Reforms to welfare spending and subsidies to prepare public finances for challenges ahead

Public spending in Kuwait has come under increased scrutiny in recent years, with a host of domestic and international experts warning that expenditure levels are unsustainable. Kuwait’s welfare system guarantees housing, education, health care and one-off grants to its citizens, as well as cheap power. However, the state is moving forward on a host of expansive mega-projects aimed at increasing oil output and improving water and power supply, meaning that the record budget surpluses of previous years are unlikely to continue.

Under Review

While government spending is projected to increase between 3% and 5% during the 2014/15 fiscal year, the recently appointed finance minister, Anas Al Saleh, has announced plans to review the current subsidy system, forming a committee which will issue recommendations in 2014. The move has been met with widespread disapproval, and Al Saleh now faces the challenging task of curbing spending while maintaining social and political stability. Whether the Ministry of Finance (MoF) reduces subsidies, or opts to introduce new taxes, prudent fiscal policies are critical to Kuwait’s long-term economic growth.

Fiscal Discipline

The spending issue garnered significant public attention in 2011, when Sheikh Salem Abdulaziz Al Sabah, the former central bank governor, urged the country to address imbalances in public spending during a televised interview. He resigned from his position in 2012 in protest at spending hikes, and was later named finance minister in October 2013. A Cabinet reshuffle saw Al Saleh appointed as the new finance minister in January 2014, announcing shortly afterwards that he planned to review the state’s current subsidy system in an attempt to curb spending and create a more sustainable welfare system.

Fiscal restraint can be a tough sell in oil-rich Kuwait, where record budget surpluses have been registered in recent years as the price of oil, which provides over 90% of government revenues, has shown steady increases, while political delays have stalled major infrastructure projects, creating artificially low budget figures. Underpinning obstacles to change, policymakers are pressing ahead with a bill popular with the public, and opposed by the government, that would increase child and housing allowances, while Kuwait’s residents have shown considerable antipathy towards subsidy reduction. Stakeholders and financial analysts have warned that the country could eventually face currency devaluation, money transfer controls, limits on remittances and unpaid public salaries if it does not implement fiscal reforms in a timely fashion.

Welfare State

Kuwait’s social welfare system is one of the most generous in the world. About 76% of Kuwaiti workers are employed in the public sector, which saw a 25% wage hike in 2012. In addition to free health care and education, Kuwaitis are entitled to a host of onetime grants, including marriage and housing payments, while all residents enjoy subsidised electricity, water, and fuel. Although Kuwaiti nationals are granted a government house, or a loan to purchase a home, upon marriage, the Public Authority for Housing and Welfare reported that the waiting list for affordable housing stood at 109,122 applications in January 2014. The list could take decades to clear, and a shortage of land has led to skyrocketing real estate prices, making the cost of buying a house prohibitive for many Kuwaitis.

At the same time, electricity costs just KD0.002 ($0.007) per KWh, a fraction of what it costs to produce. Water is similarly subsidised, despite the fact that potable water is supplied by energy-intensive desalination facilities. These subsidies have led to unsustainable consumer habits, with the Ministry of Electricity and Water reporting that a single household can consume as much as 1000 gallons of water per day.

Total government spending reached KD10.6bn ($37.27bn) in the first 10 months of the 2013/14 fiscal year, up 8% from 2012/13, according to a March 2014 report published by National Bank of Kuwait (NBK), while the 2012/13 budget reported total government subsidies for consumer services reached KD6.3bn ($22.15bn). Out of this, KD3.1bn ($10.90bn) was allocated for electricity. Fuel and energy subsidies are expected to total KD5.11bn ($17.97bn) in the 2014/15 fiscal year, and with consumption continuing to show strong annual increases, independent ratings agency Capital Standards reports that energy subsidies alone will cost KD9bn ($31.65bn) by 2030, as the state ramps up gas imports to meet domestic demand.

Tackling The Budget

In March 2014 the Kuwaiti Cabinet approved a 2014/15 draft budget that projects a 3.2% increase in spending. The projected rise is driven entirely by current expenditures, which are set to grow 7% to a record KD19.6bn ($69.92bn), led by an 8% increase in civilian wages and salaries.

“While projections on spending for next year are inevitably speculative at this stage, our working assumption is that, as usual, the level of spending ultimately comes in somewhat below budget. However, a higher than usual execution rate in capital spending means that the ‘underspend’ will be smaller than before, at 3%. This results in actual spending growth of around 5% in [fiscal year] 14/15, slightly above the 4% we project for this year,” read the NBK report. The bank also forecasts a KD9bn ($31.65bn) surplus in the 2014/15 fiscal year, equal to about 20% of GDP, a significant decline from the record KD16bn ($56.26bn) surplus witnessed in the first 10 months of the 2013/14 fiscal year.

The Economist Intelligence Unit (EIU) announced in January 2014 that Kuwait will continue to run fiscal surpluses up to 2018, although these are projected to narrow steadily due to high levels of current spending, and based on expectations of weaker world oil prices. Indeed, in October 2012 Bassam Ramadan, country manager for Kuwait at the World Bank, suggested that the average price of various types of crude oil could fall anywhere from 10-15% from current levels, to around $85 per barrel by 2020. “Given that Kuwait’s budget surplus is expected to average around 21% of GDP in 2014-18, there is no urgent imperative to implement reforms, meaning that they are likely to progress only slowly… Oil will continue to account for the bulk of revenue, as no new income or sales taxes are likely. We expect the fiscal surplus to narrow to 14.7% of GDP by 2018/19,” read the EIU’s January report.

Kuwait has a number of mega-projects planned to meet power, fuel and housing demands, including refinery upgrades, construction of new power stations and affordable housing projects that will add 174,000 new homes to the market by 2020. With 2014 seeing steady movement towards implementing billions in spending to complete these projects, the budget could witness substantially lower surpluses in the near future. Policymakers now face the uphill challenge of convincing citizens that one of the world’s richest countries needs to reduce spending to avoid a potentially damaging budget deficit later this decade.

The Subsidy Challenge

The MoF’s subsidy review is facing significant opposition from the populace, which cites the nation’s pot-holed roads, expansive foreign assistance commitments and long waiting lists for affordable housing as signs the government should in fact increase spending, despite the fact that Al Saleh has stressed subsidy cuts will not impact the lower and middle classes. Any reduction in subsidies brings the risk of instability; in 2012 thousands of Kuwaitis marched against changes to voting rules and voiced anger about slow economic development. Public sector workers went on strike the same year over pay, despite the government’s approval of a 25% wage increase.

More recently, the head of the Kuwait Oil Workers Union announced oil workers across the country were set to strike in February 2014, following a Kuwait Petroleum Corporation decision to cut benefits and reduce or eliminate bonuses for oil workers. The strike was planned to include all production operations, exports and petrochemicals staff, 19,000 workers in total.

Union head Abdul Aziz Al Sharthan said members were upset that Kuwaiti oil workers earn only half as much as their counterparts in Saudi Arabia, Qatar and the UAE, although Arabian Business reported that the head of parliament’s budget committee later announced that Kuwaiti oil workers earn approximately $19,400 per month, compared to $4500 in other public service segments, indicating the extent to which public expectations have affected reform attempts.

Tax

According to local media reports, the MoF has been studying different scenarios, including scrapping subsidies for foreigners living in Kuwait and scaling back subsidies provided to Kuwaitis. The introduction of a value-added tax has also been floated as a potential answer to declining surpluses, while in December 2013, the MoF announced it was preparing a proposal to extend the 15% corporate income tax imposed on multinationals to include Kuwaiti firms, as a means of boosting government revenue. However, introducing taxes could reduce purchasing power and dampen consumer demand, working against the long-term goal of strengthening private sector economic participation. Both private consumption and government spending drive Kuwait’s non-oil sector, which has been bolstered by debt-relief schemes and wage increases. As such, new taxes are unlikely, at least in the near future.