furthermore, at a time over half the world economy is in recession including the US, Euro zone, and Japan, and at a time the IMF (among others) doest not expect the world to return to normal growth before 2011, the assessment of risks has to be skewed to the down side. So what’s government to do? While the government can do little about the oil sector (about 50% of GDP) in the near term, it can do a lot for the rest of the economy with just one tool: the government budget. By raising spending, especially on projects and infrastructure, it can support directly and indirectly the weakening economy.
Furthermore by announcing loudly and clearly its intention, it can boost investor and consumer confidence, a pre-requisite to any recovery. On the subject of investor confidence, a word on the stock market: the size and style of the current (government market stabilization) Investment Fund have failed to do the job. It needs KD 5-6 billion, versus 1.5 billion, and it needs to buy and hold securities more aggressively. The Fund needs to buy value stocks, selected by the Kuwait Investment Authority, and it needs to keep its transactions continuous and uninterrupted. This also will go a long way in restoring lost confidence in the local market, a pre-requisite for stabilization.
Back to the fiscal side, there are currently confusing press reports of a Council of Ministers decision to cut budgeted spending by 30% in fiscal 2009/10, but no details were offered about the source of savings. NBK analysis of the budget shows that a saving of more than 30% in spending can be achieved purely by suspending exceptional transfers to PIFSS to cover its actuarial deficit and reducing the budget allocation for the cost of fuel used in power generation in line with the cut in the oil price assumed in the budget. The fiscal year starts in April 2009, so the new budget is due very soon. The current fog is weighing on business plans and confidence, and on an already wobbly stock market. Any budget cuts today would further damage sentiment and outlook, especially at a time all other GCC countries have vowed to increase their budgets (most expect deficits in 2009).
NBK looked at a number of scenarios to assess the impact of the current crisis on the Kuwaiti economy. The analysis shows that if the price of Kuwait export crude were to average $30-60 pb, and with no change in government spending other than cutting exceptional transfers to public entities like the Public Institution for Social Security (PIFSS) and transfers abroad in addition to savings on the cost of fuel as a result of a fall in the price of oil, real GDP would fall by 4-5% this year. Nominal GDP would decline by 20-40%. The declines would not be confined to the oil sector. Under that scenario, the non-oil sector would also fall in real terms by 2-3%. On the other hand, raising government spending by 5%, with increases split between current and capital expenditures, would shift non-oil sector to positive real growth of 2-4%. Of course, that might entail a budget deficit.
Budget deficits are nothing new or scary. Kuwait ran deficits 13 out of 16 fiscal years between 1981-1998. At one time, the deficit was KD 9.9 billion. Surely, the large surpluses of 1999-2009, totaling KD 32 billion ($112 billion), should be more than enough to shore up Kuwait solid financial position for years. Enhancing confidence, guarding against a worsening economy, and potential shocks, far outweigh the cost of any temporary deficit financing. Deficits are worrisome only when sustained and when adding to a large national debt. In Kuwait’s case the public debt is KD 2.1 billion, about 5% of GDP (40% in Europe). Also, Kuwait’s current debt was created only to provide needed instruments to banks and to the central bank to manage liquidity better. Issuance of new government debt would also be an added bonus. New debt instruments, such as government bonds, would be welcome by banks whose balance sheets have grown without a matching increase in the basic element of money market instruments.
At this juncture, monetary/banking policy has done its share by taking several measures in 2008, from cutting rates to insuring bank deposits, to providing liquidity to banks. These measures were necessary and did help tremendously. However, with confidence down and economic activity at a standstill, only one player can step up and increase spending significantly and that is the government. We note here that government spending has the added advantage of going directly into the spending flow of the economy and usually generates subsequent further round of spending (multiplier effect).
In the current situation, there is hardly a downside to deficits. The economy benefits and gets an insurance policy against further deterioration. Investor and market confidence is stiffened, and should that benefit balance sheets, many a troubled company would be relieved. More importantly, Kuwait would get needed new infrastructure (and perhaps faster than otherwise. We are talking about a fiscal stimulus package of increased spending on development and housing projects, especially on infrastructure projects such as the airport, hospitals, roads, oil and gas projects, power plants, as well as other vital projects that are needed and will be with us and yield benefits for the long haul. It is crucial, however, that implementation and execution be free of red-rape and bureaucratic hassles, lest these projects come too late to help with the economy’s current problems. With the new fiscal year upon us, the time for action is now. The budget sets government spending on track for a full year. Fiscal decisions are made that one time, at the start of the fiscal year (April-March). There is little point in waiting another year, or in having to legislate special emergency changes during the fiscal year, when it may be too late and when a larger dose of medicine may be required.
By National Bank of Kuwait