SAUDI ARABIA IS now delivering the reforms and sound economic management that will enable it to attract the investment required to modernize. Ministers face the challenge of ensuring that they use this opportunity to create the private-sector driven growth that will generate employment for a rapidly growing population.
Success with these reforms will also provide a much-needed positive message to the west at a time when Saudi Arabia’s traditional alliances with the US and UK are under greater pressure than ever before.
As the country was receiving the news of a positive rating from Standard & Poor’s, its foreign minister, Prince Saud Al-Faisal, was in an increasingly acrimonious dispute over the US decision to suppress a 28-page section of a congressional report on the September 11 2001 terrorist attacks.
Saud demanded the publication of the section linking the kingdom to the hijackers, arguing that Saudi Arabia can only defend itself against the charges if they are published in full. Relations between the two countries are at their worst for many years, with Saudi Arabia insisting that it is doing all it can to counter terrorism and pointing to the attacks in Riyadh earlier this year.
Despite this, the US is gradually reducing its dependence on the kingdom as its primary ally in the region. In this context the continued ability of the reformers, headed by Saudi Arabia’s de facto ruler, Crown Prince Abdullah, to modernize the economy is critical as it indicates that they still hold the initiative.
Liberalization back on track A series of announcements in recent months have confirmed that, despite frustrating delays, the liberalization strategy is back on track. It will be given added momentum following a cabinet reshuffle that has created a more reform-minded and dynamic ministerial team. Particularly significant was the creation of a ministry of water and electricity, under Ghazi Al-Qusaibi, the former Saudi ambassador to the UK. He has a mandate to revitalize these sectors and ensure that proper investment is made to meet rapidly increasing demand. The reshuffle is also expected to give new momentum to what was previously seen as a rather conservative-minded commerce ministry.
Local bankers also believe that these positive developments will more than outweigh concerns felt by international investors in the aftermath of the Iraq war and the terrorist attacks in Riyadh in May. The strongest evidence for this came in July with the revival of the initiative to explore and exploit the country’s natural gas reserves.
Among other important recent steps taken by the government are measures to modernize the capital market and the insurance industry. It is also reaping the rewards for prudent economic management in recent years; this and high oil prices have put the budget on course for a surplus for only the second time in 20 years.
The government’s strategy is also starting to receive international recognition. Standard & Poor’s has given an A+ grade to Saudi Arabia’s long-term local currency rating in its first official assessment of the sovereign.
The country is now well placed to build on the successes of its foreign investment law, which is one of the most liberal in the Middle East. And its privatization strategy received a big boost with the sale earlier this year of a 30% stake in Saudi Telecom (STC).
This demonstrated that there is a healthy appetite for investment in the right projects, that state-owned companies can deliver the necessary levels of commercial transparency and efficiency savings and that the government can find investors for privatization.
Damage limitation on gas project Even the failure, after five years of negotiations, to reach an agreement with the world’s leading oil companies for the showcase $15 billion project to develop the country’s gas sector, a crucial driver of foreign investment, has had a favourable outcome.
This initiative comprised three core ventures, ranging from upstream exploration and production to downstream use of the gas to power desalination plants, generate electricity and feed petrochemicals production.
The initial negotiations with the foreign companies, headed by Exxon Mobil, fell down, apparently over rates of return for the companies and access to the gas fields. However, the rapid restructuring of the project and the award of the first contracts ensured that any damage was kept to a minimum.
The speed with which a new announcement was made was important as it will have restored the faith of foreign investors, says Said Al-Shaikh, chief economist at National Commercial Bank. “The rapid relaunch of the initiative has ensured that there been no damage to the concept of attracting foreign direct investment into Saudi Arabia. Investors could have been deterred if the replacement plan had not been announced,” he says.
The new structure of the plan has also been welcomed. Instead of trying to award vertically integrated mega-projects covering everything from exploration to downstream businesses, the government has broken the contracts into smaller elements.
“It is a less complex plan than the one initially devised by the government, which means that it should be easier to meet the requirement of both the Saudi government and the independent oil contractors. It makes sense to start by focusing on exploration without tying in any of the other infrastructure projects,” says Al-Shaikh.
The first deal has already been struck with three oil companies. Anglo-Dutch group Royal Dutch/Shell (the lead partner with 40%) and France’s TotalFinaElf (30%) will undertake a scaled-down version of the $5 billion contract that Shell had originally been negotiating. These foreign companies will work in partnership with Saudi Aramco, the kingdom’s state-owned oil company, which will take a 30% stake, to search for natural gas in 200,000 square kilometres of the Rub Al-Khali desert. However, there are still complex negotiations ahead before this deal can be finalized.
The award of this contract was followed up by a roadshow in London at which Saudi ministers made clear that there was no change in their overall strategy of pressing ahead with the opening up of the gas sector and doing so by involving international oil companies for the first time since nationalization in the 1970s.
“Although the decision takes the gas exploration and downstream exploitation process in a different direction, it shows that the government still wants to open up the kingdom to international oil companies,” says Brad Bourland, chief economist at Saudi American Bank (Samba).
An equally important boost for Saudi Arabia came with the announcement, also in July this year, that the country had been given a series of ratings ranging from A+ to A-1 by S&P. The sovereign rating, the first ever solicited by the country, is seen by Saudi ministers as an important step towards creating a dynamic, open economy and financial markets, not least because it sets a benchmark for all companies that want to issue securities.
Ala’a Al-Yousuf, country specialist at S&P, says Saudi Arabia was given the rating because of its macroeconomic stability, its substantial external liquidity, sizeable domestic investments and favourable debt composition.
S&P says the rating was however constrained by the limited fiscal flexibility, insufficient private-sector economic growth and the slow development of the socio-political system. “The high local currency credit ratings balance the government’s ability to raise revenues and access the domestic capital markets against geopolitical risks that could impair its ability to service both local and foreign currency debt,” says Al-Yousuf.
Bourland says that the long-term local currency rating of A+, which affects the area where most of the country’s long term debt is held, is the most important of those given by S&P. “The ability of the Saudi government to get such a good rating when the world is putting Saudi Arabia under a microscope says a lot about the quality of their economic management,” he says.
He also points out that the rating removes one of the major disincentives to foreign investors who were considering buying Saudi government bonds. “Some institutions are not allowed to invest in countries which have no rating. This is one of the reasons why very few Saudi government bonds are held by foreigners. The rating removes an institutional barrier to holding these bonds and could lead to renewed interest in buying Saudi debt,” he says.
The rating is also a boost for the Saudi Arabian General Investment Authority (Sagia), which has been fighting an increasingly successful battle to remove obstacles to foreign investment. It is changing a culture that has until recently treated foreign companies as mere contractors rather than business partners. “I am pleased that they have produced this rating,” says Abdulrahman bin Zarah, deputy governor, investment promotion and services at Sagia.
However, one of the key passages in the S&P assessment highlights the need for the Saudi government to complete reforms. S&P points out how delicately poised the economy is. On the positive side, it says that the government’s creditworthiness could improve if the natural gas initiative is successfully relaunched, non-oil private sector growth accelerates, the government expands its non-oil revenue base and unemployment falls. That’s a lot of ifs.
S&P warns that there could be “downward pressure if the government’s debt burden increases significantly, external liquidity is impaired or domestic and regional political risk increase”.
Transforming legislation The government’s chances of completing the modernization of the economy have been significantly enhanced by new legislation that will transform the capital markets and the insurance sector.
These measures have been welcomed by business and finance. According to Beshr Bakheet, managing director of Bakheet Financial Advisers: “The capital markets law is the most important thing to happen in Saudi Arabia in the last 30 years.”
Saudi Arabia already has a stock exchange that is efficient, transparent and was one of the first to offer real-time settlement. Its credibility was enhanced this year with the sale of a 30% stake in STC, which brought 200,000 new investors into the equity market, boosting the number of active investors to 380,000.
STC’s shares are trading at a big premium, helping to value it as the second-largest emerging market telecom by capitalization and boosting the market index more than 40% in the first half of 2003.
The IPO, which was the second largest in the world last year, transformed the company, which had been valued at SR51 billion, already making it the largest company in the region, into one worth SR117 billion ($30.8 billion). The main index, the Tadawul All Shares Index, rose almost 60% between the start of January and early August, climbing from 2,518 to 3,953.
The capital market law is aimed at giving the stock exchange the legal and regulatory framework to make the most of its buoyancy. It creates an independent regulatory body, the Securities and Exchange Commission (SEC), a privately owned exchange, and allows foreign investment banks to operate in the kingdom.
One of the most important tests will be whether more companies will now go public. “We expect to see a significant increase in the use of the capital market by the private sector,” says Hamad Al-Sayari, governor of the Saudi Arabian Monetary Agency (Sama), the central bank.
Also important is legislation to regularize the insurance sector, a business that has been carried out in the kingdom by one legally constituted company and a series of offshore providers operating out of Bahrain. Several banks and institutions, including Bank Saudi Fransi, are already considering entering a market that will be regulated by Sama. “We will build on our experience in the banking sector to develop the necessary skills and regulatory framework so that we can supervise the market effectively,” says Al-Sayari.
These laws are also expected create a more open, competitive and dynamic financial sector that will provide the full range of services demanded by commercial and retail customers. Banks have continued to diversify their services and competition has been intense, particularly in rapidly developing areas such as Islamic banking.
Despite low interest rates, which some bankers say will put pressure on profits in a year’s time, and the political uncertainties resulting from conflict in the Gulf, which led to the delay of some investment decisions, Saudi financial institutions have produced better results in the first half of this year than in 2002. “Both domestic and international conditions – notwithstanding the war in Iraq – continue to be favourable for the Saudi banking sector,” says Al-Sayari. These include continued strong demand for consumer loans and corporate credit and abundant liquidity resulting from high oil revenues.
Ministers are determined that the banks will play a more active role in financing a private business and industrial sector, which has surprised analysts by its resilience and ability to grow in recent years. Analysts expect the non-oil private sector to grow by a further 4% this year, following a 4.2% expansion in 2002. These figures have been boosted by strong liquidity, low interest rates which triggered consumer spending, and the readiness of Saudis to spend more at home as they reduced travel to Europe and the US.
The question now is whether these structural reforms and stronger economic performance will enable Saudi Arabia to invest the billions of dollars needed to modernize its infrastructure and to create jobs for its young people.
Both these tasks are made more difficult by the 3% growth in population and the bulge in those aged 15 to 20, who will be entering the labour market in the next five years. Overall unemployment, say ministers, is about 8%. According to Bourland, one in four Saudis between the ages of 20 and 24 is out of work and the labour force is growing faster than the available jobs. However he characterizes the present position as “a concern not a crisis”.
One of the most important developments is that Saudi ministers now acknowledge publicly that there is a problem and that they have to deliver solutions. This is a clear example of the growing openness and transparency in the Saudi economy and why there is confidence in the commercial and financial sector that reform is starting to achieve a momentum that will not easily be reversed.
