Investment in infrastructure projects, such as port expansion and economic cities, will provide trade opportunities and protect the Saudi economy from the global crisis, writes Lucy Fielder and Nicholas Noe.

Riyadh’s chosen route to steer the economy to safe harbour is to make sustained investments in vast infrastructure projects. Although the oil-price slump is expected to hit revenues hard, and a budget deficit is projected for the first time in seven years, Saudi Arabia, with its healthy reserves, is so far weathering the financial crisis better than most western economies.

Saudi Arabia will, nonetheless, be knocked by the crisis, economists say, with the slowing private sector expected to suffer and the main stock index taking a nose-dive. Despite some success in recent years in diversifying its economy, plummeting oil prices have affected the kingdom’s spending power.

Oil minister Ali al-Naimi said in a speech delivered on his behalf at the Asian Ministerial Energy Roundtable in Tokyo in late April that the kingdom’s drying liquidity was affecting funding for projects in emerging and developing economies, and would start to affect investment in energy.

“This impact on investment is of great concern, notably for energy-sector projects adversely affected by oil price volatility and lower demand for oil, when long-range commitments of adequate and timely investment flows are needed to ensure future supply,” he said.

Saudi Arabia, which has the world’s biggest oil reserves, is leading the Organisation of Petroleum Exporting Countries’ campaign to cut output by 4.2 million barrels a day from September levels to bolster prices.

“Saudi Arabia is not far from what’s happening in the rest of the world,” Saleh Al-Awaji, senior specialist for the government Saudi Fund for Development Agency, tells GTR. “The only exception is that the crisis struck here with a lesser magnitude due to the precautions and conservative measures being adopted by the banking regulator Sama.”

Export support
Ahmad Al-Ghannam, director of the Fund’s Saudi Export Programme, agrees, but says that the programme has witnessed strengthening demand. “One of the main results of the crisis is low demand for products globally,” he explains.

“But because the financial markets have become hesitant to provide financing to exporters, we’re seeing the opposite; we see an increase in demand for our services.” The fund, which provides credit and guarantees to Saudi exporters and importers of Saudi products, allocated SR2bn to that end last year.

The key products the state-run export programme was asked to facilitate include agricultural equipment such as pumps and irrigation systems. Al-Ghannam gives the example of SR100mn for Egypt’s Janaat agricultural company to import irrigation pumps and fertilisers from the kingdom. The fund facilitated a similar deal for Sudan.

Fabricated steel and petrochemical products were other main areas for the programme, which aims to diversify the Saudi economy and therefore is not involved in oil-related financing. Other deals over the past few years have involved the Saudi Basic Industries Corporation (Sabic), the Hadco agricultural development company and the Al-Zamil Holding Company.

New cities and ports

Following the oil boom and years of fiscal prudence, the Middle East’s biggest economy finds itself in a better position than most. And analysts expect a significant upturn in 2010.
Over 2008, public spending increased by 24.4%. Then in December 2008, the kingdom issued its largest-ever budget, announcing a capital expenditure increase of 36%, to make use of a record account surplus of US$150bn and several years of fiscal prudence, foreign asset accumulation and debt reduction.

That the country is expected to run into deficit demonstrates the sheer scale of these plans, which include four economic cities and a major ports expansion programme, as well as large transport, education and healthcare projects to promote long-term growth. Because the Saudi private sector relies on government spending, these projects will need to create a ‘trickle-down’ momentum of their own in 2009, observers say.

Riyadh is digging deep into its reserves to create a fiscal stimulus and has factored the low oil price into its expansionary plans, setting it, for budgeting purposes, at around US$40 a barrel for 2009.

Saudi finance minister Ibrahim al-Assaf told Saudi-owned pan-Arab newspaper Asharq al-Awsat in early April that project financing was crucial to reduce the impact of the crisis on the Saudi economy. “The governmental financial institutions are speeding up their loans to projects and the percentage of loans for projects by the General Investment Fund was raised from 30 to 40%,” he says.

“The one thing we are keen on is to continue with the investment programme as approved by the budget and if there is a need to take measures to ensure full implementation, then we are ready to do this.”

The four planned ambitious economic cities form the linchpin of the kingdom’s plans to diversify and boost the economy, as well as ease the pressures of the Gulf’s largest population on its overburdened and under-served main cities, Riyadh, Jeddah and Dammam. They are slated for completion by 2020 and the flagship megacity, the King Abdullah Economic City, is expected to welcome its first industrial tenant, Attiah Steel, in mid-2009. These cities are aimed at adding US$150bn to the gross domestic product and creating 1.3 million jobs.

All eight of Saudi Arabia’s ports, long criticised for inefficiency and levying high tolls compared to elsewhere in the Gulf, are also still scheduled for expansion in a drive to compete with other Gulf ports and attract trans-shipment as well as final destination traffic. In April 2009, DPW and Emaar EC signed a memorandum of understanding to build and operate a sprawling, US$28bn ‘port-city’ at King Abdullah Economic City. The port is to have a capacity of 20 million TEUs in 10 years time, making it the biggest on the Red Sea and among the world’s ten largest ports. Another new port in Ras Azzur in the eastern province is projected to cost US$586mn.

Jeddah Islamic port on the Red Sea, the country’s biggest and likely the most affected by the new ‘port-city’ to the north, should see over US$500mn in new investment throughout this year.

Illustrating that the development plans have buoyed the construction sector despite the global downturn, sales of cement rose by 15% in the first two months of 2009, according to figures compiled by HSBC Holding, reaching 5.6 million tonnes in January and February.

Contractors are also eyeing the housing market as a potential area for large growth, particularly at the low and middle-income end, with a fast-growing population pushing up demand.

Project hold-ups
Few analysts expect the larger government projects to be scaled down, but some hold-ups now seem inevitable.

Philip Patterson, senior research analyst at ABC International Bank, the London-based subsidiary of Bahrain’s Arab Banking Corporation, says such projects remained largely on track. “I don’t think it’s unreasonable to expect some degree of caution and maybe some re-phasing of some of these mega-projects. That seems to me entirely sensible,” he says “However, I think the government both has the ability in terms of its financial reserves and seemingly the will to keep the large part of these mega-projects on track.”

Given the strong government backing and still formidable resources, these projects continue to provide major opportunities for international exporting, engineering and construction companies, he adds. Each city has substantial infrastructural requirements in water, wastewater, power and telecommunications, to name but a few areas. While the hydrocarbons and related fields remain key, this is an increasing focus for foreign economic involvement in Saudi Arabia, Patterson remarks.

“It’s still being seen as a very interesting place to do business, though that business perhaps tends to take the form of securing contracts relating to these economic cities more than direct investment in local companies and so on,” Patterson says. “I think a lot of trade flows will result from these projects.” [Saudi Arabia ranked 18th in the United Nations Conference on Trade and Development’s report on foreign direct investment flows last year.]

Imports to the kingdom grew by 12% in 2008 to reach SR610bn, according to SABB, the Saudi-British Bank, but the bank predicted some drop in demand over the coming year. Business confidence in the economy has dropped to just below 90 for the first time, the bank found, but the expansionary government programme will soon start to have a positive effect. “This spending has a delayed effect in the real economy, but we think it will become more widely felt in the months to come,” SABB said in its February report.

Of course, much of Saudi Arabia’s foreign investment centres on energy-intensive industries to make use of the cheap oil in the kingdom, which has a quarter of the world’s proven reserves. The government has announced that attracting investment to petrochemicals, aluminium, steel and fertilisers will be a focus for 2009.

Amr Al-Dabbagh, governor of Saudi Arabian General Investment Authority (Sagia), says earlier this year that the falling cost of building materials would help subsidise about 30-40% of the cost structure of the country’s mega-projects, making it more feasible to keep them on track. Saudi Aramco is already re-negotiating construction contracts signed when prices were high to reflect lower costs.

Digging deep
Many analysts are asking how even the resilient Saudi economy can steam ahead with such ambitious plans without some re-thinking. The kingdom is raising its 2009 expenditures to an expected SR475bn (US$126.7bn) while revenues are projected to fall to SR410bn (US$109.4bn). Indeed, a budget deficit is expected for the first time since 2002, which the Saudi American Bank (Samba) put at equivalent to almost 6% of GDP.

But for the moment, the outlook seems relatively rosy. Private sector investment has slowed considerably but public investment has compensated. New public sector contracts awarded between October 2008 and April 2009 amounted to over US$137bn, compared to US$62bn-worth of projects cancelled or put on hold. Fewer projects were put on hold in March and April than in January or February.

Non-oil exports hit a historic high in 2008, growing by 12%, with construction materials, agriculture and food production booming. But analysts do not expect that growth to be sustained in 2009, with constraints on credit as well as shrinking consumer confidence taking their toll.

In an April report, the Samba financial group said public investment growth appeared robust enough to offset private sector weakness. But private consumption had dropped, with point-of-sale transactions slowing, by value, to 13.5% in February, down from 39% in August, Samba says. Import demand had also dived, with the value of new letters of credit down by 40% in February from a year earlier. Taken together, the bank saw signs of a “sharp slowdown” in the non-oil economy, with a growth of just 2% in 2009.

Although Saudi banks are constrained by a mandatory 85% loan-deposit ratio and retain high liquidity, soaring corporate costs have pushed them towards growing risk-sensitivity and selectiveness, as can be seen elsewhere. That may push the government to further spending over-budget to meet its targets. The government is channeling most spending on infrastructure programmes through the banks to keep them afloat.

Ali Abdallah bin Shamlan, manager of trade finance at Riyad Bank, says the regional focus of the bank’s operations is crucial. “Most of the Middle Eastern countries are importing countries and so are still in need of our goods,” he says.  “So trade products have increased for us. The crisis has had an impact but it is not severe.”

With the slump predicted to be relatively short for Saudi Arabia, analysts say the challenges can be amply met, even if oil prices stay at the current low rate.

Patterson agrees. “Saudi is running a budget deficit for the first time in a few years because of a need to stimulate the economy, something fully consistent with its desire to continue with its public infrastructure projects, and that is entirely fundable from its amassed reserves,” he says.

“It has taken a conservative stance in how it uses and manages those reserves, so it hasn’t suffered valuation losses in the way, for example, that some other regional sovereign wealth funds are rumoured to have. Even at US$40-45 a barrel, the kingdom will ring up significant current account surpluses,” he says.

Export credit agencies (ECAs) have become an urgent need with the growing reluctance of commercial financiers, says Al-Awaji of the Saudi Fund for Development.

“The Saudi government, normally, does not interfere and leaves market forces to play liberally, but in the current tough times its intervention became necessary,” he says.
“Its support for exports was always there, but nowadays it is widely available and with competitive terms.” More than US$4bn is available this year in both finance and a credit insurance facility to Saudi non-oil exporters, Al-Awaji adds.

Nazeem Noordali, acting general manager of marketing for the Islamic Trade Finance Corporation (ITFC), says the global downturn highlighted the need to develop Islamic financial and banking models. Trade assets are among the safest securities in the market, he says, despite the expected drop in demand for exports. However, the corporation has had to put a brake on its operations.

“ITFC has adopted a prudent strategy, particularly during the last quarter of 2008 and beginning of 2009, to slow down its current level of business, whilst closely monitoring its existing portfolio until visibility in the market improves,” he comments.

“Of particular importance is the structuring of the deals in the best possible way by emphasising on moving away from the ‘plain vanilla’ to structured deals, which are engineered in a way to mitigate all possible credit and operational risks.”

Despite the relative liquidity of Saudi banks, Shamlan says Riyad Bank is having to tighten its financing criteria, in line with other private financing institutions.

Opportunities abroad
But with the economy on a stronger footing than most, Al-Ghannam of the Saudi Export Programme says many Saudi traders are seeing opportunities as well as concerns in the tough climate. “Some companies are using this crisis and have found opportunities, especially in Africa,” he says.

“Personally, I’m very optimistic, particularly for investment abroad.” Saudi investors and financers are looking to such areas, aiming to fill the gap left by increasingly inward-looking western financial institutions.

Noordali agrees, citing the Côte D’Ivoire ITFC supply chain trade finance syndication as an example. The €23mn murabaha-based financing deal revived the West African country’s cotton production after a destructive conflict, and employed 150,000 cotton farmers.

Oil, as always, remains the mainstay of the Saudi economy, accounting for nearly 90% of revenues. The big question in the coming period will be the extent and duration of production cuts to buoy prices. Many analysts say the second half of 2009 will be the tell-tale turning point.

So far, Noordali says, low oil prices have softened the blow on the hydrocarbons sector, preventing demand from falling away.

But should prices fail to rally, and further production cuts become necessary, Riyadh will certainly feel the strain – raising doubts as to how long, exactly, the kingdom can sustain its effort to buck the global downturn.