Monetary policy application in the oil-exporting countries: the case of Kuwait

Abstract

Kuwait has a small open economy, depends totally on exporting one primary single commodity (oil) to earn its Income and is dependent on the rest of the world to importits needs of consumer and capital goods. Thus, the vulnerability of the Kuwaiti economy to exogenous pressures is reflected in the local monetary sector, as well as in the other sectors. However, this external pressure on the monetary sector is isolated from the condition of the balance of payments = especially in the short-term - because the persistent surplus of the balance of payments reflects the oil revenue which is kept outside the country in the foreign reserve of the government. On the other hand, the government expenditure in the local economy is determined by some socio-economic and other political tendencies rather than the level of the oil revenue. Hence, the persistent deficit of the private non-oil balance of payments against the outside world is offset by the government monetary injection in the local economy through its annual budgetary spending to cover the cost of its development plans. Nevertheless, the external influence on the local monetary condition is due to structural and institutional constraints in the financial market and the economy on one hand, and to the policies of the monetary authorities on the other. The purpose of this study is to investigate the application of the monetary policy instruments by the Central Bank of Kuwait during the period 1970-1988 to achieve its economic and monetary objectives postulated in its Charter. Moreover, in addition to this originality, this study has also updated previous empirical works concerning the behaviour of the money stock, since the latest academic research in this field ended in 1982.The behaviour of the monetary sector is studied through the balance sheet of the Central Bank, the consolidated balance sheet of the commercial banks, specialized banks, investment companies, and other participants in the financial market. This study shows that the banking system has experienced a considerable growth in its activities inside and outside the country. But in spite of the structural shift in the investment portfolio of the commercial banks in favour of the local opportunities against foreign investment, the distribution of bank credit among the various productive sectors shows unfair trends against some sectors such as industry and agriculture, and in favour of speculative activities in the stock market and real-estate, which highlights some doubts on the credit rationing policy of the Central Bank, The econometric model of the demand for-and-supply-of money function shows that the equilibrium level of the money stock is determined by external and Internal factors, with the Central Bank playing the role to accommodate the external pressures on local liquidity, rather than controlling the quantity of money. The low interest rate policy adopted by the Central Bank shows that it has failed to secure a fair distribution of bank credit among the productive sectors in the local economy. On the other hand, it encouraged the speculative trends in the stock market and brought about inflationary impacts. Moreover, this policy along with the exchange rate policy has provided the right environment for capital outflow, and exposing the local liquidity to external influences. Nevertheless, the exchange rate regime (the basket peg) has succeeded in maintaining the stability of the Kuwaiti Dinar against the major foreign currencies, and avoiding some undesirable impacts on the Kuwaiti economy resulting from the appreciation or depreciation of the Kuwaiti dinar. The implementation by the Central Bank of monetary policy instruments shows that these instruments were introduced either to help the commercial banks to overcome their liquidity problems in local currency, or to regulate this liquidity among them: therefore, no attention whatsoever was paid to controlling the credit policies of the commercial banks. Such conclusion is evidenced throughout this study either by the exposition of the tendencies behind the introduction by the Central Bank of its instruments of control, or by its neglecting to make effective use of these instruments in accordance with their orthodox concepts. The main findings are discussed and a series of recommendations to enhance the use of the monetary policy instruments are suggested.