Saudi Arabia well placed to take advantage of its trade and investment strengths

The question of Saudi Arabia’s economic relationships with global markets has become a prominent one in 2016. Historically, the Kingdom has benefitted greatly from its ability to ship its hydrocarbons resources to consumers across the world, while its strong economic growth over recent decades has meant that it has also become a significant importer of goods and services. Meanwhile, the country’s transport links, large consumer market and a relatively high per capita income combine to make it an attractive destination for investment capital.

However, recent years have revealed a range of challenges facing the future growth of trade and investment: levels of foreign direct investment (FDI) declined for seven consecutive years until 2015, and the fall in oil prices that began in the second half of 2014 has resulted in the disappearance of the once comfortably positive trade balance. It is not surprising, therefore, that both trade and investment are treated as key priorities in the Vision 2030 strategy, which is the blueprint for the economic development of Saudi Arabia published in April 2016. With the government’s eye on these important facets of economic life, the coming months and years are likely to bring some interesting developments with regards to the Kingdom’s global connections.

Trading Activity

Foreign trade plays an important role in Saudi Arabia’s economy, with merchandise trade as a proportion of GDP reaching 68.6% in 2014, according to the World Bank’s most recent data. This compares favourably to other economies of similar size, such as Turkey (50.1%), Indonesia (39.9%) and Argentina (25.5%). The nation’s oil wealth has played a large part in this phenomenon.

According to the 2016 “BP Statistical Review of World Energy”, Saudi Arabia’s oil reserves of 267bn barrels represent 15.7% of the global total and have enabled the country to establish itself as the second-largest oil producer in the world, behind only the US. This resource underpins the Kingdom’s exporting activity and has allowed it to rank consistently in the top-20 list of global exporters over recent decades, claiming 17th place out of 50 economies in the “International Trade Statistics 2015” report produced by the World Trade Organisation (WTO).

Branching Out

However, Saudi Arabia’s oil exports form only part of an increasingly diverse range of hydrocarbons activities that further support the nation’s growth as a trading nation. These include natural gas production, refining activity and petrochemicals production, which are now playing a larger part in the energy sector mix. The nation’s vibrant energy arena is dominated by Saudi Aramco, which over the past 80 years has established itself as a global giant in hydrocarbons exploration, refining, distribution and shipping, and is the single-largest oil company in the world in terms of production levels.

The readily extractable nature of the Kingdom’s oil has helped Saudi Aramco to establish a reputation for production stability. The Ministry of Energy, Industry and Mineral Resources (MEIMR) has stated that oilfields in Saudi Arabia have decline rates of no more than 2% per year, and Saudi Aramco maintains that, unlike elsewhere in the region, its fields do not require enhanced oil recovery techniques.

Therefore, rather than seek significant production increases, the company’s long-term strategy is to develop its lighter crude oil potential while maintaining current levels of production by offsetting declines in mature fields with output from newer fields. Saudi Aramco is also investing heavily in its refining capacity. In June 2015 the Yanbu Aramco Sinopec Refining Company, also known as YASREF, a joint venture between Saudi Aramco and the China Petrochemical Corporation, announced that its new facility had reached its full capacity of 400,000 barrels per day (bpd) of Arabian Heavy crude. Elsewhere across the vast network of the Kingdom’s refining infrastructure Saudi Aramco is putting in place yet more capacity, most notably with the development of the 400,000-bpd Jazan Refinery project in the south-west of the country, due to come on-line in late 2016, and the planned expansion of the Petro Rabigh refinery, which is located north of Jeddah and currently has a capacity of some 400,000 bpd.

Non-Oil Growth

Despite the aims of Vision 2030, in the near term hydrocarbons exports will be a central part of trading activity. One of the more interesting trade trends of recent years is the relative increase of non-oil exports from Saudi Arabia as a percentage of total trading activity. In 2011 nonoil exports accounted for 12.5% of total exports of goods and services, according to data from the General Authority for Statistics (GaStat). By 2014 the share of non-oil exports had increased to 16.9% of the total, and by 2015 its contribution had soared to 24.9% – although this precipitous rise was largely the result of declining oil prices throughout 2015 that undercut the value of the Kingdom’s most valuable export. The value of oil exports fell by some 44% between 2014 and 2015, to SR592.4bn ($157.9bn).

However, whatever the future trajectory of spot prices in the oil market, the determination of Saudi Arabia to diversify its economic activity means that its non-oil exports are likely to continue to account for an increasing share of the total over the coming years. The chemical sector represents a useful starting point for government planners seeking to broaden the range of products leaving the Kingdom. In 2015 some SR58.82bn ($15.7bn) worth of chemical goods passed through the ports of Saudi Arabia, according to the GaStat’s most recent data, accounting for 7.17% of the export total. This value was nearly matched by the flow of plastic products from the Kingdom, which comprised 7.57% of total exports for the year, reaching SR57.86bn ($15.4bn).

Exports & Imports

Other sectors in which Saudi Arabia has a useful level of export activity include base metals, prepared foodstuffs and beverages, live animals and animal products, machinery and electrical equipment, textiles, and articles of stone, plaster, cement, asbestos, mica ceramics and glassware.

Looking to imports, the domestic demand for sophisticated hardware means the machinery and mechanical appliances and electrical equipment category represented the largest group of imported goods in 2015, accounting for 27.22% of the total. Similar levels of demand for personal transport, construction machinery and new mass transit options have established the transport equipment and parts category as the second-largest group of imports, accounting for some 18.4% of the total. This was followed by base metals at 9.84%, and chemicals and allied industries with 8.4% of the total.

Markets

The variety of markets to which Saudi Arabia both exports to and imports from reflects the nation’s integration with the global economy, a status that was cemented by its accession to the WTO in December 2005. In terms of exports, the largest single destination for products leaving the Kingdom is China, accounting for 12.06% of Saudi Arabia’s exports in 2015, according to the latest figures from GaStat. In the same year the Kingdom exported SR89bn ($23.7bn) worth of products to the EU, which made up 11.66% of total exports.

Japan was the third-largest export market for Saudi Arabia in 2015, with SR80.68bn ($21.5bn) in exports (10.57% of total exports), making Asia (excluding Arab and Muslim countries) the largest destination for exports by geographic group. Saudi Arabia also enjoys a long and fruitful trade partnership with the US, which received SR80.53bn ($21.47bn) worth of products from Saudi Arabia in 2015, making up 10.55% of total exports. These export destinations are followed by India (9.44%), South Korea (8.66%) and neighbouring UAE (5.26%). On the import side, Saudi Arabia sources the bulk of the consumer goods needed to meet the demands of the its local market from the EU, with SR168.48bn ($44.9bn) or 25.72% of total imports, followed by China (SR92.4bn, $24.6bn, and 14.1%), the US (SR89.68bn, $23.9bn, and 13.7%) and Germany (SR46.12bn, $12.3bn, and 7%).

Trade Agreements

Saudi Arabia’s favourable location on traditional trade routes between the East and West combines with the global demand for energy products to ensure that the Kingdom’s products are directed to a wide array of markets. In recent decades, the international framework of trade agreements has also helped to shape the Kingdom’s trading portfolio. As part of the GCC, Saudi Arabia enjoys the benefits of the 2002 economic agreement signed between the nations of the GCC, while its membership in the Greater Arab Free Trade Area provides the Kingdom with privileged access to markets in 17 states in the MENA region.

Saudi Arabia is also a leading member of the GCC free trade agreement (FTA) negotiating team and it is at the forefront of talks to establish free trade zones with a number of significant markets, such as the EU, Japan, China, India and the South American Mercosur bloc, which includes Brazil, Argentina, Uruguay, Paraguay and Venezuela. In January 2015 the FTA between Singapore and the GCC was finally implemented after nearly a decade of negotiation. The new agreement removes tariffs on 93.9% of Singaporean goods imported to the GCC, with a further 2.7% to be eligible for zero tariffs by 2018. In return, all GCC exports to Singapore are granted zero-tariff status. The FTA also established a lower value-added content threshold for Singaporean manufacturers so that they may qualify for preferential market access, as well as a commitment from the UAE, Kuwait, Oman and Qatar to recognise Singapore’s Muis Halal Standards and Halal Mark.

Full Speed Ahead

Further FTAs in the pipeline include the final implementation of an agreement with the European Free Trade Association (EFTA), comprising Norway, Iceland, Liechtenstein and Switzerland. A deal had been under consideration since the 1990s and by 2000 the two blocs had signed a declaration of cooperation.

Progress on ratifying the final deal was slow, with the EFTA-GCC FTA finally inked in June 2015. The deal encompasses a wide range of areas, including trade in goods and services, government procurement and competition. In addition, the agreement also establishes an EFTA-GCC Joint Committee, which met for the first time in January 2015 and in the future will supervise application of the FTA. Other important components include a provision for dispute settlement through arbitration and a number of bilateral arrangements on agricultural products between three individual EFTA states and the GCC.

Saudi Arabia also stands to benefit from the GCC’s focus on markets to the east. In June 2015 Mustapa Mohamed, Malaysia’s minister for international trade and industry, announced that negotiations between his country and the Gulf states would shortly resume, rekindling a process that was first set in motion in 2011. Momentum is also returning to the long-running issue of a trade agreement with Australia. Discussions aimed at establishing a GCC-Australia FTA came to a halt in 2009, but a visit to the region in 2015 by Andrew Robb, Australia’s then minister for trade and investment, has raised the possibility of a renewed effort. New Zealand has also expressed interest in revisiting a potential FTA with the GCC. With negotiations started in 2007 and concluded in 2009, the potential NZ-GCC FTA has since been waiting for legal and technical verification before signature and ratification. Throughout 2015 Tim Groser, the country’s then minister of trade, made numerous indications that New Zealand would be refocusing attention on finalising the deal; however, as of mid-2016 ratification had not yet been completed.

Trade Infrastructure

The evolution of the infrastructure underpinning Saudi Arabia’s trading activity promises to be one of more interesting economic stories emanating from the nation over the coming years. One of the key strategic pillars delineated in Vision 2030 is the transformation of the Kingdom’s “unique strategic location into a global hub connecting three continents, Asia, Europe and Africa.” According to the strategy, the government plans to engage the private sector, both domestic and international, to help it improve internal transport capacity and cross-border links.

This process will involve unlocking the hard infrastructure – ports, airports and road networks – through improved soft systems that can catalyse higher performance, including better regulatory oversight, more streamlined processes and a more efficient Customs system. Under the country’s National Transformation Programme (NTP), the Ministry of Transport has set its sights on having comprehensive public transportation plans in development for 16 cities by 2020 (see Transport chapter).

Given its existing trading infrastructure, Saudi Arabia sets about this process from a strong base. Despite the country’s size and the wide distribution of its population centres, the Kingdom’s hauliers are well served by an extensive road network which, thanks to consistent government investment, expanded at a rate of more than 11% per year in the two decades leading up to 2011, according to investment bank Kuwait Financial Centre.

The well-developed road network is currently being augmented by new inter-city rail connections. The Haramain High-Speed Rail Project, which will connect the cities of Makkah and Medina via Jeddah and King Abdullah Economic City in Rabigh, is expected to be fully operational by 2017.

This rail line along the western coast is set to be connected to Riyadh by the ambitious Saudi Landbridge project, which will see 950 km of double track laid across the desert from the Port of Jeddah to Riyadh. From there, goods can be transported onwards to the coastal city of Dammam using the already existing rail network, or, when the 2400-km North-South Railway project is fully implemented, be moved as far north as the Jordanian border, where a new international link will be created.

International Centre

Existing global connections are already in place in the form of the Kingdom’s extensive port infrastructure. Jeddah Islamic Port is the country’s largest container port with a current capacity of around 5m twenty-foot equivalent units (TEUs) per year, while the Gulf coast is principally served by the King Abdulaziz Port in Dammam, the nation’s second-largest port facility. The maritime infrastructure is further augmented by industrial and commercial ports at Yanbu and Jubail, as well as facilities at Jazan, Dhiba and Ras Al Khair. Located in King Abdullah Economic City, King Abdullah Port is the Kingdom’s newest facility, and saw 6000 vessels pass through carrying over 42m TEUs during 2014.

Air freight, meanwhile, enters and leaves the country through the Kingdom’s four international airports, which are also the recipients of large-scale investment. Saudi Arabia’s two largest airports, King Abdulaziz International Airport in Jeddah and King Khaled International Airport in Riyadh, are both undergoing expansion which will raise capacity by over 30m passengers per year. With more investment to come, according to the Vision 2030 strategy, the growing pipeline of road, rail, maritime and aviation developments will provide a crucial platform in the Kingdom’s efforts to boost its trading flows, as well as be part of a new privatisation strategy.

The NTP has also set the goal of achieving private sector contribution of 5% in regards to the construction and operation of rail and road projects, as well as 30% private sector contribution to the operation of port projects and programmes. In addition, the NTP has identified the completion of the commercialisation programme at the Saudi Port Authority as a strategic aim for the next five years.

Foreign Investment

The extensive transport infrastructure and range of international agreements that have helped to drive the growth of Saudi Arabia’s trading activity are also two of the key factors underpinning the country’s attractiveness as a destination for FDI. Other powerful draws for foreign capital include the Kingdom’s political stability, derived from the continuous rule of the House of Saud since the nation’s foundation in 1932; a diplomatic policy that has led to strong relations with countries that host large pools of potential investor capital, such as the US, Europe and, more recently, the emerging markets of the East; and a robust economy that has garnered strong credit ratings even during an era of depressed oil prices.

These factors are reflected in ratings by international agencies. In the first quarter of 2016 the Kingdom had a credit rating of “A-” from Standard & Poor’s, “AA-” from Fitch and “Aa3” from Moody’s. The NTP has set an objective of sustainability in terms of public debt and aiming for a credit rating of “Aa2” by 2020, as well as government debt equal to 30% of GDP, up from a baseline of 7.7% at the NTP’s outset.

Perhaps the biggest factors with regards to attracting foreign investment, however, are the size of the domestic market and the low cost of inputs. Saudi Arabia is the largest market economy in the MENA region, accounting for 38% of the region’s GDP, according to the Saudi Arabian General Investment Authority (SAGIA), the government body charged with overseeing investment in the Kingdom.

Though there was a reduction in late 2015, a generous framework of subsidies allows investors in the country to benefit from electricity rates for projects that are among the lowest in the world. In addition, specific sectors offer investors an expedited route to profit through other low-cost inputs: for example, investors in the petrochemicals sector receive competitive, fixed rates on natural gas feedstock which enable them to maintain healthy margins; telecoms companies benefit from relatively preferential treatment in terms of tariffs; and operators in the cement industry have access to clinker at subsidised prices.

Competitive advantages such as these ensure the Kingdom remains an interesting market whatever the global economic weather. “We had a Saudi delegation go to Washington D.C. in September 2015 for the Saudi Arabian Investment Conference on the Labour Day weekend, and the event was still able to attract more than 600 US companies,” Douglas Wallace, counsellor for commercial affairs at the US Embassy in Riyadh, told OBG.

Government Incentives

The government has sought to establish a level playing field for foreign investors by granting those projects which satisfy the Foreign Investment Law the same privileges as domestic capital, which include exemption from Customs duties on machinery and equipment, the ability for licensed companies to own property directly and the absence of a minimum capital requirement for limited liability companies. Furthermore, the Kingdom allows for 100% foreign ownership in selected sectors, and there are no restrictions on the transfer of capital or profits out of the country – a process facilitated by the Saudi riyal’s stable peg to the dollar.

While Saudi Arabia has not established duty-free zones or free ports like some other GCC jurisdictions, the government has established industrial sites attractive to FDI in Riyadh, Jeddah, Dammam, Qassim, Al Ahsa and Makkah, where subsidised utilities are provided to projects. In some cases, the government offers investment aid to foreign investors entering into partnership with local companies, the provision of which is overseen by the relevant department, such as the MEIMR or the Ministry of Finance, and is centrally coordinated by SAGIA.

The creation of a more favourable investment environment has been the central concern of SAGIA since its foundation in 2000, and its Investment Services Centre remains the first point of contact for investors seeking a licence to operate in the country, as well as a useful facilitator in the process of obtaining the necessary permissions from the relevant ministries and government departments.

Legal Changes

Both new and existing investors are also likely to benefit from some recent changes made by the government to the legislative framework in which they operate. In May 2016 the new Companies Law was finally implemented after years of discussion and consultation, replacing legislation that had been in place since 1965. The new law has been welcomed as a useful evolution rather than a radical overhaul, and its net effect will not be known until it has been fully applied by relevant agencies such as SAGIA, a process that may involve a further array of implementing regulations.

However, domestic law firms have already highlighted its potential advantages, such as provisions for single-shareholder limited liability companies, the ability to compartmentalise assets of a group, an easing of the strictures relating to structured finance and more detailed legislation that provides a greater degree of clarity for global investors. Don Babai, lecturer and research associate at the Centre for Middle Eastern Studies at Harvard University, told OBG, “The significance of the new law is that it brings Saudi Arabia closer to international standards. By relaxing some of the regulations it might even move the country up a notch or two in the World Bank’s ease of doing business rankings.”

Reversing The Trend

Despite the incentives inherent to the Saudi economy and provided by the government, FDI in recent years has generally been on the decline. FDI flows to the Kingdom peaked in 2008 at $36.5bn, but showed a steady downward trend until 2015 when a 1.6% increase was recorded. Similarly, data from the UN Conference on Trade and Development shows that the number of greenfield investments undertaken by foreign investors in Saudi Arabia has been declining in recent years, from 139 in 2012 to 87 in 2014.

While similar patterns of FDI retrenchment have been observed across emerging markets in the wake of the global liquidity crunch of 2008, the lack of a discernible recovery in FDI flows has caught the attention of the government. According to the Vision 2030 strategy, Saudi Arabia intends to increase FDI from its current level of 3.8% of GDP to an “international level” of 5.7% by pursuing a broad variety of development goals. Under the NTP, SAGIA also set the target of increasing FDI from SR30bn ($8bn) to SR70bn ($18.7bn) by 2020.

As part of the Kingdom’s efforts to achieve these targets, the country aims to increase the skillset of the domestic workforce, as well as improve institutional connections – be they business-to-business relationships or through supranational frameworks such as the GCC (see analysis).

Challenges

A number of challenges to both trade and investment are likely to claim the attention of the government over the coming years as it sets about turning the ambitions of the Vision 2030 strategy into reality. On the trade side, the most recent global trade report from the World Economic Forum (WEF) found that Saudi Arabia scored well in terms of the operating environment it provides for importers and exporters and the existence of good transport infrastructure, particularly with regard to its air and maritime connections.

The nation’s simple tariff regime and the provision of government e-services also drew praise from the WEF. Room for improvement was found, however, in the area of border administration, where the country scored poorly for the efficiency and predictability of clearance processes. The WEF also noted that the World Bank recorded an increase in costs associated with the clearance process over recent years.

Looking to investment, the World Bank’s ease of doing business index for 2016 showed Saudi Arabia performing well in the important areas of ease of paying taxes, where it ranked third out of 189 nations, dealing with construction permits (17th), obtaining electricity (24th) and registering property (31st). However, despite the nation’s well-capitalised and soundly regulated banking system, the Kingdom achieved a moderate ranking for availability of credit (79th). Protection of minority investors (99th) and contract enforcement (86th) were also shown to be areas where the government might seek improvements, while the absence of a bankruptcy law gave the Kingdom the lowest ranking of 189th on the question of resolving insolvency.

Business-minded legal reform is in the works, with and the Ministry of Justice take steps towards the necessary reforms. The NTP lays out several goals in this regard, though many of the performance indicators are still being calculated. Strategic objectives include enhancing efficiency through e-services, reducing the flow of lawsuits to courts, and improving the ranking of judicial system internationally.

Subdued oil prices since mid-2014 have also played a large part in the more recent emergence of a potential block to investment. In October 2015 Bloomberg noted that companies working on infrastructure projects reported delays in payment from the government. While payment delays of this kind are not unusual in the domestic market, a sustained stoppage runs the risk of undermining investor confidence with regard to the Kingdom. However, this issue is expected to be resolved soon, with Deputy Crown Prince Mohammed bin Salman Al Saud telling Bloomberg in April 2016 that the decision to delay payments was aimed at “trying to avoid a big danger” after official inquiries led to the discovery that ministries and government bodies had been authorised to release more than $1trn based on “decrees over the last few years”. About 70% of the government’s arrears had been paid as of April 2016, and in September 2016 the Kingdom’s biggest construction firm, Saudi Binladin Group, said the government had resumed payments, securing the company’s future.

Employment

The WEF, meanwhile, highlighted the labour market as an area where efficiency might be increased, ranking Saudi Arabia 60th out of 140 countries. The workforce is an issue that will rise in importance given the growing number of young people who will enter the labour market over the next several years. While the government is understandably keen to address an unemployment rate of around 11.6%, since 2005 the process of Saudiisation, which aims for a 75% Saudi workforce, has led to recruitment challenges in some sectors. Connected with this is the issue of work and business visas for foreigners, which can be difficult to obtain.

Outlook

The government’s determination to boost trade and investment activity in the Kingdom means that these various challenges are likely to be addressed in the medium term.

In some areas, such as the labour market, recent steps taken by the authorities are already yielding dividends. A report released in late 2015 by Riyadh-based Jadwa Investment showed that thanks to increasing educational opportunities and private sector investment, both Saudiisation levels in the private sector and labour market productivity demonstrated positive growth in 2014.

Other challenges, such as delayed payments, are expected to be mitigated by clarity and renewed momentum provided by the rollout of the NTP. “Current efforts to diversify the economy away from oil and gas will also have a positive impact on attracting foreign investment and fostering joint ventures with overseas companies,” Andrea Benzo, head of the economic and commercial affairs section at the Italian embassy in Riyadh, told OBG.

A key issue for the medium term will be the government’s ability to effect the soft changes to the trading framework it outlined in its Vision 2030 document. Similarly, the most significant challenges facing FDI growth lie within the realm of legislation and regulation, and these areas are expected to come under particular scrutiny over the coming months. While still at the conceptual stage, the prospect of relaxed licensing, visa and taxation rules is bound to be of significant interest to foreign businesses.