Banking sector buttresses economy as oil roils

Oil prices have a significant influence on market sentiment in Kuwait; a buoyancy witnessed in the market when oil prices climb, sinks with every downturn. Recent volatility, with crude oil prices falling from $73.43 per barrel in May to around $54 at the end of the year, has seen consumer sentiment once again begin to wane.

Upswing in consumer spending that lifted the broader economy through much of 2017 and early 2018, has begun to taper. According to a report from National Bank of Kuwait, growth in consumer purchases eased to 8.6 percent in third-quarter of 2018, while growth in the bank’s own consumer spending index registered a one-year low of 4.1 percent year-on-year.

Decline in consumer sentiment is one of the factors behind anemic pace of non-oil growth, which is now estimated at 2.8 percent for the whole of 2018, and only expected to inch up to 3.0 percent in 2019. Construction projects, which are another significant component of non-oil economy and have a major role in stimulating market activity, was in the doldrums through much of 2018. By the end of the year, only a dismal KD1.6 billion in projects had been awarded, which was less than half of the KD4 billion planned for the full year, and appreciably lower than the average during the past five years.

Oil sector growth, which is the mainstay of the economy, is also likely to face a double whammy in 2019 from lower global prices and mandated production cuts. Kuwait Export Crude, which began the year at $51.4 per barrel, is set to be further impacted by the six-month production cuts called for by the Organization of Petroleum Exporting Countries (OPEC). The production constriction that comes into effect from January, could see Kuwait’s crude output fall by around 2 percent in 2019, from the October production reference level of 2.76 million barrels per day.

Slower and smaller growth in both oil and non-oil sector are expected to weaken fiscal outlook for the year ahead and negatively impact the country’s GDP growth, which is now predicted to drop to 2.2 percent in 2019, from the 2.9 percent estimated for 2018.

The confluence of several external and internal factors could further dampen GDP growth in 2019, especially if global economic growth continues its slide and if there is any uptick in regional geopolitical risks. Internally, the continued lack of meaningful economic diversification and the slow pace of reforms could also impact GDP growth in the country.

Opposition to the implementation of financial reforms, including the introduction of VAT and a new debt law in Parliament, as well as public reticence to any form of entitlement cuts, such as public sector jobs and profligate subsidies, are hampering growth. Expectations are that in the short-to medium-term the government will continue to be hobbled by its large public sector wage bill and unsustainable largesse to citizens.

On the brighter side, the government’s adherence to fiscal consolidation and commitment to reining-in its expenditures, along with higher oil revenues in 2017 and in the first-half of 2018, have helped slash the deficit, which has been recurring over the past couple of years. It is now expected that at the end of this fiscal year the budget would be close to balance, and this would encourage the authorities to maintain their fiscal policy.

Also, an increase in gas condensate output — a hydrocarbon component that does not form part of OPEC production cuts — and the potential for an agreement with Saudi Arabia to restart production in the Neutral Zone, could see oil GDP rise by 1.5 percent in 2019 from the 3 percent last year. This relatively brighter oil sector scenario together with an expected pick-up in project activity during 2019, and the state’s large sovereign wealth fund reserves, will allow the government to sustain capital spending and buttress the economy in 2019. In addition, the decision by the Central Bank of Kuwait (CBK) in mid-December to maintain discount rates at 3.0 percent could revive business credit growth and potentially help private investment recover from its recent slump.

In recent years, the banking sector, led by the CBK, has had a steady and moderating influence on the economy. As the strongest non-oil economic sector, banks in Kuwait are critical to the government’s New Kuwait 2035 strategic plan that envisions transforming the country into a commercial, financial and cultural hub in the region by 2035.

The latest financial stability analysis of banks in the country by the CBK revealed that the funding structure of banks is steadily improving, with less reliance on non-core liabilities and more on time deposits. The exposure to equity markets has also been gradually declining with equity investments now accounting for 15.6 percent of banks’ total investments, and the use of firms’ shares as collaterals down to 18.8 percent of banks’ overall collaterals. Income from loans accounted for 82.4 percent of banks’ interest income and 64.4 percent of their total income in 2017.

Meanwhile, the liquidity levels have remained healthy, with Liquidity Coverage Ratio (LCR) of banks comfortably above the minimum benchmark of 80 percent for 2017. The ultimate benchmark of 100 percent, which is due in 2019, reflects the amount of highly liquid assets that the bank holds that are equal to or greater than its net cash flow over a 30-day stress period. Highly liquid assets include mainly cash, Treasury bonds and corporate debts.

According to CBK reports, the combined assets of banks in November 2018 was KD65.3 billion, an increase of 4.4 percent from the same period a year earlier. Claims on private sector accounted for KD38.3 billion and foreign assets were KD13.3 billion. On the liabilities side, private sector deposits accounted for KD36.6 billion while foreign liabilities were KD6.1 billion. Higher interest and non-interest income, lower loan loss provision expense and lower non-interest expense collectively helped improve the industry’s net income.

Despite the prevailing stability and soundness of its operations, it is relevant to note that the resilience of banks could come under pressure if operating environments were to deteriorate. Especially problematic is the banking sector’s vulnerability to fluctuations in real-estate prices in the country. Banks currently have significant credit exposure to real estate market, directly in the form of financing real estate transactions and real estate constructions, as well as indirectly through loans to consumers for paying installments on real estate purchases.

Since 2012, exposure of banks to real estate sector has kept increasing and reached KD21.6 billion in 2017. In addition, real estate constitutes the bulk of collaterals with banks accounting for 66.3 percent of banks total collateral in 2017. Banks also have exposure in terms of their own real estate investments. Any significant tremor in this triad of lending, collateral and investments, which constitute the three-dimensional exposure of banks to the real estate sector, could pose a challenge to the banks financials and operations, as well as to the country’s economy in future. The hope in such a scenario is that the dictum ‘Too important to fail’, would prevail.