Despite attracting about $12.5bn since announcing that it would fling open its doors to foreign direct investment (FDI) in 2000, few Saudis are under any illusion of the task that faces them in priming the economy for more significant inflows of foreign capital. The slow pace in dismantling barriers to investment since the Saudi Arabian General Investment Authority (Sagia) was set up is now widely recognised throughout government.
“Business decisions are still very slow,” admitted Industry and Commerce Minister Hashim Yamani at the Jeddah Economic Forum in January. “The name of the game in the future is to be able to move fast. The private sector must get moving.”
Ministers are now preparing to kick-start the reform process, starting with the slashing of tax rates on foreign investors from 45% to 20% announced on January 12. This is seen as a critical step towards creating a more investor-friendly business climate.
The new tax will apply to companies that were established with capital from non-Saudi shareholders and non-Saudi residents, as well as non-resident individuals who do business in the kingdom through a permanent firm. It will also apply to non-resident individuals who have a stable income from the kingdom’s resources.
One swallow does not a summer make, but a host of other indicators underlines the authorities’ seriousness of intent in putting economic reform at the top of the agenda. In 2003, the government gave the green light to a slew of major laws, among them the long-awaited capital market and insurance laws, and a draft mining law specifically designed to attract foreign companies to the sector, with a reduction in corporate taxation rates to 30% from 45%. By-laws approved by the health ministry will allow non-Saudis to own fully local hospitals, part of a wider pitch to investors in the local healthcare system.
Privatisation potential
Privatisation is another watchword that has worked its way into the fabric of Saudi business discourse. A successful debut initial public offering (IPO) for Saudi Telecom in 2003 looks set to be followed by another IPO in the country’s largest bank, National Commercial Bank (NCB). The NCB offering is expected to be valued at about $10bn, not far off the Saudi Telecom issue.
Public offerings will extend into the cellular phone market. The launch of the kingdom’s second GSM licence is tied to the formation of a joint stock company in which 50% of the shares will be sold to the public.
The government also announced a programme in late 2003 to privatise 200 airports. State carrier Saudi Arabian Airlines has long been talked up as a candidate for a sell-off, as is National Company for Co-operative Insurance (NCCI), which until now has monopolised the domestic insurance sector. An NCCI IPO is anticipated following implementation of the new insurance regulations, which may not see the light of day until 2006.
Significant progress has already been achieved in moves towards World Trade Organisation accession. The final bilateral trade agreement with the US is expected to be concluded soon, heralding Saudi Arabia’s likely entry into the WTO sometime during 2004.
Slow implementation
The heightened anticipation over the scale of the reform programme is tempered by the reality of slow progress on implementation. Finalisation of the new capital market law’s by-laws is taking longer than expected, as are the executive regulations of the insurance law.
But Saudis can draw other straws of comfort. Despite two major terrorist attacks on foreign resident compounds in Riyadh last year, an exodus of foreign companies has been avoided. Nerves have been steadied and the base attractions of the region’s largest economy loom larger than transient security risk concerns.
The upstream gas opening salvaged from the wreckage of the vaunted Saudi gas projects initiative has proved another strong draw, providing oil majors Royal Dutch/Shell, Total and Russia’s LUKoil, among others, with valuable footholds in Saudi hydrocarbons.
With the capital market law in the pipeline, financial services could spearhead the next wave of investment. The new law threatens to put an end to the closed market enjoyed by local players, injecting a welcome dose of competition. Banks will no longer have a monopoly of brokerage and asset management services, although they will compensate in other ways, such as gaining access to a wider range of financings and longer maturity deals.
Foreign opening
The prospect of foreign entrants to the Saudi banking market is no longer the stuff of fantasy. Deutsche Bank was granted a licence in 2003 to set up an investment banking operation, in the first major foray into the Saudi market by a foreign bank.
Insiders say Deutsche’s interest goes beyond investment banking and it is also hoping to set up a general representative office in the kingdom.
HSBC, which is already present through its 40% holding in Saudi British Bank (SBB), has also applied for an investment banking licence. Its unit will be separate from its existing affiliate, Saudi British Bank (SBB), and it will operate under the HSBC brand. The two debutants are likely to be joined by others: a couple of international players are already mulling over similar moves.
“Deutsche Bank and HSBC’s expressions of interest gives the message to others to follow suit,” says Said al-Shaikh, chief economist at NCB. “There are many opportunities, such as investment banking where the local market capacity is limited.”
European banks are understood to be particularly interested in the Saudi market, though most are adopting a wait-and-see approach until the capital market law is in place. The law, which sets up a formal stock exchange and new regulatory body – the Saudi Securities and Exchange Commission (or Capital Market Authority) – will boost new investment in the financial services sector. “Under the existing law, institutions haven’t been comfortable operating in the kingdom,” says Dr al-Shaikh. “The new law provides an umbrella for the better functioning of these institutions.”
Investment banking and brokerages
Investment banking is the top draw for foreign banks. A potentially lucrative slice of income is beckoning through advisory mandates on major energy deals, telecoms and the major syndications that issue sporadically from the likes of state oil company Saudi Aramco and petrochemicals giant Saudi Arabian Basic Industries Corporation (Sabic). BNP Paribas picked up the business on the gas projects granted to Shell and Total.
“There are a lot of things happening here,” says Mazen Hassounah, managing director of Rana Investment Company, a local investment house. “There are large IPOs coming to the market, the second GSM licence and a lot of activity on the advisory side, which will provide valuable fee-based income. Plus there are asset management and investment services opportunities.”
Saudi investment houses have already been in talks with multinationals keen to penetrate a liberalising market. “Their interest in the market is not like a local brokerage’s,” says Dr Hassounah. “But they want to share the locals’ client base. In return, they will share their experience with the local players on the premise that most of the international business will be done through the international bank – a division of roles that will suit both parties.”
The arrival of foreign competition is unlikely to result in a decimation of the local players at the hands of more resourceful international banks. Saudi banks may not be able to match foreign players’ ability to distribute debt globally, but their understanding of the local market and their tight control of retail channels gives them leverage out of proportion to their financial strength.
Local banks play to strengths
The likely division of spoils in foreign/local ventures could play to the Saudi banks’ advantage, particularly in retail and corporate banking where they have developed strong client relationships. Saudi banks have invested heavily in retail technology and branch development, but it would be difficult and expensive for foreign banks to compete directly with the locals’ retail franchises. But they can build alliances by working together in areas such as retail, corporate banking – where the Saudi banks are strongest – and private banking and investment services.
Competition from international institutions will also force Saudi banks to cut back costs, improve management and become more efficient.
Saudi bankers do not appear unduly concerned by the prospect of greater competition. The entry of three Gulf Co-operation Council banks into the kingdom in the past year – National Bank of Kuwait, National Bank of Bahrain and Emirates Bank International – has had little impact, although this might also be linked to their restriction to one Saudi branch under the terms of the licence, which limits their ability to compete with local institutions.
HSBC’s decision to set up a self-branded unit alongside SBB suggests that international banks are not seeking to increase their shareholdings in their existing Saudi operations, although later they may evolve a joint venture covering investment banking activities.
This could also provide a model for the other global banks with Saudi joint venture agreements, such as Credit Agricole and ABN Amro, to leverage strong positions. But Citigroup’s 3% reduction of its holding in Samba (renamed Saudi American Bank) late in 2003 to 20% prompted speculation – which the bank strenuously denied – that it was seeking to exit quietly from the Saudi market.
Such speculation may be premature, despite other indicators that Citibank’s appetite for Gulf risk is waning. Samba also allowed its technical management agreement with Citigroup to expire last year, resulting in the withdrawal of senior Citigroup staff from Samba. Yet the share sell-down is not unprecedented: Citibank’s stake has been reduced twice in the past – once in late 1991 (when it sold a 10% stake) and then in 1999 following the merger with United Saudi Bank. Samba and other banks regard the capital market law as having the potential to unlock new income streams, with the development of a Saudi bond market particularly sought after. A hasty exit would mean forgoing this line of business.
No easy acquisitions
Foreign players looking for an easy acquisition to get into the market are likely to be disappointed. The five joint venture banks’ holdings are not set in stone but appear to be unlikely targets for foreign takeover. That leaves the five remaining local banks as potential purchases. However, the big trio of NCB – with an IPO in the pipeline – Riyad Bank and Al-Rajhi Banking & Investment Corporation are not up for sale, and Bank al-Jazira and Saudi Investment Bank may be too small.
Before anybody gets that far, though, the authorities must first get the capital market law implemented and the new regulatory authority up and running. The failure to hit its own self-imposed deadline of February 26 – 180 days after the law was published in the official gazette – is a frustration for many in the financial services sector. “They may surprise us by announcing the regulation as well as the commission, but judging by the delay in implementing the insurance law it could still take more time,” says Dr Hassounah.
