Information about Middle East Oriente Medio
Chapter

I Introduction

Author(s):
John Wilson, Susan Fennell, Nigel Chalk, Mohamed El-Erian, and Alexei Kireyev
Published Date:
April 1997
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Information about Middle East Oriente Medio
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Author(s)
Mohamed A. El-Erian

Kuwait has made an impressive recovery from the damage and disruptions caused by the August 1990 invasion by Iraq. Oil production and capacity have been fully restored to preinvasion levels, as has infrastructure. The reconstruction and rehabilitation effort has contributed to strong GDP growth, while inflation has been contained. Fiscal deficits have been reduced in a gradual and steady fashion, the current account has resumed its traditional surplus position, and foreign assets remain comfortable (albeit at a reduced level compared to the preinvasion levels) and are rising. Progress has also been made in resolving the domestic loan problems resulting from the invasion and the earlier informal stock market crisis.

Looking forward, the authorities’ new Five-Year Plan under discussion recognizes the important structural challenges faced by Kuwait. Chief among these are (1) strengthening the structure of the budget in the context of the planned elimination of the deficit by fiscal year 2000;1 (2) continued progress in resolving past nonperforming loan problems and lowering moral hazard; and (3) strengthening labor markets and, more generally, the role of the private sector in economic activity.

Addressing these challenges holds the key to restoring Kuwait’s widely respected tradition of building substantial foreign assets for future generations and providing employment opportunities for the growing number of Kuwaiti nationals entering the labor force. The challenge is not an easy one. It involves reexamining the generous automatic entitlements that Kuwait offers its citizens. However, with a comfortable foreign asset cushion and a successful strategy of diversification in the energy sector, Kuwait has a solid foundation to build on.

This paper aims to contribute to the analysis of recent developments in the Kuwaiti economy and its policy challenges in the medium term.2 Following this introductory section, Section II analyzes economic developments since the liberation and considers policy priorities, noting the shift in policy emphasis in the last couple of years from the immediate challenge of reconstruction and rehabilitation to the longer-term structural issues. Section III discusses the structure of Kuwait’s public finances, a key determinant of the country’s financial outlook. After analyzing the manner in which the invasion accentuated underlying structural weaknesses, it reviews the steps needed to improve further the fiscal position and reduce the economy’s vulnerability to the vagaries of the oil market. In the context of the important effect of government spending on Kuwait’s non-oil GDP, Section IV provides insights on the potential impact on the real economy of fiscal retrenchment and the policy implications, taking into account the authorities’ objective to diversify the economy and provide employment opportunities for the growing number of nationals entering the labor force. Section V reviews the evolution of the financial sector in recent years, analyzing major changes in the institutional structure and policy instruments. It notes the role that monetary policy has played in supporting Kuwait’s exchange rate policy and considers the measures needed to enhance further the process of financial intermediation. Section VI analyzes in greater detail the authorities’ ongoing efforts to fully resolve the domestic loan problem.

1The fiscal year in Kuwait runs from July 1 to June 30.
2The analysis in this paper is based on work completed in mid-1996, incorporating data available at that time. Accordingly, it does not cover developments since then, including the increase in international oil prices.

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