A fierce political battle could determine Kuwait's long-term economic future.

By Nick Henry London
The outcome of the battle between the reformists and the conservatives will shape the Kuwaiti economy for the next decade, and possibly beyond.

The conflict has been simmering for years, without ever really coming to a head. But ever since a controversial cabinet reshuffle in February, which saw two crucial posts - finance minister and oil minister - go to politicians from outside the ruling family, it was clear that a showdown was imminent.

Youssef al-Ibrahim, the US-educated, reformist finance minister, got things started in June. During the final meeting of the National Assembly before its lengthy summer recess, he proposed a string of reforms that he pledged would "reconstruct the Kuwaiti economy." They included slashing taxes on foreign firms from 55 percent to 25 percent, imposing a corporate tax (although a modest 2.5 percent) on listed Kuwaiti firms for the first time and an excise duty on imported luxury goods. The reforms have won widespread approval from independent economists. In July, the International Monetary Fund (IMF) published a report applauding the moves by al-Ibrahim, encouraging him to push ahead with the reform process and agreeing to help with technical aspects of the changes.

But it has been a very different story inside Kuwait. Many of the country's 50 MPs have been vociferous in their opposition, and have ensured that it has progressed at a snail's pace over the past three years. In 1999, Emir Sheikh Jaber al-Ahmed al-Sabah took the drastic step of dissolving parliament and forcing re-elections after he grew frustrated at MPs' persistent efforts to sabotage his reforms.

Why are MPs so opposed to the process? "You have to remember that MPs rely on their constituents for their seats," says one Kuwaiti economist. "The reforms are aimed at dismantling the very system which the vast majority of Kuwaitis depend upon for their high standard of living. Are they really going to vote for MPs who did away with that system? It puts members in a difficult situation."

Welfare state. At present, the Kuwaiti economy is dominated by the government. Some 94 percent of the Kuwaiti national workforce is employed in the public sector, around half of whom are believed to be in unproductive or absentee positions that exist merely to provide employment. Kuwaiti nationals also enjoy one of the most benevolent welfare states in the world, with heavily subsidised water, electricity and health care. The government accepts that this is unsustainable, given Kuwait's rapidly expanding young population, and is striving to create a market-driven economy with a dynamic private sector that will provide opportunities for ever-growing numbers of Kuwaiti graduates and school-leavers.

Al-Ibrahim is well aware of the vested interests seeking to derail the process. "Parliament is a labor union," he said earlier this year. "It is a natural result to see the majority of MPs defending their labor unions." Matters are further complicated by the interests of influential Kuwaiti trading families, of which there are around 40. They have thrived under the existing system, which has protected them from outside competition with legislation such as exclusive distribution agency laws and high taxes for foreign firms. Many will suffer if these barriers are swept aside in favor of a level playing field, as al-Ibrahim wants to do. There is no evidence that these families have tried to bribe any MPs, but their influence in Kuwaiti society should not be underestimated.

Nowhere is the rift between MPs and the government more evident than in the oil industry. The government is desperate to attract foreign investment into the sector, which was fully nationalized more than 20 years ago, in a bid to increase its production capacity from the current 2.4 million barrels per day (b/pd) to more than 3 million b/pd. The National Assembly backs the plans to boost production, but objects strongly to the $7 billion foreign investment proposals, known as "Project Kuwait." First, MPs cite the Kuwaiti constitution, which bans any foreign ownership of Kuwait's vast hydrocarbon wealth - Kuwait sits on roughly 10 percent of the world's proven oil reserves. Second, they claim that Kuwait does not need foreign investment to develop its oil fields, that it can hire Western contractors to do the job without giving them a stake in the process.

Indeed, MPs question the true motives of ministers in luring the energy majors. They believe that some ministers are hoping to gain significant "commissions" when deals with the likes of ExxonMobil and BP are signed. Furthermore, some members argue that the government's main motive is security. The fields being offered are on the border with Iraq, and some feel that the government wants to secure American - and, to a lesser extent, British - investment primarily to cement their military commitment in the event of another invasion by Iraq.

This situation has inevitably led to conflict. In August, a group of Kuwaiti MPs took the government to court over a proposed deal with the Arabian Oil Company of Japan, which has held a concession for 40 years in the "neutral zone" that Kuwait shares with Saudi Arabia.

After months of stalemate, the issue was finally resolved in early November when the cabinet gave the green light to new contracts that will allow Arabian Oil to continue operations in the country's Khafji field. With the political backing behind them, Arabian Oil and the Kuwaiti government will now launch negotiations on transitional measures and the transfer of operational liabilities. A service contract to provide paid technical advice to a new company likely to be established by Kuwait will allow the firm's continued involvement in tapping the field, while a long-term oil-purchasing contract is designed to ensure stable supply.

The government has already shortlisted a few companies with which it will begin negotiations soon. These include nine global oil majors that have been shortlisted as operators and 17 as non-operators. The 20-year proposed deal is likely to be based on fees-for-services in order to get around the constitutional ban on production sharing or foreign ownership of oil reserves.

Kuwait began seriously courting energy majors during the last oil price slump in 1999, at the same time as neighboring Saudi Arabia. But while the kingdom signed $25 billion of gas deals with international energy companies, Kuwait is some way off even preliminary agreements. For all these reasons, the current session of parliament will be uniquely volatile. But there are some grounds for optimism. First, a number of economic reforms have already been passed. In the last 12 months, the National Assembly has approved important reforms in the fields of foreign direct investment, foreign portfolio investment and labor market reform. In July, the IMF noted that "the structural reform process has advanced significantly since late 2000."

Even in the most controversial field - foreign oil investment - there have been some positive developments. Most of these have been achieved since February, when Adel al-Sabaih, who has strong links with conservative MPs, was appointed oil minister. MPs have signalled that they are prepared to accept foreign investment in the upstream sector, but only on terms that technically deny foreign companies ownership rights. Oil companies do not like these terms, but Kuwait is such a big player that they cannot afford to miss any opportunity.

It would be wrong to overstate the chances of success for serious change. Some reforms, notably a proposed income tax, proved too bitter a pill for MPs to swallow - the government was forced to back down. A repetition cannot be ruled out on any of the new proposals. But there is a growing sense that MPs accept that the status quo is unsustainable. They will have to be seen to be defending their constituents, so heated debates are bound to ensue - but the reformists look set to prevail.