It is not surprising that the asset class to which banks in Saudi Arabia and the rest of the GCC have the largest exposure is real estate, followed by equities. Although Saudi and foreign banks now increasingly participate in financing the real economy in the Kingdom through project and structured financing, istisna (Islamic construction financing) and ijara (leasing), their role in financing industrialization and infrastructure has been limited.
Thanks to high oil prices and revenues, the government has largely been responsible for financing hospitals, schools and other infrastructure from the budget. The banks have been largely confined to do cash-and-carry business including consumer financing. Private-public financing initiatives were until very recently almost unheard of in the Kingdom let alone the region; project financing structures such as BOT (build-operate-transfer) and BOO (build-operate-own) were hardly ever seen. Things are starting to change especially now that the Saudi government encourages the private sector to play a greater role in contributing to GDP and has given the green light to the opening up of the Saudi banking market, with new banking licenses given to HSBC, Deutsche Bank, Gulf International Bank and JP Morgan.
Petrochemicals is a good example. According to the Saudi Arabian Monetary Agency (SAMA), some $40.6 billion will be invested in the Saudi petrochemical industry alone in the five-year period starting 2006. The private sector increasingly plays a pivotal role. Even more so with polypropylene (PP). Last year, the private sector accounted for 35 percent of PP capacity in Saudi Arabia, with SABIC supplying the majority 65 percent. By 2010, according to SAGIA, there will be a role reversal, with privately-owned plants supplying 62 percent of PP capacity and SABIC 38 percent. The private sector is more reliant on raising financing through the market, as SABIC did recently through its SR3 billion sukuk, and its SR1 billion murabaha facility. In total, it has accessed some SR7.5 billion from Islamic banks alone in 2006 so far; it is also going to the Eurobond market imminently to finance the acquisition of Huntsman Petrochemicals’ operations in the UK. Private liquidity in Middle East and North Africa (MENA) region has soared to a staggering estimated $2.3 trillion, of which $1.5 trillion is in the GCC alone. As such, private sector involvement in industry (especially oil, gas, petrochemicals, metals and mining) is set to increase dramatically over the next few years. Government budget surpluses too are breaking records, with public expenditures over the next five years running into mind-boggling billions of dollars. For instance, state-owned Saudi Aramco, the world’s largest oil company, confirms that it alone has earmarked investment expenditure of $137 billion for the period 2006-2010. Banks are rubbing their hands with glee at the potential business opportunities. In the power sector alone, according to Dr. Ranald Spiers, CEO MENA International Power, the growth rate in demand for power in the Kingdom is set to rise at four percent a year and for water at eight percent a year. In addition to the four current planned independent water and power plants (IWPP) projects (Shuaiba 3, Shuqaiq 2, Ras Azzour and Jubail 3), eight more are planned for the next few years. This would require a massive investment. Banks are already underwriting such projects. Syndicated finance for Shuaiba 3 IWPP involved Riyad Bank, Arab Bank, ABN Amro, Al-Rajhi and 19 others with Riyad and Standard Chartered as joint advisers. Banks have financed the Al-Hidd IWPP in Bahrain and others in Dubai, Abu Dhabi and Qatar. Bankers such as Dr. John Sfakianakis, chief economist at SABB in Riyadh, are bullish about business and investment opportunities in the Kingdom in an era of high liquidity driven by high oil prices. “There is great business for all of us to be taken and done,” he stresses. “Clearly, the opportunities are huge, both for local businesses, private individuals and investors — and for foreign entities in Saudi Arabia and the wider GCC.” These opportunities range from construction and real estate to IWPPs and the oil and gas sector, including upstream (through the subcontracts Saudi Aramco places with both local and foreign companies) and downstream, especially petrochemicals. In the banking sector, Sfakianakis sees growth in all areas — retail banking, corporate finance, project finance and consumer lending, especially real estate. “In banking, for instance, you see more competition than before. Banks can open up and there is 100 percent ownership. HSBC, Deutsche Bank and BNP Paribas are here. You will see this with the financial services sector soon. Even Citigroup is willing to come back.”
Sfakianakis is confident that the impact of the Kingdom’s membership of the World Trade Organization would be positive. “It has been a process whereby economic reforms and changes have been gradually implemented in order for Saudi Arabia to comply with WTO,” he explained. “It is not a case whereby the Kingdom had to enforce certain rules and regulations out of the blue. Both the government and the private sector were aware of the changes and these have been slowly coming about.”
The region’s nascent capital markets have been capitalizing on this liquidity wave, only to be brought down to earth earlier this year with a long-overdue market correction, one that has now been going through a second phase. The Tadawul stock exchange in Saudi Arabia, for instance, in March 2006 fell in value by 30 percent, which led to many investors scurrying to seek a safe haven in gold, real estate and government bonds. The market jitters, stress bankers, were precipitated by the lack of market makers — and the “irrational exuberance” of investors fueled by the high gearing (borrowing money to finance investment in the stock mart). Since then, the Saudi Arabian Monetary Agency (SAMA) has taken measures to curb such consumer lending. Banks, apart from their bread-and-butter, cash-and-carry and consumer finance business, have been leveraging the new opportunities with some relish. These include: The record public share offerings for both state-owned and new companies; arranging the financing for the expansion of key areas such as oil and gas, petrochemicals, power and water, minerals and industry; innovating capital markets products such as Islamic bonds (sukuk); and managing foreign direct investment (FDI) flows. Inward FDI into the GCC for the first eight months of 2006 totaled $18.03 billion, modest by international standards. But as Abdulmagid Breish, deputy CEO of Arab Banking Corporation (ABC), one of the largest banks in the Arab world, warned that a lot more needs to be done by governments, regulatory authorities and financial institutions to leverage the huge liquidity in the region. He is wary of the current investment climate in the Kingdom and the rest of the GCC. “In general and not restricted to Islamic investors,” he explained, “we see interest in regional stock exchanges by domestic investors adopting a cautious wait-and-see attitude following the recent corrections in regional bourses.
Too much pain has been inflicted on small and unseasoned investors during the second quarter of this year from the steep drop in IPO shares that then spilled over to other shares.” However, regional investors are relatively active in new real estate ventures and in manufacturing/industrial startups. “To a smaller extent, we are also starting to see interest in regional private equity. FDI is, however, very low profile except for selective and very few oil and gas mega projects,” he added.
Breish acknowledged that there are many challenges for regional financial regulators and governments in helping to facilitate world-class capital markets and FDI regimes. The long-term challenge for the GCC regulators is whether they can reform and modernize their legal and regulatory platforms quickly enough and whether they can provide an environment conducive to attracting talented international and local professional players to add depth to local stock exchanges through the provision of sophisticated products and services. “A pan-Gulf shares clearing system and high standards of disclosure, transparency and execution,” he contended, “are similarly major prerequisites.” Breish saw a definite need for banks to take on a greater role in facilitating investment flows especially if markets are to prosper and develop. However, this would depend on how quickly regulators can deliver on reforms and the new challenges.
To him, crossborder mergers and acquisitions in the financial sector, together with the utilities, manufacturing upstarts, selective residential and commercial property and private equity present the best opportunities for investment, especially in Saudi Arabia. He is not unduly concerned that GCC banks reportedly have high exposure to real estate and commodity investments, but an unduly high market correction, he said, could have a damaging effect. “I suspect there are pockets of high concentrations of exposure to these sectors. A sizable market correction will not bode well for the region if it occurs, especially if it comes soon after what we have witnessed in the second quarter of this year. If the correction is sizable, it will however set back confidence in regional investment for some time to come,” he warned. He is confident that capital markets investment instruments such as bonds can be leveraged, but what is required are more credit worthy borrowers for such instruments, plus adept intermediaries to create depth and demand in primary and secondary markets. To him all three main investment asset classes — gilts, equities and real estate — are promising if the financial intermediaries can provide innovative products. Others such as Ali Al-Ghannam, head of International Real Estate at Kuwait Finance House, wanted to see a more standardized approach to capital markets in the Gulf “for the benefit of both investors and customers.” He is optimistic that once a unified GCC currency is introduced in 2010, regional capital markets would automatically become integrated under one umbrella. This would in turn boost cross-listing between the various stock markets in the region. The GCC stock markets, according to Said Al-Shaikh, chief economist at National Commercial Bank, the Kingdom’s largest bank, “are modest in terms of total market capitalization (value of stocks) — only $914 billion at end 2005 compared with $2.934 trillion for the UK and $941 billion for Spain.” But at $570 billion, the Saudi Tadawul stock market capitalization is by far the largest in the GCC. Al-Shaikh sees good prospects for the Saudi capital market because of the robust activity in initial public offerings (IPOs), the growing equity and bond markets, increased opportunities for securitization and the emergence of crossborder acquisitions and mergers. However, there are challenges too — a rapidly changing marketplace, better disclosure by listed companies, fair valuation of new issues, introduction of world-class regulatory standards, the strengthening of corporate governance and greater stock market access for foreign investors.
Last year, there were 15,370 IPOs floated globally totaling $167 billion. Of this, the Middle East accounted for only $7.6 billion. The UAE accounted for $1.9 billion and Saudi Arabia for $1.67 billion. The general consensus is that the recent stock market correction in the Gulf bourses, which saw half of the value of the Tadawul wiped off in March 2006, has had no impact on GDP growth. Gulf markets have suffered from “irrational exuberance” over the last two years.
Samra Al-Kuwaiz, managing director of the women’s department at Osool Brokerage Company in Jeddah, blamed this on the sheer greed in the market. “No one wanted to know. People were netting 20 percent to 30 percent per week. Some people were manipulating the market, forcing the CMA to act.”
Some Saudis were even jailed for insider dealing. The reasons for the market volatility were down to the speculators, the lack of market makers and the high gearing — forcing SAMA to curb consumer lending for gearing purposes.
