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Executives in Malaysia are likely to be undergoing intense stock take and reviews of their overseas investments and assets abroad as the repercussions of a possible global recession looms. For corporates and investors with exposure to Saudi Arabia, a triple whammy of threats has emerged in the last few months – economic, political and financial.
The country’s current economic and fiscal pressures will complicate the investments made on the back of Saudi Arabia’s growth prospects and shared cultural affinity with Malaysia, particularly long-term infrastructure projects dependent on government spend such as tolled roads, rail, ports, utilities, and oil and gas services. According to a press release by the Malaysia External Trade Development Corporation (MATRADE) in 2019, more than 25 Malaysian companies have ventured into Saudi Arabia including investment funds such as Khazanah Nasional Berhad; and publicly-listed companies like Tenaga Nasional Berhad, Malakoff Corporation Berhad, Felda Global Ventures and Prasarana Malaysia Berhad just to name a few.
Saudi Arabia’s heavy dependence on oil as a main source of government revenue did not deter them from starting a price war just as the COVID-19 pandemic began. Government coffers were already stretched and ambitious infrastructure projects such as the Riyadh Metro were recently scaled down. State-owned enterprises and government agencies, once good paymasters, are now significantly reducing spend and suppliers and advisors are managing their account receivable risk. Infrastructure companies, construction firms and service providers face a dilemma of whether to stop work or to continue in the hopes that delivery will resolve payment issues and protect the goodwill they have cultivated in the Kingdom.
In addition, the much-hyped initial public offering of national oil company Saudi Aramco in 2019, which failed to attract foreign investors at the desired valuation of USD 2 trillion, fell short of its initial target and had raised only USD 29.4 billion (bn), instead of USD 100 bn previously announced by the Crown Prince Mohammad bin Salman in 2016.
The March 2020, arrests of members of the Saudi royal family and 298 government officials by the Nazaha, the Saudi Arabia anti-corruption commission, shifted the sentiments for most investors who had historically enjoyed a certain degree of political access and assurances with established conglomerates in Saudi Arabia. These arrests are reminiscent of the landmark Ritz Carlton corruption purge in 2017. While these recent arrests in early 2020 may have been aimed at addressing domestic issues, the resulting headlines are bound to raise some concerns among foreign investors, including those in Malaysia, as previously privately-owned businesses have now changed hands and come under the control of the government. Cases in point of this change in ownership would be the Saudi Binladen Group and Middle East Broadcasting Corporation (MBC). There is a possibility that more arrests could be made as a result of a deepening corruption probe, from members of the royal family and ministers to less senior public officials.
Political expropriation of assets may not directly target foreign investors, but lucrative concessions and service contracts negotiated in earlier years could be jeopardized. In May 2017, a consortium led by Changi Airports International (CAI), part of Singapore’s Changi Airport Group was awarded a 20-year concession to operate and manage Jeddah’s new airport following a competitive tender. In February 2018, it was widely reported that the contract was terminated although CAI stated that it had strictly adhered to the bidding process. The importance of scrutinizing the level of political risk local joint venture partners bring cannot be overstated.
The commercial and financial pressures resulting from the pandemic, as businesses are shuttered across the country, are adding to the political maelstrom. With Makkah and Medina temporarily closed to worshippers, spillover spending from Hajj and Umrah pilgrimages – the second largest source of government revenue – is now under threat. According to the World Travel and Tourism Council, travel and tourism which grew 14% year on year accounted for 9.5% of Saudi Arabia’s Gross Domestic Product (GDP) and employed more than 10% of the country’s workforce in 2019. As a result, asset owners s such as Malaysia’s Urusharta Jamaah Sdn Bhd, which took over Tabung Haji’s portfolio of hotel accommodations in the two holy cities, will likely face short-term cash flow pressures. Other investors should expect similar heightened solvency and liquidity risks from stalled projects and distressed customers and suppliers. Banks have become cautious, and the central bank, Saudi Arabian Monetary Authority (SAMA), urged banks on 30 March 2020, to provide concessionary loans to businesses to safeguard jobs, but this comes at the detriment of shareholder returns.
The Saudi Arabia government announced a USD 32 billion emergency stimulus on 20 March 2020 to support small and medium sized businesses. It was the first of several economic responses. Value added taxes (VAT) was tripled and public sector allowances were slashed in early May 2020. As the largest and lowest cost producer of oil, Saudi Arabia’s total reserves remain significant at USD 473 billion as at end March 2020 according to SAMA’s monthly statistical bulletin, although economists expect it to continue falling as oil price remains subdued. Saudi Arabia has been spared by downgrades in its credit risk ratings unlike other oil-dependent nations in the Middle East, but ratings agency Moody’s Investor Services has revised its outlook on the country to negative in early May 2020. As government revenues shrink, it may no longer have the same financial firepower to backstop economic vulnerabilities and the viability of certain public sector projects will be questioned.
There is still room for optimism. Despite its challenges, Saudi Arabia holds an undiminished status as the largest economy in the Middle East. Economic distress may also create opportunities. Since the events surrounding Jamal Khashoggi’s death, investors from the West have taken pause, but Asian investors have not shied away from making investments in Saudi Arabia and are more inclined to stay out of Middle Eastern politics. Foreign direct investments in the first nine months of 2019 posted strong growth of 10% to USD3.5 billion compared to the same period in 2018, according to the national investment promotion brand of the Kingdom, Invest Saudi. There is a possibility that the country may still achieve a reduction in reliance on oil under Vision 2030 initiatives, albeit at a protracted pace.
Commercially, the inherent risks of investing and operating in Saudi Arabia have arguably been amplified in the near-term. Keeping a keen watch on the situation is warranted, especially for Malaysian companies with long-term contracts in infrastructure, utilities, logistics and real estate development. There remains a need to mitigate against the potential risks of unknown ultimate beneficial owners, unforeseeable political exposure, weak balance sheets of local partners, lack of control over joint ventures and weak legal enforcement.
In addition to monitoring the political and economic situation on the ground, Malaysian investors in Saudi Arabia may seek to conduct additional due diligence, restructure holdings, re-negotiate terms and/or de-risk by bringing in better-positioned local partners. Operationally, it may be time to review internal processes and procedures such as contract management and fraud risk assessment to protect against any potential losses from vulnerable projects in Saudi Arabia. Although reforms have been promised, enforcing legal rights in Saudi Arabia has been historically challenging. The Insolvency Law updated in 2018 provides for restructuring and liquidation procedures but is still largely untested by foreign investors. Foreign seats of arbitration are traditionally preferred and public sector contracts are by and large, harder to dispute.
Saudi Arabia will be keen to make its mark in the runup to the G20 Summit in November 2020, the country’s first time as host. It will likely do what is necessary to allay foreign investors’ fears, although its geopolitical imperatives and domestic pressures are unlikely to subside in the short term. Its sovereign wealth fund, Public Investment Fund, continues to be outward looking and recently made investments in an American cruise operator and European oil majors. Investments strategic to Saudi Arabia’s Vision 2030 may have some cushion against domestic uncertainties thereby opening new doors for foreign investors despite the amplified risks in the short term. Malaysian investors will be keenly watching these developments as they assess the risks and opportunities of doing business in Saudi Arabia going forward.
Sultana El-Sayed is an associate managing director in the Business Intelligence and Investigations practice, based in the Riyadh office.
Jenn Beh is a vice president in the Business Intelligence and Investigations practice, based in the Singapore Office.