The pandemic has prompted measures that threaten to undermine the crown prince's ambitious economic transformation plans, writes Yigal Chazan
A foreign investment recovery in Saudi Arabia following recent confidence-sapping reputational crises may be put at risk by Riyadh's attempts to cushion the dire financial impact of the coronavirus with unprecedented austerity measures, including tax hikes and cuts to a flagship domestic economic programme.
With plunging oil prices slashing revenues, the kingdom is tripling VAT and suspending a cost of living allowance for state employees, which will very likely hit consumer demand in a country long accustomed to generous state subsidies.
FDI is critical to efforts by the country’s leader, Crown Prince Mohammed bin Salman, better known as MbS, to pursue his multi-billion dollar Vision 2030 plan, which envisages the private sector playing a much bigger role in the kingdom."
These measures, coupled with an $8bn cut to the country's Vision 2030 economic reform programme, might put a break on foreign direct investment in the private sector just as investor sentiment recovers from the fallout of the extra-judicial killing of the Saudi journalist Jamal Khashoggi in late 2018.
FDI is critical to efforts by the country's de facto leader the crown prince, Mohammed bin Salman (known as MbS), to pursue his multi-billion dollar Vision 2030 plan, which envisages the private sector playing a much bigger role in the kingdom, in an effort to diversify the oil-based, state-dominated economy.
In the immediate aftermath of the Khashoggi killing, a number of western politicians and business executives, including top bankers, boycotted Saudi Arabia's premier investor conference, the so-called Davos in the desert, amid mounting nervousness over the reputational cost of engagement with the kingdom, whose headstrong, unpredictable leader had come under increasing scrutiny.
Just a year earlier investors were shaken by the round-up of hundreds of Saudi businessmen, officials and princes in a much-criticised, anti-corruption campaign, the detainees released after agreeing to settlements, amounting to over $100bn in total. The purge, which raised serious questions over the rule of law, coincided with an economic contraction, the first for nearly two decades, and FDI levels hitting a 14-year low, $1.4bn, mainly due to the fall in oil prices since 2014 when the crude market plunged.
In the wake of the Khashoggi affair which damaged MbS's emerging reputation as a modernising, albeit authoritarian, ruler, the Crown Prince introduced sweeping business reforms seemingly aimed squarely at reviving investor confidence in his administration.
The reforms eased the process of starting a business, getting construction permits, acquiring credit, protecting minority investors, importing and exporting, enforcing contracts and resolving insolvency. At the same time, a number of sectors were opened up to full foreign ownership.
In its latest Doing Business report, the World Bank ranked Saudi Arabia amongst the top ten business climate improvers, moving 30 places to 62nd spot in 2019. The healthier investment environment saw the creation of 1,131 foreign companies, a 54% increase on 2018, the biggest rise in ten years. Of the investment licences issued last year, 69% were for full foreign ownership, the remainder for joint-venture partnerships with local investors.
This despite investor disincentives such as costly fees for employing foreign workers and restrictions on the employment of expats in certain sectors, so-called Saudisation.
Overall FDI for 2019 was estimated at $4.6bn, a 9% increase on the year before and that upward trend has continued into 2020, with 1Q seeing the strongest period of investor interest in ten years. Nearly 350 international companies were granted investment licences, 19% up on the same period the year before, although growth slowed in March as the impact of covid-19 began to be felt.
The oil price crash, accelerated by the kingdom's price war with Russia, coupled with lockdown have heaped unprecedented pressure on government finances. The first quarter witnessed a budget deficit of $9bn - the same period last year registered a $7.4bn surplus.
The kingdom has already drawn on massive foreign reserves - their preservation key to supporting the riyal-dollar peg - with the some $40bn transferred to its sovereign wealth fund, the Public Investment Fund (PIF), to snap up stakes in foreign assets amid the market turmoil. The strategy appears aimed at generating returns over time, with borrowing and austerity measures currently the main means to shore up finances.
However, the tripling of VAT to 15% and cuts to living allowances could harm the very sector of the economy that MbS is trying to promote, private business, even as it receives substantial support from the multi-billion coronavirus stimulus package. The austerity measures, on the back of the pandemic-related squeeze on household incomes, look set to hit consumption and competitiveness.
That together with cuts to Vision 2030 and a probable slowdown of associated economic reforms may prompt some investors to postpone investment decisions or even switch their attention to other Gulf countries. The UAE, in particular, seems well-placed to benefit, having recently identified a raft of businesses that can be fully foreign-owned under a new FDI law. Additionally, it has no plans to raise VAT.
The Saudi authorities have been keen to reduce citizens' dependence on subsidies as part of their Vision 2030 reform plans, but it has proved to be a difficult task because of a social contract offering welfare in exchange for loyalty and obedience. The pandemic has provided MbS with a strong argument for rowing back on state generosity, but in doing so he risks losing investment so crucial to his economic ambitions.
Yigal Chazan is head of content at Alaco, a London-based business intelligence consultancy
Rising incomes in Asia will probably be the most important investment story of the 2020s. Asia is home to 60% of the world's population, with both China and India each accounting for about 18% of the global total.