x Abu Dhabi, UAEFriday 21 July 2017

Gulf has clear route to gains on Silk Road

Private investors from the Gulf should pick up the pace in China as the headlines have been dominated by news of big strategic deals.

An employee works at a textile factory in Suining, Sichuan province.
An employee works at a textile factory in Suining, Sichuan province.

China and the Gulf states are natural allies. One needs oil, while the other has plenty of it. Not surprisingly, China-GCC economic and political ties have strengthened dramatically in the past decade. Yet the much acclaimed new Silk Road has run into major roadblocks: its investment ties are struggling.

The problems are not immediately obvious. The two sides both make a special point of holding the highest-level government meetings, and they have signed the type of big-ticket strategic deals that spark talk of a new geopolitical axis. Saudi Aramco has formed a partnership with Sinopec, the major Chinese oil firm, to build a US$5 billion (Dh18.36bn) oil refinery in eastern China's Fujian province. Sabic, the Saudi chemicals giant, meanwhile, recently received permission to build a $3bn petrochemical complex in the north-eastern Chinese city of Tianjin.

These China-GCC joint ventures are both large and strikingly different to those done with western companies. They are as much political deals as they are commercial ones, in so far as they involve largely state-owned companies capable of long-term strategic actions. They find support at the highest government levels. Yet dig below the surface and these fast growing state-backed alliances are a stark contrast to stagnant private investment flows. The much anticipated Silk Road has both fast and slow lanes.

Private Gulf investors have, by and large, sat out the 20-year boom of the world's fastest growing economy. Compared to the hundreds of billions of dollars invested in the US and Europe, investment into China has been a fraction of what was predicted. After conducting interviews across the GCC, we found four main reasons for the Silk Road's slow lane. First, much of the $900bn invested in China over the past two decades has been used to build factories, supplying the type of low-cost consumer goods that are popular among consumers abroad. But most Gulf investors have little familiarity with this business.

Second, GCC investors are more likely to behave like private equity investors internationally, taking large stakes in established companies. Yet buying a minority stake in a Chinese electricity producer is far harder than purchasing a majority stake in a British supermarket or football club. Limited opportunities for majority ownership, red tape and official regulations are obstacles in China. Third, GCC investors lack expertise in Asian - particularly Chinese - markets and companies. While we found a universal belief among Gulf investors that China will become "the other superpower", few private companies had an actual plan on how to profit from China's rise. And few had internal staff with enough China expertise to develop such opportunities.

This included both moving investment dollars into Asia as well as bringing rising Chinese companies into the Middle East. Fourth, and most problematic, is the cultural divide. The Gulf's relationship with the West stretches back to at least the 1930s and the discovery of oil, while its relationship with China dates back no later than the 1990s. Jiang Zemin's visit to Saudi Arabia in 1999 was the first by a Chinese president.

By contrast, the West still has a strong gravitational pull for the Gulf's private companies. It is still an easier place to invest and find business development opportunities. Given this situation, the Silk Road offers a compelling opportunity to both broaden the fast lane and increase speed in the slow lane. The joint ventures between state-owned firms will be the fastest growing investment flows between China and the Gulf.

In our discussions with major Gulf state-owned enterprises, we have found significant interest in finding new ways to expand and broaden these existing relationships with Chinese companies. While the core activities of these joint ventures are resource agreements, ancillary activities were identified as an area ripe for expansion. Utilities, manufacturing and industrial equipment were cited as high priority ancillary opportunities that utilise both Chinese and GCC capabilities.

These joint ventures between state-owned companies are strategic platforms upon which multiple government-to-government interests can be developed. For private Gulf investors in the slow lane, the key will be the creation of cross-border investment vehicles that compensate for the lack of expertise and personal relationships on both sides. These Gulf-owned vehicles can identify rising Chinese companies that can add value to the Gulf's projects.

Encouragingly, China may also be softening its stance on private equity firms, recently permitting a few to raise Chinese yuan-denominated funds. Still, government priorities will continue to dictate the large opportunities and investments must speak strongly to these interests. On the one hand, China's government is keen to see greater investment in small and medium-sized enterprises, green companies and infrastructure firms.

On the other, Gulf governments are supportive of investments that diversify their private sectors, increase health and education capabilities, improve agriculture supplies, and help to solve power and water shortages, all while creating jobs for young citizens. The Silk Road is no longer just a romantic ideal, but a commercial reality. State-owned companies have so far led the way, but private firms will now have to catch up if this new route is to be built on sturdier foundations.

Ben Simpfendorfer is the chief China economist at the Royal Bank of Scotland and author of The New Silk Road. Jeffrey Towson is an adviser and former head of direct investments at Kingdom Holding Company, the investment company of Prince Alwaleed of Saudi Arabia.