State’s oil output could remain unchanged for the rest of 2019 and beyond

KUWAIT: While concerns over the global economy have risen over the past few months, the performance of the Kuwaiti economy has been mostly steady or slightly improving. Oil prices, although under pressure from the global outlook, rose in 2Q19, on supply cuts by the OPEC+ group of oil producers and geopolitical tensions. Indicators of non-oil activity including consumer spending and credit growth have picked up, and the equity market has outperformed GCC peers helped by another confidence-boosting index upgrade triggering capital inflows. Although the need for macroeconomic and structural reforms to boost long-term non-oil growth and strengthen the public finances persists, in our view the economy is reasonably well-placed to cope with any moderate slowdown in global growth and consequently oil prices over coming quarters.

Oil prices up in Q2
Oil prices started 2Q19 strongly, but then fell back as concerns about the global economic outlook escalated. The price of Kuwait Export Crude peaked at almost $75/bbl in late April amid signs that the oil market was tightening in response to supply cuts by OPEC+, but had fallen to $61 by mid-June before rallying slightly on regional geopolitical tensions to finish the month at $66. On average, prices were 9 percent higher in 2Q19 than in Q1. Amid downward revisions to oil demand growth and ‘large uncertainties’ facing the oil market, OPEC+ agreed in early July to extend its expiring supply cuts for nine months until end-March 2020. Kuwait’s crude production stood at 2.71 million b/d in May, leaving it 116 percent compliant with its share of the targeted cuts. This suggests that Kuwait’s oil output should be broadly unchanged for the rest of this year and beyond, assuming no change in overall market conditions that could provoke an early OPEC+ policy response. Our expectation remains that a combination of OPEC+ supply restraint and fairly subdued oil demand growth will leave the market broadly balanced ahead, and that Brent oil prices will average $65/bbl both this year and next having averaged $66 year-to-date.

GDP growth rose to 2.6 percent in 1Q19
Preliminary official data for 1Q19 show that economic growth picked up slightly in the first quarter of this year, despite OPEC-led oil output cuts weighing on overall performance. GDP rose 2.6 percent y/y in 1Q19, firmer than the 1.7 percent recorded in 4Q18 (which was revised down from 2.0 percent). Oil GDP – which includes the refining sector – grew 1.3 percent (2.0 percent in Q4) which was slightly stronger than the rise in official oil production through the quarter – perhaps helped by a year-on-year rise in refined product output. Of greater surprise however was non-oil growth, which picked up sharply to 4.1 percent from 1.5 percent in 4Q18 (revised form 2.0 percent). But most of this acceleration was due to a change in the erratic taxes and subsidies adjustment used to distinguish market from producer prices. Excluding this, non-oil growth would have been a more modest 2.3 percent in 1Q19, which is closer to our view of underlying economic performance.

The quarterly official data pointed to growth last year of 1.2 percent and 1.1 percent for total GDP and non-oil GDP, respectively, but these figures may be revised when more comprehensive annual data are released in coming weeks. We have left our (stronger) estimates of growth last year unchanged, and expect non-oil growth of 2.5 percent this year and slightly higher in 2020.

The government’s budget for FY2019/20 was approved by parliament, with overall spending unchanged from the draft budget at KD 22.5 billion, a 5 percent rise on the budget for the previous year. Although final details have not yet been released, the draft budget showed (construction-related) capital expenditure little changed at KD 3.3 billion and at a relatively high 15 percent of total spending. Revenues however were revised down from the draft to KD 15.8 billion due to lower oil receipts and with the oil price assumption left at $55/bbl, this revision was likely due to lower projected oil output due to OPEC supply cuts.
The figures imply a budget deficit of KD 6.7 billion, or 17 percent of GDP, before transfers to the Reserve Fund for Future Generations. Due to a combination of conservative oil price assumptions and underspending (particularly on capital spending), the government’s deficit projections are usually far too pessimistic; based upon a $65/bbl Brent oil price assumption and another underspend we project a much smaller deficit of KD 1.2 billion, or 3 percent of GDP this year. Final figures for FY2018/19 have not yet been released but we estimate a surplus of KD 0.8 billion (2 percent of GDP) based on the provisional data for the first 11 months. However, our estimate could be optimistic as large spending could take place in the final month to settle some commitments before closing the end of fiscal year accounts.

Project awards lower than initial projections in Q219
Project awards slowed to only KD 377 million in 2Q19, down from a better-than-expected KD 700 billion in 1Q19. Total awards for 1H19 therefore stood at KD 1.1 billion, pointing, pro rata, to a slightly better performance this year than the KD 1.7 billion awarded in 2018. Awards in 1H19 were dominated by the construction (KD 523 million) and transport (KD 360 million) sectors, mostly for housing and roads.
Delayed projects have been rolled over to 2H19, when a large KD 4 billion in awards are now provisionally scheduled. These include large projects in transport and power, such as phase 1 of the Mubarak Al-Kabeer seaport, the Dibdibah solar power plant and the Kabd solid waste project. If these major awards are delayed, H2 performance will be substantially weaker. Based upon historical trends, we expect a more conservative award figure of around KD 2-2.5 billion for 2019 overall, which would still be an improvement on last year.

Real estate sector on a positive trend
Real estate sales stood at KD 225 million in May, declining 36 percent m/m after a robust April and also down 25 percent y/y.The fall is likely to have had a seasonal element, with trading typically slower during the month of Ramadan, which fell mostly in May. Slower sales were due to a drop in the number of transactions in the investment (i.e. apartment) and residential sectors (-46 percent m/m, -20 percent). Commercial sector activity on the other hand surged more than three-fold m/m to a record 120 transactions, possibly due to the sale of small commercial properties in the new areas of southern Kuwait. Sales are still up 3 percent y/y to May amid a solid rise in residential sales but apartment sales are down following a buoyant 2018. We think the market is in a reasonably stable phase overall.

Prices were mostly positive in May on a month-on-month basis, except for home prices which saw a mild 0.6 percent decline. However on an annual basis prices in most market segments are stable-to-rising, with residential home prices for example up 7 percent y/y despite May’s monthly drop. Single apartment prices are the notable exception, with prices down 1.3 percent y/y in May. This reinforces our previous view that the property market overall appears to be reasonably healthy, but the investment sector may still be vulnerable amid oversupply and relatively weak demand reflected by ongoing vacancies; housing rents in the CPI have also recently seen a small decline.

After trending lower in 1Q19, consumer spending growth appears to have improved in 2Q19, albeit mildly. According to the NBK consumer spending index, spending rose 1.9 percent y/y in 2Q19 up from 1.4 percent in 1Q19, as growth in services outlays held firm at 5.8 percent and durable goods purchases picked-up 1.9 percent from 0.4 percent the previous quarter. Non-durable sales growth however, remained in decline, falling by a sharper 7.0 percent versus a 5.7 percent drop the previous quarter, as clothing, cosmetics and general store sales remained weak.

These figures correspond to broad trends in data on POS sales and ATM withdrawals by the central bank, where growth slipped to a more than two-year low of 4 percent y/y in 1Q19. Based upon the NBK index, some pick-up might be expected when data is released for 2Q19.
We expect spending growth to be steady or improve slightly in 2H19 given the stable macroeconomic climate, oil prices at $60-70/bbl maintaining confidence, an expansionary government budget (including on wages and salaries) and reasonable employment growth. Moreover, the decision by the central bank to loosen consumer loan limits (now up to KD25,000 from KD15,000 previously) in December has since led to a notable rise in consumer borrowing – though the magnitude is quite small relative to the level of consumer spending overall.

Inflation remains low
Consumer price inflation edged up to 0.8 percent y/y in May from 0.7 percent in April. The rise was driven mainly by higher food inflation (1.0 percent from 0.8 percent in April) and slightly slower deflation in the housing segment (-0.5 percent from -0.6 percent in April) due to a rise in maintenance costs, but more significantly higher inflation in the communications segment. Core inflation, which excludes food and housing, was unchanged at 1.6 percent. The pick-up in food prices came mostly from seafood and meat items (unsubsidized), likely stemming from higher demand during the holy month of Ramadan which fell largely in May.

Inflation has drifted slightly higher so far this year having ended 2018 at 0.4 percent, but nevertheless remains at very low levels. Moreover, much of the recent rise reflects base effects following price falls a year ago. We therefore expect inflation to see only a modest rise overall this year, averaging 1 percent compared to 0.6 percent in 2018, and another sub-1 percent figure is possible given recent signs of continued softness in housing rents. Core inflation could be at or below 2 percent versus 1.9 percent last year, reflecting moderate economic growth, a strong dinar with respect to trade partner currencies, and the unlikely implementation of taxes (VAT, Excise) or subsidy cuts this year.

Credit growth continued its gradual recovery
Credit growth has continued the gradual recovery seen since late 2018, accelerating to an almost three-year high of 6 percent y/y in May from 5 percent in April and 5.2 percent in March. This improvement was supported by an increase in lending to both businesses and households. In fact, lending to businesses grew at a near three-year high of 6.5 percent in May, helped by the real estate sector (+7.5 percent) and industry (+5.9 percent), while household credit (excluding for security purchase) remained reasonably steady at 5.6 percent, despite housing loans decelerating (4.3 percent). As per consumer loans, its growth continues to benefit from the central bank’s loosening of lending restrictions last December, reaching 14.2 percent in May. We expect overall credit growth to end 2019 at around 5 percent y/y, supported by the stable macro climate, a slight pick-up in project awards and growing employment market.

Meanwhile, deposit growth edged up in May but remained soft at 1.5 percent y/y versus 1.3 percent in April. The rise was due to a surge in government deposits, while private deposit growth decelerated to just 0.1 percent from 2.2 percent in April.

Current account surplus doubled in 2018
The current account position strengthened in 2018, recording a surplus for the second consecutive year since 2016, when the country posted its first deficit in more than twenty five years. The surplus in 2018 increased to KD 6.2 billion (14.8 percent of GDP), more than double 2017’s figure of KD 2.9 billion (8 percent of GDP). This was primarily due to a 31 percent rise in oil export revenues thanks to higher oil prices and also record foreign investment income of KD 6.4 billion. The latter is mainly a reflection of higher returns on the government’s overseas investments. Growth in goods imports was a moderate 6 percent, reflecting somewhat subdued growth in the broader non-oil economy last year.

Meanwhile the capital and financial account balance – the main counterpart to the current account and reflecting movements of capital into and out of the country – saw net outflows increase to KD 7.4 billion from KD 5.4 billion in 2017. FDI inflows stood at KD 104 million (0.3 percent of GDP), which is the second lowest level in ten years. However, net portfolio investment turned positive at KD 726 million, as Kuwaiti residents sold their foreign bond holdings and as foreign investors bought Kuwaiti bonds and equities, the latter stimulated by the country’s inclusion in the FTSE Russell Emerging Markets Index.

Boursa Kuwait’s All-Share index gained 1.9 percent m/m in June, slightly underperforming the MSCI-GCC (2.1 percent) which was lifted by Saudi Arabia and Qatar. Liquidity was relatively high, with an average daily turnover of KD 38 million. Price gains were led by the consumer goods and banking sectors which rose 12 percent and 3 percent m/m, respectively. Net foreign inflows in June were well down from the exceptional peak of KD 141 million in March, but remained relatively healthy at KD 35 million. For the second quarter as a whole, the Kuwait market’s performance was strong relative to peers, up 3.8 percent versus 0.5 percent for the GCC.

Good sentiment this year has been supported by favorable stock re-weightings by the FTSE in March and good corporate earnings, coupled with the anticipation of the MSCI Emerging Market inclusion announcement which took place officially on June 25, to be implemented in May 2020 once confirmed in December. This is expected to generate further passive inflows in the range of $2.3-$2.8 billion, plus large active inflows. Regional markets however face various downside risks: we have already seen a marked deceleration in Q2 performance versus Q1 amid escalating geopolitical tensions, faltering trade talks, lower oil prices and slower global growth.

Economic outlook for 2019-20
A soft oil sector will limit GDP growth this year and next given the extension of OPEC+ agreement to March 2020 and possibly beyond. Non-oil growth will likely be in the 2.5 percent to 2.8 percent range, supported by an accommodative monetary policy and a budgeted increase in public spending. The financing of budget deficits will fall mainly on the General Reserve Fund (GRF) resources if the draft debt law is not approved. This calls for adopting fiscal and structural measures to broaden the revenue base (VAT, excise taxes), cut subsidies, and stimulate private sector activities including by creating a friendlier investment environment through improving the ease of doing business and reducing restrictions that would constrain foreign direct investment.