Expectation Gap Clouds Saudi Arabia’s Investment Climate

Saudi officials will host government leaders and business executives at the Future Investment Initiative conference in Riyadh October 29-31. Yet there is a growing disconnect between the expectations of Saudi Arabia’s government and the interests motivating the global investment community. Saudi Crown Prince Mohammed bin Salman reportedly seeks a $2 trillion valuation of Saudi Aramco for its anticipated initial public offering, whereas some analysts and observers have suggested that the company’s actual value could be as low as $1.1 trillion or $1.2 trillion. Major attacks on Aramco facilities in September presented a justifiable excuse for delaying the process, but Saudi officials nevertheless pushed onward. In spite of this effort, uncertain investor confidence and an inability to secure anchor investors appear to have further delayed the listing of the energy giant until after the reporting of third-quarter results.

A broader expectation gap has widened since 2016, when the young crown prince charmed tech titans and hedge fund managers with a bold vision for the future of his hydrocarbon-dependent country. Initial excitement subsided following a series of political and economic crises, both domestic and regional. Multinational firms are ultimately profit driven, and consequently commercial interest in Vision 2030 hinges on their ability to secure lucrative contracts in the country. The International Monetary Fund slashed Saudi Arabia’s 2019 growth forecast to a mere 0.2%, denting the country’s attractiveness as a destination for global capital. Without substantial buy-in from foreign investors, government expenditures must power the engines of Vision 2030 and its 13 Vision Realization Programs. With benchmark Brent crude trading around $60 per barrel, it will be difficult for Saudi Arabia to balance its 2019 budget, which requires prices closer to $80-$85, according to IMF officials.

Foreign direct investment trends in Saudi Arabia do not look promising. Over the past decade, net inflows of FDI have steadily declined from $39.5 billion in 2008 to $4.2 billion in 2018. Meanwhile, net outflows of FDI increased slowly over the same period, with the exception of 2018, when outflows spiked from around $7.3 billion to nearly $23 billion. The National Transformation Program sets a minimal goal of attracting FDI inflows equivalent to 1.46% of gross domestic product by 2020, from a baseline of 1.3% in 2016. Given that this ratio stood at 0.54% in 2018, even this conservative target will be a challenge to meet.

Saudi Arabia’s annual Future Investment Initiative conference is intended to showcase the country’s thought leadership and flagship commercial initiatives for a global audience of government officials, investors, and innovators. Yet the killing of Jamal Khashoggi prior to the 2018 conference led several Western businesspeople to stay away. For many business leaders, the optics of attending the glitzy event, known as “Davos in the Desert,” this October still poses reputational risks. As this year’s conference revolves around three tech-focused themes, the absence of  top brass from U.S. and European technology firms would be noticed, although plenty of senior-level meetings between U.S. and European tech firms and Saudi government and private-sector actors are likely to take place on the sidelines of the event.

That said, a number of prominent figures have confirmed their attendance. Presidential advisor Jared Kushner and Secretary of the Treasury Steven Mnuchin will lead a U.S. delegation to the conference. Indian Prime Minister Narendra Modi will likewise attend the event and deliver a keynote address. As part of his visit, Modi aims to sign an agreement over the Strategic Partnership Council – a mechanism for monitoring the strategic partnership between the two countries. He also intends to launch the RuPay card system, a card payment scheme launched by the National Payments Corporation of India, in Saudi Arabia. However, neither conference attendance nor the number of commercial agreements signed at the conference serve as an accurate reflection of the country’s investment environment. The 2018 Future Investment Initiative conference concluded with a reported $56 billion worth of commercial deals. However, deals signed with Saudi Aramco accounted for about $34 billion of this total, which included memorandums of understanding and pre-planned agreements.

Source: World Bank

Wealthy Saudi citizens represent another potential pool of investors. Riyadh has strongly encouraged wealthy Saudi families to invest in major government initiatives, such as the Aramco IPO and other development projects. These developments can be viewed as well-intentioned government efforts to shift some distributive responsibility away from the public sector or as a means of coercing local investment – reflecting another example of an expectation gap. Tapping a pot of pliable domestic capital can partially supplement fickle FDI inflows, yet there is a limit. Value-added tax, subsidy reductions, strict Saudization regulations, and fees related to expatriate employees have cut into profits for many Saudi-based firms. The Saudi Shura Council requested a freeze on expatriate-related fees until a study can be conducted.

There is some cause for optimism. Saudi Arabia ranked as one of this year’s top 10 global business climate improvers, according to the World Bank Group, with the country’s largest strides relating to starting a business. The Saudi Arabian General Investment Authority licensed 8,442 foreign companies in 2018, a slight improvement from the 7,911 it licensed in 2017. Multinational firms are finding opportunities in sectors heavily promoted by the government, such as technology and tourism. In September, Nokia signed an agreement with the Saudi Ministry of Communications and Information Technology to launch a global software and support center, while Oracle announced plans to open two new data centers in the country. Deloitte opened the firm’s first Middle East-based digital center in Riyadh earlier in October. Hyatt expects to double the number of its hotels in Saudi Arabia by 2023, and India-based OYO Hotels & Homes will invest $1 billion to expand its Saudi operations.

Beyond the Future Investment Initiative, Saudi Arabia will host the G-20 summit in 2020 in Riyadh. World leaders are unlikely to miss this event, and the occasion gives Saudi Arabia a year of breathing room to advance key development initiatives and economic reform agendas. In the meantime, the government may need to adjust its expectations surrounding the willingness of international and local investors to foot the bill for an increasingly expensive economic transformation.

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