Funding Riyadh's economic cities: Attracting the private sector

04 April 2008

Riyadh is relying on private investors to provide the $500bn needed to fund the development of its six economic cities.

Even by the standards of the Gulf’s recent spending boom, raising $500bn is a colossal target. But this is the amount Riyadh requires to develop six new economic cities across the country. The government’s plan is to tap private sector investors for this sum to fund the cities.

In comparison, by 2004, the Royal Commission for Jubail & Yanbu estimated that only $46bn worth of private sector investment had made it into the kingdom’s first two industrial cities.

By contrast, government funding for Jubail was $35bn by 1982, and overall it is estimated to have spent about $100bn in total on developing the two cities.

The biggest challenge for the cities is whether they can succeed without the state offering financial support. Nawaf al-Gain, investment promotions manager at Sagia, is confident that they are attractive to private sector investors.

“The cities are great locations with huge potential for both direct and indirect investors looking to get access to the 27 million consumer population in the country,” he says.

In spite of speculation that the current global financial crisis could dampen appetite to invest in the kingdom, Al-Gain is more confident than ever. “Given the current global con-ditions, I believe there is a major call from international investors for diversification strategies,” he says.

Economic growth

Al-Gain sees a huge potential pool of investors from the international community aiming to get access to the Saudi market and eager to profit from the country’s remarkable economic growth, particularly given that other areas of the Saudi economy, such as the stock market, remain closed to foreign investors.

However, some observers are more pessimistic. “Jubail and Yanbu were based on state intervention, while the new cities are predicated on infrastructure development from the private sector,” says John Sfakianakis, chief economist of the local Sabb bank. “That is the basic difference between the two. It is the state’s initial intervention that gave the private sector the confidence to get involved at a later stage. That is the biggest lesson to learn from Jubail and Yanbu: that the private sector will be involved in projects that get state financial support.”

Sfakianakis says this has left the private sector spoilt for opportunity in the kingdom, and could make investors reluctant to take on projects without government support. “The global market is getting seriously lukewarm towards project debt, and if we see further turmoil, that could curtail the appetite for investing in these developments,” he says.

Despite this, early indications for the individual cities are favourable. Partnership agreements such as the ones between Dubai’s Emaar and King Abdullah Economic City (KAEC), the local Rakisa Holdings and Prince Abdulaziz bin Mosaed Economic City, and Malaysia’s MMC and Saudi Binladin Group for the Jizan Economic City, demonstrate the willingness of the private sector to get involved.

The most significant fundraising that has been done for the new cities so far has been the flotation of Emaar, The Economic City, on the Saudi stock exchange (Tadawul). This is the company through which Emaar will finance the development of KAEC. The initial public offering (IPO) raised SR2.25bn ($600m), although that remains only a fraction of the SR100bn initially estimated for the development of the city.

Marketing drive

“The fact that the Capital Market Authority [CMA] allowed the King Abdullah Economic City to float on the stock market indicates it has faith in its business plan and cashflow projections,” says Amgad Husein, head of the Riyadh office of law firm Denton Wilde Sapte.

Eventually, all the cities will IPO about 30 per cent of their shares in the city development companies. This will provide some of the initial cash to begin developing the cities.

Sagia’s strategy is then to split up the dev-elopments and achieve several initial milestones before beginning a more significant marketing drive.

“As of now, we are looking at splitting the developments so we get things like 5 per cent of the residential sites finished, 5 per cent of the infrastructure and 5 per cent of the industrial sites,” says Al-Gain.

Once this has been achieved, a more substantial international marketing drive will begin. “We don’t want to just promote a dream; we want to be promoting the dream come true,” says Al-Gain of the strategy. “There has been some criticism that we have not been marketing that aggressively. But that is because we were waiting for development to start on the ground.

“So far, we have not been as aggressive as I would like, but by the second quarter of this year, we will begin to step up the campaign to develop interest and start using our international offices a lot more.”

International expansion

Part of this will also involve Sagia expanding its network of international offices, which includes offices in the US, the UK, France, Germany, Italy, China, Singapore and Japan. More offices are expected in key markets concen-trating on the US, Europe and Asia. Sagia governor Amr al-Dabbagh has also stepped up promotional efforts and was in the US in late February promoting the economic cities to US businesses

For now, King Abdullah Economic City is the main focus of Sagia’s fundraising efforts, which, some argue, poses the risk that other cities could be neglected before they start. First, anchor tenants are being secured, starting with those who will develop the port and initial energy needs of the city.

As a result of this focus from Sagia, King Abdullah Economic City is the most advanced in terms of construction.

Sagia denies it is behind schedule or had trouble attracting investment, However, in 2006, it agreed with the Finance Ministry to introduce tax credits for foreign investors to attract more of them. These changes, implemented by Al-Dabbagh, were the first amendments to the national tax code since its introduction in 2001.

In fact, with no personal income tax and corporate taxes of 20 per cent, Saudi Arabia was recently ranked sixth out of 175 countries in the International Finance Corporation’s Doing Business report for 2007. The organisation is part of the World Bank

Other incentives include the ability to have 100 per cent ownership of their projects in the cities, including property for the business and employee accommodation, and no restriction on the repatriation of capital.

Businesses can also gain low-cost debt financing from the Saudi Industrial Development Fund (SIDF) for up to 50 per cent of the cost of a project for up to 15 years, with a repayment plan structured to match the projected cash flows of the project.

Re-export zones will also offer businesses the opportunity to import raw materials for manufactured products and export them without imposing import fees. Additional customs-fee exemptions will be available on machinery and tools for manufacturing industrial products.

Licence applications

Sagia has also been at work streamlining the process for investing in the new cities. The investment body has created smart service centres, enlisting the help of the NCS Group to manage these after it successfully used this model to encourage domestic investment in Singapore and the Asia Pacific.

These centres commit to process and respond to licence applications in 30 days, although advisers who have taken firms though the process say, in practice, Sagia is often in more active contact with potential licensees to ensure applications are successful.

Other aspects of the licensing process could still be streamlined, though, according to sources in the kingdom. Husein says that after dealing with Sagia, it can sometimes be a four-to-eight-week wait for the Commerce & Industry Ministry to respond to requests for a commercial registration certificate. However, he says the situation is “much better than it was 10 years ago”.

Providing incentives

Sagia has made major progress in providing incentives for the private sector. However, questions remain over whether that is enough to convince investors to get involved in these projects without the safety net of direct government financial support.

It is unclear whether turmoil in global financial markets will help Sagia’s case in promoting Saudi Arabia as an alternative investment destination decoupled from the rest of the world, or whether a global flight from risk will leave the organisation struggling to convince foreign companies to overcome worries about the perceived political and economic risks.

With economists predicting that the oil price will remain high, even in the face of a US slowdown, the Saudi economy is set to continue to grow and remain attractive for foreign investors.

The attraction of a cheap workforce and a 25 million-strong under-penetrated consumer market should make Sagia’s job easier.

Key facts

  • Up to $500bn will have to be raised for the six economic cities.

  • Emaar, The Economic City, initial public offering raised $600m.

  • Saudi Industrial Development Fund will provide cheap loans for up to 50 per cent of project costs.

  • Saudi tax regime is ranked the seventh easiest in the world for simplicity, and second in the region behind the UAE, which is fifth.

  • Tax credits are available for businesses employing Saudi nationals.

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