CHAPTER ONE:
STATE-OWNED ENTERPRISES IN KUWAIT
1.1 Introduction: Kuwaiti
society draws its roots from the mid-18th century, when the Al-Sabah family
settled in what today is Kuwait. Although the population of neighbouring
countries come from similar Arab tribes, the common history of those settled in
Kuwait with the Al-Sabah family gave them elements of cohesion that have
maintained the unity of Kuwaiti society to this day. Unlike most other
countries of the Middle East and North Africa (MENA), Kuwait was never
colonised. It was considered as a British Protectorate for about 60 years,
although the involvement and impact of the British government on Kuwaiti
society and politics was minimal. The development of the hydrocarbons sector,
beginning with the first oil shipment in 1946, marked the emergence of a modern
economy in Kuwait. The fast development of the country’s infrastructure, public
services, institutions and welfare systems attracted professionals,
entrepreneurs and private sector entities from abroad and contributed to the
development of the Kuwaiti economy, within the framework and vision established
by the ruler. At the same time, the influx of oil revenues increased public
sector involvement in the economic sphere. The priorities of the government at
the time were oriented towards providing basic services such as water,
electricity, health care and education to the population. For instance, the
first water desalination plant was built in Shuwaikh area to replace the
unsuitable and sporadic supply of water from Shatt Al-Arab, reducing the
dependence of the population on the water wells (Ministry of Oil, 1983). The
first public hospital was built in 1949, and several schools were built in
subsequent years. In parallel, significant efforts were made to upgrade the
country's infrastructure and to build homes for low-income Kuwaitis. The
ambitious industrial development agenda of the Kuwaiti government has to some
extent resulted in the traditional activities of the private sector such as
pearling, fishing and shipbuilding taking a secondary priority in the overall
economic development of the country, and indeed with time some of these
industries have disappeared. From 1946 until Kuwait's formal independence in
1961, the government's key priority was institution-building and the
development of welfare-oriented programmes, with the state subsidising many
enterprises that provided basic goods and services such as electricity, water,
gasoline, education and health care. These subsidies were introduced in tandem
with a generous housing scheme and social security system for Kuwaiti
nationals.
During this period, private sector
activity was focused primarily on trading, construction and banking. The
largest Kuwaiti companies at the time were operating in the banking and
hydrocarbons industries. For instance, the Kuwait Oil Company (KOC) was
established as a joint venture between British Petroleum and the Gulf Oil
Company as per the concession agreement signed with the ruler of Kuwait in
1934. The National Bank of Kuwait (NBK) was established in 1952 as the first
private national bank in Kuwait and indeed in the Gulf region, following the
refusal of the British Bank of the Middle East to grant credit to one prominent
Kuwaiti merchant1. In 1957, the Kuwait Oil Tanker Company (KOTC) was
established by a group of private investors who grasped the importance of
maritime transport for the oil industry. At this time, the Kuwaiti government
started to involve the private sector in its ambitious infrastructure projects,
mainly through public procurement. Foreign companies seeking to be involved in
procurement for the Kuwaiti government were required to work through a local
agent paid on commission. The laws of Kuwait at the time favoured involving
Kuwaiti nationals in public sector activities as intermediaries. Nevertheless,
this policy did not deter foreign private companies from the Kuwaiti market,
where they were able to find business opportunities and execute profitable
infrastructure contracts. During the 15 years preceding Kuwait's independence,
a welfare state emerged. All basic services were provided by the government at
subsidized prices to make them affordable to every Kuwaiti, irrespective of
income level. The state took a lead in almost all economic activities, while
the role of the private sector was limited to trading and providing services
that supported the objectives of the public sector. Oil revenues soared from
$0.75 million in 1946 to about $500 million in 1961 (Khouja and Sadler, 1979).
While there are no official figures on the magnitude of the economic activity
at the time, it is estimated that the oil sector already represented more than
60% of Kuwait's GDP in the 1960s.
1.2 Political Background of Kuwait:
Kuwait, one of the richest Arab nations, is a
constitutional monarchy ruled by the al-Sabah dynasty. During the Arab Spring
of 2011, young activists called for political reforms, and residents unlawfully
in the country demanded citizenship and jobs. After Islamists scored major
gains in parliamentary elections in February 2012, Amir Sabah al-Ahmad al-Jabr
al-Sabah annulled the results and changed the election laws. This sparked
protests and triggered a boycott of the new election in December. The results
of that election were annulled by the Constitutional Court, and in new
balloting held in July 2013, pro-government Sunni candidates achieved a
significant majority. Kuwait controls roughly 6 percent of the world’s oil
reserves. The oil and gas sector accounts for nearly 50 percent of GDP and 95
percent of export revenues.
Five opposition
members of parliament resigned in May 2014 after they were denied a request to
question the prime minister about corruption. There are occasional accusations
of attempted bribery in the government’s lengthy procurement process. The
legal framework is not well developed, and the rule of law remains weak.
Foreigners face difficulties enforcing contract provisions in the local courts.
CHAPTER TWO
HISTORICAL BACKGROUND OF STATE-OWNED ENTERPRISES IN KUWAIT
2.1 The emergence
of state-owned enterprises in Kuwait (1946-1961): In
considering the origins of the Kuwaiti state-owned enterprise (SOE) sector, it is important to keep
in mind the social orientation of the government after it attained independence. The Constitution of Kuwait
provides that the government
is responsible for providing health care, education, water and electricity to the population.
In its efforts to redistribute the oil wealth, the government introduced a
welfare system that has historically been, and remains, an important fiscal burden.
During this period, the state moved
to strengthen the welfare system by adopting a number of subsidised programmes
and services. For example, a housing scheme for newlywed Kuwaitis that did not
cover the real cost of housing was introduced. In addition, the Credit and
Saving Bank was established to provide loans to Kuwaitis planning to build
their own homes, initially at concession interest rates and later with no
interest.
The cost of the welfare system
established in the early state-building years was initially prohibitive and has
grown over the years. Subsidies provided by the government are currently
estimated to reach 15%-20% of GDP (Central Statistical Office, 2010). The real
cost of goods, whether produced by public or private Kuwaiti companies, is
underestimated because of these subsidies. The government remains concerned
about the high cost of subsidies across sectors and services; however, it has
become politically difficult to reduce or abolish them. Several attempts to
increase tariffs on water and electricity have been made over the years, but
the necessary parliamentary approvals were not obtained.
The dominant role of the public
sector in the local economy was to some extent welcomed by the private sector,
which saw it as an opportunity to obtain contracts without taking the
corresponding economic risks. The private sector's position was further
strengthened by the legislative framework that protected it from outside
competition. Indeed, until recently, the local commercial law prevented the
establishment of majority foreign-controlled enterprises in
Kuwait.
In addition, foreign and local companies were not subject to the same fiscal
treatment.
The post-independence era witnessed the
establishment of several enterprises with majority government ownership. The
key objectives behind the establishment of these SOEs related to the lack of
the financial capacity of the local private sector to establish large-scale
business ventures. These SOEs were provided with incentives and benefits such
as heavily subsidised utilities, land concessions and customs exemptions that
were politically acceptable because these companies were majority
government-owned. SOEs were also shielded from competition and bankruptcy, and
many benefited from a monopoly in the local market, which could have been
viewed as favouritism had similar protections been offered to a private sector
firm.
In the petroleum sector, enterprises were
established with a majority ownership of the state. This was the case of the
Kuwait National Petroleum
Company
(KNPC) established in 1960 and the Petrochemical Industries
Company
(PIC) established two years later with a minority shareholding from the private
sector (limited to Kuwaiti nationals). Similarly, the National
Industries
Company was established in the 1960 as a wholly state-owned company to set up
large construction projects that could not, at the time, have been undertaken
by the private sector. Kuwait Flour Mills Company (KFMC) and Livestock Trading
& Transport Company (LTTC) were also established in the 1960s to provide
subsidised food products.
2.2
Growing state presence in the
economy (1961-1980): During
the 1970s, two major events led to a further increase of government ownership in the
commercial sphere. The first was the
nationalisation of the oil sector, which resulted in the state
taking full control over
the crude oil production and hence the determination of the price of crude oil, refined and petrochemical
products. Efforts to bring the petroleum sector under government control began with negotiations between
the state of Kuwait, British
Petroleum and Gulf Oil to acquire 60% ownership in the KOC established in 1934 under their
joint ownership. A year later another round of negotiations was initiated, resulting in a complete
transfer of ownership of KOC to
the state.
This was followed by the state's acquisition
of a 40% stake in Kuwait
National
Petroleum Company (KNPC), then a 5% stake in the Petrochemical
Industries
Company (PIC) and then, in 1979, the full nationalisation of the
Kuwait
Oil Tankers Company (KOTC). By the end of 1970s, the entire hydrocarbons sector
was nationalised with the result that KNPC, PIC and
KOTC
were all de-listed from the Kuwait Stock Exchange and became 100% state-owned
enterprises. Despite government efforts to diversify the local economy, oil
revenue continued to provide more than 90% of the government revenue,
especially after the oil shock of 1973 that resulted in a tremendous rise in
oil prices.
The second event was the crash of
the stock market in Kuwait in 1976-
1977.
In response, the government sought to shore up the market by buying shares in
listed companies, which resulted in wide-scale state ownership in the banking,
insurance, and real estate sectors. At the same time, the ongoing development
of state institutions and companies established for specific projects continued
to expand the state's role in the commercial sphere. These years saw the
establishment of a number of authorities (e.g. the Supreme Petroleum Council,
the Public Port Authority) as well as additional SOEs (e.g. Kuwait Finance
House). Again, significant benefits were bestowed on these newly established
enterprises and they created highly paid managerial jobs for Kuwaiti nationals.
These trends continued unabated in
the 1980s, and government ownership in commercial enterprises increased
further, especially after the second stock market crash of 1982 - this time not
of the official stock market, but of the parallel market, Souk Al-Manakh.3
Similarly to the previous crash, the government injected substantial funds into
the market, purchasing shares in most listed companies. However, the local
economic context during this crash was different from the previous one in some
important respects. On the one hand, the rescue required was more extensive. On
the other, oil prices were low and the government was facing a real fiscal
deficit. The government was forced to tap into its fiscal reserves to salvage
the stock market. By that time, it was clear that the public sector was very
much dominating local economic activity. The contribution of the public sector
to GDP was already in 1980s estimated to be above 65% (Ministry of Oil, 1983).
One policy that further increased the size of the public sector over the years
was a decision to provide lifetime government employment for all nationals
entering the labour force, irrespective of their qualifications. In addition,
key infrastructure development projects such as building power and water
desalination plants, airports, sea ports and roads, were executed only by the
public sector.
In 1980, a law was issued to
establish Kuwait Petroleum Corporation
(KPC)
with paid-up capital of KWD 1 billion paid in kind and in cash (Legislation and
Fatwa Department, 2005). KPC was structured as a statutory corporation not
subject to commercial legislation. Effectively, it was established as a holding
company consolidating the state's ownership in all oil-related companies and
projects, including concession contracts. KPC's capital was increased to KWD
2.5 billion in 1982 (Kuwait Al-Youm), and today its capitalisation represents
more than 30% of the total capitalisation of all companies listed on Kuwait
Stock Exchange.
2.3
Reduction of the State's Role
During Post-War Reconstruction (1991-2000): The intensive
reconstruction programme introduced after Kuwait's liberation from the Iraqi invasion
in 1991 forced the government not only to use most of its financial reserves,
but also to borrow on the international financial market for the first time.
Oil revenues were low and could not cover all government expenditures due to
the low oil production caused by the destruction of oil wells during the war.
At the same time, the state's financial obligations established
post-independence, such as providing employment to Kuwaiti nationals, continued
to weigh heavily on its budget.
In the early 1990s, the government
had shares in 61 companies in a variety of sectors, with ownership ranging from
as little as 1% to 100%. For a list of these companies, please see Table 4.1
below. All companies in this table were established pursuant to the Commercial
Companies Law. Although the number of companies appears small, representing
approximately 3% of the total number of commercial enterprises in Kuwait at the
time (World Bank, 2001), they accounted for about 70% of the total
capitalisation of the corporate sector (Kuwait Stock Exchange, 2010), without
even including government authorities and statutory corporations. Given the
strain on the budget, the government took serious steps to divest some of the
assets acquired during previous years and reduce its investment in the SOE
sector, despite the losses suffered by SOEs during the war with Iraq and as a
result of the subsequent economic slowdown. This period saw the introduction of
various policies aimed at turning over the control and management of a significant
number of SOEs to the private sector as well as at encouraging the private
sector to employ Kuwaiti nationals.
The procedure that the government used
to divest its holdings in these companies involved selling shares through a
variety of methods, including auctions, initial public offerings (IPOs), direct
sales to existing shareholders, or a combination of the above (Al Rifai, 2006).
In some cases the government divested its ownership stake entirely, while in
others the stake was reduced based on the relative importance of the sector and
on future return expectations. It bears mentioning that some government
holdings were not divested either because the enterprises were loss-making or
because the time frames set for divestment were unrealistic. In most cases,
however, the rationale behind the continued presence of SOEs often related to
the limited financial capacity of the private sector, to the need to deliver
commercial activities that could not be performed profitably or to the state's
wish to continue its presence in certain strategic sectors
2.4
Current Composition and Practices
Despite
the privatisation activities conducted in the 1990s, the public sector
dominates most economic activities, and its contribution to local GDP still exceeds
60%. The state's involvement in local economic activities is not declining,
considering that the line ministries and various authorities continue to provide
services through unincorporated entities. The state also has significant stakes
in private companies, established in accordance with the Kuwaiti Commercial
Companies Law, some of which are listed on the Kuwaiti Stock Exchange. Consequently,
the role of the state as an employer remains considerable. As of June 2010, the
private sector employed only 72,000 from the national labour force of 348,000,
while it employed more than one million of foreign workers (Central Statistical
Office, 2010). Whereas KIA's local holdings have declined from 61 companies to
14 as of January 2011, the state remains a shareholder in a number of large
companies.
As mentioned above, the oil sector
in Kuwait was nationalised and delisted in 1970s. Thus, for the past 30 years,
the oil sector has been fully owned and operated by the public sector. During these
years, it has experienced growth both in absolute terms and in relative
importance in the local economy. In 2004 the sector was estimated to generate
just over half of Kuwait's GDP - USD 60 billion. By 2008, it was contributing
over 64% of the GDP, estimated at USD 140 billion. Likewise, in terms of
government revenues, the oil sector's contribution was 88% in 2004; it
increased to 94% in 2008.
Kuwait
has no individual income tax. Foreign-owned companies are subject to a 15
percent tax. Taxes make up a small portion of government revenue, with most
financing coming from oil and gas windfalls. Overall tax revenue is less than 1
percent of domestic output. Public expenditures equal 36 percent of domestic
production, and government debt amounts to 5 percent of gross domestic product.
CHAPTER THREE
SOE performance
and prospects
Assessing
SOE performance
Studies show
that Kuwaiti SOEs are inefficient, both in terms of their use of human and
financial resources. For instance, the KPC appears inefficient when benchmarked
against similar private sector enterprises – in fact, government investments in
KPC have not realised a financial return higher than investing in bonds (World
Bank, 1994). Additional evidence of the inefficiency of Kuwaiti SOEs is that
some of them are not able to compete successfully with private sector entrants.
This was the case with both the Kuwait Airways Corporation and the Kuwait
Public Transport Company, which were unable to compete when their respective
sectors were liberalised and opened to competition. Both have been loss-making
since then, in spite of the various direct and indirect subsidies made
available to them. Similarly, some SOEs in the food sector appear profitable
only because of the subsidies they receive. Over the past decade, the
government of Kuwait has been rethinking its role in some sectors of the
economy, previously seen as strategic (e.g. airline transport). At the same
time, while the Parliament recently passed antitrust legislation to prevent
market monopolies by the private sector, some SOEs continue to enjoy monopoly
or oligopoly positions. For instance, the KPA has total monopoly on seaport
services. That said, although some SOEs benefit from an uneven playing field,
they are subject to sectoral regulation. For example, their fee structure must
be approved by the Council of Ministers. If the price of refined oil products
in Kuwait is to be raised by KNPC, a decision from the Council of Ministries is
required. The reasons for Kuwaiti SOEs' low productivity and weak performance
are numerous. First, management incentives and accountability structures are
not in line with international good practices. Line ministries seldom hold SOEs
accountable for their performance, and SOE managers have almost never been dismissed
for inadequate performance. Even when SOEs incur losses, the state usually
covers any deficits, in part to protect employment of nationals. Since SOEs are
not required to report publicly on their performance, public scrutiny is not a
consideration for the management. Last but not least, SOE management does not
face market pressures to improve company performance considering that many SOE
operate in non-competitive sectors.
3.2 Recent
privatisation effort
During the past
decade, the government of Kuwait has moved to divest some of its holdings in
commercially oriented SOEs in order to energise the private sector and reduce
the financial burden on the state. The first step was the sale of some stakes
in SOEs owned by the Ministry of Finance/KIA and not part of the government
budget. The privatisation methods varied from IPOs limited to Kuwaiti nationals
to open auctions, closed bidding contests and combinations of the above. For
instance, the Ministry of Finance/KIA stake in the Kuwaiti
Mobile Telephone
Company (now Zain) was diluted from 51% in the early 1990s to 24%. Mobile
telephony is now entirely controlled by private operators.
Some government
stakes managed by the Ministry of Finance/KIA were divested completely (e.g.
Kuwait Facilities Company, Gulf Cable Company). In the oil sector, the
government divested its interests in the refined product distribution segment.
The Lube Oil plant part of the Kuwait National Petroleum Company, wholly owned
by KPC, was sold to the private sector. Similarly, the Salt and Chlorine Plant
of Petrochemical Industries Company (PIC), wholly owned by KPC, was also
entirely privatised. Nevertheless, government ownership in the KPC or in its
associated companies remained at 100%. In addition, none of the basic services
such as electricity or water has been privatised so far. The privatization process
in Kuwait can be described as rather slow despite progress in certain sectors,
such as mobile telecommunications. State ownership in some sectors continues to
be a heavy burden on the fiscal budget. For instance, both public and private
companies provide health related services. The cost of publicly provided health
care is estimated to be approximately USD 3 billion annually and is rising.
Water and electricity are provided at heavily subsidised tariffs and are
therefore also costly for the state.
During the past
decade, the government has made a serious effort to pass
the
privatisation laws. In June 2010, Parliament passed the first Privatisation
Law in the history
of Kuwait, establishing the Higher Council for Privatisation.
The law mandates
the creation of a public shareholding company for each
privatisation
deal and requires the retention of two consulting companies, one
with
international experience, to evaluate each privatisation transaction.
The Law also
requires that the share capital of each privatised company be
allocated as
follows: no less than 35% to be auctioned among interested
investors, no
more than 20% to be retained by the state, no more than 5% to be
sold to the
employees and no less than 40% to be sold to nationals through an
IPO.
The state will retain a golden share in each of the privatised companies.
