Even though crude oil has lost about 70% of its value since June 2014, we shouldn’t assume that all of the Middle East is in crisis mode.
Yes, many MENA (Middle East and North Africa) nations are suffering, since oil serves as the lifeblood of their economies. But due to its well-managed banking and financial systems, one nation is better able to withstand the current energy price shock: Kuwait.
The Kuwait Stock Exchange (KSE) reported that banks were the main driver of corporate earnings growth in 2015, accounting for almost 50% of the total earnings of the exchange’s listed companies.
Among Arab markets, KSE has consistently had one of the largest market capitalizations, with over two hundred companies totaling more than KD 28 billion ($100 billion) in market value.
And with a market capitalization-to-GDP ratio of approximately 100%, KSE has a stock market that’s deeper than many of its regional peers.
One of Kuwait’s differentiating factors is a predominantly manufacturing-based economy.
Manufacturing and industry accounted for 73.3% of GDP and employed 20.6% of the population based on 2013 statistics, while services accounted for 26.3% of the GDP and employed 76% of the population.
Thus, even as oil sector output is falling in annual terms, growth in non-oil industries is stable and gaining momentum. Demand for credit is also growing as the government has stepped up its capital spending on infrastructure.
Digging, Building, Constructing
With approximately $600 billion in reserves, Kuwait’s government was able to comfortably award more than $30 billion worth of contracts last year, second only to Saudi Arabia among Arab Gulf nations.
The government is encouraging a more entrepreneurial business culture, according to the National Bank of Kuwait (NBK), the nation’s dominant bank, by providing legislative and regulatory incentives to small and medium sized enterprises. In Global Finance’s annual list of the world’s safest banks, NBK has ranked in the top 50 for the past 10 years.
Recent projects include a new airport terminal, a refinery, and road improvements.
The increase in infrastructure spending should lead to higher corporate lending, which in turn will raise interest revenues and lower loan-impairment charges. Furthermore, it should increase asset quality and improve reserve coverage ratios.
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On top of that, the Central Bank of Kuwait has heightened regulation and supervision of the banking system, and its banks have made considerable progress in rehabilitating their loan books. According to the Central Bank, Kuwait’s bank assets rose 12.2% in 2014 to $220 billion. Growth was driven in part by international activity, which accounted for over 20% of business.
According to Moody’s, nonperforming loans at Kuwaiti banks are expected to drop to about 3% of gross loans for the fiscal year ending 2016, down from a peak of 10% in 2009. Moody’s currently rates Kuwait’s Government bonds at Aa2, while S&P rates them at AA.
One final advantage that Kuwait has is better interest-rate flexibility than most Gulf Cooperation Council (GCC) states. Kuwait abandoned its currency peg to the U.S. dollar in 2007, and the Kuwaiti dinar is now tied to a trade-weighted currency basket, with the dollar being the highest component.
Kuwait a Minute
Of course, all emerging market investments carry some risk.
Kuwait’s government spending is skewed toward wages and subsidies, with subsidies on goods and services accounting for approximately 10% of GDP. This isn’t sustainable indefinitely.
Under current subsidies, the price of electricity is fixed at 5% of the cost of production, which means it’s been about $0.007 per kilowatt-hour (nearly free) since 1966. Meanwhile, gasoline is $0.20 per liter. These prices are low even by Middle Eastern standards.
A gradual phasing out of the energy subsidy, a move suggested by the IMF last September, is a very sensitive issue and could only come about very slowly as it would inevitably raise inflation, currently at 3.3%.
Second, according to Rachel Ziemba, Managing Director of Emerging Markets at Roubini Global Economics, “There are still some underperforming assets on the bank balance sheets from the 2008 episode (shadow banks). These are largely cleaned up but still a drag on investment.”
That said, Kuwait’s government spending and strong domestic consumption will continue to drive growth, and financing infrastructure investment will likely continue to offset the oil sector’s falling profitability in this current stage of low prices.
Perhaps more importantly, the financial industry is backed by a sovereign wealth fund estimated at three times the size of Kuwait’s GDP, or just over $490 billion, which is a nice anchor to hold onto in a low energy price world.