Kuwait's Monetary Policy - Statistics Project Example

MONETARY POLICY Kuwait, the third largest country of the Gulf Cooperation Council (GCC) six-member economies, is in buoyant shape. The removal of a major geopolitical risk from neighbouring Iraq, coupled with recent liberalisation measures have improved business optimism--evident by a surge in private sector investment over the past two years. Real Gross Domestic Product (GDP) grew at an average annual rate of 7.3% between 2003 and 2005, its fastest pace in 15 years, fuelled primarily by higher crude prices and production. The US Energy Information Administration projects Kuwait's 2006 oil-exports at US$40.3 billion dollars, up from US $36.9 billion dollars in 2005. The International Monetary Fund (IMF) noted: "The fastest pace of economic expansion since the 1990 Gulf war, combined with the oil-related terms of trade gains, has boosted per capita income by 34.5% during 2003-04 and helped build up assets for future generations at a record pace." It added: "With oil prices likely to remain firm over the medium-term, Kuwait's medium-term outlook has improved and is likely to remain favourable, supported by large fiscal and current-account surpluses, and low inflation. The Kuwait economy is characterized by sound creditworthiness which in turn reflects sustained macroeconomic stability, good governance, twin surpluses (the government budget and current-account), manageable domestic debt (17% of GDP in 2005), the sophisticated banking sector and huge net (official) external assets. Overall GDP growth has been increasing at a steady rate from 2001 to 2005 due to the stability of the money supply. Through a judicious application of effective open market operations, the central bank was able to mop up excess liquidity in the system resulting in a stable economic growth. The Central Bank of Kuwait (CBK) has imposed a ceiling on the credit to deposit ratio. It was implemented in order to address prudential concerns over rapid expansion of credit to the private sector in recent years without a parallel increase in bank deposits. Kuwaiti banks are, however, heavily capitalised and liquid. The capital adequacy ratio remained comfortable (17.3% as of end-September 2004), well above its minimum regulatory level (12%). In 2004-05, asset quality improved further and net profits and returns on equity/total assets also rose significantly. The Kuwait central bank had reined in liquidity growth in order to attain macroeconomic stability. This policy resulted in a minimal increase in M2 supply from 9646.3 million Kuwait dinar (KD) in 2001 to 10401.2 million KD in 2002. This strict monetary policy resulted in a high increase in the Gross Domestic Product (GDP) growth rate of 11584 .5 million KD in 2002 to 14253.5 million KD in 2003. At the same time, inflation remained at respectable levels from 0.89 percent to 0.98 percent during the same period. The GDP climbed steadily from 14253.5 million KD in 2003 to 17466 million KD in 2004. The M2 supply increased only slightly from 10401.2 million KD in 2003 to 11655.2 million KD in 2004. The GDP scored a big leap from 17466 million KD in 2004 to 23588 million KD in 2005. Steady monetary policies kept the M2 supply level from 11655.2 million KD in 2004 to 13088.2 million KD in 2005. On the macroeconomic front, the authorities have pursued prudent monetary/fiscal policies, thus underpinning price stability and the exchange rate peg. Consumer price rises have averaged just 1.4% annually over 2000-05, thanks to a stronger currency and subdued import prices. The Kuwait central bank has maintained very stable exchange rate levels to maintain stable inflation rates. This effective policy has resulted in minimal inflation rates. The Kuwait dinar has been appreciating vis-a-vis the US dollar from 2001 to 2005. The exchange rate was 307.36 dinar to 1 US$ dollar in 2001 compared to 299.7 dinar to 1 US$ in 2002. Inflation rate at 2002 was only .89 percent. The local currency further appreciated from 299.7 dinar to 1 US$ in 2002 to 294.7 dinar to 1 US dollar in 2003. The inflation rate remained flat at 0.98 percent. The exchange rate levels stabilized at 294.7 dinar in 2004. Inflation rates were stable at 1.26% in 2004. The exchange rate further appreciated to 292 dinar to 1 US dollar in 2005. The inflation rate recorded a slight increase at 4.11 percent in 2005. The appreciation of the Kuwait dinar stems from a host of positive factors: robust revenues from oil, the continued stability of the financial system, manageable domestic debt and huge net external assets. There is a perfect synchrony between the movement in US interest rates and Kuwaiti interest rates. Therefore, the CBK has steadily raised Dinar rates in line with hikes in Fed Funds rate (currently 4.25%) to maintain positive differentials in favour of Dinar-denominated assets, such as Treasury bills, one-year bonds and fixed bank deposits relative to US money rates. The Central Bank of Kuwait's (CBK) monetary policy has a tight correlation with the US Federal Reserve Board. In 2002, the US Fed rate was 1.67 percent. The CBK rates was 4.25 percent. In 2003, the US Fed rate was further decreased by 1.13 percent. In response, the CBK rates was pegged at 3.25 percent. In 2004, the US Fed rate was 1.35 percent. Similarly, the CBK rates were pegged at 5.25 percent representing an increase of 200 basis points. The CBK rates had seven consecutive increases during that year in response to the increases of the US Fed rates during the same period. There was a need to ensure consistency with domestic monetary developments and a need for the alignment of the dinar to major currencies such as the US dollar. Then, in 2005 the US Fed rate was 3.22 n the first quarter which was subsequently increased to 3.25 percent. When the US Federal Reserve Board raised the federal funds rate a quarter-percentage point to 3.25 percent, the CBK raised the raised its discount rate by 25 basis points so it becomes 5.50 percent. In a report by Arab News, the CBK is keen on securing consistency of the Kuwaiti dinar's interest rate with that of major currencies, topped by the US dollar. The Central Bank of Kuwait Governor Salem Abdulaziz Al-Sabah told the Arab News that the successive rate hikes aim to safeguard the competitiveness of the national currency in the face of the rising interest rates on the other world currencies. "The central bank will not hesitate to move in the suitable direction to guarantee the continuing competitiveness of the interest rates on the Kuwaiti dinar with the rising trend for the interest rates on the foreign currencies, especially the US dollar," he said. "This will help create monetary stability in the local economy, safeguard the purchasing power of the national currency and worth to curtail any increase in the inflationary pressures in the local economy," Salem added. WORKS CITED "Report on the Gulf Cooperation Council". International Monetary Fund. 2006. Annual Report 2005-2006. Central Bank of Kuwait. 2007. 06 May 2007 Monetary Policy. Central Bank of Kuwait. 2007. 06 May 2007 < http://www.cbk.gov.kw/PDF/Book2Eng/part02.pdf> Newspapers Haitham Haddadin. "Kuwait Central Bank Hikes Key Rate to 5.5 Percent". Arab News. July 3, 2005. Read More