The New York Times editorial board recently published an editorial bemoaning corporations’ continued interest in investing in Saudi Arabia. The article highlighted a few reasons for Saudi Arabia’s attractiveness to foreign capital, but provided little context to those reasons, which may be why the board remains puzzled. Here is a little more on what makes Saudi Arabia eye-catching to foreign investors.
To start with, it is instructive to see what investors think about when they consider investing in a foreign country. There are two main questions that investors ask themselves.
First, what is the potential for returns based on the prospective investment’s innate commercial characteristics? Here, a key issue is the existence of a high potential resource that is underdeveloped, either because it has recently been discovered, or because other factors, including political or cultural ones such as wars or policy errors, have left the resource underutilized.
Thus, when mobile telephones started proliferating in Europe and the US after cellular technology advancements, big productivity returns were realized. These did not initially extend to Africa due to the absence of the requisite physical capital and political stability. Once those two gaps were addressed, investors were able to secure large returns on their investments in Africa, too.
The second question investors ask is: What is the likelihood of political shocks in the country, including government expropriation or civil war? In countries such as Germany or Japan, in the 21st century, these are essentially non-considerations, allowing investors to focus on the innate commercial properties of the prospective investment. But as investors in Latin America and the Middle East have discovered, even the best laid plans can unravel when a junta decides to seize assets or a militia decides to start a war.
The Political Risk Group is a private company that sells analysis to prospective investors, and one of their leading products is the International Country Risk Guide (ICRG). This composite index assigns each country a rating of how risky it is to foreign investors, based on three sub-indices.
The political risk sub-index (50 percent of the weight) gauges factors such as government stability, corruption, ethnic tensions, and so on. Here, poor performance can present a threat to an investor’s returns, because it can lead to bad policy decisions or violent conflict.
The economic risk sub-index (25 percent) is a list of the key macroeconomic performance indicators, such as per capita income, the level of economic growth, inflation, and the budget balance. A poor macroeconomy – a condition that can afflict rich and poor countries alike – is a considerable threat to investor returns.
The financial risk sub-index (25 percent) looks at an additional suite of finance-centric macroeconomic indicators, such as public debt, exchange rate stability, and foreign reserves. These are the macroeconomic factors that are most relevant to foreign investors, as they rely upon a country’s sound integration into the global financial system for their returns to be secure.
Investors do not seek answers to these questions in a vacuum – they are ultimately interested in how the country compares to the alternatives on offer. Thus, a mediocre investment can suddenly look very attractive if the global economy is performing poorly, and emerging markets are full of investment risks.
In the context of Saudi Arabia, this last point is very important. Prospects for the global economy are currently dim, both in advanced and emerging markets, meaning that sound investments are likely to ignite a feeding frenzy among foreign capitalists. Consequently, the bar is lower than usual for Saudi Arabia – a point that many analysts keen to criticize the Kingdom typically fail to mention.
But what about its commercial and political risks?
On the commercial front, Saudi Arabia checks all the right boxes: In addition to its oil, it has several underdeveloped resources. In some cases, such as with mineral resources, these are underdeveloped due to the indifference of policymakers as high oil prices alleviate the pressure to develop new sectors. In others, it is due to cultural and political factors, such as Saudi Arabia’s tourism and entertainment sectors, including its religious tourism – a sector with massive potential. And in the case of shale oil, it is due to the novelty of the technology – only the US is a real player in this market at the moment, and like many countries, Saudi Arabia is yet to start developing its own shale oil fields.
Another key reason for the under-exploitation of commercial opportunities in Saudi Arabia is the historic lack of focus on foreign direct investment as a source of economic growth. Unlike its neighbors Bahrain and the UAE, which have made it very easy for foreign capitalists to invest in their economies, Saudi Arabia has only recently developed a tourist visa. The Economic Vision 2030 firmly reverses that policy stance. Moreover, Saudi Arabia has a large and young population, amplifying the commercial advantages of investing there.
With regard to political risk, despite its recent struggles, Saudi Arabia still gets a lot right from the perspective of foreign investors. The Kingdom performs well in terms of many ICRG political risk factors. And even in the areas where it performs more weakly, analysts puzzled by Saudi Arabia’s continued attractiveness must recall that such factors bear a very limited weight on an investor’s decision calculus. While it is understandable for a media outlet to fixate on the Khashoggi affair and to ignore Saudi Arabia’s low debt-to-GDP ratio and massive foreign reserves, this is not how a private investor evaluates the situation.
Aramco seizing the headlines is probably not an accident, either. Most likely, it is part of a Saudi strategy to remind foreign investors of one of the most successful foreign investments in history. The Saudi Arabia that discovered oil and sought US assistance was massively underdeveloped economically. Yet through prudent, technocratic management, respect for property rights, and intelligent transfer of foreign knowledge, Saudi Arabia was able to create the most profitable company in the world. Three of the other countries in the world’s top five countries by oil reserves are Iran, Iraq, and Venezuela, all of which have oil sectors operating massively below potential, and which exemplify why foreign investors are wary of investing in such economies.
Another advantage Saudi Arabia has is its acumen in global oil markets since the 2014 crash. Despite a bizarre three-year spell in which media analysts have accused Saudi Arabia of simultaneously flooding oil markets as part of a scorched earth geopolitical strategy, and restricting oil production to raise oil prices, Saudi’s oil policymakers have remained remarkably calm and contributed to a significant improvement in market conditions from the perspective of producers.
Investors are cognizant of such successes, and are understandably far more likely to notice them than journalists with no skin in the game - which is ultimately why, if you really want to understand what an investor thinks of Saudi Arabia, you should listen to everything the investor has to say.