Thursday, 29th November 2018

Weak Saudi investment flows point to economic trouble ahead

Away from the spin and razzmatazz of last month’s Future Investment Initiative (FII) conference in Riyadh, analysts are starting to question whether the sums underlying the economic reform initiatives being pursued by Saudi Arabia really add up.

McKinsey & Company, the chief architect of the Vision 2030 strategy, has previously estimated that $4trn of investment is needed to implement the sort of wide-ranging economic reforms it has suggested for the country. Where all that money will come from remains a matter of debate. Riyadh had hoped to raise $100bn from a sale of a 5% stake in Saudi Aramco, but the $2trn valuation this implied for the company is seen by most analysts as grossly optimistic – if a sale could be done at all in the current climate.

Meanwhile, the kingdom continues to record a fiscal deficit and, although this has been falling for the last couple of years, it could start to rise again if recent lower oil prices persist. Even allowing for the $500bn worth of assets held abroad by Saudi Arabian Monetary Authority (Sama – central bank), the only plausible hope for bridging the massive funding gap is foreign direct investment (FDI).

The much-hyped FII events led by Crown Prince Mohammed Bin Salman (MBS) have been an attempt to address the funding gap, but to date they have largely failed. According to data presented by the United Nations Conference on Trade and Development (Unctad) to the 2018 International Institute of Finance Mena Financial Summit in Abu Dhabi, FDI flows into Saudi Arabia dropped by 81% in 2017, falling to $1.42bn compared to $7.45bn in 2016 (GSN 1,062/11).

There has been some recovery this year: one figure says inward investment totalled around $1.8bn in H1 2018 and MBS told Bloomberg in October that FDI for the full year “will be 90 percent more” than in 2017. The scandal surrounding the murder of journalist Jamal Khashoggi (see Politics) may yet dent inward investment in H2 18, but even if inflows hold steady the kingdom is still nowhere close to meeting the $4trn target.

Chairman of the powerful Council of Economic Affairs and Development since 2016, MBS has been banking on Saudi private investors supporting his plan. Many of them have substantial overseas holdings and the government no doubt hoped some would step forward to invest more in the kingdom. But following the Ritz-Carlton arrests in November 2017.

(GSN 1,048/1), rich Saudis have been straining every sinew to move money out of the kingdom, avoiding as best they can the newly-imposed capital controls to protect their wealth from extra-judicial seizure by MBS and his team. Some estimates put the amount of money leaving the country since the Ritz-Carlton clampdown at $150bn.

At the same time, the government is struggling to rein in public spending on salaries and pensions, tackle unemployment and redirect money to capital investment; it must also meet the high cost of the Yemen war. As has been evident in King Salman’s nationwide tour (see Royals watch), the government sees a need to shore up domestic support in the traditional manner, by reintroducing annual bonuses, salary increases and hiring more government employees, as well as announcing more infrastructure projects.

Such moves may help to offset domestic critics, but they do nothing to assuage the concerns of international investors. One well-respected Saudi corporate lawyer told GSN that inward investment had fallen so sharply because of a significant loss of foreign confidence in the market. The lawyer pointed to two primary reasons, which says much about how MBS and his allies are running Saudi Arabia. Firstly, the terms of trade which foreign companies are expected to comply with, including up-front payments of substantial performance bonds, might be suitable in an environment with a fair legal system, but the Saudi legal system rarely works in favour of foreign-owned companies and is particularly prejudiced against small- and medium-sized non-western companies. One major gripe is that it is very hard to recover debt.

The second issue is the difficulty in repatriating profits. Government departments are accused of abusing the General Authority of Zakat and Taxation annual tax clearance certification process to extort inflated sums in tax; without such certification, foreign companies cannot recover profits nor liquidate funds invested in locally-registered companies.

Some business leaders believe a more hostile environment for foreign investors is deliberately being created, through the co-ordinated action of different government departments, so that non-GCC and smaller western companies are pushed out of the market, allowing MBS-connected Saudi companies to take advantage.

Weak FDI and a bleak business environment signal trouble in the medium- to long-term. For now, the government has enough savings to continue with business as usual, postponing the day of reckoning by buying off potential social unrest. But in the longer term, economic nationalism and the lack of foreign investment will cripple plans to transform an economy hobbled by well-entrenched social constraints and persistent unemployment.

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