Kuwait has long been nicknamed the Sleeping Giant of the Gulf, and it is not exactly intended as a compliment. Kuwait is considered one of the least interesting of the Mideast regional economies and has done little to attract foreign investment. But that reputation might be set for a change.
Kuwait’s stock market is being considered for a bump-up to emerging markets status by major index providers, and that would be a significant reclassification within the world of investors. Index funds tracking emerging markets benchmarks, and active fund assets benchmarked against emerging markets indexes, are far larger in size and popularity than frontier markets portfolios.
There are 30 exchange-traded funds tracking EM benchmarks, and the three largest ETFs tracking the MSCI and FTSE emerging markets indexes have roughly $135 billion in assets between them. There are two frontier market ETFs with a total asset base of roughly $600 million. Kuwait is the largest country weight in the MSCI and FTSE frontier markets index, at over 21 percent and 19 percent, respectively.
In June, MSCI said it would place the MSCI Kuwait Index under review for a potential reclassification from frontier markets to emerging markets status in 2019. Rival index provider FTSE Russell hasn't classified Kuwait historically, but starting September of this year, it will be classified as a secondary emerging market — it also has an advanced emerging market group.
What happens to stocks when index providers preview a move up
These moves up to emerging markets status could mean billions of global investing dollars for the first time being tied to Kuwait's economy as emerging markets investors and funds that track index exposure, or have their performance measured against the EM index, are forced to buy shares of Kuwait stocks. Market history shows that, in the short-term at least, the index-review process can mean momentum for stocks in the market up for reclassification.
Here are some recent examples.
Argentina and Saudi Arabia went through similar emerging markets index reclassifications that started last year and resulted in official upgrades in June. The Saudi stock market was one of the top-performing equities markets around the globe during that process and has outpaced most of the globe this year as well, though there are multiple reasons — oil prices have been rising strongly, and the economic reforms being promoted by the Saudi Crown Prince have contributed to investor confidence. Argentina shares have suffered recently, but its stocks were strong performers in 2017 — it was the No. 1 country stock market in the world last year.
Kuwait has the oldest stock exchange in the Gulf, and several of the companies that trade on it are multinational in scope and would benefit greatly from reclassification, said Kristian Coates Ulrichsen, Fellow for the Middle East at Rice University’s Baker Institute.
Trading volume and price action in Kuwaiti stocks has picked up in 2018. Some of the top Kuwait exchange-listed stocks in frontier markets indexes have been on a strong performance run, including Kuwait Finance House and Mobile Telecommunications, 13 percent and 26 percent, respectively, between June and July. The relatively small size of the market overall, and its limited liquidity, also contributed to big run-ups in stock prices since the June news. But any short-term pop in Kuwaiti stocks based on investors getting ahead of the index moves doesn't reflect a very large hurdle that will remain for Kuwait's economy: Its massive public-sector reliance on oil, and its lack of investment in the private sector, has led to a series of large budget deficits.
An oil-heavy economy in need of change
Kuwait’s economy, like much of the Middle East, is heavily reliant on oil exports. It is home to 6 percent of the world’s crude-oil reserves, or more than 100 billion barrels. Kuwait has the highest percentage of GDP tied to oil among OPEC nations. Ninety-two percent of export revenue and 90 percent of the government income is reliant on oil.
The private sector is expected to grow between 3.5 percent and 4 percent between 2018 and 2021. But the lack of diversification in its economy makes it hard for corporations to find employees and bridge the wide gap between private (36 percent) and public (74 percent) employees. Kuwaiti nationals are guaranteed public-sector employment as part of the oil wealth distribution, while most private-sector employees are migrant workers.
As in the case of Saudi Arabia, the Kuwaiti government has released a broad plan for economic development beyond oil, its Kuwait Visions 2035 plan, which aims to increase foreign direct investment and streamline the process for foreign corporations seeking to operate in the nation. The country's stock exchange, the Boursa Kuwait, has also made recent changes to encourage more listings and investment.
It used to be much harder for a foreign investor to obtain a commercial license, having to wait an average of 60 days, which in 2015 was reduced to three days. The costs of licenses have also decreased. Foreign investors also are now able to own 100 percent of the shares of companies they incorporate in Kuwait, and receive exemption from income taxes for up to 10 years. These changes have prompted the private sector to pick up.
Sophie Olver-Ellis, a research officer at the Middle East Center of the London School of Economics, said Kuwait's Vision 2035 is promising and that the private sector is spearheading the transition to a non-oil economy. She said that the public sector assumes as much as 90 percent of development projects and the nation is trying to reduce that role by 30 percent to 40 percent.
Kuwait has a unique political impediment compared to other Gulf states as it attempts to diversify. It has an active parliament, the National Assembly, which calls the government to account for economic decision-making and has, in the past, blocked major infrastructure and energy initiatives that would modernize and expand Kuwait’s existing economic base. This political brake on economic reform is not present in other GCC states, Coates Ulrichsen said. He noted that the nation is still recovering from the political paralysis that gripped Kuwait between 2006 and 2012, when there were six elections and more than a dozen Cabinet. That did "great harm" to Kuwait’s international investor image and regaining lost confidence among investors about parliamentary pressures remains an issue.
Kuwait’s movement to a more balanced economy could reduce volatility in the market. Dramatic changes in oil prices lead to huge swings in its economy. Even with the recent recovery in oil prices, Kuwait is expecting another budget deficit for the 2018-2019 fiscal year of $21 billion (about 17.5 percent of gross domestic product), its fourth-straight annual deficit. The government has had to finance recent deficits from its $600 billion state reserves and bond offerings.
"Government spending is tied heavily to oil revenues, so the health of the public sector closely tracks oil price rises and falls," Coates Ulrichsen said.
State revenue of $49.5 billion is below the expected spending level of $71 billion. Many have criticized the government's failure to diversify, and its decision to increase revenue during its years of deficit by increasing electricity and water charges.
“It remains to be seen how successful it is going to be because it [diversification] is in the early stages,” said Oliver-Ellis.
According to Moody’s, Kuwait has been slower than its regional peers in developing its non-oil and private sector. But Oliver-Ellis said she does not view the country's economic liberalization plan as being far behind efforts in Saudi Arabia, whose larger population prompted a quicker diversification effort. Kuwait has a population of roughly 4.4 million, while Saudi Arabia's population over 32 million. But if Kuwait does not diversify, it will not be competitive in the 21st century, she said.