With its sound government finances coupled with investor- and trade-friendly policies, Saudi Arabia has been successful in attracting strong investment inflows. Now the government appears determined to proceed with reforms that are designed to garner further foreign direct investment (FDI).
According to the IMF, the Kingdom “compares relatively well across a number of business indicators”. Meanwhile, in the 2014-15 edition of the World Economic Forum’s (WEF) “Global Competitiveness Index”, Saudi Arabia ranked 24th overall, having dropped four positions since the previous year’s edition and seven positions since 2011-12. This slight downgrade was driven primarily by a less positive assessment of the quality of the Kingdom’s education system, reflecting an area of concern to investors. According to World Bank data, FDI dropped from $12.2bn in 2012 to $9.3bn in 2013. Conscious of such challenges, the government is proceeding with reforms, the most significant of which is the opening of the Saudi Stock Exchange (Tadawul) to foreign investors as of June 2015. Other less conspicuous initiatives also under way, like the overhaul of bankruptcy laws, should attract further interest from investors to this fast-growing market.
From an investment standpoint, Saudi Arabia benefits from high levels of macroeconomic stability combined with low debt and a budget that until 2015 had been consistently in comfortable surplus. Indeed, this track record led the WEF to rank the Kingdom second and sixth in the categories of general government debt as a percentage of GDP and government budget balance, respectively, in its 2014-15 “Global Competitiveness Index”. The one area of concern was inflation, a category in which the WEF ranked the country 72nd out of the 144 countries it surveys. However, inflation rates have declined slightly in 2015 and appear to be stabilising in the near term, largely due to weak global commodity prices.
In an early bid to boost FDI, the Kingdom’s Foreign Investment Law, which was introduced in 2000, created the Saudi Arabian General Investment Authority (SAGIA). The authority is the sole body responsible for issuing investment licences to foreign investors and liaising with other government agencies to obtain their approval.
According to SAGIA, its stated target is to ensure that foreign investors can complete their business registration in the Kingdom within 30 days from the submission of their investment application.
Foreign investors benefit from the same incentives the government extends to local investors, such as the ability for licensed companies to own property directly and the absence of a minimum capital requirement to be held by limited liability companies.
There are no restrictions on the transfer of capital or profits out of the Kingdom, which is facilitated by the riyal’s stable peg to the dollar.
“Given that most large multinationals are already represented here in Saudi Arabia, we’re now working to attract small and medium-sized foreign enterprises to set up here, particularly those at the cutting edge of technology,” Osama Mansouri, advisor to the minister of economy and planning, told OBG.
Incentives such as 100% foreign ownership of businesses have been devised to entice these types of companies, which Mansouri believes have a role to play in developing the economy through the transfer of skills and expertise that they bring.
According to Andrea Benzo, head of the economic and commercial affairs section at the Italian embassy in Riyadh, some of the challenges that foreign companies may encounter in the Kingdom include information and communication gaps on new investment rules and related procedures and requirements.
These hurdles can be particularly problematic for smaller firms, which have less institutional capacity to help them navigate complex regulation. However, Benzo told OBG that SAGIA is taking welcome steps to address these issues, for instance by the introduction of English-language guides for investors in 2014.
The difficulty of obtaining visas to visit the Kingdom is another common obstacle for foreign businesspeople. “The system for obtaining visas through personal invitations from companies works well, but obtaining visas for delegations is more difficult due to the number of bodies that the application has to go through. This unfortunately puts Saudi Arabia at a disadvantage when it comes to facilitating foreign investment relative to other countries,” Benzo told OBG.
For US firms exporting to Saudi Arabia, standards and regulations can sometimes be an additional challenge. “The Kingdom’s standards are primarily based on US standards, but certain products such as electronics follow EU standards, which can create market access issues for US exporters,” Jeff Geiger, commercial officer at the US embassy in Riyadh, told OBG. The US Embassy in Riyadh was planning to hire a full-time standards officer as of early 2015 to liaise with the Saudi Standards Metrology and Quality Organisation and help US firms overcome these issues.
Saudi Arabia’s institutions and infrastructure are two of the Kingdom’s competitive strengths according to the WEF’s “Global Competitiveness Index” for 2014-15. The report ranks the country 25th and 30th in these categories, respectively. Specifically with regards to its institutions, the Kingdom scores highly in the areas of the public’s trust in politicians, investor protection, the protection of minority shareholders’ interests and the business costs of crime. Perhaps surprisingly considering the scale of government investment in recent years, Saudi Arabia is also recognised by the WEF for the efficiency of its government spending, ranking 12th in that particular category. This is part of the explanation for how the Kingdom has managed to develop such an advanced infrastructure system in a relatively short period. The country’s roads, the quality of its electricity supply and its port infrastructure all rank within the top 40 in the world, according to the WEF. The Kingdom’s railway infrastructure, which is currently undergoing significant upgrades, is ranked 50th globally.
The sophistication of the Kingdom’s infrastructure is matched by that of its businesses, according to the WEF, which ranks Saudi Arabia 30th globally in business sophistication. This is a reflection of factors such as the large number of suppliers present in the market, the advanced state of cluster development, the breadth of the value chain and the sophistication of production processes.
Spurring the continual development of the country’s businesses is the government’s support for innovation as part of the transition towards a knowledge-based economy. For example, the Saudi government is a major procurer of advanced technology products, ranking seventh globally in this area, while the Kingdom also places in the top third of countries in company spending on research and development and in collaboration between universities and industry players.
Such partnerships have in turn played a part in boosting Saudi Arabia’s technological readiness. In terms of FDI and technology transfers, the Kingdom is in 10th place, with the country also doing well with respect to the availability of the latest technologies and firm-level technology absorption. Nevertheless, there is still further progress to be made in the field of technology, as this is an area in which Saudi Arabia remains less competitive than its GCC counterparts.
Another key area the Kingdom is looking to build on to enhance its competitiveness is education. “Room for improvement remains in particular with respect to higher education and training, where Saudi Arabia’s assessment has weakened in recent years,” noted the WEF in its latest report. Business leaders also consider that the quality of education could be improved, especially with respect to training in management, in which the WEF ranks the Kingdom 78th, and maths and science, in which it comes 73rd – a score corroborated by Saudi Arabia’s poor performance in the Trends in International Mathematics and Science study.
The IMF supports this assessment, stating: “Spending has been increased at all levels of the education system and also on vocational training. However, educational attainment is still low, and a greater focus is needed on the quality and focus of education to ensure skills are being developed that are sought by the private sector.” The IMF has called for new systems to be put in place to ensure that spending on education results in improved outcomes. Meanwhile, data cited by the IMF on the distribution of unemployed Saudi nationals by education status indicates that almost half of unemployed nationals hold bachelor’s or higher degrees, suggesting that educational outputs are not catering adequately to the needs of the job market.
Progress is being made in tackling these challenges, as is reflected in the fact that while adult literacy rates in Saudi Arabia are slightly below the GCC average, youth literacy is largely in line with GCC peers and has improved markedly since 2004. The Kingdom is investing heavily in education and vocational training programmes; public spending on education as a share of national income between 2004 and 2013 exceeded that of other GCC economies, the BRICS (Brazil, Russia, India, China and South Africa) and a number of advanced economies. The IMF has also praised the impact of the King Abdullah scholarship programme, under which 185,000 students are currently studying overseas, in improving educational outcomes. Nevertheless, as the IMF has recognised, “it will take time for these investments to improve educational outcomes.”
The WEF has identified the efficiency of the local labour market, an area in which the Kingdom ranks 64th out of 144, as ripe for improvement, noting that “reform in this area will be critical for Saudi Arabia, given the growing number of young people who will enter its labour market over the next several years. More efficient use of talent – in particular, enabling a growing share of educated women to work – and better education outcomes will increase in importance as the country attempts to diversify its economy, which will require a more skilled and educated workforce.”
Saudi Arabia does well in terms of the flexibility of wage determination policies, incentivising work through taxation and managing to both attract and retain talent. However, high redundancy costs and still-low female participation in the workforce help explain why the labour market is not yet as efficient as it could be.
As John Sfakianakis, Middle East director at investment manager Ashmore Group, told OBG, much of the manufacturing in Saudi Arabia exists thanks to cheap inputs, including labour. However, it will be hard for the Kingdom to achieve long-term competitiveness by relying on low-cost labour alone. Rather, Sfakianakis argues that Saudi Arabia should seize the opportunity to become globally competitive in high-value-added industries that require significant research and development spending, such as solar panels.
A major attraction of Saudi Arabia to international investors lies in the sophistication of its financial markets, a category in which the Kingdom is ranked 30th internationally by the WEF. The soundness of the country’s banks and the availability of financing through local equity markets are two standout strengths in this regard, while the ease of access to loans and the availability of venture capital are considered further advantages.
Against this backdrop, the opening of the Tadawul to qualified foreign investors in June 2015 is a highly significant event. The exchange’s size and importance could see it join the MSCI Emerging Markets index sooner than expected, according to Sfakianakis. “Banking stocks and those of companies related to domestic demand will be particularly interesting to investors, as well as petrochemicals stocks now that their valuations are so attractive,” he told OBG in January 2015.
According to the rules for foreign institutions seeking to invest in the Tadawul, qualified foreign investors must be banks, brokerages, securities firms, fund managers or insurance companies. They must have assets under management of at least $5bn, though the Capital Market Authority can reduce this to $3bn at its discretion, and Sfakianakis expects the minimum to fall over time. Eligible companies must also have at least five years of investment experience. Limits have likewise been set on participation, with foreign investment capped at 5% of shares in any one company and 20% of the market’s shares overall.
The increased participation of institutional investors should help reduce the Tadawul’s volatility. “Currently the Tadawul is very volatile because it is driven by retail investors,” Fahad Al Turki, chief economist and head of research at Jadwa Investment, told OBG, while acknowledging that this volatility created attractive opportunities for investors willing to take a long-term view.
Another positive effect of the opening of the Tadawul to foreign investors is likely to be an improvement in governance at some of Saudi Arabia’s largest companies. “The Tadawul’s opening will help raise the quality and professionalism of the Saudi private sector,” Omar Bahlaiwa, secretary-general of the Committee for International Trade at the Council of Saudi Chambers and former secretary-general of the Council of Saudi Chambers, told OBG. Foreign investment should also accelerate the transfer of technology and know-how to Saudi companies, Bahlaiwa expects, which in turn will encourage other Saudi firms to go public and look for investment from abroad. From an exporters’ perspective, Feras Abalkhail, director of marketing and PR at the Saudi Export Development Authority, also welcomed the likely impact of the Tadawul’s opening. “International investors will be pushing Saudi companies to grow more internationally, and the Saudi companies can leverage the international investors’ relationships and experience to help them build their international presence,” Abalkhail said.
In financial terms, foreign direct investors in the Kingdom stand to benefit from the absence of personal income taxes, low utility rates and a relatively low corporate tax rate of 20%, while companies can carry over losses for tax purposes.
Licensed foreign investors also gain access to financial support from Saudi Arabia’s numerous business incubators and development funds, including the Saudi Industrial Development Fund, the Human Resources Development Fund (to support the training and recruitment of Saudi labour) and funding from the country’s leading research institutions, the King Abdullah University for Science and Technology and the King Abdulaziz City of Science and Technology.
Meanwhile, with regard to multinational organisations, investors in Saudi Arabia are eligible for support and financing from institutions such as the Arab Fund for Economic and Social Development, the Arab Monetary Fund, the Arab Trade Financing Programme, the Inter-Arab Investment Guarantee Corporation, as well as the Islamic Development Bank.
The government extends additional tax breaks for investments in the regions of Hail, Jizan, Najran, Al Baha, Al Jouf and Northern Borders in an effort to boost the employment of Saudi nationals. These incentives include tax reductions equivalent to up to 50% of the costs borne by companies in relation to the salaries, training and recruitment of Saudi nationals, as well as additional tax incentives for industrial projects.
Viewed as a market for consumer goods, Saudi Arabia’s attraction lies in its combination of size and per capita incomes – both of which continue to rise. The Kingdom already accounts for 25% of total Arab GDP and expects to see its per capita income increase from $25,000 in 2012 to $33,500 by 2020. Indeed, the attractiveness of the Saudi market from an investor’s perspective is reflected in the WEF’s 2014-15 ranking of the country at 20th globally in terms of the appeal of its market size.
The wider service sector presents a range of opportunities for companies capable of providing the required expertise, with health care training being one of the areas that Geiger at the US embassy highlighted as an especially bright prospect. Meanwhile, Benzo pointed out, “Saudi Arabia is at a relatively early stage of its economic diversification so the opportunities here are even greater right now than in more mature markets.”
At a government level Geiger expects defence and security equipment, including service and maintenance contracts, to remain the principal category of American exports to Saudi Arabia, as well as continuing to be an attractive market for the predominantly Western companies that supply the Kingdom’s armed forces.
Besides defence, Geiger told OBG that significant opportunities lie in the public transportation sector in particular, which is currently seeing considerable investment. This offers foreign companies the chance to supply not just industrial equipment but also engineering, architecture and project management services.
Benzo agrees that transport projects should remain an area of focus for foreign firms, particularly those seeking opportunities on a scale that is rarely to be found in other countries. For example, the $6bn contract for the construction of line 3 of the Riyadh metro was awarded to a consortium led by Italian firm Salini Impregilo in 2013. “Such opportunities in infrastructure extend beyond the transportation sector though,” Benzo added. “A large portion of other significant departmental budgets, such as health and education, will go into infrastructure too, in the form of buildings such as schools and hospitals.”
When it comes to import tariffs, Saudi Arabia has a low average rate of 5.1%. The IMF has highlighted that this is much lower than the rates applied in other MENA countries and by the BRICS, and in line with rates applied in the case of advanced economies and in other GCC states. The tariff for agricultural products is 6.2% while for non-agricultural commodities it is 5%. It is also noteworthy that according to the Trade Monitoring Database of the World Trade Organisation (WTO), Saudi Arabia has not been subject to any anti-dumping or countervailing trade measures, export duties, or other export quantitative restrictions in the six years to 2015.
The Kingdom’s business environment is also an important factor in investment decisions. “Although doing business takes time in Saudi Arabia, business partners are very loyal,” Geiger told OBG. According to Philipp Schönbrunn-Knappmann, head of economic affairs at the German embassy in Riyadh, small and medium-sized German enterprises, otherwise known as Mittelstand companies, have been particularly successful in Saudi Arabia for cultural as well as technical reasons. “German exports to the Kingdom principally come from the automotive, precision machinery and renewable energy sectors, all of which there is great demand for in Saudi Arabia,” Schönbrunn-Knappmann told OBG. “Saudis appreciate the close, trusting relationships they are able to establish with Mittelstand firms, many of which are family-owned, which is another reason why these businesses do so well here.”
While Western firms increasingly find themselves competing with Asian companies for contracts in Saudi Arabia, so too has Saudi Arabia steadily increased the proportion of its exports that head East rather than West over the past decade. In total, the value of the exports during 2014 reached SR1.28trn ($342.2bn), according to 2014 Export Statistics Bulletin by the Central Department of Statistics and Information (CDSI). This was a decrease of SR125.4bn ($33.4bn), equivalent to 8.9% on the previous year. Exports had fallen by 3.2% between 2012 and 2013, with the two-year decline largely due to fluctuations in global oil prices.
The top 10 markets for Saudi exports together accounted for 71.5% of all foreign sales in 2014, equivalent to SR918.5bn ($244.8bn) in goods and services. The US remained Saudi Arabia’s leading export partner, absorbing SR162.5bn ($43.3bn) worth of exports, which amounted to 12.7% of the Kingdom’s total export value. This came despite a year-on-year (y-o-y) decrease of 18.4% in the value of Saudi exports heading to the US. Rapidly catching up with the US is China, which imported a total of SR160.7bn ($42.8bn) in goods and services from the Kingdom, equivalent to 12.5%, though it too fell in absolute value by 15% y-o-y. Japan was Saudi Arabia’s third-largest export partner, with SR156.8bn ($41.8bn) of exports (12.2% of the total) heading there in 2014, representing a 12.8% fall in value terms y-o-y.
Other large Asian oil-importing economies occupied the next three positions in the list of Saudi Arabia’s export markets in 2014, with South Korea, India, and Singapore receiving SR123.6bn ($32.9bn), SR113.8bn ($30.3bn) and SR46.8bn ($12.5bn) in Saudi exports, respectively. Completing the top 10 were the UAE, with SR44.4bn ($11.8bn) in exports, Taiwan, with SR43.8bn ($11.7bn), Bahrain, with SR34.6bn ($9.2bn) and France in 10th place, with SR31.6bn ($8.4bn).
At a global level, exports data suggests that Saudi Arabia has continued shifting more of its exports to faster-growing Asian economies, with Asian countries (excluding Islamic and Arab countries, which are reported separately) receiving SR685.5bn ($182.7bn) of its exports, representing 53.4% of the 2014 total and a decrease of 10.4% in value terms y-o-y. By contrast, exports to the EU, which totalled SR156.5bn ($41.7bn) or 12.2% of the total, fell by 4.1% y-o-y.
Saudi Arabia acceded to the WTO in December 2005. Regionally, the Kingdom is a member of the GCC and the Pan-Arab Free Trade Area, which comprises 12 Arab states in addition to the GCC member states and came into force in January 1998. Through its membership of the GCC, Saudi Arabia is a party to agreements between the GCC and the European Free Trade Area, Australia and Japan. The Kingdom has also entered into bilateral preferential trade arrangements with countries around the world, including Australia, New Zealand, Russia, Switzerland and Turkey.
The IMF has observed that Saudi Arabia’s total trade value per capita is the lowest among GCC economies, primarily due to its relatively large population. However, the Kingdom’s trade value per capita is still comparably higher than that of most other MENA countries and is also comparable to that of the BRICS.
In terms of merchandise trade, which includes trade in goods but not services, capital transfers or foreign investments, Saudi Arabia’s share in total world exports stands above 2%, according to IMF data. This is much higher than that of other MENA countries, above that of the other GCC states (the UAE comes closest with a share of 1.9%) and greater than that of a number of emerging markets like South Africa, Brazil, Indonesia and India. However, manufactured exports as a share of total Saudi exports are low, standing at under 15% compared to a share of up to 70% for other MENA states, reflecting oil’s dominance of Saudi exports.
In its report accompanying the release of the 2014-15 “Global Competitiveness Index”, the WEF noted that Saudi Arabia “will need to enhance competitiveness to further diversify its economy and create sufficient numbers of jobs for the growing workforce”. From the government’s point of view, attracting foreign investment is an effective way of accelerating this economic diversification, not least because of the foreign expertise that investment from abroad can bring.
From an investor’s perspective, although short-term challenges exist for first-time entrants to the market, these are largely outweighed by the opportunities available in the Kingdom’s large and dynamic market, as well as by the Saudi government’s enthusiasm for foreign trade and investment and its commitments to further streamlining the regulations for foreign participation.
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