Picking up the pace on the path to development

The Kingdom has taken a steady approach to diversified growth, but there are signs the process is gradually gaining ground as FDI makes a concerted recovery

We all know it, but it is important to remind ourselves of the importance of oil in any discussion of Saudi Arabia's liberalising economic landscape. With a quarter of the global reserves, it is the world's leading oil producer and exporter.

Oil still provides 90 per cent of government revenue, and the high prices of the past few years have led to increasing government and private sector spending.

The government's policy of economic reforms to boost
non-oil growth and create employment opportunities
needs to be placed in that context.

Whether the twin policies of foreign direct investment and privatisation have met the expectations of those following the progress is a matter for debate. It depends on whom you ask.

Yet, clearly Saudi Arabia has opened up considerably in the last few years. In 2006 the Saudi Arabian General Investment Authority (Sagia) issued 1,389 licences to both joint and exclusively foreign projects, valued at 253 billion Saudi riyals (about $67.5 billion).

It expects to attract projects worth more than 300 billion Saudi riyals (about $80 billion) this year.

"Certainly, issuing of licences is one way of measuring
success, but of more importance is the actual flow of FDI rather than commitments," says M. A. Ramady, Associate Professor of Finance and Economics at King Fahd University of Petroleum and Minerals in Riyadh.

"Till recently, the actual inflow was not commensurate with the size of the Saudi economy, and tended to concentrate in the energy-related sector where the Kingdom has a comparative advantage."

But he does acknowledge Sagia's efforts and the introduction of a more friendly investment regime, which - coupled with higher oil prices, low inflation and a higher international credit rating - have started to accelerate FDI flow.

Recent figures show FDI on the rise, to an estimated $3,650 million in 2006 (see chart). Recent FDI investment laws allow repatriation of profits, ownership of land for company use, and no restrictions on imports and exports as long as they do not conflict with the basic principles of Sharia.

Still, currently such flows to the Kingdom are less then 1.5 per cent of GDP.

"The FDI climate has improved in the Kingdom, but Compared with Bahrain or the UAE, it has lagged behind in the diversification of potential FDI partners, although the Chinese, Indians and Russians are now showing greater interest in Saudi Arabia, and this could bring in significant synergies with these countries," Ramady says.

Providing licences to BNP Paribas, HSBC, Deutsche Bank, and J. P. Morgan Chase, National Bank of Pakistan and State Bank of India shows Saudi Arabia's commitment to opening its banking sector to foreign investment.

The insurance industry has also opened up, and reform measures in the mortgage finance laws and securitisation are expected to be enacted soon.

This is where liberalisation of activities also intercedes, with aspects of investment banking entering the scene.

"The financial services sector (evolution) used to be primarily driven by commercial banks-some in (cross-border) joint ventures, some 100 per cent Saudi-owned," says Basel Algadhib, CEO of The Capital Group, which has entered into a joint venture with Morgan Stanley to offer investment banking services.

"Some of these banks ventured into securities business. Now new entities have been licensed to do securities business."

By January 2007 Capital Markets Authority had licensed about 45 foreign and local companies to provide financial and brokerage services. However, Pascal Devaux, economist at BNP Paribas thinks that better regulation is the need of the hour in the banking sector.

There's also a long way to go in the non-banking financial sector - bonds, insurance and equity - he suggests, as the capital market is still in its infancy and public intervention still strong, although Capital Markets Authority, the regulator, is fast coming of age.

It should be kept in mind that Saudi Arabia is not really in need of foreign capital.

"The desire to attract foreign investment is motivated by the realisation that it can benefit greatly from the transfers of skills and technology associated with foreign direct investment," says Jane Kinninmont, editor and economist at London-based Economic Intelligence Unit.

"The Kingdom has sizeable capital surplus in the private sector but needs effective technology partners," concurs Ramady.

"As such, the Kingdom's FDI requirements might differ from lower capital surplus countries such as say Bahrain or Oman, where FDI capital flows are Probably more important."

Saudi Arabia's entry to the WTO has certainly boosted the momentum. The medical sector, franchising and wholesale trade are now opening up fast. There have also been significant investments in the hotel and leisure industry, and real estate, with foreigners acquiring property rights.

WTO accession allows large-scale imports into the Kingdom, with fewer restrictions and easing of non-technical barriers to trade. It is perhaps too early to judge its impact.

"If the pace of reforms does indeed gather pace and
transforms the Saudi economy, with the private sector
gearing up to face the challenges of import liberalisation, accession will have been worthwhile," Ramady argues.

Petrodollars
Hinting at the slower than expected pace of reforms,
Kinninmont says floating on an enormous pool of
petrodollars can sometimes slow economic and political reforms.

Ramady agrees. "One reason for the slowdown in the
privatisation programme could be the better government financial fortunes over the past four years (with) a reduction in domestic debt and build-up in international reserves of the Kingdom to around $290 billion."

Since 2002 the Higher Economic Council, seeking to
revitalise the programme, has nevertheless approved
privatisation in 20 sectors, which includes postal services, water desalination, air transport, airport and seaport services, municipal construction and educational, health and social services.

Plans for divestment of state-owned mining firm Maaden next year and the national carrier Saudi Arabian Airlines in 2009 is in the offing.

However, with the exception of the postal service, which has been fully privatised, the others have been only part privatised. In terms of effective competition, the telecom sector, with three mobile phone suppliers, seems to be ahead of the rest.

Ramady characterises the part-privatisation programme as "paternalistic," whereby a minority stake is sold to the public - to date limited to 30 per cent - and the government still maintaining both a majority stake and management control.

It will be while, he says, before a state enterprise is
privatised 100 per cent. He cites other obstacles to rapid privatisation, such as how to assess the fair market value of public assets, a rigid pay structure in the state enterprises that might not be easily changed if the private sector took control, uncertainty on whether government subsidies will
continue after privatisation, and concerns that the
private sector might shed employees.

One of the main reasons behind the privatisation initiative has in fact been to address growing unemployment and to move away from the national habit of the public sector as regular employer (state employment has remained stable since 1993).

However, the impact on unemployment has so far been poor. "Skills shortage is the main reason why privatisation does not appear to have significantly reduced unemployment among nationals," says Kinninmont.

"Private businesses still say they need to recruit expatriates to obtain the right mix of skills and experience."

Improving human capital takes time, and unemployment is likely to remain an issue as the growth of the non-oil private sector is not expected to offset population growth of the young.

Policies of economic reform generally involve a delicate political balance.

"As with other forms of policymaking, the government would seek to balance its desire to attract foreign investment and open up the economy with the need to maintain some sort of consensus within the royal family and clergy," Kinninmont says.

The pace of reforms may be slow, but there remains a sense of optimism among experts.

"It is gradual. The market is developing in the right direction. You don't need international investors to bring in capital. What you need is to bring in discipline and market research," says Algadhib, The Capital Group's CEO.

Ramady agrees. "While the Kingdom is sometimes perceived to move more slowly, the pace is definitely picking up and the next few years will see some positive convergence with the others in the Gulf."