Reforms needed to sustain growth, future savings

Presenting his estimated state budget for fiscal year beginning in 1 April 2019, Finance Minister Nayef Al-Hajraf last week disclosed that the government would continue to encourage economic growth by boosting capital spending. Meanwhile, a report from the International Monetary Fund notes that despite short-term growth, the country urgently needs to implement deeper economic reforms if it is to sustain savings for future generations.

The government’s budget for fiscal year 2019-20 envisions a 4.7 percent increase in spending to KD22.5 billion, while maintaining capital spending at 17 percent as in the previous budget. Based on an average oil price range of $55 to $65 per barrel — higher than the $50 projected in the previous budget — the budget expects KD16.3 billion to flow in as revenue to the state exchequer. Outcome of the overall budget for the fiscal year is a deficit of KD7.7 billion, after the mandated 10 percent of revenue transfers are made to Future Generation Fund.

The finance minister’s decision to sustain capital spending in the face of other budgetary demands, including incurring a deficit that is expected to be covered by drawing on the state’s General Reserve Fund, highlights the important role that state spending plays in spurring domestic economic activity and non-oil growth. The non-oil revenue is now expected to rise by 5.4 percent in fiscal 2019-20 compared to the current year’s budget.

In its country assessment following a visit to Kuwait last week, the International Monetary Fund (IMF) also reiterated that higher oil prices could see capital spending boosted. The Fund projected Kuwait’s non-oil growth to increase to about 3.5 percent in 2020, from 2.5 percent last year. The IMF assumption of non-oil growth is based on an average oil price of $57 per barrel in 2019-20, and increasing to $60 per barrel over the medium term.

“As capital project implementation accelerates, non-oil growth is projected to increase to about 3.5 percent in 2020,” said the Fund. Meanwhile, the decision by Organization of Petroleum Exporting Countries (OPEC), to reintroduce production cuts by member countries starting in January 2019, is likely to hold Kuwait’s oil output to 2 percent growth in 2019, which could rebound to 2.5 percent in 2020 given the spare capacity, said the Fund. As deflationary factors seen in 2018 begin to unwind, inflation rate is expected to rise in 2019–20 to about 2.5 percent, the Fund added.

However, non-oil growth spurred by state spending from higher oil prices, is not a sustainable long-term economic policy. The government has to urgently come up with an alternative to the capital spending model — which is overly dependent on volatility of oil prices in the international market — to invigorate market activity. This view is reiterated by the IMF, which noted in its report on Kuwait that deeper economic reforms are needed, not only to stimulate the market but also to sustain savings for future generations.

Kuwait needs to implement deeper reforms to secure adequate savings for future generations despite forecasts of stronger growth in its non-oil economy, the IMF said. Pointing out that delays to the passage of a new debt law have left the government unable to issue debt since October 2017, the fund said, “Continued fiscal consolidation will be needed to reduce financing needs over the medium term.”

The delay in passing the debt law has forced the government to draw on the state’s General Reserve Fund for financing, including to repay maturing debt, the IMF noted. The General Reserve Fund is the depository for government surpluses after the mandated transfers are made to the Future Generation Fund (FGF). Operated separately by the Kuwait Investment Authority (KIA), the country’s sovereign wealth fund manager, the FGF and investment revenues from the fund are separate from the general budget. According to the Sovereign Wealth Fund Institute, the KIA reportedly has over $590 billion in assets under management, making it the world’s fourth-biggest sovereign wealth fund.

But dipping into the General Reserve Fund to fund deficit budgets is not an economic strategy that any Kuwait finance minister would like to pursue over the long term. The finance minister’s promise to curb wasteful spending, rein in expenses and gradually introduce fiscal reforms are however unlikely to tackle the elephant in the room — the unsustainable public sector wage bill and profligate subsidies to citizens.

More than 70 percent of the annual budget expenditure currently goes on salaries to public sector employees, and lavish subsidies to citizens. In the prosed budget for fiscal 2019-20, the finance minister has placed an outlay of nearly KD4 billion to cover subsidies, while public-sector salaries and wages account for an additional KD12 billion annually.

Rather than tackle the public wage bill, the finance minister has proposed other reforms to improve the country’s fiscal position over the medium term. Among the measures being contemplated are the introduction of excises on tobacco and sugary drinks in 2020/21 and a value-added tax (VAT) in 2021/22, as well as small increases in fees for government services, and stricter enforcement of eligibility rules for transfers.

Urging greater and more in-depth reforms, the IMF said even if implemented fully and on time, the measures under consideration by the government would not close the intergenerational equity gap. The fund warned that the government’s non-oil balance would fall well short of levels needed to ensure equally high living standards for future generations — a gap of 13.5 percent of non-oil GDP by 2024. Additional fiscal consolidation will therefore be needed to close this gap, which would also reduce financing needs and preserve liquid buffers, the IMF noted.

The Fund suggested that the government must urgently curtail the public wage bill, which constitutes 18 percent of GDP, by encouraging nationals to seek opportunities in the private sector, thereby enhancing its productivity and competitiveness. The IMF also urged the authorities to gradually phase out fuel, electricity, and water subsidies and transfers saying that despite earlier reforms, at 5.3 percent of GDP, the fuel and utility subsidy bill remains large.

“Not only are these subsidies costly, they also encourage excessive consumption and inefficient investment and, being untargeted, disproportionately benefit the wealthiest,” the IMF said. It also urged broadening the coverage of the profit tax and introducing an excise on luxury goods. Applying the profit tax to all companies operating in Kuwait would raise non-oil revenue while leveling the playing field. Meanwhile, an excise tax on luxury goods would contribute to a more socially-balanced adjustment mix. A personal income tax on high-income individuals could also be an alternative, the IMF noted.

Incidentally, in the recent Corruption Perceptions Index 2018, published annually by Transparency International, the Berlin-based international organization, Kuwait ranked a relatively low 78 out of 180 countries assessed. With a score of 41, where 0 denoted highly corrupt and 100 signified very clean, Kuwait clearly has a long way to climb and needs to urgently implement necessary institutional reforms to empower and make institutions more resilient and transparent.

In this regard it is heartening to note that the IMF Middle East Center for Economics and Finance (CEF), which is based in Kuwait, and the Arab Fund for Economic and Social Development (AFESD), also headquartered in Kuwait, are jointly organizing a symposium on ‘Good Governance and Transparency in the Arab World’, on 13 February at the Arab Fund, Arab Organizations Headquarters Building in Shuwaikh. The symposium will hopefully foster open discussion not only among experts and scholars, but also among people and in civil society on policies for a more proactive, buoyant and open government, and society.