Global crisis casts shadow over Saudi’s futuristic cities

Wayne Arnold

• Last Updated: February 01. 2009 6:28PM UAE / February 1. 2009 2:28PM GMT

A model of what the King Abdullah Economic City will look like: the kingdom hopes the project will help diversify its economy away from oil sale dependence. AFP

There is a string of superlatives that promoters use to describe this infant city: a US$26.6 billion (Dh97.7bn) project where as many as two million people will some day work and live that is so large – as big as Ras al Khaimah – and so important – Saudi Arabia’s largest private-sector investment – that it bears the imprimatur of the kingdom’s most powerful man.

Driving through King Abdullah Economic City’s lavish entrance gate and down its palm-lined boulevard to the Red Sea, though, the city’s most striking feature is how little there is on its 168 square kilometre expanse of waterfront dirt.

Down at the seaside showroom, where the Starbucks coffees are complimentary, cleaners use leaf blowers to keep the driveway from being slowly buried in sand. Nearby, about 500 workers are putting finishing touches on a handful of buildings due to open next month, three months behind their original schedule. Most of the cranes towering over them stand idle.

King Abdullah Economic City, or KAEC, is one of six planned “economic cities” designed to help promote private investment and so wean Saudi Arabia’s economy from oil and generate jobs. A tired policy mantra elsewhere, it has real urgency here. While the UAE is racing against the depletion of its petroleum reserves, Saudi Arabia is racing against its birth rate – about three of every five Saudis are under the age of 25.

But the global economic crisis has put an abrupt halt to the Gulf oil boom, and the easy money that came with it, casting doubt over whether KAEC and the rest of Saudi Arabia will generate enough private investment soon enough to defuse what many economists call a demographic time bomb.

“The recessionary forces that are impinging on the economy from lower oil prices and the credit crunch and the changed investment climate are crucial,” says Howard Handy, the chief economist at Samba Financial Group in Riyadh. “The consequences from the standpoint of employment creation and growth opportunities are quite significant.”

KAEC’s owner and developer, a Saudi-listed affiliate of Emaar called Emaar the Economic City, or Emaar EC, has lined up plenty of big investors to help build it, from DP World and Mubadala to Siemens, Total and the confectionery maker, Mars. But sales executives are reportedly shifting their efforts to Saudi businesses as foreign investors pull out. And those sales people say buyers are asking for discounts.
They include buyers such as Tai Nazer, a Dubai-based Saudi banker who says he bought an apartment last year and returned recently to ask Emaar for a discount on the sales price, or at least to agree to postpone his instalments to reflect the dimmer global financial environment.

KAEC’s royal connection makes its progress a politically sensitive topic in Saudi Arabia. Emaar EC declined repeated requests for interviews with company executives to talk about the impact of the global recession. Government officials are also reluctant to discuss such issues. “We do not know anything about the forecast,” said Ahmed Hakami, the Saudi deputy minister for economy and planning, when asked to discuss the country’s economic outlook.

But the economy is clearly high on the agenda of King Abdullah. Since assuming the throne just over three years ago after the death of his half-brother, King Fahd, the ruler has made economic liberalisation a hallmark of his efforts to reduce poverty and nudge the country away from the kind of religious ultra-conservatism that some say produced 15 of the 19 World Trade Center ­attackers.

Saudi Arabia’s per-capita GDP of $18,500 is among the lowest in the Gulf. Its National Strategy to Combat Poverty estimates that about 19 per cent of Saudi families earn less than $12,000 a year.

Still, Saudi Arabia enters the crisis in enviable shape. It remains the world’s largest producer and exporter of oil, with about 20 per cent of the world’s known supply.
The nation has tried to solve the economic diversification puzzle before. It tried to make the deserts bloom in the 1970s and 1980s by building desalination plants and planting crops, until slumping oil prices derailed its efforts.

Having learned the lessons of past oil booms and busts, Saudi Arabia went into the boom of this decade with a much more conservative approach. Instead of spending its windfall, the government used part of it to pay down its debts. Last year, it posted a record 590 billion riyal (Dh577.53bn) surplus and cut its overall borrowings to 13.5 per cent of GDP, down from 120 per cent in 1999.

The rest it invested. Unlike other governments around the region, Saudi Arabia resisted the temptation to buy global equities, private equity or high-profile companies. Instead of launching a sovereign wealth fund, Saudi poured its savings into the central bank, the Saudi Arabian Monetary Agency (SAMA), which invested largely in US government bonds and other relatively safe government bonds.

While sovereign wealth funds are estimated to have suffered losses of up to 40 per cent on their portfolios, SAMA has more than $500bn in reserves and other assets. “It is now likely to hold the largest sovereign portfolio in the Gulf,” say the economists Brad Setser and Rachel Ziemba in a paper on sovereign wealth funds by the Council on Foreign Relations in New York.

Thus cushioned, the government last month unveiled its largest-ever budget to help offset the global economic downdraught. It will put the government into a slight deficit – about 6 per cent of GDP.

Whether that will be enough to keep Saudi Arabia from slipping into recession this year is debatable. However much growth slows, few economists believe the nation will maintain the 5 per cent growth rate believed necessary to absorb new job entrants.
Unemployment is reported to be at 5.4 per cent but the government’s own employment figures reveal that it is closer to 11 per cent and economists say it is likely to be much higher than that.

“They have to create jobs for a growing population and an increasingly young population,” says Mohsin Khan, who stepped down last year as the IMF director for the Middle East to join the Peterson Institute for International Economics in Washington. “Oil isn’t going to do it for them.”

Oil still accounts for more than half of Saudi Arabia’s economy. By comparison, the private sector generates just 28 per cent of GDP.

When the latest oil boom erupted, therefore, the Saudis began trying to liberalise their economy. In late 2005, the nation joined the World Trade Organisation, a move economists have hailed as a watershed.

“The entire economy had to open up and liberalise, much more than anything else they had been doing,” says John Sfakianakis, the chief economist in Riyadh at SABB, ­HSBC’s ­Saudi affiliate.

The government has been trying to promote manufacturing industries such as cars and construction materials, packaging and electronics, though economists say it has little hope of competing with cheap Asian labour. Even traditional ghutra Islamic scarves are imported from China.

Saudi Arabia has a natural advantage, economists say, in industries that benefit from access to cheap and abundant energy – fertilisers, plastics and aluminium. Financial services also are a promising source of jobs for those Saudis with the appropriate skills.

Whatever works is likely to require money and knowhow from overseas. So Saudi Arabia has lowered its tax on foreign firms to 20 per cent from 45 per cent. In 2000, it passed a Foreign Investment Act that provided for 100 per cent foreign ownership of companies and set up the Saudi Arabian General Investment Authority (SAGIA) to promote overseas investment.

SAGIA set up a one-stop shop for foreign investors that brings together representatives from nine separate ministries. Last year Saudi Arabia rose to 16th on the World Bank’s “Doing Business” list, making it the highest-ranking Middle Eastern nation. Just three years before it was 67th.

SAGIA is also in charge of the economic cities. Launched in 2005 and due for completion by 2020, the cities are supposed to boost the economy by $150bn, create 1.3 million jobs and house five million people. “It will create jobs, permanent jobs, and help balance regional development,” says Essam Bukhamseen, the manager of SAGIA’s economic cities agency in Riyadh.

That last point is an important one in a nation where two thirds of the people live in the three largest cities – Riyadh, Jeddah and Dammam – and where an acute shortage of housing means that three out of four Saudis do not own their own home.

The economic cities are therefore located in underdeveloped areas. Three have been launched near Medina, Hail and Jizan on the southern Red Sea coast. Two others are still on the drawing board near Tabouk and the eastern region.

KAEC is the flagship. The city has been laid out by planners to include six districts: a seaport being built by DP World, an industrial district, a financial “island”, a university zone, residences surrounding an 18-hole golf course and a waterfront resort area already planned to include a Ritz-Carlton by 2011. KAEC will also feature a terminal to receive haj pilgrims bound for Mecca.

All of these projects are owned and developed by the private sector, without government financing, according to Mr Bukhamseen. The project has generated significant public interest. When Emaar EC offered 30 per cent of the company to investors in mid-2006, it said that 10 million Saudis – almost half the population – applied for shares.

Emaar EC started selling the first residential units, marina apartments and villas, a year ago. Last July, it ventured to Dubai to market the development there. Later that month, the company announced that it had sold 1bn riyals of residences, all due for completion by the end of last year.

For investors such as Mr Nazer, KAEC has less to do with economic liberalisation than with finding a more liberal social environment. “I bought it as a Saudi hoping that this city is going to be something unique, something different, a more open society,” he said.

In a country where restaurants and banks still have separate entrances for men and women, many in Saudi Arabia believe the economic cities will sweep aside convention, even letting women drive. Emaar EC’s promotional video shows men and women sitting on either side of the same classroom – an impossibility in a nation where a glimpse of the future is available just south of KAEC, where workers are building the King Abdullah University of Science and Technology (KAUST). Scheduled to open in August, KAUST will be Saudi Arabia’s first co-educational university.

KAUST also offers a stark contrast to KAEC in that it is busy. Its access roads sit beneath a cloud of dust kicked up by the incessant stream of dump trucks and cement mixers rolling in and out. KAUST is being built by the state-owned petrochemical company, SABIC, using money from the government.

KAEC so far relies entirely on private investment at a time when private-investment projects are rapidly falling victim to the cooling global economy. A long list of oil-related projects in Saudi Arabia have already been delayed. Total and Saudi Aramco have delayed refineries in Jubail and Yanbu, representing $22bn in combined investment. Similar delays have been announced at a new refinery in Jizan and the $15bn Munifa offshore oilfield.

Mr Bukhamseen says there is no sign of a slowdown at KAEC and Emaar EC’s press statement says the project is proceeding on schedule. Last month, the chief operating officer at Emaar EC, Joseph Kilar, told London’s Financial Times that the global crisis was forcing the company to look for buyers at home. “Right now, everybody is so cautious to do anything: that’s the problem even if it’s a good deal.”

There are other obstacles, though. With a long-awaited mortgage law still awaiting final passage, home financing remains a luxury for the wealthy. And most of KAEC’s residences appear targeted at affluent buyers with an appetite for golf and waterfront property.

Many analysts and economists, therefore, warn that KAEC is unlikely to succeed without state support, whether through outright investment, financing or investment incentives such as tax holidays.

Yet even as global recession has made state intervention fashionable again, others say Saudi Arabia is mindful that any government role in the economic cities would defeat their purpose. “The state doesn’t want to spend good money on a project that could run into trouble,” says Mr Sfakianakis. KAEC may have a prestigious name, but it is not too big to fail. “There’s more to Saudi Arabia than the cities,” he says.

warnold@thenational.ae