JULY 2000, pages 72, 113

Trade and Finance

Saudi Arabia: Major Change in Investment Climate

By Colin MacKinnon

Keep your fingers crossed, but it looks as if Saudi Arabia is abandoning almost 70 years of restrictive, even unfriendly policy toward foreign investment.

In May the Umm al-Qura (the Saudi official gazette, which corresponds roughly to the American Federal Register) published a long-awaited new Investment Regulation, which, if implemented fully, would drastically change how business is done in the Kingdom.

An attorney at Bryan Cave, a Saint Louis-based law firm with a strong presence in the GCC states, calls the new regulation “potentially one of the most significant changes in Saudi Arabian law and practice in the last 20 years.”

According to an analysis done by Baker & McKenzie, a large Chicago law firm which has offices in Riyadh, the new regulation is “an encouraging step in the right direction.” A new investment authority the regulation creates may, say Baker & McKenzie, “take the lead and serve as a real catalyst for change.”

Could be. On the face of it, the new regulation introduces a host of important changes in Saudi investment law. Foreign firms, even those with no Saudi partners, will now be eligible for government financing (from the Saudi Industrial Development Fund). They will be able to own real estate if doing so will support their projects. They will apparently no longer need Saudi sponsors. And though it’s not in the text of the regulation, Saudi newspapers are reporting that yet-to-be-issued implementing regs will cut the taxes that foreign firms pay from a top rate of 45 percent to 30 percent. All this, if it occurs, will be a huge step away from past practice.

Further, the regulation creates an important new investment body, the General Investment Authority. Prefixed by SA—for Saudi Arabia—the new body’s English acronym is SAGIA, which in Arabic means “brook” or “stream,” a felicitous connection its coiners intended.

SAGIA will license new ventures, issue implementing regulations for the law (these will spell out the details of how the law is to be administered and interpreted), do strategic planning for foreign investment, and evaluate performance of the law and the companies operating under it. The new body is also supposed to become a kind of “one-stop shop” for investors, something Saudi Arabia has never had. Currently companies have to run a long gamut of required steps to open offices in the Kingdom.

When SAGIA gets an application for a foreign investment license, it will have 30 days to approve or reject it. If SAGIA rejects a proposal, it will have to say why it did and a rejected investor will have the right to appeal.

Oil revenues, even in the current flush period, are simply not enough anymore.

The new Authority will be headed by Prince Abdullah bin Faisal bin Turki, a nephew of the head of state, King Fahd. Prince Abdullah once chaired the Royal Commission for Jubail and Yanbu, supervising the creation and operation of the massive petrochemical and other projects at those two Saudi industrial cities at the Red Sea and Arabian Gulf terminals of the trans-Arabian pipeline. He is considered a liberal on foreign investment.

The new regulation is an admission that oil revenues, even in the current flush period, are simply not enough anymore.

Demographics are the reason. The Saudi population is now just over 22 million persons, almost 48 percent of whom are under the age of 18. This young age cohort is a ticking bomb, and the government is well aware of that fact. The strain they are putting on Saudi budgets for education, health care, and basic services is severe now. It will get worse in the future.

And for all the increased revenues that have flowed into the country since the middle of last year, the economy is not doing well. Unemployment runs to between 20 and 30 percent in the Kingdom’s larger cities. In 1984, when Saudi Arabia was flying high economically, per capita income was $11,450. By 1998 that figure had fallen to $9,000. In 1982 the Kingdom had a foreign exchange surplus of $140 billion. Now it owes close to $130 billion to foreign creditors.

The International Monetary Fund, in its latest World Economic Outlook published in April, predicts a growth rate for the Kingdom of just 2.2 percent this year, even with oil prices firm. The IMF sees even less growth next year, perhaps 2 percent. (In 1999 the economy contracted 2.3 percent.)

The Current Account

The IMF thinks Saudi Arabia’s current account, basically the trade balance in goods and services, will be in the black this year, for the first time in nearly two decades, at $8 billion, or five percent or so of GDP. But next year, says the IMF, the current account balance will go back into the red. Unless new sources of revenue are found, the current account will probably stay more or less in the red into the indefinite future.

Two-percent growth, if that’s all the Kingdom can manage, is pretty anemic. And with Saudi Arabia’s population growing at a rate of 3.4 percent a year. Two percent growth means the per capita income of Saudi nationals will actually decline 1.4 percent this year. Not good.

Very little private Saudi capital, by the way, goes into local investment. Much flows abroad. According to the U.S. Embassy in Riyadh, Saudi private capital overseas now totals $600 to $700 billion. And every year foreign workers send $16 billion in remittances home, a perpetual drain on the economy.

Hence the need to encourage foreigners to bring their money in and invest it in job-creating projects.

Lawyers, as is their wont, remain cautious. Attorneys in Riyadh point out that the details, most importantly those covering taxes, aren’t out and that companies will have to have a close look at them before starting up projects under the new regulation. And they note also that the regulation states that certain areas will be closed to foreign investment. These areas have still not been spelled out formally either.

Speaking to the London daily Financial Times, SAGIA head Prince Abdullah ruled out investments in banking and financial services, retail trade and distribution, the crude oil industry (though downstream projects will be okayed), and said a foreign presence in the areas around Mecca and Medina will be off-limits. Dealing in real estate will not be permitted. Whatever the final list turns out to be, the government seems to be emphasizing manufacturing.

The Kingdom also wants to enter the World Trade Organization. To do that it will have to make even more changes in its business regime. In particular, foreign and Saudi investors will have to be treated on an equal footing, something the new regulation still does not do. Further legislation will have to address inequities in the tax code, for example. And WTO rules won’t allow any extensive list of areas in which foreigners may or may not invest.

But the Kingdom will have to change. The British bank Standard Chartered, which is active in emerging markets, in a study of the Saudi economy released in May, says, “With the GCC states already offering more liberal regimes and Iran also starting to open up to outside investment, competition for foreign investment is rising in the region.”

So it is. The new regulation, despite its hesitant and incomplete nature, looks like a step forward toward meeting that competition.

Colin MacKinnon is contributing editor to the Washington-based Middle East Executive Reports.