Foreign direct investment (FDI) or inflow of foreign capital to a country to promote economic growth to the benefit of foreigners and the national economy is a hot topic in developing countries. The Saudi Arabian government has sent some strong signals that it welcomes such an inflow by establishing an empowered entity — the Saudi Arabian General Investment Authority (SAGIA) — to spearhead the FDI effort. Some countries evaluate their domestic economic reform programs in terms of how much foreign direct investment has been obtained. However, the quantity of inflow of capital is not enough to judge the effectiveness of such foreign investment flows.
Saudi Arabia is in a fortunate position whereby its citizens hold substantial liquidity and monetary assets both in the Kingdom and abroad. The size of the liquidity surpluses generated by the most recent initial public offerings of shares on the Saudi Stock market illustrate this and nowhere in the world do oversubscriptions of new listings in the multiples of 40 or 50 routinely occur. As such, questions concerning foreign direct investment into Saudi Arabia have to be discussed in terms of what benefits FDI can bring to the Kingdom that is currently missing.
The advantages associated with foreign direct investment for those countries fortunate to be in a capital surplus situation such as Saudi Arabia are several. Firstly, foreign investments into a country are assumed to lead to higher productivity and labor standards through the demonstration effect of foreign multinationals in the way they manage advanced production processes and systems. Domestic companies benefit from modern know- how and technological transfer, as well as the creation of a pool of a domestic skilled labor force that foreign companies have trained, and who could be employed in domestic companies. The Saudi banking sector is one such case in point, whereby the foreign joint venture banking partners brought in advanced management and training practices and young Saudis benefited from foreign partner training programs and moved on to senior positions and management responsibilities in other national banks. However, this argument does not hold if the foreign company is highly capital intensive and relies on a few foreign skilled workers.
Secondly, FDI in a country’s infrastructure will not lead to banking or debt crisis compared with financing lending from abroad such as happened with many Latin American countries that saw inward flows of capital, not in projects, but to government lending. Some economies become so dependent on foreign loans that it takes decades for them to remove the debt servicing obligations and gain better borrowing credit ratings. Some are fortunate and can repay such non-FDI international loans, as recently announced by Russia, which finished paying off its $22.5 billion Soviet era debt to the so-called Paris Club creditor nations ahead of schedule. This has saved Russia around $7.7 billion in servicing costs. Thirdly, unlike international loans, part of the profits of the FDI is reinvested in the country of investment, which leads to further growth in project investments.
The disadvantages of FDI should not be overlooked. The first disadvantage is that successful foreign operations could drive domestic competitors out of the market and this might be the case with sophisticated financial services. Secondly, if the FDI sector is large enough and they borrow from domestic banks to expand, their action could drive borrowing rates up causing problems to domestic operations. Again, if the foreign direct investment sector is large in a country, this could cause balance of payments problems for the domestic economy with large profits being repatriated by the foreign companies. Finally, one of the major criticisms of FDI is that they could concentrate on a narrow base of investment in the economy, which could benefit a small section of the population, or concentrate in special “economic enclaves” such as mining or other natural resources extraction.
Fortunately for Saudi Arabia, some of these potential negatives of FDI are minimized as the oil sector is in state control, and most mineral activity is through joint ventures. While there is some concentration of foreign investments in petrochemical industries, yet foreign participation is also evident in many sectors, and the Saudi financial services sector does not seem unduly worried at the opening up of this lucrative market to FDI, post the Saudi WTO entry. FDI has forced Saudi financial institutions to become more competitive and identify core niche areas such as Islamic financing to compete with foreign institutions. The major FDI benefit that the Kingdom has acquired is to be considered in terms of the transfer of technology and management expertise, rather than capital inflows.
The emphasis on technology transfer has been recently emphasized in the Saudi government’s invitation for foreign investment participation in the Kingdom, coupled with parallel initiatives to ensure a more transparent administrative, judicial and regulatory regime. SAGIA is doing its best by listening to foreigners complaints about various well founded obstacles to doing business in Saudi Arabia, and at the same time, is prodding government agencies and bureaucracies to adapt to the needs of FDI if the Kingdom is to remain competitive.
(Dr. Mohamed A. Ramady is visiting associate professor finance and economics at King Fahd University of Petroleum and Minerals.)