Deficit budgets based on oil untenable

In January, while presenting a deficit budget proposal for the financial year that began on 1 April, the Finance Minister Nayef Al-Hajraf had been equally optimistic on the country’s economic growth. Speaking on the occasion, he said, “The new budget aims to drive economic growth by maintaining a high capex ratio of 17 percent” while “tightening controls to curb wasteful spending and continue to gradually introduce fiscal reform.”

Notwithstanding the wishful words of Al-Hajraf, the budget that he projected for the country in 2019-20 only underlines the government’s continued commitment to higher spending, with little or no signs of the reforms that the finance minister endorses and the country badly needs. The projected budget for fiscal year 2019-2020 envisages a deficit of KD7.7 billion from a revenue of KD16.3 billion and spending of KD22.5 billion, after mandatory transfer of 10 percent of income to the Future Generations Fund (FGF) are made.

Last year, while presenting the budget for financial year 2018-19, the finance minister had similarly promised that projected spending would be capped at KD20 billion in the 2019/2020 fiscal year and at KD21 billion the following year. Asked about the KD2.5 billion discrepancy in this year’s budget projections, Minister Al-Hajraf said spending had been adjusted in accordance with “real needs” including new hiring and anticipated additional parliamentary outlays.

It is this “real needs”, which keep arising every year that have been a major stumbling block to the government’s attempts to rationalize spending, diversify the economy and bring in much-needed financial reforms. Due to the “real needs”, oil income projected at KD14.52 billion in the budget for 2019-20 once again dwarfs non-oil revenue estimated at KD1.87 billion, while public wages and subsidies will continue to account for over 70 percent of the budget spending. Luckily, the budget projections are based on an oil price of $55 a barrel, compared with the current prices that are expected to hover around $60 per barrel for the rest of the year. The price discrepancy will give the government some leeway in reducing, or even wiping out the deficit by the end of the fiscal year.

At the start of August, the Central Bank of Kuwait  announced that it would maintain its main policy rate unchanged at the current level of three percent. This monetary confidence in the country’s currency and its economy is certainly commendable, especially as it came on the heels of the decision by the US Federal Reserve to cut interest rates for the first time since the financial crisis, and given corresponding cuts to discount rates by central banks in other neighboring Gulf Cooperation Council (GCC) states.

Clarifying the decision, Kuwait’s Central Bank Governor Mohammad Al-Hashel said the decision to keep the rate unchanged was made to improve the non-inflationary growth-enabling environment in the country and to ensure continued attractiveness of the national currency, the Kuwaiti dinar, as a reliable store of domestic savings. These confident measures would do much to maintain a healthy margin in favour of the national currency, boost returns on dinar deposits and allow for a conducive environment for economic growth, said the governor.

To be fair to the finance minister and central bank governor, both ardent supporters of fiscal and economic reforms, the government has under guidance from the central bank and the ministry of finance, attempted to bring in fiscal belt tightening and economic reforms.In fact, it looked very much like reforms finally had a chance when oil prices slumped in the wake of its precipitous fall in mid-2014, and the government introduced steps to rationalize subsidies, introduce taxes and diversify the economy. But then, oil prices recovered from their slump and the government loosened its austerity belt and gave up on reforms.

A major reason why financial reforms have not moved beyond the blueprint stage in many cases is the strong opposition in parliament to any reforms that touch upon entitlements that citizens have been receiving and have grown accustomed to. Entitlements are fine as long as oil revenues keep flowing in.

But oil is, at best, a fickle commodity to base a country’s economy on. Last week, the country’s Oil Minister Khaled Al-Fadhel said that Kuwait had maintained a lower output than required by the accord on production cuts agreed among the Organization of Petroleum Exporting Countries (OPEC) and its non-OPEC partners.

The 1.2 million barrels per day (bpd) production cut mandated by the OPEC and its allies, now known as OPEC+, which are intended to bring down oil surplus in the global market and ensure fair prices for producers, have so far failed to materialize. Sluggish growth of the global economy and the potential for a trade war between the US and China escalating have dampened demand for oil.

Nevertheless, Kuwait’s oil minister was upbeat about production cuts eventually helping stabilize prices, Al-Fadhel said that fears of a global economic downturn were “exaggerated,” and global demand for crude should pick up in the second half, which would help reduce the surplus in oil inventories gradually.

But, rapid expansion of shale oil production in the United States has persistently eroded attempts by OPEC+ to remove excess supply from the market and thereby raise oil prices.The output from seven major oil formations in the US is expected to rise by 85,000 bpd in September, to a record 8.77 million bpd, according to forecasts by the US Energy Information Administration.

Gloomy forecasts for the global economy, ongoing trade skirmishes between the US and China and sluggish oil demand growth have also dragged on oil prices. Oil industry analysts now say it is unlikely that oil could move higher than $60 per barrel, unless the global economy picks up and prospects of a prolonged US-China trade war diminishes. But that does not appear likely to happen any time in the immediate future. Basing one’s budget and the country’s economic future on volatile oil prices is fraught with risks, and no one is more aware of it than the finance minister and central bank governor.