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Saudi business feels ‘pain’ of the crown prince’s reforms

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Among a network of alleyways and cobbled streets in Jeddah’s old town more than 20 stores are firmly shuttered, “for rent” signs plastered on large wooden doors. Traders in adjacent shops, selling everything from abayas to mattresses, Chinese watches, perfumes and spices, lament plummeting sales, the exodus of more than 1.7m foreigners and rising costs driven by government policies.

Across town, a Saudi lawyer echoes the pessimistic tones — their office has been involved in the closure of more than 50 businesses over the past 18 months. “It’s mainly cash, it’s not the viability of the business, it’s [a shortage of revenue],” says the lawyer, who like many people interviewed asks not to be named for fear of falling foul of the regime. “[Closures have] gone up over the past year.”

Yet in a sand-blown industrial park on the other side of the Saudi Arabian city — where camel and sheep markets meet modern manufacturing — Sami al-Safran, chief executive of Mepco, one of the region’s biggest paper producers, is unwaveringly upbeat.

Like many Saudi companies, it has endured five years of lacklustre growth and government austerity measures. Mepco and its recycling subsidiary have laid off scores of staff to “mitigate the effect of the expatriate levies” and adjust to the shifting environment. But Mr Safran is looking at expanding its capacity as he weighs the impact of Crown Prince Mohammed bin Salman’s reforms that include the goal of increasing waste recycling, which should benefit the company.

“I see no direction but upwards,” he says. “There will be issues along the way, but this is the new reality. Change is coming and you have to be a part of it, it’s not an option any more.”

Such competing narratives have become normal in a nation experiencing dramatic change — steamrollered through — since Prince Mohammed launched his “Vision 2030” modernisation plan. Three years on, the country is still in flux and while some Saudis speak with hope and optimism, others whisper anxiously about their concerns — heightened by the grisly killing of Saudi writer Jamal Khashoggi last October.

These conflicting moods lie at the heart of one of Prince Mohammed’s biggest tests: can the de facto leader of the kingdom secure the buy-in of a bruised private sector to help reboot the economy and generate the jobs needed to reduce rampant youth unemployment?

From the outset, the 33-year-old’s plans emphasised the role of the private sector: Vision 2030’s targets included raising its contribution to gross domestic product from 40 per cent to 65 per cent. The government also set the goal of creating 450,000 non-government jobs by 2020, with the aim of reducing Saudi unemployment, currently 12.5 per cent, to 9 per cent next year.

Crown Prince Mohammed bin Salman’s leadership style can be brash and unpredictable © AFP

“None of this works without the private sector,” says one western executive.

It is Saudi companies that have borne the brunt of Prince Mohammed’s sweeping changes. Massive cuts in energy subsidies, as well as the introduction of VAT, have hit household spending. After the 2014 oil price slump, tens of billions of dollars of government contracts went unpaid. Large increases in tariffs on foreign workers — who filled about 90 per cent of private sector jobs — and their dependants sent costs soaring and profits plunging, triggering an expatriate exodus. The fall in consumer demand has led to deflation.

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“There are about 7,000 industrial firms in Saudi Arabia and many of them are losing money or barely making money,” says a foreign executive. Some are still reeling from Prince Mohammed’s ostensible anti-corruption drive, which saw more than 300 princes, businessmen and former state employees incarcerated at the Ritz-Carlton hotel in Riyadh in late 2017.

The result is that many in the private sector sat on their cash or looked offshore. Meanwhile, the newly empowered Public Investment Fund went in search of foreign deals and partners, while announcing projects, worth hundreds of billions of dollars at home, and the establishment of new companies.

It seemed that Prince Mohammed was bent on developing a new private sector using state tools, notably the PIF, and riding roughshod over traditional companies he viewed with disdain for having got rich on the back of state contracts and cheap foreign labour, people familiar with the royal court say.

Yet the calculation may have started to shift in the wake of Khashoggi’s killing in Istanbul. As many of the foreign investors who Prince Mohammed had sought to woo think twice about the political risks of investing in the world’s top oil exporter, the government is putting a new emphasis on courting Saudi firms, executives say. “They are respected now, before they were spat on,” says a foreign executive.

The royal court has even set up a WhatsApp group that includes Prince Mohammed, ministers, other senior officials and top industrial leaders to improve communications between those inside and outside the leadership.

“It was only natural for people, given the huge uncertainty and the lack of clarity,” says a senior Saudi banker, “to take a wait-and-see attitude. [But] in the last few months we have seen a significant change in sentiment.”

Jeddah, Saudi’s commercial capital, is home to many prominent merchant families © Bloomberg

Like other supporters of reform, he adds that “mistakes” are inevitable. It is a term that has become a euphemism to describe anything that could be deemed a negative, from the killing of Khashoggi to a diplomatic spat with Canada and the way the Ritz round-up was handled.

The government has been desperately trying to put the October killing of Khashoggi — which the CIA reportedly concluded was authorised by Prince Mohammed — behind it and turn attention back to economics. It was buoyed by massive demand for the $12bn debut bond issuance by Saudi Aramco in April, and officials insist the state oil company’s much-delayed listing will go ahead around 2021.

The kingdom continues to attract investment in traditional sectors, notably oil and petrochemicals. Ineos, a privately owned British group, said this month that it will spend $2bn building three chemicals plants in the country.

Top bankers have also shown a willingness to move on, lured by the promise of more multibillion dollar deals. Larry Fink, the chief executive of BlackRock, and John Flint, his HSBC counterpart, were among senior western bankers who shared a stage with Saudi ministers at a financial conference in Riyadh in April having joined others in boycotting PIF’s flagship investment conference after the Khashoggi murder.

But in other sectors that will be critical to the diversification effort, investors remain wary. “Lots of people want to invest, but are shamed,” says the foreign executive. “Everybody was waiting for how and when and where, then Khashoggi happened.”

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In their absence, Riyadh has become more dependent on local investors to support its plans, experts say.

Mohammed al-Jadaan, finance minister, insists it is all on track, saying there is an “incredible alignment between the government and the private sector”. Some companies still complain about non-payment, but Mr Jadaan says the government has settled arrears of SR160bn ($43bn) to companies over the past two years and only owes about SR9bn, some of which is disputed.

A man on a scooter rides past graffiti alluding to the crown prince’s Vision 2030 programme © Getty

He accepts that the reforms have brought “pain” but says “dynamic” companies are prospering. “When you go through . . . overwhelming reform of your economy there will be pain, and that has been very clearly communicated to the private sector,” he says. “They need to restructure their businesses to the new reality.”

The IMF last month said the economic reforms “have started to yield positive results”, citing an improvement in non-oil growth and increases in female labour force participation and employment. But progress is fragile and dependent on oil prices and government spending — despite the genesis of Vision 2030 being to reduce the role of the state and weaken the kingdom’s addiction to petrodollars.

Gross domestic product expanded by 3.6 per cent year on year in the last quarter of 2018, its fastest pace in three years, but that was largely driven by the oil sector, while the non-oil private sector GDP grew 1.96 per cent.

Overall, the economy expanded by 2.2 per cent last year following recession in 2017. The IMF forecasts it will slow slightly this year to 1.9 per cent, but says non-oil growth will rise to 2.9 per cent based partly on higher government spending. And yet, while it was aggressive over austerity, Riyadh has made little headway on other reforms such as a promised privatisation programme.

“Some of the companies . . . their unhappiness or resentment is not about the reform itself, but the pace of [fiscal] reform and the lag of economic reform,” a retired Saudi banker says. “How many public-private partnership projects? You can count them on your hands. How many privatisations have taken place? Almost none.”

Winners and losers are emerging from the upheaval. In the latter sits the Binladin Group, which was for years the rulers’ contractor of choice. It was hit by the downturn after the oil price fall, the crackdown saw its chairman detained in the Ritz and the government take a stake in the company. In contrast Nesma Holding, a conglomerate founded by Saleh al-Turki, who became mayor of Jeddah last year, has won a string of contracts from the government and state entities, say locals.

In Jeddah, the commercial capital that is home to many prominent merchant families, the contradictions that Prince Mohammed’s rule have brought are stark. A member of one wealthy family — who has had two relatives jailed in the crackdown — says its businesses are “doing very badly”, adding: “There is a lot of adjustments — real estate has been hit from many angles, the huge number of expatriates who left created a void. Then you have Riyadh sucking in all the high-calibre people.”

Saudi Aramco is the world’s most profitable company, generating $111bn of net income in 2018. High demand for its bond boosted Riyadh © Reuters

But he is still supportive of the reforms, believing the old economic model, the paternalistic role of state and the patronage that fostered, was unsustainable. “We were spoilt, we had a return of investment of 8-12 per cent, and when I invest in Europe it gives me 3-5 per cent, now investments in Saudi give me 5-7 per cent. It’s just becoming real, it was too easy,” he says. “The window, they see [for reform] is so small, if you don’t turn it around we are done.”

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Other young businessmen talk of the opportunities in new sectors like technology and entertainment, while lauding changes that have allowed women to drive and break into domains previously limited to men. Some restaurants no longer segregate single men and women; many hip new cafés even play music.

Even those concerned by Prince Mohammed’s brash and unpredictable leadership acknowledge that the kingdom was desperately in need of reform to ensure the stability of a country in which 70 per cent of the population is aged under 35 and youth unemployment is above 30 per cent. But it is his authoritarian style that strikes fear.

“The brain knows they [some of the traditional businesses] are on borrowed time, the heart says ‘does it have to be so painful’, do they have to step on our necks and insult us? Does it all have to be this inhumane?” says the foreign executive.

The sentiment is palpable among businesspeople in Jeddah, which lies in the western Hejaz region and has political as well as geographical distance from the more conservative centre of power in Riyadh. Many Hejazis were among those rounded up in the Ritz-Carlton.

Shoppers in a Riyadh mall. In Saudi Arabia, 70 per cent of the population is under the age of 35 © Bloomberg

“It’s not just the people in the Ritz, but also those who were providing their supply chains, they weren’t being paid,” says a Saudi executive in the city.

Most of the detainees were released having transferred cash and assets to the state. But the bigger problem now is trust, says a western executive.

“There is no trade except in Riyadh. People are in poverty and there is no accountability,” says one Jeddah businessman. He accuses the PIF of “squandering state money”. The role of the $300bn sovereign wealth fund is contentious — some argue it is needed to incubate and develop new sectors. Others see it as a personal tool of Prince Mohammed that is crowding out the private sector. The IMF warned that government interventions “need to be carefully handled”, citingthe “growing role” of the PIF.

“The crown prince was misinformed that state capitalism would push forward the economy just like in China or South Korea. The institution that represents that is the PIF, while the private sector was debilitated because in his mind it could not be trusted, he saw it as parasitic,” says a Saudi-based executive. “You cannot expect them to be with you if you purge them, it’s all about control — he wants to control the levers of the economy.”

Such debates are indicative of the challenge Prince Mohammed still faces.

“You need 12 to 18 months of no more self-inflicted wounds and some good indicators before [the economy] really starts to move,” says one western executive. “When I talk to the private sector, I still hear a lot of scepticism.”

Additional reporting By Simeon Kerr in Dubai



Via Financial Times

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