Just months after King Salman ascended to the throne, he presided over a cabinet meeting that would have a profound effect on the future of Saudi Arabia and the way the world’s top bankers view the conservative kingdom.
Yet the decision taken inside the al-Yamamah Palace garnered little attention either inside, or outside, the country. Buried near the bottom of a 1,400-word statement was the news that the Public Investment Fund would report to the newly-created Economic and Development Affairs Council instead of the finance ministry. And the president of that council, Prince Mohammed bin Salman, known as MBS, would take over as PIF chairman.
The meeting in March, 2015 was an early indicator of the crown prince’s ambitions and the financial power the ageing monarch’s favoured son would soon come to wield. It marked the beginning of the radical transformation of the PIF from a near-dormant state holding company into arguably the world’s most active sovereign investment vehicle, likened by some to a “parallel state”.
Activity
In the three years since, the PIF has invested tens of billions of dollars at home and abroad, in companies ranging from Uber to Magic Leap, and in ventures with Blackstone and SoftBank, while targeting a doubling of its assets under management to $600 billion (€523 billion) by 2020. In the process it has morphed into the most powerful force in the Arab world's biggest economy. The flurry of activity has been driven by Prince Mohammed, the country's de facto leader, who chose the fund as the vehicle to spearhead the modernisation of the oil-addicted economy.
“It was one of the first departments targeted by Prince Mohammed,” says a Saudi analyst. “It’s become the most important vehicle for MBS [in terms of his] political, personal, economic and social agenda in the country. It’s a one-man investment vehicle.”
But the scandal triggered by the killing of Jamal Khashoggi, a Saudi journalist, has put the PIF, like its patron, in jeopardy of losing its lustre. Amid macabre reports of the journalist's killing, the fund has become a glaring example of the potential economic damage for the kingdom as Riyadh grapples with Saudi Arabia's biggest diplomatic crisis with the west since the September 11 attacks on the US in 2001.
For the past week, the PIF has been scrambling to save its flagship investment conference, due to open in Riyadh on Tuesday. Last year, the event underlined the fund’s pulling power as the world’s top financiers and executives flocked to a gathering dubbed “Davos in the desert”. This year it has been about crisis management as a string of western trade ministers and executives have pulled out over the Khashoggi case.
“No one can brush this off,” says a financial executive with an operation in the kingdom. “The crown prince [will be] forever associated with this.”
At risk is Riyadh’s ability to attract the foreign investment, skills and technology it needs to build the modern economy Prince Mohammed has promised and address the urgent need to provide jobs for a youthful population blighted by rising unemployment.
Setback
“It is a huge setback for the PIF strategy of partnerships with foreign investors and joint projects inside the kingdom,” says Karen Young, a Gulf expert at the American Enterprise Institute. “[Riyadh] may well try to increase forms of patronage and pull back from painful reforms.”
After two weeks of denials, Riyadh admitted on Saturday that he died in the diplomatic mission, but said his the death was the result of a “fist fight”. But analysts and western politicians are sceptical about the kingdom’s version of events, and many believe no operation against the journalist could have been authorised without Prince Mohammed’s knowledge.
Multinational groups including Deloitte, HSBC, McKinsey, Boston Consulting Group and Siemens are still listed as conference partners. But even before the Khashoggi crisis the task of overhauling an economy built with and dependent on petrodollars was daunting. And it just got harder.
“The market has been underestimating the political and macro challenges Saudi Arabia is facing for some time. Recent events have raised the political risk premium further, with international companies having taken a strong position on the Khashoggi incident,” says Jubin Jose, an investment adviser to the Gulf Investment Fund. “This won’t help economic diversification, given the cornerstone idea was to have increased private sector participation and to attract foreign funding.”
Growth has been stagnant in the world’s top oil exporter since crude prices plummeted in 2014 and the kingdom slipped into recession in 2017. Unemployment rose to 12.9 per cent in the first three months of this year, according to government data, the highest level on record. In a country where two-thirds of the population is aged under 29, youth joblessness is more than 25 per cent, a figure that doubles for young women.
Transformation
It was against this backdrop that Prince Mohammed wooed young Saudis and enchanted western politicians and executives by promising an aggressive transformation of the economy and a more tolerant society. Two years ago, Riyadh launched a national transformation plan with the goals of reducing the dominant role of the state and developing the private sector with a target of creating more than 450,000 jobs by 2020.
The 33-year-old’s plans drew plaudits, with few disputing that the kingdom was in dire need of a shake-up. The PIF, central to the plan, would invest in international assets, partly to use its financial muscle to bring foreign capital, technology and skills to the kingdom. But it is inside the country of 33m people where its reach has been most deeply felt.
But away from the eye-catching deals and announcements, there have been increasing signs that the economic reform programme is under strain.
Created in 1971 to finance domestic projects, the PIF also acted as “custodian” of the government’s stakes in companies, including chemicals producer Sabic, National Commercial Bank and Saudi Telecom. For decades it did little more than provide loans. But in 2008 it dipped its toe into the world of active state investment with the launch of Sanabil, a sovereign wealth fund with initial capital of just $5 billion.
Since it came under Prince Mohammed’s leadership, the fund has set up an array of companies ranging from energy efficiency and waste management, to entertainment, defence and religious tourism, its tentacles reaching across all sectors as it promises to create entire new industries and “ecosystems”. In tandem, it has announced half a dozen huge projects, each with bold targets of adding billions of dollars to the economy and creating thousands of jobs. They include Neom, which was branded as a $500 billion futuristic investment zone.
But away from the eye-catching deals and announcements, there have been increasing signs that the economic reform programme is under strain. The much-anticipated initial public offering of Saudi Aramco, the oil company, has been shelved, and a broader domestic privatisation programme looks to have stalled, analysts say.
Growth
Instead, the state, through the PIF, appears to be entrenching its dominance of the economy while many companies in the private sector, which in 2017 accounted for 48 per cent of gross domestic product, have been battered by weak growth, as well as fuel and electricity price rises and new tariffs on foreign workers.
The bleak mood has been exacerbated by Prince Mohammed’s anti-corruption purge that has cowed wealthy merchant families. About 300 princes, tycoons and former government officials were rounded up in the Ritz-Carlton hotel in Riyadh last November. Most have been released, but only after transferring cash and assets to the state, including from Saudi Binladen, the kingdom’s biggest construction group, and the Middle East Broadcasting Centre, the region’s largest media company.
At the time of the crackdown, Khashoggi wrote: “There are rumours that the state will place some private companies under the custody of the government’s Public Investment Fund, further entangling business and government, preventing the Saudi economy from realising its full potential”.
Prince Mohammed told Bloomberg this month that the seized assets would be managed by Istidama, a state company formed in the wake of the purge, and cash moved to the Treasury.
Arrests
A banker with Saudi clients says the arrests of businessmen have continued, adding that some people are selling luxury goods, from watches to private jets, to stash cash offshore. “People are worried and scared,” the banker says.
Yet in an increasingly autocratic environment, any debate about Prince Mohammed’s plans and the role of the PIF is muted. The authorities have detained activists, academics, bloggers and clerics. Essam al-Zamil, an economist who criticised the planned Saudi Aramco IPO, has been in prison for a year and is reportedly charged with membership of a terrorist organisation and meeting foreign diplomats.
“Saudi has just reminded people that there’s a law that makes it a crime, punishable by five years in prison, even to spread rumours, including just to have it on your computer,” says Sarah Leah Whitson, Middle East director at Human Rights Watch. “So he’s not only threatening people from discussing, he’s threatening people from reading.”
The concentration of power in the PIF reflects Prince Mohammed’s desire to control all spheres of the kingdom. The crown prince regards the traditional private sector – much of which depends on government contracts – as “a leech that does not deliver value, just sucks money out and is taking no risk”, says a person familiar with the royal court.
Sectors
“That is why his view is: ‘I’m going to build a different private sector,’” the person says. “In the beginning, there was this deep-seated belief that ‘we need the private sector but not the Saudi private sector’, which was a bit naive because the international private sector won’t come in if the domestic private sector is not investing.”
The PIF insists it is “evolving” new sectors. “We are proud of what has been achieved in just a couple of years,” a PIF spokesman says. “We have carried out investments and built partnerships at home and abroad that are already generating sustainable returns and delivering a positive impact.”
By elevating the role of the fund, Prince Mohammed, who heads its five-man executive committee, believes he can shape the direction of economic development and the outcomes, such as levels of Saudi employment in the private sector, a senior banker says.
It is, however, a risky strategy and with every new deal announced questions have been raised about the PIF’s transparency, its management capacity – it employs close to 300 people, up from 70 two years ago, who are supported by an army of western consultants – and how it intends to finance the tens of billions of dollars of investments. The IMF estimates that the PIF is expected to invest SR83bn ($22 billion) in the domestic economy this year alone.
If you end up with Mohammed bin Salman, who is supposed to be the conservative monarchies' answer to the Arab spring, and this is the way you get reform. . . I don't see how you come back from that."
“You need 500 people [to manage the fund and its projects], and where are you going to get the management teams, the middle management? And then there’s the money you are going to have to invest,” says the person with knowledge of the royal court. “There’s no way they can do the reform programme without foreign and domestic capital. So how is he going to square that? Over 10 years, the PIF will get some liquidity, but you need it in three to five years.”
Fund
The fund raised $11 billion in syndicated loans in August, an unusual step as sovereign investment vehicles typically only borrow against specific investments. It is also at the centre of the surprise shake-up of the kingdom’s two corporate champions – Aramco’s decision to acquire a 70 per cent stake in Sabic was largely driven by the need to raise cash to fund the PIF’s spending. That deal, which officials are using to justify delaying Aramco’s privatisation, is expected to net the PIF $70 billion when the fund’s holding in Sabic is transferred to the state oil company next year.
For all the hype, foreign direct investment into the kingdom plunged from $7.45 billion in 2016 to $1.42 billion last year, according to UN data. “People have been looking [to invest] but it’s not straightforward because you’ve got risks coming at you from all angles,” says the senior banker speaking even before Khashoggi’s disappearance. Moreover, the crisis threatens to heighten tensions in the ruling family.
The Khashoggi case may not undermine the PIF’s ability to continue snapping up foreign assets, bankers say. The challenge will be inward investment. “It is way more unpredictable now,” one banker says.
“You look at the people willing to take a hit now in international business [by boycotting the PIF’s conference]. No one is going to want to touch him [Prince Mohammed],” says a former diplomat who knows the country. “If you end up with Mohammed bin Salman, who is supposed to be the conservative monarchies’ answer to the Arab spring, and this is the way you get reform. . . I don’t see how you come back from that.”
Copyright The Financial Times Limited 2018
