KUWAIT: Analysts from three British consulting firms who specialize in Middle East trends collaborated with Reconnaissance Research to examine the outlook for Gulf investment given developments over the past few months. Foreign investors have long acknowledged volatile oil prices, inconsistent legal frameworks, and opaque business environments as weaknesses in Gulf Cooperation Council (GCC) economies. However, the outbreak of the coronavirus pandemic has exposed just how wide-reaching the consequences of these weaknesses can be, as GCC countries are being forced to dramatically accelerate their efforts to diversify their sources of revenue and expand private sector activity.
Kuwait is no different, though recent events have underscored the prevalence of corruption and the impact it can have on foreign investment. More specifically, details emerged in May regarding the alleged involvement of one Kuwaiti royal family member in a massive international money-laundering scandal.
Consultants from Castlereagh Associates, Alaco Limited, and Wallbrook each assessed how these events will impact the GCC and Kuwait. Their answers share a number of similarities; while they agree the GCC’s outlook is concerning, the general sentiment is that progress can—and must—be made. For Kuwait specifically, it seems the pressure is on now more than ever to adapt and regain public trust as it defines itself to investors in the post-coronavirus era.
Challenges already plague the GCC
Perhaps the single most frequently cited issue plaguing GCC economies is preferential treatment for influential individuals, often closely related to ruling families, in the awarding of contracts and loans. Rachna Uppal, a senior analyst at Castlereagh Associates, suggests that the regional banking sector can be characterized by a “name lending” process, whereby lenders prioritize the elites without significant regard for due diligence procedures. These conflicts of interest open the door to wealth mismanagement and even money laundering, particularly in the prominent real estate and construction sectors. They are most evident as many GCC company boards, even across differing sectors, repeatedly feature the same managers.
The prominence of the public sector in Gulf economies further exacerbates the impact of preferential lending. According to Oliver Radway, an associate at Wallbrook, “governments are still far more likely to award lucrative state contracts to royal family members or their proxies over ordinary citizens or foreign nationals.” Unsurprisingly, the mechanisms by which these contracts are awarded are largely opaque. He notes, “[this] reduces competition and ultimately the quality of work delivered.” Additionally, its role in perpetuating the wealth of the elites has a political impact—though the region has remained relatively stable in recent years, government graft and inequality were “a key factor in the demonstrations that shook the region in 2011.”
Although many GCC governments have implemented regulatory measures to mitigate corruption, wealth mismanagement, and money laundering, their implementation is patchwork and insufficient. Ultimately, according to Austen Josephs, an associate director at Alaco, “the perception is that the authorities lack the will or the legal tools to properly investigate and clamp down,” and “Western clients particularly in financial services consider the Gulf ‘high risk.’” There is even a perception that “international accounting firms tend to not apply the same strict standards to review Gulf financial budgets as they do or are expected to do in other places.”
With that said, Gulf countries have exhibited tepid improvement in their commitment to anti-corruption measures. Radway notes that “Gulf states have made moves to improve anti-money laundering controls in recent years.” Additionally, Josephs suggests that compliance procedures for state-owned companies and sovereign wealth funds have been beefed up, though they still lack transparency.
Nevertheless, due to the overwhelming importance of investment to all Gulf economies, GCC governments must view these issues as a top priority. If they aren’t addressed, Radway says, “government tax revenue will continue to be hit and criminal enterprises allowed to flourish.”
Investment in the age of COVID-19
The most glaring result of the coronavirus impact on GCC countries is its widespread suppressive impact on demand for oil. Prices for oil famously fell into the negatives briefly in April as global production outpaced storage capacity, spurred on by tensions between Russia and Saudi Arabia. As Radway put it, “GCC governments can no longer rely on vast oil reserves to prop up their sclerotic economies.”
The immediate impact will be a rapid reduction in GCC foreign currency reserves and capital flight to markets perceived less risky by both domestic and foreign investors. Further, Josephs warns that indebted companies may collapse, which could lead to “claims of mismanagement and fraud,” reinforcing foreigners’ poor perceptions of the GCC investment climate.
Gulf economies’ heavy reliance upon oil prices is well known, and several governments have taken steps to diversify their sources of revenue and promote private sector growth. Saudi Arabia’s Vision 2030 and Kuwait’s Vision 2035 both feature among them. However, the coronavirus is forcing Gulf countries to implement measures much more rapidly than previously anticipated, likely at great short-term cost. These measures would have to feature a more robust and onerous system of taxation to replace oil receipts, according to Josephs.
Corruption in Kuwait
For Kuwait, each of the aforementioned weaknesses in Gulf financial systems combined in dramatic fashion last month. According to a series of exclusive stories published in May, about the claims of collaborated involvement of a prominent figure with a Chinese bank to allegedly launder money for Jho Low, the infamous Malaysian businessman at the center of the 1Malaysia Development Berhad (1MDB) scandal. Though the scandal first came to light in 2015, investigators from the US Department of Justice and the Malaysian government are still uncovering new evidence.
As the story goes, the Kuwaiti government became aware of the businessman’s alleged involvement in this scandal in early 2019 and seems to have allegedly actively worked to conceal it from the public, until Reconnaissance Research broke the story officially in Kuwait in May 2020. In spite of whistleblower protection laws, Kuwaiti officials also allegedly tried to prevent details from leaking.
The reports also call for extra scrutiny into the Chinese-led Silk City project across the bay from Kuwait City, given China’s presumed role in money laundering efforts. Fortunately, according to Uppal, the Kuwaiti government’s Financial Intelligence Unit is now probing the scandal and its reports have so far been favorably received. However, as she notes, “the true test will be whether any punitive measures will be imposed.” Even if they are, Josephs points out that “international investors will likely continue to see Kuwait’s political system as dysfunctional [and] its legal system as unpredictable.”
There are a number of steps that Kuwait must take in order to improve its international reputation in light of these scandals, according to Josephs. With regards to 1MDB, authorities must comply fully with US and Malaysian authorities seeking to recover embezzled funds, and courts must determine any wrongdoing independently. Whistleblower protection laws must be reinforced and implemented more consistently. The head of the money laundering authority, who resigned after the Kuwaiti government allegedly suppressed investigation into the scandal, must be replaced. Speaking more broadly, the culture must change so that due diligence becomes the norm rather than the exception.
Along those lines, Kuwaiti Members of Parliament have been pushing for greater government accountability. And yet, the coronavirus pandemic has already exposed these issues’ persistence; Uppal notes that there have already been some tensions over the award of contracts worth billions of dollars to purchase medical supplies and equipment—without bids—to a select group of companies and individuals.
The next few months will prove instrumental in determining whether Kuwait and the rest of the GCC are able to successfully attract investment and expand their private sectors. As each expert pointed out, failing either of these goals will expose still deeper fault lines across the GCC’s economies.