Saudi Arabia - WikiLeaks · 2014-01-13 · Saudi Arabia 3 Country Finance 2008 ' The Economist Intelligence Unit Limited 2008 Market assessment • All commercial banks had to spin

Country Finance

Saudi Arabia

Released February 2008 The Economist Intelligence Unit 111 West 57th Street New York NY10019 USA

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Saudi Arabia 1

Country Finance 2008 www.eiu.com © The Economist Intelligence Unit Limited 2008

Contents 3 Market assessment

3 Market watch

4 Saudi Arabia at a glance

5 Banks Overview Bank regulators Domestic banks Foreign banks Investment banks and brokerages Development and postal banks Offshore banks

15 Other financial institutions Overview Insurance companies Pension funds Mutual funds Asset-management firms Venture-capital and private-equity firms Factoring firms Financial leasing companies Other institutions

21 Monetary system Overview Base lending rates Monetary policy Fiscal policy

24 Currency Overview Currency behaviour Currency outlook

25 Foreign-exchange regulations Overview Incoming direct investment Portfolio investment Restrictions on trade-related payments Loan inflows and repayment Non-residents borrowing locally Repatriation of capital Remittance of dividends and profits Remittance of royalties and fees Hold accounts Netting

29 Taxation and investment incentives Overview Corporate tax rates Taxable income defined Tax traps Incentives

33 Cash management Overview Payment clearing systems Receivables management

Payables management Cash pooling

35 Securities markets Overview Trading, clearing and settlement Listing procedures Underwritten offerings Rights offerings Private placements GDRs/ADRs Alternative markets

40 Currency and derivatives markets Overview Currency spot market Futures and forward contracts Options Swaps Exotics Regulatory considerations

42 Short-term investment instruments Overview Time deposits Certificates of deposit Treasury bills Repurchase agreements Commercial paper Banker�s acceptances

44 Short-term financing Overview Overdrafts Bank loans Discounting of trade bills Commercial paper Banker�s acceptances Factoring Supplier credit Intercompany borrowing

46 Medium- and long-term financing Overview Bank loans Financial leasing Corporate bond issues Private placement of notes Structured finance Infrastructure financing

50 Trade financing and insurance Overview Export insurance programmes Official export-credit programmes Private export-financing techniques Import credit Countertrade Forfaiting

2 Saudi Arabia


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Rosemary Didomizio

Amy Ha

Ali Kabir

Tom Ehrbar Managing editor, Country Commerce

Rachel Makabi

Conrad von Igel

Debarati Ghosh Managing editor, Country Finance

Saudi Arabia 3


Market assessment • All commercial banks had to spin off their investment-banking, brokerage and asset-management divisions into separate legal entities by end of the second quarter 2007. As a result, some banks created new divisions and subsidiaries to conduct their portfolio management and investment-banking operations. 11

• Morgan Stanley and Merrill Lynch (two major US investment banks) entered the Saudi market in 2007 to offer investment-banking and financial services. Morgan Stanley has a joint venture with Saudi-based Capital Group, and Merrill Lynch is also working to establish itself as a player in the local Islamic-banking sector. Saudi Hollandi Capital Company, a venture of Saudi-Dutch bank Saudi Hollandi, also received a licence to provide financial services. 13

• The Council of Ministers in August 2007 announced that the Capital Market Authority (CMA) must treat Saudi nationals and citizens from the other five members of the Gulf Co-operation Council (GCC) equally with regard to share ownership and trading on the Saudi stockmarket. The decision is in line with the 2002 GCC summit resolution that required all GCC nationals to be given full equality in all economic activities by end-2007. 28

• The Saudi stockmarket made a comeback in 2007 along a more reasonable and sustainable trend, compared with the boom and bust in 2006. The Tadawul all-share index (TASI) gained 41% in 2007. 35

• The CMA in October 2007 launched a new electronic trading platform for the Tadawul (the Saudi Arabian stock exchange operator), developed with the Scandinavian stock exchange operator, OMX. The new system increases the capacity for processing share transactions and strengthens the CMA's ability to monitor activity and detect market manipulation. The OMX-inspired system replaces the last update, which occurred in 2001. 38

• The Tadawul absorbed 26 initial public offerings (IPOs) in 2007, roughly two-thirds of which were from insurance companies. The flurry of IPOs by insurance companies reflects the new regulatory regime for the industry; under the new regime, firms that are approved by the Council of Ministers must complete the listing requirements for the stock exchange before the Saudi Arabian Monetary Agency (SAMA�the central bank) will grant them a licence. The IPOs have all been heavily oversubscribed. 39

• In July 2007 the Saudi Electricity Company (SEC) launched the largest sukuk (Islamic investment certificate) ever issued by a Saudi entity, one year after a SR3bn record-breaking sukuk issue. HSBC Saudi Arabia was the sole lead manager and bookrunner for the issue, which was double the company�s issuance target. 48

Market watch • The Saudi government will launch an initial public offering (IPO) in 2008 of its newest domestic bank�Bank Inma�after failing to bring the shares to market by end-2007, though it did not specify the month the IPO would take place. The government is looking to sell 70% of the bank�s shares of the new Islamic bank. 11

• Saudi Arabia in early 2008 was anticipating the implementation of the new and comprehensive mortgage law, which could revolutionise housing finance in the kingdom. Given robust property prices and Saudi Arabia�s high rates of population growth, the new mortgage law is expected to lead to strong growth in demand for mortgages. Several local banks have already launched Islamic mortgage products in anticipation of the coming law. 20

• The Saudi Arabian Monetary Agency (SAMA�the central bank) will likely preserve its currency peg to the US dollar to reduce investor risk perceptions, as it tries to attract more inward investment at a time when regional political risks remain high. An upward revaluation would also reduce the competitiveness of non-oil exports as well as the value of the country�s US dollar holdings. 22

• The Economist Intelligence Unit expects the fiscal account to remain in surplus in 2008-09, buoyed by strong oil export earnings, which will continue to account for around 90% of government revenue. Meanwhile, few, if any, steps to increase tax revenue are likely to be taken. 23

4 Saudi Arabia


Saudi Arabia at a glance

Government: Saudi Arabia is an absolute monarchy, ruled by the Al-Saud family. The death in August 2005 of Fahd bin Abdel-Aziz al-Saud, who had been king since 1982, was followed by a smooth transfer of power to Abdullah bin Abdel-Aziz, who had been the de facto ruler for most of the past decade. The post of crown prince has gone to Sultan bin Abdel-Aziz al-Saud, as had been widely expected.

The monarch appointed a Consultative Council in 1993, but it has a very limited mandate and does not affect the power structure or decision-making process. The House of Saud maintains close relations with the country�s religious leaders, and sharia (Islamic law) is the basis for legislation. Political parties are prohibited, and there are currently no prospects of lifting the ban.

Moody�s Investors Service: Aa3

Standard & Poor�s: AA−

Fitch: A+

*Senior unsecured long-term foreign-currency debt ratings.

Economist Intelligence Unit country risk rating Sovereign risk Currency risk Banking sector risk Political risk Economic structure risk

A BBB A B BBB * Overall scores for each risk category are on a numerical scale of 0�100 (0 least risky, 100 most risky). There are ten rating bands based on this numeric scale�AAA, AA, A, BBB, BB, B, CCC, CC, C and D�each comprising ten units of the 0�100 scale. For example, scores 0�10 = AAA and > 10�20 = AA. If the score is in a boundary area between two rating bands (scores ending in 0, 1, 2and 9), it is at the analyst�s discretion whether to assign the higher or lower rating. The overall score for each category of risk is a weighted combination of the scores assigned to the qualitative and quantitative indicators that inform our credit risk model.

Economic assessment 2006a 2007 b 2008c

GDP (US$ bn at current market prices) 349.1 372.4 402.6GDP growth (% real change) 4.3 3.5 6.0Private consumption (% of GDP) 25.5 26.9 28.1Government consumption (% of GDP) 25.2 26.0 26.5Gross fixed investment (% of GDP) 17.0 18.8 19.9Exports of goods and services (% of GDP) 62.2 58.3 57.7Imports of goods and services (% of GDP) 30.7 30.8 33.0Consumer prices (% change av) 2.3 4.0 5.0Exports fob (US$ bn) 211.3 230.8 254.2Imports fob (US$ bn) -63.9 -82.4 -103.9Current-account balance (US$ bn) 99.1 92.0 87.9Current-account balance (% of GDP) 28.4 24.7 21.8Public-sector debt (% of GDP) 32.2 23.4 18.2Exchange rate (SR:US$1, av) 3.745 3.745 3.745

(a) Actual. (b) Economist Intelligence Unit estimates. (b) Economist Intelligence Unit forecasts.

Source: Economist Intelligence Unit, Country Forecast Saudi Arabia, January 2008.

Political structure

Sovereign debt ratings*

Saudi Arabia 5


Executive summary

Saudi banks are a mix of conventional, Western-style banks and Islamic institutions that avoid charging interest. The sweeping Capital Market Law, passed in 2003, is permitting a greater number of foreign banks to enter the once highly restricted market. Other financial intermediaries�such as investment banks, fund managers and leasing companies�have enjoyed only limited development. Insurance companies, both foreign and domestic, were officially recognised by a new insurance law that sanctions their operation. Formerly hemmed in by religious restrictions, the Saudi cabinet acted to meet the demand spurred by the introduction of mandatory automobile insurance and health coverage for expatriate workers. Foreign financial institutions have traditionally been barred from the local market, with a few exceptions for banks from neighbouring states and Western investment bankers with international mandates. In addition, in early 2008, the country was awaiting the passage of a long-awaited mortgage law, which would greatly expand the country�s mortgage-finance market. Saudi Arabia has a stable economy in which the local currency and interest rates are tied to their counterparts in the United States. Foreign direct investors continue to face many restrictions on their activities, despite the passage of liberalising legislation in 2000 and 2001. Saudi Arabia boasts the largest stockmarket in the Arab world by capitalisation. The stockmarket has grown into an important venue for mobilising capital and is now one of the most dynamic in the region, despite the relatively limited number of companies listed. The passage of the Capital Market Law established an official trading floor for the new Saudi Arabian Stock Exchange, an independent market regulator and a new securities clearinghouse. Markets for debt securities, particularly those compliant with Islamic law, are developing rapidly and fast becoming a common source of corporate finance. Although Saudi Arabia has a relatively large financial system, its development remains constrained by restrictions in Islamic law and a tradition of secrecy in corporate affairs. Conventional bank credit, Islamic financing and leasing are all viable sources of funds.

Banks

The Saudi government is gradually opening up the banking sector to competition, as shown by the spate of new branch openings since 2002. The Saudi Arabian banking sector comprised 12 locally incorporated commercial banks and ten branches of foreign banks as of end-January 2008. Eleven of the 12 local banks are majority privately owned. The largest, National Commercial Bank (NCB), is majority-owned by the Saudi government through the Public Investment Fund (69.3%) and the General Organisation for Social Insurance (10%). The government holds various minority shares in many other Saudi-incorporated banks.

Al Bilad Bank launched in the first half of 2005, becoming the first domestically developed bank in many years. Private investors own 50% of the bank and the balance is held mostly by private institutional investors. Along with Al Rajhi Bank and Bank Al Jazira, Al Bilad operates on Islamic principles. The Saudi government announced the creation of the kingdom�s newest bank, Bank Inma, in March 2006, with an initial public offering (IPO) that was to follow in 2007. This did not happen, but the government claimed in late 2007 that it will sell 70% of the bank�s shares in 2008, though it did not specify when.

There has never been a bank failure in the kingdom, and all local commercial banks are highly capitalised, profitable and well supervised. According to the latest aggregated analysis of financial soundness of Saudi banks from the NCB, in 2006 the Tier 1 capital adequacy ratio (CAR) for Saudi Arabia�s domestic banks averaged 19.5%, the highest level in at least five years. Bank Al Jazira registered abnormally high growth in Tier 1 CAR, which rose to 40%, up from an already high level of 25%, according to the NCB report. According to the

Overview

6 Saudi Arabia


same report, Saudi banks� non-performing-loan ratios ranged from Bank Al Jazira�s high of 3.1% to Saudi British Bank�s low of 0.4%. According to the Bank for International Settlements, Saudi banks have agreed to implement the Basle II Capital Adequacy Standard by end-2008. The Basle II Framework describes a more comprehensive measure and minimum standard for capital adequacy that national supervisory authorities are now working to implement through domestic rule-making and adoption procedures.

However, the health of the banking sector is somewhat precarious, as it is closely linked to the strength of the country�s petroleum earnings, which continue to dominate the economy. This was strikingly apparent in 1998 and the first half of 1999, when a slump in oil revenues forced the government to delay payments to its creditors, which in turn put strong pressure on domestic bank profits. After the liquidity crunch of 1998�99, banks recorded strong profit growth as oil prices recovered and hit record highs from 2005 that continued as of early 2008�boosting government revenues and investment levels accordingly.

According to the Saudi Arabian Monetary Agency (SAMA�the central bank), combined bank assets continued to climb in 2007 on the back of the positive effects of record-high oil prices and economic expansion. At end-October 2007, the sector�s total assets�excluding SAMA�s assets�stood at US$272bn, up 22% from end-October 2006. A breakdown of the combined assets of the banking sector revealed that 54% of the total was accounted for by loans to the domestic private sector, 16% by loans to the domestic public sector and 16% by foreign assets.

Historically, banks have dominated the financial system in Saudi Arabia, being the main providers of funding to companies, not counting self-financing. Bank credit to the private sector�consumer and corporate�accounted for a major source of banks� resources (SR496bn in the second quarter of 2007), averaging above 50% of banks� total assets, according to NCB�s Market Review and Outlook, published in October 2007. Because of increases in domestic saving and a current-account surplus over the last few years, Saudi banks are awash with liquidity, as credit to the corporate sector accounted for nearly 50% of non-oil GDP in mid-2007. Saudi accession to the World Trade Organisation in December 2005 and financial liberalisation have accelerated foreign financing and direct access to capital markets, reducing corporate-sector reliance on banks� funding. Moreover, other avenues of financing have opened up in recent years with the growth in IPOs and corporate debt issuance. Between September 2006 and June 2007, funds raised through IPOs and sukuk (Islamic investment certificates or bonds) totalled SR16.4bn and SR27.4bn, respectively, according to the same NCB report.

In The Banker�s �Top 100 Arab Banks� list, published in November 2006 (but not updated again as of early February 2008), Saudi banks dominated the list, as they had in previous years. Overall, banks of the Gulf Co-operation Council (GCC) were prominent in the Top 100 listing. Saudi banks accounted for well over a third of all Arab bank profits in 2005 and, with assets of US$193bn that year, also accounted for more than a quarter (25.2%) of aggregate Arab assets.

Saudi Arabia 7


The sector�s proven ability to earn profits partly reflects the terms on which many bank liabilities are held. Although most deposits are placed in interest-bearing accounts, a substantial proportion are held in demand accounts that bear no interest (in accordance with Islamic law), which increases bank margins on credit facilities. The short-term nature of such demand deposits creates a potential mismatch between short-term deposits and longer-term credit outlay; ultimately, it has simply limited the banks� ability to extend long-term facilities. However, banks are increasingly lengthening the terms on loans, reflecting their growing sophistication.

All the kingdom�s commercial banks offer a broad range of services, but institutions have established themselves as market leaders in particular areas, often as a result of the expertise of their foreign partners. Samba Financial Group, for instance, has pushed itself to the fore as a provider of investment-banking services, in large part by drawing on the expertise of its former minority shareholder, Citigroup of the US. NCB has led the way in establishing and marketing mutual funds to local savers.

As of early February 2008, Al Rajhi Bank, Bank Al Jazira and Al Bilad Bank were the kingdom�s only fully operational Islamic commercial banks, but all banks have introduced Islamic products and services as the market for such investments has surged in recent years. For instance, at end-2006 (latest available information), of each bank�s overall loan totals, NCB�s sharia-compliant facilities took a 45% share, Riyad Bank 38%, and Saudi Investment Bank 19%, according to an October 2007 Middle East Economic Survey report based on banks� annual reports.

In addition to the commercial banks, there are five state-run specialised credit institutions that provide funds for targeted sectors. Despite marginal lending activities in recent years, these agencies are still important players, with a combined outstanding loan portfolio of SR130bn as of June 2007, according to SAMA.

The nucleus of the banking sector is the capital city, Riyadh, where SAMA is based and where the country�s key banks have their headquarters. Jeddah, the traditional trading hub, also has a substantial financial-services sector�it hosts much of the insurance business as well as the largest bank in asset terms, NCB.

The importance of offshore banking units in Bahrain and Dubai, previously major players in Saudi Arabia, is diminishing.

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Financial market indicators Demand for financial services

Population (estimated), mid-2007a (m) 24.29 Under 15 (m) 9.27 Between ages 15 and 64 (m) 14.44 Age 65 and above (m) 0.58Gross domestic product (estimated), 2007a (US$ bn) 372.38Gross domestic savings (estimated), 2007a (US$ bn) 165.33Gross domestic product per person (estimated), 2007a (US$) 15,330Personal disposable income per person (estimated), 2007a (US$) 4,310Private consumption per person (estimated), 2007a (US$) 4,120Financial intermediaries

Total lending by financial sector (estimated), 2007a (% of GDP) 52.30Total lending to the private sector (estimated), 2007a (% of GDP) 38.79Insurance companies total premiums, 2006b (% of GDP) 0.46 of which life insurers, 2006b (% of GDP) 0.01Pension-fund assets, end-November 2007c (% of GDP) 32.21Mutual-fund assets, end-June 2007c (% of GDP) 5.71Factoring turnover, 2006d (% of GDP) 0.00Capital markets

Domestic equity market capitalisation, end-2007e (% of GDP) 136.20International financial sector and corporate debt issues outstanding, September 2007f (% of GDP) 1.91

Sources: (a) Economist Intelligence Unit, Market Indicators and Forecasts. (b) Swiss Re, Sigma 4/2007. (c) Saudi Arabian Monetary Agency (SAMA�the central bank). (d) Factors Chain

International. (e) Tadawul. (f) Bank for International Settlements, Quarterly Review on International Banking and Financial Market Development.

The Saudi Arabian Monetary Agency (SAMA), based in Riyadh, is the kingdom�s central bank and is under the supervision of the Ministry of Finance. SAMA issues currency and regulates commercial banks and other financial institutions under its control. It manages the government bond programme, oversees the foreign-exchange market and stockmarket, and manages the nation�s electronic debit-payment system. SAMA also closely monitors international loan syndications and has a say in any government or private-sector moves to develop financial institutions, systems and instruments. The Ministry of Commerce and Industry also has a role in licensing banks and certain areas of regulation related to the stockmarket and government-bond markets, but SAMA is the dominant force. The Capital Market Authority (CMA) is responsible for licensing and regulating investment-banking activities.

Staffed largely by Western-educated technocrats, SAMA is well regarded as an efficient and effective regulator, and has been the driving force behind most efforts in recent years to strengthen and reform the banking and financial-services sector. It has broadened the range and depth of its supervision in recent years and has stepped up disclosure requirements for the banks it oversees. For example, in 2000 SAMA decreed that all banks adopt International Accounting Standards Nos. 34 and 39, which standardise accounting rules between interim and annual reports and establish guidelines for valuing certain assets in company balance sheets, respectively. SAMA also introduced rigorous disclosure requirements for banks in relation to money-laundering legislation enacted in the aftermath of the September 2001 terrorist attacks in the US.

Bank regulators

Saudi Arabia 9


SAMA carries out a full review of the operations of each bank every three years and more regular assessments of specific functions within each institution. Aside from the formal inspection process, the small number of banks operating allows SAMA to stay closely informed on developments in the largest institutions on an ongoing, informal basis.

SAMA has intervened to support banks that have found themselves in difficulties, and it is widely believed that no bank failures will be allowed. It intervened most explicitly in the early 1960s, when it saved Riyad Bank from insolvency. More recently, it acted to ease the panic that followed the 1990 Iraqi invasion of Kuwait, which directly threatened Saudi Arabia�s own security.

SAMA exercises broad control over the local availability of credit by enforcing the provisions of the Banking Control Law of 1966. Among the important regulations are the following:

• a bank�s risk-weighted capital-to-assets ratio must exceed the agreed minimum international standard of 8% (under Basle I; Saudi Arabia and the other Gulf Co-Operation Council (GCC) states plan to implement Basle II standards by end-2008);

• total deposits may not exceed 15 times a bank�s capital and reserves;

• loans to a single customer may not exceed 25% of a bank�s capital and reserves, and exposures of more than 10% must be reported to SAMA; and

• lending to shareholders and other related parties is limited to 10% of a bank�s capital.

Banks must also maintain a liquid-asset level of 15% of deposit liabilities. Banks may not hold more than a 10% stake in any company.

Banks must keep 7% of their demand deposits and 2% of their time/savings deposits with SAMA in non-interest-bearing accounts. The banks may not access these statutory requirements.

In addition to SAMA and the Ministry of Commerce and Industry, the clergy (ulema) play an occasional role in banking by ruling on whether certain instruments contravene Islamic law. There are occasional difficulties, but the clergy have proved to be quite lenient in their interpretation of what constitutes a violation of Islamic law prohibitions on the charging or payment of interest, and they have caused little disruption to the financial markets.

10 Saudi Arabia


Top ten commercial banks Ranked by assets as of end-September 2007a�SR m

Bank Assets Net profit Loans and advances Deposits

Number of branches

National Commercial Bank 192,388 4,815 86,793 136,428 265Samba Financial Group 141,287 3,868 77,914 105,905 65Al Rajhi Bankb,c 105,209 7,302 � 73,101 403Riyad Bank 105,280 2,218 64,843 76,397 198Al Saudi Al Fransi 90,279 2,071 57,047 66,484 71Saudi British Bank 89,577 1,902 54,185 70,287 62Arab National Bank 85,631 1,976 57,786 61,773 123Saudi Hollandi 48,100 545 27,400 30,600 41Saudi Investment Bank 45,127 868 21,746 30,538 24Al Bilad Bankb,d 15,352 60 � 9,808 58

(a) Figures for nine months ending September 30th 2007, unless otherwise noted. (b) As Islamicbanks, Al Rajhi and Al Bilad do not characterise advances to customers, shareholder projects orcompanies as loans. (c) Figures for end-2006. (d) Figures for six months ending June 2007.

Sources: Individual banks� quarterly and annual reports; Saudi Arabian Monetary Agency.

The first stop for any corporate or project borrower is one of the commercial banks specialising in corporate or project credit, or one of the well-known non-bank investment and financial-consulting firms, such as Rana Investment and Bakheet Financial Advisors in Riyadh. Financial-advisory services are available from all the major banks, several private firms and some banks located abroad. Fixed-rate, long-term debt financing is difficult to secure, and most commercial banks still primarily provide short-term financing, in large part because of their short-term balance-sheet liability structure. However, banks are increasingly lengthening the terms on loans, reflecting their growing sophistication. Most of the major banks act as universal banks.

Saudi Arabia�s economy is highly dependent on oil exports, and world oil prices remained robust in 2007, as they did for much of the preceding three years. The firm prices supported high levels of government expenditure, consumer and business confidence, and loan demand. Consequently, bank lending, particularly to the private sector, reinforced economic growth and fuelled greater demand in credit.

According National Commercial Bank�s Saudi Banking Sector Update published in March 2007, the bank�s analysts expected Saudi banks to witness two main changes in the operating environment over the next couple of years: first, competition in the commercial-banking business will further stiffen; and second, competition in the investment-banking business will reduce the contribution of equity-related banking fees to bottom lines.

The number of retail branches of domestic banks grew from 1,267 by end-September 2006 to 1,340 by end-September 2007, according to the Saudi Arabian Monetary Agency (SAMA�the central bank). Savings, mortgage and co-operative banks do not exist as such in Saudi Arabia. All commercial banks offer savings accounts as part of their broader retail-banking services. To ease Islamic sensibilities on the payment of interest, these �investment accounts� are often operated on a mudarabah, or profit-sharing, basis. Under this system, payment on a savings account is linked to the profit generated by the bank as a

Domestic banks

Saudi Arabia 11


whole, with the proportion increasing with the length of the withdrawal notice period. Current accounts offer no remuneration.

Islamic finance, particularly in the Gulf, has grown at double-digit annual rates for over a decade, and shows no sign of slowing. Governments and investors are feeding the demand. The Saudi Council of Ministers in March 2006 approved the launch of a new Islamic bank, Bank Inma, with SR15bn (US$4bn) in capital. The government planned to launch an initial public offering (IPO) in 2007, but as of February 2008, was looking to sell 70% of the bank�s shares to the Saudi public later in the year (though it did not specify when); under the plan, the state-owned Public Investment Fund, the General Organisation for Social Insurance and the General Pensions Authority would each hold a 10% stake.

In February 2008, the country was anticipating the implementation of the new and comprehensive mortgage law, which could revolutionise housing finance in the kingdom. For years, in the absence of clearly defined repossession laws, commercial banks could not offer traditional mortgages. At the same time, rising rental costs have pushed up the rate of inflation in the kingdom. Samba Financial Group estimates that banks and financial institutions financed only 6% of house purchases in 2007. To circumvent the restrictions on mortgages, Saudi banks created new methods of mortgage financing. For example, Saudi British Bank launched a housing-finance product in June 2001, based on a joint venture with the Saudi Real Estate Company, whereby the bank legally owned the property during the term of the loan.

In early February 2008, the government took initial steps toward the promulgation of a mortgage law when the International Finance Corporation (IFC�the private-sector financing arm of the World Bank) signed an agreement with Saudi Arabia�s three principal savings institutions to set up a housing-finance facility. The three institutions are the Public Investment Fund, the General Organisation for Social Insurance and the Public Pensions Agency. The IFC envisages using the facility, set up in partnership with the three agencies, to provide long-term financing to banks and housing-finance institutions to help them provide affordable financing to lower-and middle-income households. Given robust property prices and Saudi Arabia�s high rates of population growth, the new mortgage law�when passed�is expected to lead to strong growth in demand for mortgages. Several local banks have already launched Islamic mortgage products in anticipation of the coming law.

All commercial banks had to spin off their investment-banking, brokerage and asset-management divisions into separate legal entities by the end of the second quarter 2007. As a result, some banks created new divisions and subsidiaries to conduct their portfolio-management and investment-banking operations. For example, Al Rajhi Bank in mid-2007 created Al Rajhi Financial Services as a separate division, which manages the company�s mutual funds.

Ten majority foreign-owned banks operate in the kingdom through branches. In October 2000 the Saudi Arabian Monetary Agency (SAMA�the central bank) granted a licence to the Bahrain-based Gulf International Bank (GIB) to open an office in Riyadh. This was the first licence to be issued to a foreign bank in

Foreign banks

12 Saudi Arabia


many years. Although GIB is majority foreign-owned�just over 60% of the bank is owned by the five other member-governments of the Gulf Co-operation Council (GCC)�the Saudi government holds the largest single stake (34%).

Since granting the licence to GIB, the Saudi government has approved similar operating licences for Emirates Bank International of the UAE (February 2002), National Bank of Kuwait (September 2002) and National Bank of Bahrain (September 2002). All three banks opened branches in Saudi Arabia during 2003. Deutsche Bank (Germany), BNP Paribas (France), JP Morgan Chase (US), Bank Muscat (Oman), State Bank of India and National Bank of Pakistan followed in 2004�06. The opening of the banking sector promoted greater integration with the GCC and helped pave the way for Saudi Arabia�s accession to the World Trade Organisation in December 2005. Furthermore, given that Saudi banks are among the largest and most profitable in the region, there is little threat to their well-being from the entry of neighbouring competition. In fact, Saudi banks could stand to gain from the policy, should reciprocal access to other GCC markets be granted.

The passage of the Capital Market Law in July 2003�which, among other changes, encouraged limited entry of foreign branch banks�also facilitated Saudi Arabia�s entry into the World Trade Organisation in December 2005, which in turn made financial services in the kingdom more transparent.

Foreign presence in banking is not limited to branches, however. Western banks have maintained minority holdings in some of the kingdom�s largest banks for decades. HSBC (UK) has a 40% stake in Saudi British Bank; Crédit Agricole (France) has a 31% share in Al Saudi Al Fransi; and ABN AMRO (Netherlands) has a 40% share in Saudi Hollandi. Citigroup (US)�one of the first foreign banks to establish a presence in Saudi Arabia, in 1955�sold its 20% stake in the Samba Financial Group to the government�s Public Investment Fund in May 2004. Citigroup and Samba already agreed in October 2003 to end their technical management agreement, which had existed since Samba�s establishment in the 1970s.

The major Saudi commercial banks dominate the investment-banking market through specialised corporate-finance divisions. The domestic commercial banks used to hold a monopoly over primary and secondary dealings in stocks and government securities. This broke under the Capital Market Law passed in July 2003, which allowed the establishment of independent brokerages that operate on a formal stock exchange under an industry regulator. Before the promulgation of the Capital Market Law, the well-regarded private firm Rana Investment was the only domestic non-bank institution providing financial-advisory and investment-banking services. Rana provides equity valuations and merger-and-acquisition advice, and arranges securitisation of consumer and trade credit. But since the passage of the law, spurred by burgeoning development options and record-high oil prices (which have generated wealth), foreign and domestic financial-services companies have rapidly entered the Saudi market. Saudi Arabia�s accession to the World Trade Organisation in December 2005 also helped make the financial sector more transparent.

Investment banks andbrokerages

Saudi Arabia 13


According to the US�Saudi Arabian Business Council, as of September 2007, the Capital Market Authority had granted 67 licences to investment companies to operate in the kingdom. However, it is unclear how many of these will begin operations in the coming years for two central reasons: first, some companies may not want to currently enter Saudi Arabia, but have a licence in the event that they decide to enter Saudi Arabia in the future; and second, the Saudi government could slow the process of operations after giving out licences, if it feels the market has become saturated.

Morgan Stanley (US) signed an agreement in April 2007 to partner with Saudi-based Capital Group to offer investment-banking services. Morgan Stanley will own the majority stake (though the exact amount was not specified) in the venture�named Morgan Stanley Saudi Arabia�with offices in Riyadh, Jeddah and Alkhobar. In July 2007 Merrill Lynch (US) received a licence to offer a full range of financial services, including merger-and-acquisition services in the kingdom. Merrill Lynch is also working to establish itself as a player in the local Islamic banking sector. In September 2007 Saudi Hollandi Capital Company received a licence to provide financial and consultancy services and hold client portfolios. Regional financial-services companies also entered the Saudi market in 2007, including Watheeqa Capital (Kuwait) and Shuaa Capital Saudi Arabia (UAE-Saudi Arabia), among others.

Saudi Arabia granted two licences in late 2005 to foreign investment banks�HSBC (UK) and Credit Suisse (Switzerland)�to offer brokerage services in the kingdom. HSBC holds 60% of the equity in HSBC Saudi Arabia; Saudi British Bank (in which HSBC owns a 40% stake) holds the remaining 40%. In addition to conducting international equity brokerage, HSBC Saudi Arabia provides corporate finance and asset-management services, including initial public offerings, private placements, rights issues, conventional debt securities, and mergers and acquisitions. The company is headquartered in Riyadh. Saudi Swiss Securities�the joint-venture brokerage between Credit Suisse and Saudi investors�opened in Riyadh during the second quarter of 2006. Credit Suisse was a founding member of the Dubai International Stock Exchange and aims to increase its presence in the Middle East. Deutsche Bank (Germany) entered a joint venture in April 2005 with local Al Azizia Commercial Investment Company to form Deutsche Al Azizia Financial Services to offer brokerage and investment-banking services.

There are no financial institutions in Saudi Arabia analogous to the development banks of other countries. The five government development funds, however, have a long history of providing funds to the kingdom�s agricultural, real-estate and industrial-project sectors. They provide subsidised funding to areas targeted for special development support, but there has been little net lending by specialised credit institutions since the mid-1990s, with outstanding loans remaining almost level since then. Saudi Arabia�s increasingly sophisticated financial markets and access to capital have lessened the importance of these specialised institutions in providing long-term financing, but an increase in liquidity in 2006�07 and the development expansion gave a slight boost to these institutions in the first half of 2007. According to the balance sheet of the Saudi Arabian Monetary Agency (SAMA�the central

Development and postal banks

14 Saudi Arabia


bank), development funds had SR121.5m in assets at end-2007, compared with SR114.5m at end-2006 and SR71.6m at end-2001.

Saudi Arabian Agricultural Bank was established in 1961 to provide financing for irrigation and agricultural projects. Through some 70 offices across the country, the bank extends loans that are usually interest-free and repayable over a period of 15 years. These loans are part of the government�s long-held but diminishing strategy of reducing dependence on imported foods. At the end of the second quarter of 2007 the bank�s total outstanding loans stood at SR9.4bn, according to the most recently published data provided by SAMA, almost unchanged from the SR9.3bn recorded at the end of the first quarter of 2006. Lending has stabilised since the initial drive to boost agricultural production, and outstanding loans have remained more or less unchanged since the mid-1990s.

The Real Estate Development Fund was founded in 1975 and provides subsidised funds for urban development, mainly the construction of new residential property. For personal mortgage use, the fund grants interest-free loans for up to 70% of the value of a home, repayable over 25 years. For investment purposes, the fund finances up to 50% of the construction costs. At end-June 2007, outstanding loans stood at SR72.6bn, marginally higher than the amount at end-March 2006. Despite the boom in the housing market, the fund�s loans have remained constant, a sign that Saudis are tapping the private commercial banks for housing loans.

The Saudi Industrial Development Fund (SIDF), established in 1974, offers subsidised medium- and long-term credits to private-sector industrial projects. The loans are part of the government�s effort to diversify the kingdom�s industrial base away from oil, reduce import dependence and boost non-energy exports. In April 2005, for example, SIDF approved SR515m for five industrial projects on polypropylene, fruit juices, poultry-meat processing, pastries and steel galvanising to domestic and foreign companies. Under the Foreign Investment Act of April 2000, majority foreign-owned ventures can gain access to funds, provided projects are in line with the government�s development goals. Loans are provided for a maximum of 15 years, with the repayment schedule designed to match the projected cashflow of the borrowing projects. SIDF finances up to 50% of the fixed assets, pre-operating expenses and start-up working capital. At the end of the second quarter of 2007, outstanding loans stood at SR12.4bn, up from SR10.2bn at the end of the first quarter of 2006.

The Public Investment Fund (PIF) provides low-cost medium- and long-term loans to what SAMA terms �commercially orientated public corporations�. This refers principally to the state airline, Saudia, and the large conglomerate Saudi Arabia Basic Industries, though other interests have also benefited. At end-June 2007 (latest available information) the fund�s total outstanding loans stood at SR19.5bn, significantly lower than the SR26bn at end-2003, but an increase over SR18.1bn at end-2006. The fund is unlikely to be a major source of financing for investment projects in years to come. However, according to a UAE-based newspaper, Saudi Arabia in November 2007 announced that it would transform PIF into a more flexible financing body to speed up decision-making, but no time frame was announced.

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The much smaller Saudi Credit Bank, founded in 1973, extends interest-free credit to support low-income individuals for home improvement, marriage, vocational training and purchase of cars for use as taxis, as well as for small-scale business activities. The bank�s total outstanding loans at end-June 2007 amounted to SR1.4bn, growth of almost 30% from end-March 2006.

There is no postal bank in Saudi Arabia.

There are no offshore banking centres that operate outside the normal regulatory environment. Offshore entities that play a role in Saudi Arabia�s financial system are based outside the kingdom (in Bahrain and Dubai, for example).

Other financial institutions

Banks dominate the financial sector; other institutions are still only marginal players. The passage of a new insurance law in 2003 has brought greater depth to the market by attracting new foreign and domestic insurers. That said, insurers will not offer financing, as is common in other countries. They will instead focus on traditional insurance activities, and consequently will not compete with banks. The state runs pension funds, leaving no room for private managers to enter.

The Capital Market Authority (CMA) received legal standing with the passage of the Capital Market Law in July 2003. The CMA became operational in mid-2004 with the naming of its directors, who hail from the Saudi Arabian Monetary Agency (the central bank), the Ministry of Finance, and the Ministry of Commerce and Industry. Based on the regulatory statute of the Securities and Exchange Commission of the US, the CMA may publish rules relating to the sector, approve the flotation of securities, determine the maximum and minimum commissions to be charged by brokers, determine the content of periodic financial reports, and license brokers and securities dealers.

Top ten foreign and domestic insurance companies Ranked by market capitalisation as of January 29th 2008�SR m

Company Market capitalisationNational Company for Co-operative Insurance (NCCI) 6,750Med Gulf Insurance 3,340Malath Insurance 2,940Alahli Takaful 1,130Salama 1,048Arabian Sheild 1,040Al Ahlia 985Gulf Union 957Allianz S F 948SAAB Takaful 933

Source: EFG Hermes Regional Valuation Table for January 29th 2008.

In July 2003, the Saudi cabinet approved the groundbreaking new insurance law, the Co-operative Insurance Companies Control Law. The law aims to improve regulation of the insurance sector in the kingdom. Under the law, all

Offshore banks

Overview

Insurance companies

16 Saudi Arabia


insurance companies providing policies in the kingdom must be locally registered and operate according to the principle of co-operative (or mutual) insurance, known as takaful. Customers put money into a communal fund and take out what they need in the event of a claim. Insurance companies charge a fee for managing the operation, and any money left over at the end of the year is paid back to customers. Crucially, all funds are invested according to Islamic, or sharia, principles. In practice, this means funds cannot be invested in companies whose main business is in gambling, alcohol, pork or interest-earning.

Insurance companies must also register as joint-stock companies and engage only in insurance and re-insurance activities. According to the standards of the law, an insurance company must be set up with at least SR100m and a re-insurer with at least SR200m. The Saudi Arabian Monetary Agency (SAMA�the central bank) regulates the sector. The maximum foreign investor equity participation is 49% and foreign branches are not permitted.

The law also made it possible for foreign firms to officially operate on an open and more extensive basis. Foreign insurance providers had previously operated in Saudi Arabia without being based there or subject to local regulation; some 100 or so insurance agencies (foreign companies registered offshore) had provided cover to Saudi nationals without official recognition. Foreign insurers are aware that there is major potential for growth in the Saudi insurance sector.

Prior to the opening of the sector to greater competition and foreign insurers, the state-run National Company for Co-operative Insurance (NCCI) had a virtual monopoly over the market. In January 2005 NCCI launched an initial public offering (IPO) on the Saudi exchange and listed 70% of its shares. Many new insurance companies raised capital through IPOs in 2007. The IPOs were staggered, at the discretion of the Capital Market Authority (CMA), to avoid overloading the local stockmarket.

Most of the new companies are joint ventures with foreign insurance companies. The government has also specified that 30% of the premiums must be retained within Saudi Arabia and that 30% of reinsurance must be conducted within the kingdom. Another critical element of the insurance law is the requirement that Saudis must make up 30% of the workforce of each firm. The government was aiming to create some 10,000 Saudi jobs by opening up this sector, but no information was available as to whether it was successful in this as of early 2008.

The insurance law builds on a programme launched in September 2002 that required mandatory health insurance for all expatriate employees in the kingdom by end-2005. From September 2003, all companies with more than 500 expatriate workers had to provide medical insurance for the expatriate staff and their families. According to the deputy general manager of Arabian Shield Co-Operative Insurance, as of end-2006 (latest available information) only about 500,000 of the estimated 7m foreign workforce had signed up for health-insurance programmes, indicating that in this segment alone, there is likely to be rapid growth. In addition, in November 2002 the government put in place a motor-insurance law that made third-party motor insurance compulsory.

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SAMA published the most comprehensive regulatory statements on conducting insurance business in the kingdom on January 5th 2008. Called the Draft of the Market Code of Conduct Regulation, the regulations, when implemented, would provide insurance providers and customers the rights, obligations and disclosure requirements to better regulate the sector. But before the code goes into effect, SAMA has requested that insurance companies, service providers and the general public provide their comments on the regulations by early March 2008.

Insurance, particularly life insurance, has historically been viewed as going against Islamic principles, which claim the practice is a form of gambling (in this case, betting against sickness and death). In order to circumvent accusations of legitimising this form of gambling, the more religiously rigorous principle of co-operative insurance enables those with insurance policies to be treated akin to shareholders, with an entitlement to a share in profits, but also with a potential obligation to pay additional money should unexpected losses occur. SAMA must approve licences to operate under the law, with input from the Ministry of Commerce and Industry. The Saudi Arabian General Investment Authority (SAGIA) issues the licences.

According to SAMA�s 2006 insurance-market survey�SAMA�s most recent comprehensive insurance survey�at end-2006 the insurance market experienced growth of 33% over the previous year, with gross written premiums reaching SR6.9bn, compared with SR5.2bn in 2005. This growth was driven by favourable economic conditions and the continuation of compulsory motor insurance and health insurance. General insurance gross written premiums represented 65% of the insurance market in 2006 and increased by 25% over the amount in 2005. Health insurance gross written premiums represented 32% of the insurance market during 2006, with protection and savings insurance gross written premiums taking 3%. Health-insurance coverage, which started from a low average, has shown the highest growth in recent years, according to SAMA.

According to the 2008 Saudi Arabia Insurance Report, published by Business Monitor International (BMI), out of 88 countries surveyed, Saudi Arabia fell in the third quartile in terms of absolute non-life premiums in 2006, but in the second quartile in terms of the growth of non-life premiums. The report categorises Saudi Arabia as a moderately large national market for non-life insurance, and one where premiums are growing quickly. In 2006 non-life insurance penetration in Saudi Arabia grew by 22.5%, while life-insurance density rose by 10.1%.

According to a 2007 report from the central bank�s Insurance Supervision Department, 42 companies had applied for an insurance licence as of September 2007, 18 of which had been approved by that time; most of these companies held IPOs as of January 2008. The remaining applications were still under consideration as of that time. The companies have until March 2008 to obtain a licence, after which they must cease operating in the country. The Saudi government in early January 2007 asked all unlicensed insurance companies to formulate an exit policy before January 15th 2008 and wind up operations on or before March 11th 2008. These insurance companies had to inform the regulator whether they will transfer their portfolio to a new

18 Saudi Arabia


company, which is licensed, or would cease writing new business from January 16th onwards.

The state-run General Organisation for Social Insurance (GOSI) and the Retirement Pension Agency are the country�s two primary pension funds. Both use the Saudi Arabian Monetary Agency (SAMA�the central bank) to manage their investment portfolios. Though portions of their funds are invested in local companies (both listed and non-listed) and foreign equities, the largest share is invested in government bonds.

According to SAMA�s balance sheet, as of end-November 2007, the Retirement Pension Agency and GOSI together had SR449.3bn in assets, up from SR420.4bn at end-November 2006.

Top ten investment funds Ranked in SR by net asset value (NAV) of one share as of January 20th 2008a

Fund name NAV Fund ManagerSaudi Istithmar Fund 6,437.59 Banque Saudi FransiCommodity Trading Fundb 1,821.36 Riyad CapitalRiyad Money Fund 1,382.81 Riyad CapitalAl Jawhara Ladies Fundb 905.62 Al Rajhi BankSaudi Equity Trading Fundb 777.44 Saudi Hollandi BankSaudi Banks Index Fund 532.86 Saudi Hollandi BankAl Rajhi Local Shares Fundb 394.66 Al Rajhi BankAl Taiyebat Saudi Equity Fundb 288.85 Bank Al JaziraSAIB Saudi Equity Fund 196.12 Saudi Investment BankAMJAAD Mizan Portfolio 194.23 Saudi Hollandi Bank

(a) Funds reporting between December 31st 2007 and January 20th 2008. (b) Sharia-compliant equity fund.

Source: Zawya Mutual Funds Monitor.

All mutual funds�also known as investment funds in Saudi Arabia�are managed by the commercial banks under the supervision of the Saudi Arabian Monetary Agency (SAMA�the central bank). They have experienced rapid growth since they were first introduced in 1979. By the end of the second quarter of 2007, 217 investment funds had been incorporated within the kingdom, with assets worth SR79.7bn, according to the latest figures published by SAMA. Mutual-fund assets had reached SR139bn at end-March 2006, but declined sharply after the stockmarket decline that followed in April of that year.

There were dramatic declines on virtually every local equity-based investment fund during 2006, owing to a market correction which started in February 2006. As a result, the best-performing investment funds in Saudi Arabia in 2006 were money-market or related funds; equity funds, particularly those with heavy biases towards domestic shares, posted large losses. Along with the general upswing in regional stockmarkets in 2007, following the 2006 correction, mutual funds turned in healthy returns for investors, but no single reliable source for aggregate returns is available.

Saudi mutual funds historically invested heavily in international stocks and bonds, but this changed in 2001, when Saudi investors began looking for safer

Pension funds

Mutual funds

Saudi Arabia 19


markets as the domestic market became more sophisticated and offered better returns. At end-June 2007, Saudi investment funds invested 71% of their assets at home, according to SAMA. In contrast, less than 50% of funds were invested at home as of early January 2001. Saudi investment funds have changed not only their geographic preference but also their portfolio allocations. Investors and investment funds were typically risk-averse and invested most of their assets in low-risk money-market instruments. From 2000 to 2006, investment funds invested heavily in domestic equities. At the end of the second quarter of 2006, 57% of all money invested in investment funds was placed in domestic equities, a dramatic turnaround from 2000, when only 11% was invested in domestic equities, according to SAMA. But following the bear market of 2006, Saudi investors decreased their equity preference, and by end-June 2007 only 31% of investment-fund assets were in domestic equities.

The number of subscribers to investment funds has also increased dramatically since 2000, from less than 96,000 investors to a historic high of more than 663,000 as of end-March 2006. But given the correction during 2006 and more moderate gains in 2007, the number of subscribers had fallen to 448,000 by end-June 2007, SAMA�s most recently published figures.

The growth and returns of mutual funds in Saudi Arabia have also led to portfolio managers� finding market niches. Al Rajhi Financial Services (ARFS), for instance, launched Al Jawhara Ladies Fund in 2001, which by end-2007 had increased in value by more than 130%. ARFS announced in January 2008 that it plans to build on that success and launch more funds catering to Saudi women. It is unclear, however, how the portfolio composition of Al Jawhara is distinct from other standard equity funds offered by ARFS.

The Council of Ministers in August 2007 announced that the Capital Market Authority (CMA) must treat Saudi nationals and citizens from the other five members of the Gulf Co-operation Council (GCC) equally with regard to share ownership and trading on the Saudi stockmarket. Previously, residents of GCC countries could not trade in banking and insurance stocks.

All the major banks offer asset-management services outside their investment funds. However, as banks have started consolidating niche roles within the banking system, National Commercial Bank has emerged as one of the most important players. The most significant non-bank financial institution offering asset-management services is Rana Investment Company. Established in 1986, Rana also provides its services to surrounding Gulf states. The emergence of foreign investment banks and brokerages since 2005 should also provide greater competition and services in the asset-management sector.

Since first-round capital is traditionally sourced from family and friends, the venture-capital sector is at an early stage of development in Saudi Arabia, as it is across much of the Middle East. However, the growth of the Saudi banking sector and financial services is pushing new investments in venture capital. The Saudi Arabian General Investment Authority (SAGIA); Venture Capital Bank, a Bahrain-based Islamic investment bank; and Global Emerging Markets (GEM), an international investment house, announced in February 2006 the

Asset-management firms

Venture-capital and private-equity firms

20 Saudi Arabia


establishment of an independent US$100m venture-capital company. According to the statement issued by SAGIA, the company aims to provide growth capital and late-stage financing to venture-capital opportunities and small and medium-size companies in Saudi Arabia in compliance with sharia principles. However, as of mid-February 2008, SAGIA had not released any additional statements on its ventures or status.

Prior to the creation of SAGIA�s firm, the nearest approximation to a venture-capital firm was the Saudi Industrial Investment Group (SIIG)�a local firm jointly owned by a number of leading Saudi businessmen. As its name suggests, SIIG focuses on industrial projects, most of which are large scale. SIIG in September 2007 announced that it will establish a new petrochemical company at a cost of SR18bn in joint venture with Chevron-Phillips (US). The project will likely start production in the last quarter of 2011.

The state-run Saudi Industrial Development Fund also provides �venture capital� but again focuses mainly on large industrial ventures. It is too constrained by government development objectives to constitute a venture-capital firm in the usual sense.

Factoring has attracted virtually no interest in Saudi Arabia. However, one company, Al Dhimmah Credit Collection Office, which is based in Damman, does specialise in collection services similar to factoring.

Equipment leasing in nearly all forms is available in Saudi Arabia through banks and vendors. It is popular because it can lock in returns on collateralised credit without breaking Islamic prohibitions on interest. As a result, Islamic finance houses in particular have shown a strong appetite for fixed-asset finance. In some cases, they have demanded smaller spreads and easier conditions than conventional funding sources.

The establishment in December 2000 of the first dedicated leasing company with foreign involvement�the Saudi Orix Leasing Company (SOLC)�further increased provision of this type of finance. SOLC is a joint venture involving the Japanese finance company Orix, the Saudi Investment Bank and the World Bank�s International Finance Corporation. In line with the requirements of the Saudi Arabian Monetary Agency (the central bank), SOLC focuses on medium-term leasing for small and medium-sized enterprises in the light-industrial and manufacturing sectors.

Home financing gets remodelled

In December 2007 the Saudi government approved the launch of Saudi Home Loans (SHL) to tap into a market where four out of five Saudis do not own a home. The Ministry of Commerce and Industry approved the launch of SHL�with capital of US$520m�which will provide loans compliant with Islamic law. Arab National Bank and Kingdom Instalment, a private housing-finance firm, each hold 40% in SHL. Dar Al Arkan Real Estate Development Company and the International Finance Corporation (the private-sector financing arm of the World Bank) hold the remaining 20%. The managing director of SHL, Abdullatif Al-Shelash, said the kingdom will need about 4.5m new housing units within the next five years to accommodate its growing population. SHL aims to cater mainly to the middle and the poor segments of the Saudi population. SHL will originate, underwrite and service real-estate loans. It will also use mortgage-backed securities and other financing structures to optimise the funding options.

Factoring firms

Financial leasing companies

Saudi Arabia 21


Many mortgage companies and specialised banks have been reluctant to enter Saudi Arabia because of the lack of clarity on mortgage regulations. The Saudi population is looking forward to clarity as well. The government announced in early 2007 that it would pass the long-awaited mortgage law at end-2007 or early 2008, though the law had not passed as of early February 2008. Most observers believe the law will be passed later in the year. Without the law the Saudi housing mortgage-finance market is virtually non-existent, mainly because of the absence of a clear mortgage system governing property ownership, property repossession, enforced eviction and asset liquidation in the case of delinquency. Anticipating the mortgage law, a number of banks in the kingdom have started offering sharia-compliant home-financing credit, with tenors extending up to 25 years. National Commercial Bank estimated that the size of outstanding housing credit is likely to rise from SR4bn at end-2007 to about SR46bn by the end of the decade, assuming a gradual rise in the share of new residential units purchased through housing loans, from 10% in 2007 to 55% by 2010. Most Saudi citizens rent their homes, and by January 2008 a number of local press reports said rents had risen by 10�50% over the previous months, building on years of rental-price increases. Many tenants have refused to pay the increases and accused real-estate owners, who demand higher rents, of being greedy. Some expatriates�primarily from India and Pakistan�have left the kingdom as a result of rising cost of living in recent months, and fewer skilled workers from countries such as India and Pakistan are seeking jobs in Saudi Arabia because of rising prices and the declining exchange rate of the riyal.

Aside from the commercial banks, the most important domestic sources of finance are the government�s five specialised credit agencies (see Development and postal banks). However, the following two sectors provide the most substantial funding to the commercial and consumer sectors.

Two Islamic financing companies of note are Dallah Al Baraka Group (DBG�based in Jeddah and owned by billionaire Saleh Kamel) and Dar Al Mal Al Islami (based in Geneva and operating through its Faysal Islamic subsidiaries in Saudi Arabia and Bahrain). Both institutions are active and carry sizeable portfolios. They have developed as quasi-banking entities and take in consumer savings in the form of share ownership in numerous vehicles, such as mutual funds or unit trusts. These funds are then deployed in a range of investments, from funding working capital for businesses via inventory or trade-finance lines to longer-term fixed-asset financing. They are also active in consumer-receivables financing, especially for automobiles.

A second area of funding development has been the expansion of the consumer instalment sector. Firms such as National Instalment compete for the rich spreads available for purchasing consumer receivables from dealers of automobiles, furniture, white goods (large household appliances) and other durable assets. The instalment finance sector may in future provide the basis for a mortgage-securities market, which does not yet exist.

Saudi banks and car dealers started the securitisation of receivables in 1993 to improve the liquidity of the dealers. It has spread to other sectors, and a high degree of sophistication has been achieved in pooling asset classes, such as consumer furniture loans, and measuring their default and payment performance over time. Standardisation of documentation and credit analysis has reached international levels.

Monetary system

The government�s approach to interest rates is governed by the primary goal of its monetary and exchange-rate strategy�the maintenance of the riyal�s fixed

Other institutions

Overview

22 Saudi Arabia


peg to the US dollar. Consequently, Saudi rates tend to track their counterparts in the US. With the riyal managed as a freely convertible currency, interest rates are the key tool in efforts by the Saudi Arabian Monetary Agency (SAMA�the central bank) to maintain the currency�s value. To that end, SAMA historically offered a positive differential for riyal deposits over dollar rates prevailing in the US. That changed in 2006 and carried through 2007, when US dollar deposit rates averaged roughly 40 basis points higher than the riyal deposit rates.

The flexibility of interest rates is limited by the Saudi riyal�s peg to the US dollar. A positive differential with US interest rates has been the historical norm in Saudi Arabia, reflecting the higher risk premium placed on a commodity-dependent emerging market with relatively high political risk. Nonetheless, the spread of 100 basis points in late 2007 and early 2008 between US and Saudi policy rates was high by historical standards, suggesting that the Saudi Arabian Monetary Agency (SAMA�the central bank) may need to cut the repo rate (its key policy rate) in 2008 to avert speculative pressure on the peg. The repo rate stood at 5.50% in January 2008, compared with 5.20% in January 2007, according to SAMA. SAMA will also continue to use other instruments, such as lending caps and reserve requirements, to manage money-supply growth.

Saudi banks establish their own cost-of-funds indexes and set commercial prime rates, though given the competitive nature of funding, the resulting rates are fairly consistent. The Saudi interbank offered rate (SIBOR) is the name given to the rate at which Saudi banks borrow and lend to one another. It is usually around 50 basis points above the London interbank offered rate (LIBOR). SIBOR stood at 5.05% at end-June 2007 and 5.09% at end-September 2007, according to SAMA.

The Saudi prime rate is the rate at which a bank�s best clients may borrow. The rate typically ranges from 300 to 500 basis points above SIBOR, depending on market supply and demand and banks� willingness to lend. Like prime rates everywhere, the Saudi prime is not a true market rate, meaning it is quick to go up but slow to come down.

Religious observances often affect the availability of credit. Because these observances are based on the lunar calendar, the Gregorian month in which they fall varies from year to year, and it is important to determine in advance when they will occur. Businesses often plan for the impact of tight monetary conditions due to restricted cashflow during the holy month of Ramadan and the annual haj season (a period during which up to several million visitors may arrive in Mecca and Medina). Another traditional period of tight liquidity occurs during the months immediately before and after the announcement in late December of the government�s budget. For all government and most private-sector accounting (with some exceptions), the January�December Gregorian calendar is used.

The Saudi Arabian Monetary Agency (SAMA) executes monetary policy under the authority of the Ministry of Finance and National Economy. Its approach is highly conservative and centres principally on maintaining the riyal�s peg against the US dollar at SR3.745:US$1, thereby restricting inflation and fostering

Monetary policy

Base lending rates

Saudi Arabia 23


financial stability. The peg has remained at this rate since 1986, proof of SAMA�s successful implementation of its mandate.

The end to historically low inflation in Saudi Arabia came to an end in 2006 and 2007, hitting 4% at end-2007, according to Economist Intelligence Unit estimates. We also expect inflation to rise to an annual average of 5% in 2008. For decades, inflation in Saudi Arabia had averaged well under 2% per year, with many years registering no price increases. The rise in inflation can be attributed to domestic and external factors. Domestically, inflation is driven by the expansion of liquidity in response to banks� lending and rising aggregate demand due to higher public spending. Externally, inflation is attributed to the rise in global commodity and food prices and a weakening US dollar. The depreciation of the dollar, and hence Saudi riyal, against partners� trading currencies has inflated the prices of imported goods. Broad money (M2; money including time and savings deposits and quasi-money) increased by 25% from the year to November 2007, according to SAMA. M2 will continue to grow strongly as oil export revenue feeds through into the local economy. Local economists believe SAMA is keen to preserve the exchange rate to the US dollar as an anchor to reduce investor-risk perceptions and attract more inward investment during a time of high political risks. An upward revaluation would also reduce the competitiveness of non-oil exports and the value of the country's US dollar holdings. It is also unclear how useful it would be in reining in inflation, which is largely driven by strong domestic demand and increasing rental costs, as well as by rising international commodity prices. SAMA may switch the peg to a basket of currencies in the medium to long term, but this option would likely require greater development of the local financial sector and markets�including the development of local-currency hedging facilities and new exchange-rate management capacity at the central bank.

Saudi Arabia is heavily dependent on oil revenue and its fiscal position is consequently highly vulnerable to the vagaries of world oil prices. Despite repeated talk about diversifying the revenue base, official breakdowns of oil and non-oil income show that oil earnings usually account for 70�80% of total fiscal revenue. Provisional data from the Ministry of Finance show that the fiscal account recorded a surplus of SR179bn (US$47.7bn) in 2007, equivalent to 12.8% of GDP. Budget surpluses will be used to retire elements of local-currency debt and to add to foreign assets and the Public Investment Fund.

The fiscal account is expected to remain in surplus in 2008�09, according to the Economist Intelligence Unit, buoyed by strong oil export earnings, which will continue to account for around 90% of government revenue. Meanwhile, few, if any, steps to increase tax revenue are likely to be taken. The budget surplus is forecast to decline from an estimated 12% of GDP in 2008 to 8% of GDP in 2009, as government spending continues to grow strongly, at an annual average of 16%. Much of the increase will be directed towards capital projects, which account for some 40% of planned spending in the 2008 budget, although the implementation of these projects will be hindered by an inefficient bureaucracy. At the same time, public-sector salaries will likely rise, and spending on subsidies will probably increase to mitigate the impact of inflation on consumers.

Fiscal policy

24 Saudi Arabia


Currency

The value of the Saudi riyal is set by the Saudi Arabian Monetary Agency (SAMA�the central bank) at a fixed rate against the US dollar; its price is thus unaffected by short-term fluctuations in supply and demand. For commercial purposes, the riyal is quoted by banks on a bid-offer basis, usually at a small premium to the parity fix. This premium partly reflects the fact that SAMA sells riyals at same-day value but credits banks with US dollars only on a next-day basis, thus forcing banks to forgo a day�s interest.

Source: Bloomberg.

Monthly average of the riyal versus the dollar, euro and pound

8.0

7.5

7.0

6.5

6.0

5.5

5.0

4.5

4.0

3.5

3.0

SR:£1SR:€1SR:US$1

J08

NSJMMJ07

NSJMMJ06

NSJMMJ05

NSJMMJ04

NSJMMJ2003

January 2003 to January 2008

Since June 1986 the Saudi riyal has been pegged to the US dollar at a rate of SR3.745:US$1. The decision in 1986 that the currency should track the US dollar at this rate was motivated by a number of considerations. First, it allowed for a stable exchange rate in relation to other Gulf Co-operation Council countries, whose currencies at that time were also, for the most part, pegged to the dollar. Second, it aimed to provide a stable investment environment for international and Saudi expatriate private capital. Third, with the vast majority of its exports (oil) denominated in US dollars, ensuring the currency is fixed to the dollar was seen as a natural way of minimising revenue volatility and imported inflationary pressures.

Maintaining the peg is the central element of monetary policy, as the Saudi Arabian Monetary Agency (SAMA) seeks to ensure stable prices and foster financial stability. However, as the peg is solely with the US dollar, the riyal�s nominal and real effective exchange rates appreciated significantly from the late 1990s to 2002, in line with an appreciation in the value of the US dollar. This trend only reversed in March 2002, when the US dollar began to lose value, causing a steady depreciation of the Saudi riyal in both nominal and real terms against other foreign currencies. This trend continued through 2007, resulting in increased inflation domestically and a reduction on the returns on dollar-based assets.

Overview

Currency behaviour

Saudi Arabia 25


There has been growing speculation that the Saudi Arabian Monetary Agency (SAMA�the central bank) will upwardly revalue the riyal�s peg to the dollar. However, the Economist Intelligence Unit expects that a revaluation is unlikely over the next two years, given SAMA�s long-standing commitment to the peg, which acts as a nominal anchor to reassure foreign investors and limits exchange-rate risk to the country�s main export�oil�which trades in dollars. The main argument favouring an upward revaluation is that it would dampen the inflationary pressure that has resulted from the weakness of the dollar (which has placed upward pressure on the price of some imported goods). However, consumer-price inflation remains contained, and import prices are only one of several factors contributing to inflation (including rising domestic rents and increasing world-food prices).

That said, if Saudi Arabia does revalue, the most likely scenario is that SAMA would peg the riyal to a basket of currencies, the way Kuwait does, rather than simply carry out a one-off upward revaluation against the dollar. A basket would probably be strongly weighted towards the dollar.

Foreign-exchange regulations

The government is committed to maintaining the free convertibility of the riyal; consequently, no significant restrictions are placed on the inward or outward movement of funds by companies or individuals. The only bar is on transactions with Israel. Transfer operations are increasingly sophisticated and fast, although occasional constraints on working hours or working days may cause a delay of one or two days in implementing orders.

Although there are no restrictions, foreign-exchange transactions are closely monitored by the Saudi Arabian Monetary Agency (SAMA�the central bank) to protect against speculation, fraud and money-laundering. Banks must report the export of riyal bank notes to SAMA and gain approval prior to the participation of foreign banks in riyal-denominated syndicated loans or foreign-currency syndicated transactions arranged for non-residents. SAMA has shown considerable flexibility in its approach to such arrangements, however, and has co-operated speedily with the vast majority of transactions.

Key SAMA banking regulations include requiring holders of personal accounts, and those authorised to sign on company accounts, to supply valid identification. Penalties for failing to meet the identification requirements differ according to whether the accounts in question were held by Saudi nationals or foreigners. In the latter case, any failure to comply with SAMA regulations results in an immediate freezing of the account. Saudi nationals, in contrast, receive a 90-day grace period to take the necessary action, provided their identification papers are updated.

In the wake of the terrorist attacks in the US in September 2001, in which 15 of 19 hijackers came from Saudi Arabia, the US and other countries began pushing Saudi Arabia to enforce more strictly laws against terrorist financing, particularly from charitable organisations serving as a front for other activities. In August 2003 Saudi Arabia passed into law the Rules Governing Anti-Money-

Currency outlook

Overview

26 Saudi Arabia


Laundering and Combating Terrorist Financing, the kingdom�s first anti-money-laundering legislation. The law makes terrorist financing a punishable offence, with jail terms of up to 15 years and fines of up to US$1.86m imposed on individuals who launder money through charitable organisations. The legislation implements all 40 recommendations of the Financial Action Task Force (FATF) regarding money-laundering and all eight of its recommendations regarding terrorist financing. The law took effect in October 2003.

The 29-article law requires banks and financial institutions to maintain records of transactions for a minimum period of ten years. This is even more stringent than the requirements for European Union banks, which must retain records of financial transactions for a minimum of five years. The legislation also compels Saudi financial institutions to formulate intelligence operations dedicated to foiling money-laundering schemes. These units must be capable of receiving and analysing money-laundering claims, preparing reports on suspicious transactions and recommending the seizure of money for a provisional period of no more than 20 days. Finally, the anti-money-laundering law calls for the exchange of information, as well as judicial action, with nations with which the kingdom maintains official agreements.

Before the passage of this comprehensive legislation, Saudi Arabia had undertaken a number of anti-money-laundering measures. It froze several bank accounts suspected of having been used in illegal dealings and took measures against other accounts submitted to the kingdom by the US on suspicion of funding terrorism. This new law, however, institutionalises the kingdom�s fight against money-laundering and was immediately praised by US officials. In April 2004 the special committee at SAMA responsible for fighting financial crime and money-laundering began a month-long process of freezing bank accounts defined as not operating in accordance with official regulations.

In September 2003, a team of assessors from the FATF conducted an evaluation of Saudi Arabia�s procedures against money-laundering and terrorist financing. The report produced by the team, which was submitted to the FATF in February 2004 and was the latest one as of early 2008, concluded that the systems and legislation in place in Saudi Arabia met the general obligations of the FATF recommendations. However, the FATF review was confined to examining the country�s laws and regulations, and it did not look at how effectively these are being implemented. Saudi Arabia is also a member of the Middle East and North Africa Financial Action Task Force, an associate member of the FATF.

Legislative watchlist

A comprehensive mortgage law is slated to pass in early 2008, which could provide the greatest boost to the Saudi home-finance market in history. Without the law, the Saudi mortgage-finance market is virtually non-existent, mainly because of the absence of a clear mortgage system governing property ownership, property repossession, enforced eviction and asset liquidation in the case of delinquency. The Saudi cabinet in November 2007 decided to appoint a board to the Saudi Capital Market Company (Tadawul), a fresh step in the institutional development of the Saudi stockmarket. Tadawul will now assume entire operational responsibility for the market, leaving the Capital Market Authority (CMA) to concentrate on regulatory matters. The board comprises one member each from the Ministry of Finance, the Ministry of Commerce and Industry and the Saudi Arabian Monetary Agency (SAMA�the central bank); four members from financial-services companies; and two from listed firms. Although

Saudi Arabia 27


practical details of the decision were absent as of early February 2008, the move should foster additional changes and allow for better management and transparency of the equity markets.

The United Nations Conference on Trade and Development (UNCTAD) defines Saudi Arabia as having high foreign direct investment (FDI) potential but low FDI performance. Nonetheless, Saudi Arabia attracted US$18.3bn in FDI in 2006, according to UNCTAD, an increase of 51% over 2005. Total stock of FDI in the kingdom in 2006 amounted to 19% of GDP, compared with 21% of GDP in the United Arab Emirates and 21% in Turkey, according to Economist Intelligence Unit estimates. In addition, the EIU estimates that Saudi Arabia attracted US$16.5bn in FDI in 2007.

The legislative framework governing FDI was thoroughly revamped in April 2000, when the government approved a Foreign Investment Act aimed at liberalising the rules regarding foreign investment. The legislation, which came into effect one month later, replaced the Foreign Capital Investment Act, issued in 1979, which had previously governed FDI.

The new law established a series of broad principles governing FDI (but not foreign-portfolio investment), including guarantees against expropriation and nationalisation, and allowance for the free repatriation of capital and earnings. Key improvements for foreign investors in the kingdom included the reduction of the maximum corporate-income tax rate to 30% (which later fell to 20%); access to the Saudi Industrial Development Fund, which now offers concessional finance for majority foreign-owned ventures (previously only locally owned ventures were eligible to apply); the right to own real estate; and companies� right to sponsor their own expatriate employees, rather than relying on a local sponsor.

The legislation also established a new body, Saudi Arabian General Investment Authority (SAGIA), to replace the Foreign Capital Investment Committee at the Ministry of Industry and Electricity. SAGIA is charged with serving as a �one-stop shop� for licensing and the provision of various government services to investors. SAGIA must directly answer to the Supreme Economic Council (SEC), headed by Crown Prince Sultan bin Abdel-Aziz al-Saud. Prince Abdullah bin Faisal bin Turki, a well-regarded former director of the Royal Commission for Yanbu and Jubail, heads SAGIA.

SAGIA promises to either grant or refuse a project licence within 30 days of application. According to the new code, if a decision is not reached within this time, the licence will be issued by default. In fact, reports suggest that SAGIA has been issuing licences in as little as one week.

SAGIA was also charged with drawing up detailed secondary foreign-investment legislation for approval by the SEC and the cabinet. In February 2001 it published a detailed �negative list� of sectors closed to majority foreign-owned firms, with a pledge that it would be reviewed annually and eventually eliminated in line with Saudi Arabia�s obligations to the World Trade Organisation (WTO). As of early February 2008, the list contained 16 sectors (three industrial and 13 service sectors, two less than the previous year. Several of the service sectors still closed to FDI�including defence, health and broadcasting�are subject to FDI restrictions in most countries, even in those

Incoming direct investment

28 Saudi Arabia


WTO member nations most vocally in favour of opening service sectors to foreign investment. The list was first shortened in February 2003, with the removal of insurance, power transmission and distribution, education, and pipeline services.

There are hopes that the Capital Market Law passed in July 2003 will help stimulate interest from foreign institutional investors. Most of the law�s provisions came into effect in 2004, and these are resulting in initial public offerings (IPOs) of shares in some of the companies that are currently state-owned.

The 1983 Royal Decree (Resolution 124), which requires foreign contractors (companies with less than 51% Saudi ownership) to subcontract at least 30% of the value of a contract to 100% Saudi-owned firms, is still widely enforced by all ministries and agencies. To obtain advance or initial contract payments and to subsequently repatriate profits, foreign contractors must prove their contracts are at least 30% subcontracted. The contractor may comply with the ruling during any period of the contract but will receive only a proportion of payment until compliance has been proved. Operations and maintenance contracts fall within the scope of the resolution. There is more leniency in this regard in manufacturing, and foreign firms willing to transfer advanced technology, especially in telecommunications and data-processing, find that the rules may be relaxed.

For further information on setting up an investment, see the Economist Intelligence Unit report Country Commerce Saudi Arabia.

Direct participation in the stockmarket remains closed to non�Gulf Co-operation Council (GCC) investors. The Council of Ministers in August 2007 announced that the Capital Market Authority (CMA) must treat Saudi nationals and citizens from the other five members of the GCC equally with regard to share ownership and trading on the Saudi stockmarket. Previously, GCC residents could not trade in banking and insurance stocks. The decision is in line with the 2002 GCC summit resolution that required all GCC nationals to receive full equality in all economic activities by end-2007. Tax consequences. There are no direct taxes on investment and securities transactions. Capital gains on in-kingdom asset sales must be included in gross income, though gains from offshore sales are generally not reported. There is no withholding tax on dividends.

There are no regulations regarding foreign exchange obtained from exports, and there are no restrictions on import payments. Moreover, no restrictions apply to leading and lagging payments. Because of religious and social custom, the importation of a relatively small number of items is prohibited, as are imports from Israel.

There are no restrictions on borrowing from abroad by resident or non-resident companies or individuals, and no restrictions apply to the remittance of foreign loans.

Tax consequences. No withholding tax is levied.

Portfolio investment

Restrictions on trade-relatedpayments

Loan inflows and repayment

Saudi Arabia 29


Non-resident companies and individuals may borrow locally with prior approval from the Saudi Arabian Monetary Agency.

There are no restrictions on the repatriation of capital.

The remittance of dividends and profits is not limited. However, to remit profits, foreign contractors must prove that their contracts are at least 30% subcontracted to Saudi firms.

No restrictions apply.


There are no restrictions on foreign or domestic currency accounts held by residents or non-residents.

Netting services are not permitted in Saudi Arabia.

Taxation and investment incentives

Foreign entities and resident trust companies doing business in the kingdom are subject to Saudi corporate income tax, whereas wholly Saudi-owned companies and Saudi shareholdings in mixed companies incur only zakat (a fixed-rate tax of 2.5% levied on the sum of a corporation�s current assets plus the current year�s operating profits). Tax morality is high among foreign-owned companies.

The corporate tax rate of 20% is applicable for the following entities: resident trust companies, non-Saudi residents who conduct a business activity and non-resident persons who conduct a business activity through a permanent firm in Saudi Arabia. Corporate tax is payable on profits attributable to foreign companies doing business in the country, whether through a branch, through equity participation in a local company or through any other form. A foreign company that does in-kingdom business through a local representative or service provider may expose itself to tax on revenues from goods sold offshore to in-kingdom purchasers. The 20% rate became effective at end-July 2004, following the publication of the executive byelaws, which implemented the new tax law promulgated in January 2004.

Tax on investments in natural gas is calculated on the internal revenue generated from investments in this sector (including �cash expenses�). These are subject to a sliding scale of tax, beginning at 30% on revenue of 8% and running to a maximum of 85% if the internal rate of return exceeds 20% of investments. Although not itemised in the new corporate tax law, investments in oil and associated gas projects will continue to be subject to tax on the same sliding scale, also up to a maximum of 85%.

Non-residents borrowinglocally

Repatriation of capital

Remittance of dividends andprofits

Remittance of royalties andfees

Hold accounts

Netting

Overview

Corporate tax rates

30 Saudi Arabia


Saudi shareholdings in mixed companies and wholly Saudi-owned companies are subject to zakat (religious obligation), a fixed-rate tax of 2.5% levied on the sum of a corporation�s current assets plus the current year�s operating profits.

For further information on the tax consequences of operating in the kingdom, see the Economist Intelligence Unit report Country Commerce Saudi Arabia.

Article 8 of the tax law states that the income �subject to tax is the total income including all revenues and profits whatever their type and form for practising the business�. This appears to suggest that all operating revenue might be subject to tax. However, the clause then goes on to state that these �operating revenues� include �capital profits and any incidental revenues from which tax-exempted income has been discounted�, which suggests that profits, not operating revenue, are liable. Capital gains on in-kingdom asset sales must be included in gross income, though gains from offshore sales are generally not reported. There are no special provisions for the taxation of foreign-exchange gains and losses.

Each year, 10% of a company�s net profits must be placed into a statutory corporate reserve before any profit distributions are made. The remaining profit, adjusted for deductions, is taxable. The reserve allocations may be discontinued once the fund equals one-half of the company�s capital.

All necessary business expenses incurred in-kingdom are deductible, including salaries, services, rentals and depreciation. Payments for offshore technical and engineering services are normally permitted as deductions. Intercompany charges for technical and engineering support and research services are generally deductible, provided that the documented costs have actually been incurred; that they do not result in an increase in the value of fixed assets or inventories, or a reduction in liabilities; and that they have been incurred to gain locally taxable profits. Deductions are not allowed for intercompany payments to cover general overhead costs. Payments of dividends and interest are not deductible in Saudi Arabia.

Under the Foreign Investment Act of April 2000, foreign companies may carry losses forward against income tax for an indefinite period. This new system replaces the old practice of granting tax holidays of variable lengths, which are now banned for new projects. However, those tax holidays granted prior to April 2000 are still valid.

Council of Ministers Resolution 17, of September 1985, prohibits tax-exemption and tax-reimbursement clauses in contracts between government agencies and foreign contractors and suppliers.

It is important for any foreign company operating in Saudi Arabia to consult a qualified professional to determine tax liability and to keep abreast of changes as they occur.

Royalties, consultant fees, management fees, licence fees and other technical-service fees are generally assessed by the Directorate General of Zakat and Income Tax (DZIT) to include a 15% deemed profit, which is aggregated with other corporate income and taxed at sliding-scale rates.

Taxable income defined

Tax traps

Saudi Arabia 31


The DZIT requires Saudi taxpayers to withhold corporate income tax on behalf of foreign companies working as subcontractors for them. Foreign entities subject to Saudi withholding tax typically include �gross-up� clauses in their contracts, holding the customer liable for any taxes that may be withheld. At the very least, the DZIT demands evidence that the tax withheld has actually been paid on the subcontractor�s behalf.

The Foreign Investment Act of April 2000 abolished all tax holidays for foreign firms on new projects. However, tax holidays granted prior to April 2000 are still valid.

For companies engaged in mining, prospecting or ore extraction, incentives still include a 30-year extraction concession and duty-free import of equipment. Joint ventures that are majority Saudi-owned can also be exempt from import duties within the Gulf Co-operation Council (GCC), provided the firm can demonstrate that 40% of the value of goods is added locally. Foreign employees are exempt from personal taxation.

The government provides a variety of incentives to encourage domestic private investment. As the country is rich in hydrocarbon resources, the kingdom�s economic-development initiatives have historically been geared towards downstream hydrocarbon industries, as seen in the specialised industrial cities of Jubail and Yanbu and in investments in the Saudi Arabian Basic Industries Corporation.

Specialised government credit institutions make low-cost loans to Saudi nationals and businesses. The institutions are large and important actors, and though they have been winding down their activities since the late 1980s, their total capital and net outstanding loans are still significant.

The Saudi Industrial Development Fund (SIDF), under the aegis of the Ministry of Finance and National Economy, is the key institution in the government�s drive towards industrialisation. It has a worldwide reputation for the quality of its underwriting capabilities and has worked closely with a number of joint ventures.

In the past, the SIDF support had been limited to projects that had a minimum 50% local or Gulf Co-operation Council equity. This was amended under the Foreign Investment Act of April 2000, and majority foreign-owned companies are now entitled to apply for funds. Nevertheless, the SIDF still favours projects that have a high local-equity profile.

Although most of the SIDF�s lending continues to target large-scale industrial projects, in August 2002 it established a new lending programme for small and medium-sized enterprises (SMEs) to stimulate non-oil development at a grassroots level. These advances aim to stimulate the economy and address areas that were traditionally neglected, like small-scale industrial enterprises.

A typical industrial project-financing deal will have 25�50% of a company�s capital needs contributed by the SIDF and no less than 25% contributed by private-equity investors. The balance is made up by either short-term working-capital facilities from Saudi or regional banks or by a parent company line of

Incentives

32 Saudi Arabia


credit if the project is a joint venture with an offshore partner. Typically, the SIDF will match each riyal invested by local projects, with bank debt or a parent-company line of credit taking the remaining portion of a project�s capitalisation. Although the SIDF generally limits funding to a maximum of SR400m on any one project, this level is rare; the bulk of funding is in the SR20m�100m range. Consequently, its role in financing very large projects must be co-ordinated with other public or private sources of funds.

SIDF loans are generally long term (5�15 years) and are made on a no-interest or low-interest basis, though service charges apply. A repayment grace period of 12�18 months is usually provided. However, the SIDF requires that all borrowers ensure that any future debt is subordinated to the rights and claims of the SIDF portion of the loan. In practice, this means that commercial bank loans are junior to the SIDF in regard to loan default and collateral collection by creditors. Banks will often fund a transaction because the SIDF is involved in the deal, but they may be reluctant to fund any but the best project credits because of the subordination issue.

SIDF loans incur a 2% annual charge from the day a facility is granted, not the day it is drawn down. There are a number of typical project-finance criteria, including evidence that a project is viable from marketing, technical and financial standpoints; that it is capital- and energy-intensive; and that it will offer employment and training to Saudis�a measure of increasing importance to government regulators. SIDF underwriters will be more amenable to funding projects if, rather than submit poorly assembled applications, the sponsors assemble world-class business plans, submit three- to five-year financial projections and are prepared to �sell� the deal.

The agency will not approve a loan unless it is assured that the project will purchase locally all needed manufactured products, to the extent that they are available. A Saudi consulting firm must also be retained during the implementation period, and a registered Saudi accountant must also be employed to meet SIDF requirements. Given the criteria that SIDF has established and the professional assistance that it offers, no company should consider establishing a manufacturing venture in the kingdom without consulting the agency at an early stage.

The other credit agencies have a less prominent role in funding joint-venture projects. The largest single domestic loan provider, the Real Estate Development Fund, has participated in commercial real-estate projects with foreign involvement. But it is shifting its focus away from such projects and towards its primary role of underwriting housing costs for first-time Saudi homeowners. Given the long and lengthening backlog of Saudis waiting for home loans, this trend is expected to continue over the coming years.

The Public Investment Fund (PIF) has provided long-term soft loans over the past two decades to major government investments or mixed government and private-sector investments. In October 2002, the fund approved a US$360m loan to Jubail Chevron Phillips (a joint venture between Chevron Phillips Chemical of the US and the Saudi Industrial Investment Group) to part-finance the construction of a petrochemicals project in the industrial city of Jubail. After

Saudi Arabia 33


the Real Estate Development Fund, the PIF has the second-largest portfolio of any of the five institutions, but its lending activities have been vastly reduced compared with years past. In fact, the fund�s net lending has been negative for most of the past ten years, save for a small uptick in lending in 2006, suggesting that the fund is unlikely to be a major source of funding for foreign-investment projects in years to come.

Other available incentives include financial support for the employment and training of Saudi staff in designated high-skill fields. Government-run industrial cities across the country also provide factory sites at nominal rents, together with access to subsidised water and power supplies.

Cash management

Saudi Arabia long ago ceased being a cash market. It has a highly evolved consumer and commercial credit industry. All commercial banks have introduced sophisticated cash-management systems that include computerised processing with customer terminals. Until recently, banks supplied little corporate cash-management advice, and the little that was on offer was rarely accessed. However, the severe economic slowdown of the mid-1990s and greater competitiveness among banks stimulated new technology investments, resulting in both banks and corporate borrowers spending more energy on all aspects of cash management. For instance, Al Rajhi Bank launched a service in August 2003 called �Cash Online� that enables expatriates residing in the kingdom to send remittances to their home countries within two hours for a charge of SR20.

According to the latest data published by the Saudi Arabian Monetary Agency (SAMA�the central bank), the number of payment cards in circulation�such as those used for ATM and EFTPOS (electronic funds transfer point-of-sale) transactions�increased 12% from September 2006 to September 2007, resulting in four consecutive years of double-digit annual growth. The number of cards issued has more than doubled since 2000. Similar increases were shown in the number of accepting terminals. The number of ATMs increased from 5,764 in September 2006 to 7,150 in September 2007, an increase of 24%. The growth in ATMs since 2000 has been spectacular, as only 2,222 were in operation at end-2000.

Saudi Arabia�s commercial banks created the kingdom�s first consumer credit-rating agency, the Saudi Credit Bureau, in April 2004. Participating member banks disclose credit-related information to and obtain information from the bureau to assess the creditworthiness of their existing and prospective customers. The bureau will facilitate higher levels of transparency in the consumer-credit market. Before the launch of the bureau, commercial banks shared a blacklist of defaulters and conducted their own ad hoc credit assessments.

Sales terms vary considerably, according to the consignor, the consignee, and the value and type of goods. Credit sales followed by cash collections are a common payment method. Debts that are not paid within credit terms are first

Overview

34 Saudi Arabia


subject to negotiation and attempts at compromise, then require intensive efforts to collect if unresolved.

US-based Western Union Financial Services announced in February 2006 that it had entered a strategic alliance with Al Bilad Bank to provide money-transfer services to its customers in Saudi Arabia. Al Bilad Bank is Western Union�s second representative in Saudi Arabia, after Samba. Following the agreement with Al Bilad, there were more than 90 locations that have Western Union facilities in Saudi Arabia as of early February 2008.

The Saudi Arabian Riyal Interbank Express (SARIE) began operations in May 1997. The Saudi Arabian Monetary Agency (SAMA) owns and operates SARIE. It is a modern payment-settlement system, and it has become the basic infrastructure on which a number of advanced payment settlement systems depend. Those systems include the Automated Clearing House (ACH) and the Saudi Payment Network (SPAN�upgraded to the second-generation SPAN2 in May 2006), which connects ATMs and terminals for electronic funds transfer point-of-sale (EFTPOS). It also includes the banknote settlement system. The technical improvement and the modern banking services that SARIE contributed to the Saudi banking sector are considered pivotal events in the history of the kingdom�s payment-system development.

SPAN2 is the national ATM and EFTPOS network that connects all Saudi banks and provides a common service point in the kingdom. The network has facilitated transaction availability regardless of terminal ownership. The movement towards electronic transactions has reduced the overall demand for bank notes and increased the uptake in banking facilities. SPAN has increased the efficiency in the banking sector by avoiding ineffective competition at the transaction delivery points.

SPAN2 provides other banking services as well, such as supporting international-association transactions, including those of Visa and MasterCard, originating either within or outside the kingdom. SPAN2 has direct connections to these associations and provides connectivity in a pass-through mode to the Saudi banks. This support includes a full range of credit- and debit-card transactions at both ATM and EFTPOS terminals.

Although larger creditors are protected by the mechanisms for default-collection under the central bank�s Board for the Settlement of Commercial Disputes, no effective mechanism has been established for smaller debt disputes. As a result, collection is often time-consuming, laborious and expensive. Some companies anticipate writing off a percentage of bad debt; others seek settlement through discounting, rescheduling or bartering.

Debt-collection companies have proliferated in recent years, and they use the same methods to secure repayment as those in the West. In general, the debt-collection industry and processes have become more sophisticated.

Court settlements may be obtained against debtors, especially if signed contracts can be produced. The Saudi tradition of negotiation and compromise, however, pervades the judiciary, and authorities will almost always attempt to

Payment clearing systems

Receivables management

Saudi Arabia 35


guide parties towards settlement. In addition, some practices, such as foreclosure, are rare. Since no official bankruptcy figures are published, it is difficult to assess trends in the legal system with regard to the actual enforcement of judgments.

Payables management is becoming a fine art, with businesses giving greater attention to the timing of their obligations and receipts. The periodically sluggish economy and related liquidity shortages have the virtue of forcing all businesses to concentrate on improving their cash-management practices and, in the process, increasing efficiencies in receivables and payables management. Corporate-finance departments of major banks continue to aid this process by offering cash-management advice to their clients.

As the use of electronic payments has surged, cheques are declining in importance as a non-cash payment instrument. The use of post-dated cheques is prohibited, and violators can receive up to a three-year jail sentence and fines up to SR50,000, or both.

There are no restrictions on cash pooling, although the Saudi Arabian Monetary Agency (the central bank) must approve crossborder transfers. Major banks offer this cash-management service.

Securities markets

Sources: Bloomberg; US Department of Energy.

Monthly close of the stockmarket index and the Saudi Light oil spot price

0

2,500

5,000

7,500

10,000

12,500

15,000

17,500

20,000

20

30

40

50

60

70

80

90

100Saudi Light Spot Price FOB; US$/barrel; right scaleTadawul all-share index; left scale

J08

NSJMMJ07

NSJMMJ06

NSJMMJ05

NSJMMJ04

NSJMMJ2003

January 2003 to January 2008

The Saudi bourse�the Tadawul�is the largest stockmarket in the Middle East, with a market capitalisation of about SR1.9trn (US$519bn) at end-2007, up from SR1.2trn (US$320bn) at end-2006. Direct participation in the stockmarket remained closed to non�Gulf Co-Operation Council (GCC) investors in February 2008, though they could invest via mutual funds. The Council of Ministers in August 2007 announced that the Capital Market Authority (CMA) must treat Saudi nationals and citizens from the other five members of the GCC equally with regards to share ownership and trading on the Saudi stockmarket.

Payables management

Cash pooling

Overview

36 Saudi Arabia


Previously, GCC members could not trade in banking and insurance stocks. The new decision is in line with the 2002 GCC summit resolution that required all GCC nationals to receive full equality in all economic activities by end-2007.

The Tadawul has grown into an important venue for mobilising capital and is now one of the most dynamic markets in the region, despite the relatively limited number of companies listed. At end-2007, 107 companies were listed on Tadawul�an increase of 27% from a year earlier, but only a fraction of the thousands of companies that operate in Saudi Arabia. The largest ten made up 60�70% of total capitalisation and profits. Furthermore, listed companies include many loss-making parastatals (partially or wholly government-owned companies) whose shares are held by the government; state-controlled funds and are rarely, if ever, traded. However, the surge in interest in the stock exchange is leading the government to pursue its long-stated, but often underachieved, goal of privatisation, and newer companies are overtaking their state-controlled entities in terms of volumes traded and investor interest. Tadawul has also become an acceptable form of private finance. Despite the growth and increased depth of the market, the frequent over-subscription of initial public offerings indicates that the Tadawul still has years to go before being a fully mature market.

The market is measured on the Tadawul all-share index (TASI), which measures the movement of all listed shares. In addition to the general index, the exchange publishes returns on the following sectoral indices: banking, industry, cement, services, electricity, telecommunication, insurance and agriculture.

The bull run in the Saudi equity market caused the TASI to climb 586% from end-2001 to end-2005. Then a selling spree turned the direction of the market on February 26th 2006, leaving the market in the doldrums for the remainder of the year. The TASI fell from 19,503 at end-February 2006 to 7,933 at end-December 2006. The Saudi bourse, along with other markets in the Gulf, clearly went through a bubble period of unsustainable gains in the three years to 2006. However, the market made a comeback in 2007 along a more reasonable and sustainable trend. The TASI reached 11,176 at end-2007, an annual gain of 41%. The price/earnings ratio of companies traded on Tadawul averaged an unusually high number of 66 in 2005, before dropping to 16 in 2006 and 2007.

In addition to the unsustainable growth in the market, which necessitated a correction, two strategic decisions made by the CMA added fresh worries to the market, further shaking investors� confidence, according to an analysis by National Commercial Bank. In February 2006 the CMA changed the daily stock price fluctuation limits from ±10% to ±5% and required listed companies to declare any investment activity they have in the local capital market along with the amount of capital assigned for this purpose.

Despite the decline in 2006, the Tadawul has become a much more vibrant and liquid market in the past few years, compared with its early days of infrequently traded shares and shallow trading. The average value of shares traded during 2007 reached SR10.3bn a day, with an average of 237.4m shares traded a day.

Saudi Arabia 37


The single most important development for the local securities market in many years was the passage of the Capital Market Law in July 2003, though it took another 12 years for the law to go into effect. With its promulgation, the kingdom had its first fully functioning stock exchange, the Saudi Arabian Stock Exchange. The system in existence at the time of the law�s passage did not host a trading floor, and orders were conducted electronically via an infrastructure set up by the Saudi Arabian Monetary Agency (SAMA�the central bank).

Following on the heels of the Capital Market Law, the Saudi cabinet issued a royal decree on July 1st 2004 announcing the names of the chairman and four members of the board of the CMA. The CMA was envisioned in the 2003 law, but it only became a fully operational authority in mid-2004, with the naming of its directors. The CMA took over the task of regulating the market from a committee made up of SAMA, the Ministry of Finance, and the Ministry of Commerce and Industry. The new body also registers securities and regulates the activities of non-bank financial intermediaries that provide services such as brokerage, portfolio management and credit rating.

The Saudi cabinet announced in late-November 2007 that Tadawul would have a nine-member board, consisting of government officials and trading-company representatives, to oversee the electronic trading system�s activities. This step consolidates the bourse�s move toward greater transparency, following the bourse�s incorporation in March 2007. Also in November 2007, Tadawul announced measures to tighten trading rules, to counter allegations of dubious trading activity. Economists addressing a forum on �Capital Markets and the Middle East� at the Dubai stockmarket in November 2007 said that if the Saudi stockmarket continues to broaden and deepen and eventually opens up to foreign investment, it could easily outstrip the Dubai bourse and provide a key capital-raising vehicle for regional companies.

The rules and regulations are still in a state of flux and development. It is clear that Saudi Arabia is attempting to incorporate the best practices of Western securities while avoiding some of the impeding, if not unlawful, tactics practised among the experienced operators in the US and elsewhere.

In August 2006 the CMA issued instructions to all listed firms to make full disclosure through the Tadawul trading system of relevant information about their company, including financial results, decisions on increasing or lowering capital, and plans for ordinary or extraordinary general assemblies. Disclosure requirements were required before, but this ruling makes it more thorough.

In June 2006 the Tadawul published its standards for trading commissions, calculated as follows: maximum commission of the trade value was set at 0.12% of the trade value; the minimum commission was set at SR12.00 for any executed order equal or less than SR10,000. Authorised people may agree with their customers to apply a lower commission than specified above, and this discount must be agreed and documented in advance. Records must be maintained for all discounts.

In September 2006 the Dubai-based Hawkamah Institute of Corporate Governance and the Institute of International Finance (IIF) established a GCC task force to conduct an investor-centric assessment of corporate governance in

38 Saudi Arabia


the region and to create a benchmark on corporate-governance practices. According to the assessment, the downward corrections in GCC stockmarkets in 2006 and increased activity by GCC corporations in Western markets have driven improvements in corporate-governance standards. The report was part of a co-ordinated strategy towards the harmonisation of corporate-governance standards in the GCC and their alignment with international best practices.

The Capital Market Authority (CMA) on October 23rd 2007 launched a new electronic-trading platform for the Tadawul, which it developed with the Scandinavian stock exchange operator, OMX. The new system increases the capacity for processing share transactions and strengthens the CMA�s ability to monitor activity and detect market manipulation. Some local observers opined that the improvement in the regulatory authority�s ability to spot suspicious trades�aided in part by the new trading platform�may have caused some speculators and day traders to pull out of the market. Plans to build the system were announced at the height of a crash that wiped off more than half of the market capitalisation at the end of the first quarter of 2006. The OMX-inspired system replaces the last update, which occurred in 2001 and ushered in up-to-the-minute market data with straight-through processing and real-time settlement.

Share broking will remain a relatively restricted practice in Saudi Arabia. Banks are still barred from trading in the domestic market on their own account and may not hold substantial inventories of shares. As a result, they do not perform a true market-maker function.

The Capital Market Law passed in July 2003 established the Securities Depository Centre, Saudi Arabia�s first and only entity to handle transfer, settlement, clearing and registration of securities traded on the exchange. The centre became fully functional in January 2005.

Riyadh-based Bakheet Financial Advisors is the leading non-bank firm providing fund management and advice on the Saudi share market. The company provides both online and print versions of its monthly market reports to subscribers inside and outside the kingdom. In addition, Bakheet publishes reports on other Arab markets and can provide detailed analyses of their fundamentals for clients.

Trading hours are from 11.00 am to 3.30 pm. Trading days are Saturday through Wednesday, except official holidays.

The Ministry of Commerce and Industry set requirements for firms seeking to list as joint-stock companies in a 1997 resolution. The requirements were more demanding than those found in other emerging markets, reflecting the government�s traditionally conservative approach. However, in 1999 the ministry unexpectedly revised the key requirements for firms seeking conversion into joint-stock companies, easing the way for firms to seek listings. The most important changes include the following:

• a reduction in required total assets to SR50m from SR75m;

Trading, clearing andsettlement

Listing procedures

Saudi Arabia 39


• a requirement that a firm show �substantial� profit over the year preceding application, rather than a return on capital of at least 10% over the previous five years, as was formerly the case;

• a reduction of the percentage of shares that must be offered for sale to 40% from 51%;

• a reduction to five years (from ten) of the period for which a firm must have been incorporated prior to listing; and

• an easing to three years (from five) of the period for which audited balance sheets are required.

Tax consequences. There are no taxes associated with listing or other sales of new equity.

Initial public offerings

Of the 33 initial public offerings (IPOs) launched in 2007 among Gulf Co-operation Council (GCC) countries, the Saudi market absorbed 26 of them. A critical boost to the financial sector, roughly two-thirds of the IPOs came from insurance companies. The flurry of IPOs by insurance companies reflects the new regulatory regime for the industry; under the new regime, firms that are approved by the Council of Ministers must complete the listing requirements for the stock exchange before the Saudi Arabian Monetary Agency (SAMA�the central bank) will grant them a licence. The IPOs have all been heavily over-subscribed, partly because they have been deliberately under-priced by the regulator (book-building has yet to be used by any of the insurance companies coming to market). Consequently, share prices have tended to surge on the first day of trading, by 607% in the case of Al Ahlia and around 1,000% for several earlier offerings. The share price of Saudi Fransi Co-operative Insurance Company (Allianz SF), for instance, rose by 997% on the first day of trading. Given the limited track record of the companies, insurance stocks have tended to be volatile. Three of the largest offerings in 2007 and early 2008 were Kyan Petrochemical Company�s offering of US$1.8bn in May 2007, Jabal Omar Development Company�s offer of US$537m in June 2007 and Petro Rabigh�s offering of 219m shares, which raised SAR16.02bn (US$4.28bn) in January 2008, according to its company web page. Petro Rabigh is a joint venture between Saudi Aramco and Sumitomo Chemical of Japan. HSBC Saudi Arabia was the lead manager of the issue. Al Inma Bank�Saudi Arabia�s newest bank�plans to list 70% of its share capital in April 2008 in a US$2.8bn offering. Samba Financial Group will be the lead manager. Saudi Arabian Mining Company (Ma�aden) will offer 50% of its shares on Tadawul by end-2008, but did not specify when. JP Morgan Chase has been chosen as the lead manager in the IPO. The size of the offering is estimated to reach US$2.5bn.

Underwritten offerings are growing in popularity, and most companies now choose to use the services of an underwriter�usually one of the large Saudi banks or new Western investment banks, such as Morgan Stanley and Merrill Lynch, both of the US�before launching an initial public offering (IPO). In September 2006 the Capital Market Authority awarded a licence to Dubai�s Rasmala Investments to open a wholly owned subsidiary in Riyadh, and in November 2007 let it expand to offer services associated with mergers, acquisitions, IPOs and other financial dealings through its Saudi offices. Deutsche Bank (Germany) and the Samba Financial Group are shareholders in Rasmala. JP Morgan, Chase and Merrill Lynch, all of the US, are new players in the market.

Underwritten offerings

40 Saudi Arabia


No special regulations or restrictions exist for rights offerings to current shareholders. Foreigners may purchase rights offerings only with Saudi Arabian Monetary Agency approval.

Given burdensome public-listing requirements, there is a very active but informal private-equity market. It generally consists of large investors that buy into major merger-and-acquisition transactions and small investors seeking mid-market opportunities. The major universal banks, plus financial-advisory firms�such as Rana Investment, Financial Transaction House and Swicorp Financial Services�regularly show offering memoranda to their clients. Frequently, they successfully place equity for transactions both inside and outside the country.

As the regulator of companies, the Ministry of Commerce and Industry exerts influence over equity placement deals, but the Saudi Arabian Monetary Agency (SAMA�the central bank) also examines the role of the bank or banks engaged in the deal. The Capital Market Authority gradually took over responsibility for overseeing private placements from SAMA and the Ministry of Commerce, but SAMA continues to exercise its mandate over transactions involving banks. Ostensibly, the Capital Market Authority will have the overall authority for such transactions, but SAMA will continue to have responsibility in overseeing transactions dealing with banks.

Tax consequences. There are no special tax withholdings on private-equity placements, since taxes are collected on gains realised in gross income.

Saudi companies have not issued any Global Depositary Receipts, and there are no immediate plans to create them.

None.

Currency and derivatives markets

Most financial instruments relating to the currency market are available in Saudi Arabia, and the market is relatively active because of the kingdom�s importance in the international trade of petroleum. But instruments for interest-rate products are limited because of the regulatory antipathy with regard to the payment of interest, which is contrary to Islamic law, and limited enthusiasm among the public. Complex derivatives are virtually unknown.

An active spot market and a less active forward market for the Saudi riyal exist in Jeddah, where National Commercial Bank is the major dealer, and in Riyadh, where Samba Financial Group is a major player. All Saudi banks actively trade the riyal. The foreign-exchange market remains relatively underdeveloped, however. According to the latest triennial bulletin published by the Bank for International Settlements in December 2007, daily foreign-exchange market turnover in Saudi Arabia averaged only US$4bn, about the same level as turnover in countries such as the Czech Republic and Chile, and unchanged as a percentage of global foreign-exchange turnover.

Rights offerings

Private placements

GDRs/ADRs

Alternative markets

Currency spot market

Overview

Saudi Arabia 41


Active spot and forward markets in the riyal also exist in Bahrain, where many local and international banks form a market. Some spot and forward riyal dealing takes place in London, particularly through the branches of Gulf International Bank and Riyad Bank. Samba Financial Group also provides a facility.

About 15 banks may be termed market-makers in the riyal, willing to quote two-way prices during �normal� business hours and on �normal� business days. Saudi banks deal from Saturday through Wednesday and on Thursday morning during the hours of 6 am to 4 pm GMT. Outside of these hours, the market is much thinner, and spreads may be very wide. The stated minimum wholesale transaction size is US$5m (although smaller amounts may be traded).

There are no legal restrictions on companies or individuals engaging in forward exchange transactions. No liquid market exists beyond one year for forward trading. Professional market-makers are prepared to quote rates beyond one year for forward trading on a case-by-case and one-sided basis.

Tax consequences. Capital gains on assets, including derivatives, are included in gross income and are taxable at normal rates. Capital gains from assets sold outside the kingdom are generally not reported.

Options on interest rates, currencies and stock indices are limited to central bank�approved, over-the-counter transactions. Although a great deal of freedom exists to arrange contract sizes and the time frames for which contracts are arranged, options�which follow both American and European styles (depending on the lender)�are monitored carefully by the Saudi Arabian Monetary Agency (the central bank) and, through it, both the ministries of commerce and finance.

Saudi banks conventionally arrange currency swaps of almost any size and maturity up to five years, and will custom-design products for individual customers. Swaps and other hedging techniques are difficult to arrange beyond five years. The government�s five-year bonds are a natural counterpart to developing swaps within this time frame, but costs for such hedging techniques are relatively high.

There is no market for exotic derivatives in Saudi Arabia. This is because of the conservatism of the Saudi Arabian Monetary Agency (the central bank), which has not approved them, and the relatively unsophisticated corporate financial environment, which presently has no need for such products. Nonetheless, the kingdom�s religious conservatism with regard to finance�such as scepticism of interest-based products and risk�will likely change over the coming years as Islamic scholars increasingly approve such products.

Banks are licensed to arrange contracts under the supervision of the Saudi Arabian Monetary Agency (the central bank).

Futures and forward contracts

Options

Swaps

Exotics

Regulatory considerations

42 Saudi Arabia


Short-term investment instruments

Bank deposits remain the principal outlet for excess funds. Commercial banks accept demand and time deposits for periods ranging up to 12 months. About 50% of all banking-system deposits are demand deposits or otherwise do not pay interest. Treasury bills offered by the Saudi Arabian Monetary Agency (the central bank) offer another straight, short-term investment instrument, but there is no sizeable secondary market in them. Nonetheless, the Capital Market Authority is working to establish a secondary market for tradeable debt.

Investment funds (mutual funds) have gained widespread acceptance in recent years and are a growing destination for investors. Equally important is the advent of Islamic investment accounts, which have become increasingly common as Islamic banking and finance become more popular. Islamic funds do not participate in the money market per se�as Islamic law prohibits charging interest�but the result is very similar to typical money-market instruments in terms of rates and liquidity.

Source: Bloomberg.

0

1

2

3

4

5

6

One-yearThree-monthOne-monthOne-week

J08

NSJMMJ07

NSJMMJ06

NSJMMJ05

NSJMMJ04

NSJMMJ2003

January 2003 to January 2008End-month, % pa

The rates payable on riyal and dollar time deposits vary and are usually 0.5�1 percentage point below SIBOR (the Saudi interbank offered rate), depending on the customer and the size of the deposit. At end-January 2008, three-month deposits on the Saudi riyal were paying 3.10% interest, compared with 4.77% interest the previous year.

Islamic investment accounts have also become increasingly common; they link payments on time deposits to profits made by the banks to bypass Islamic prohibitions on interest. Increasing volumes of funds from major corporations have been directed towards the government Treasury bill programme or, on a more speculative basis, into the stockmarket.

Tax consequences. Interest received by foreign financial institutions is not subject to withholding tax. Interest received by foreign affiliates or non-resident third parties is usually taxed at a minimum 15% of deemed profit.

Overview

Time deposits

Saudi Arabia 43


CDs do not exist in Saudi Arabia.

Since 1991 the government has offered Treasury bills every Tuesday of every week in various short-term maturities (one, four, 13, 26 and 52 weeks). Banks and other financial institutions use T-bills for short-term cashflow management. Government development bonds have been issued since June 1988. They carry fixed coupons payable semi-annually and are offered to banks and other financial institutions every month in two-, three-, five-, seven- and ten-year maturities. Since December 1998 the bonds have been priced off the one-year riyal interbank rate to reflect domestic money-market conditions, rather than from US Treasuries.

Only Saudi banks may serve as distributors and market intermediaries, but there is very little secondary trading of government securities.

Tax consequences. Government securities are exempt from zakat�the 2.5% Islamic tax levied on the sum of a corporation�s current assets plus the current year�s operating profits�provided they are held for at least one year by Saudi investors. Foreign investors in government bonds pay no withholding tax on coupon payment.

Repos are a common feature of Treasury functions within large corporations, banks and institutions in Saudi Arabia. Their use is identical to that in repo markets in developed economies. The Saudi Arabian Monetary Agency, the central bank, offers repo facilities from overnight to seven days for up to 75% of banks� T-bill holdings. However, no market exists for Saudi government bills and notes outside the kingdom, since regulations prohibit repo dealing beyond national borders.


Although there is no express ban on the sale of commercial paper, a formal market has not yet developed.

There is no major market for acceptances. Nevertheless, Islamic institutions often provide this type of financing.

Corporate financial strategies

Given the increased visibility and (overall) positive returns on the stockmarket in recent years, companies are increasingly tapping equity finance, and the stockmarket has grown into an important venue for mobilising capital. The government has actively promoted equity financing as an option�demonstrated most notably in the 2003 Capital Market Law. Privately placed equity has become popular, primarily as a way to carry out mergers and acquisitions. The growing popularity of share offerings notwithstanding, Saudi companies tend to rely on bank loans for their financing needs. But given the short-term nature of banking-sector liabilities (mostly current-account deposits), Saudi banks rarely offer long-term credit lines, though longer terms are increasingly available. Credit tends to come in the form of short-term overdraft facilities or loan terms of one year or less. For long-term financing, companies look to the government�s five specialised credit agencies. However, these agencies are scaling back their lending activities and, in any case, only offer it for specific types of projects, usually of a large-scale industrial nature. As a result, Saudi companies are increasingly forced to look outside the kingdom for long-term financing through syndicated loans from a combination of Saudi and foreign banks. More often, however, Saudi banks are becoming

Certificates of deposit

Treasury bills

Repurchase agreements

Commercial paper

Banker�s acceptances

44 Saudi Arabia


more capable of financing projects domestically without the aid of outside banks. With the ever-increasing sophistication of Islamic finance�offered by both regional and Western financial institutions�this, too, has become a significant avenue of funding.

Short-term financing

Most bank credits in Saudi Arabia are short-term in nature�usually self-extinguishing overdraft facilities or loan terms of one year or less. However, the trend towards balancing loan portfolios with longer maturities is continuing. Short-term bank credit totalled SR331bn at end-October 2007, roughly the same as a year earlier, according to the latest information from the Saudi Arabian Monetary Agency (the central bank). This constituted 57% of all bank credit�compared with 56% in 2006 and 2005�but a significant decline from 70% in 1999.

Some banks offer short-term cash facilities in the form of one-, three- or six-month rollovers that the bank has the right to call. Banker�s acceptances, commercial paper and factoring are not commonly used financing techniques, although some banks put their own acceptances on letters of credit.

Saudi banks used the 1998�99 liquidity squeeze to increase their exposure to more creditworthy borrowers (with some exceptions, in which credit was given to salvage major customers from collapse). They also forced private-sector borrowers to raise their standards of investment and cashflow projections for existing and new projects. These higher standards created better documentation and greater discipline and sophistication among borrowers.

Personal relations still interfere with lending policy, but standards have become more professional�though those individuals with connections to the large ruling family still receive special treatment. The kingdom has gradually evolved from the informal and easy credit market of the 1980s�which contributed to massive loan defaults during the 1985�89 recession�to a market with greater uniformity and international lending standards. Collateral rights in the event of default are less of an issue than in the past, because banks are sharing bad-credit information, using the new Saudi Credit Bureau established in 2004, and are benefiting from the increased enforcement measures available from the government.

Islamic financing is penetrating more and more areas of traditional finance, as well as playing a major role in all aspects of trade finance. Several Islamic financing techniques are of particular relevance to short-term and trade-related debt.

Overdrafts are an important form of short-term borrowing, and most short-term loans are issued in the form of self-liquidating overdrafts. Banks do not generally ask for compensating cash balances on overdraft borrowings (instead, customers sign blanket collateral rights), so they represent the least expensive and most convenient form of short-term financing. Most foreign firms must produce a parent-company guarantee to obtain an overdraft, though this is often waived for established customers.

Overview

Overdrafts

Saudi Arabia 45


Overdraft interest rates fluctuate in line with short-term indices, such as SIBOR or LIBOR (the Saudi or London interbank offered rates, respectively). Despite the �prohibition� on charging interest, the Saudi banking sector is not fully �Islamisized�, and interest charged on overdrafts or bank loans is done quietly. In other words, there is no objection to �special commission charges� or disguised interest.

Companies generally establish overdraft limits with their banks annually. Overdraft facilities are frequently rolled over automatically, although during the slowdown of the mid-1990s, a number of weaker borrowers found their facilities cancelled without notification, even if they had never been in default. This was less common during the 1998�99 recession, largely as a result of the banks� more rigorous approach to the extension of credit. In general, no special penalty or fee is charged for rolling over a credit line. When a borrower temporarily exceeds a limit in terms of the amount borrowed, the bank may charge an over-limit fee at its discretion.


Formalised short-term loans are popular as a form of short-term commercial credit. Rates are usually floating and based on a spread above the Saudi prime rate. Short-term loans often take the form of uncollateralised notes of one year or less. For blue-chip domestic borrowers, the Bahrain and Dubai offshore markets are supplemental loan sources, although as local banks have become more sophisticated and larger, their importance has declined.


The increase in the volume of trade-bill discounting for Saudi exporters reflects the steady growth of the nation�s non-oil exports in recent years. Islamic finance houses and the commercial banks fund export receivables at rates and conditions that depend on their relationships with the borrowers, but within a fairly standard range.


Though the product is allowed, CP has not generated interest in either investors or borrowers.

Islamic institutions often provide this type of financing.

Factoring is not a common practice, but debt collection on a commission basis is well known.

Supplier credit is widely available, with highly standardised terms and conditions applied throughout the kingdom. Terms of payment are usually 30 days, with some discount offered for cash payments.


Bank loans

Discounting of trade bills

Commercial paper

Banker�s acceptances

Factoring

Supplier credit

46 Saudi Arabia


Intercompany borrowing is common among government agencies and between companies facing working-capital shortages. Many companies are linked through intra-family ownership structures in which divisions with cash surpluses may be used temporarily to support new projects or other divisions experiencing deficits. There are no restrictions on intercompany borrowing.

Tax consequences. Deductions are not allowed for intercompany payments to cover general overhead costs.

Medium- and long-term financing

Saudi banks� historical aversion to medium- and long-term financing is gradually changing. By end-October 2007, medium- and long-term facilities took up 43% of banks� lending (or SR245bn)�roughly the same percentage as a year earlier, and up from 30% (SR50bn) in 1999, according to the latest figures from Saudi Arabian Monetary Agency (the central bank). The relatively high proportion of medium- and long-term lending in the economy reflects the growing sophistication of the local banks, which are now more comfortable extending loans beyond the traditional one-year mark. In numerical terms, however, short-term loans far outnumber loans of longer maturities, because small and medium-sized commercial borrowers make much greater use of short-term facilities. Although banks still appear to drive financing options for corporate borrowers, corporate debt and equity financing have gained prominence and are common.

Historically, few Saudi banks had resources deep and broad enough to underwrite conventional commercial credit, as is common in more developed economies. In addition, banks have a long history of committing longer-term funds only to large industrial projects, like those sponsored by Saudi Arabian Basic Industries Corporation (SABIC), or to parastatal (wholly or partially government-owned) enterprises, such as the telephone monopoly or power company. In these cases, it is usual to find a Western investment partner and full disclosure of financing.

Moreover, the imbalance of asset and liability term structures has limited the ability of local banks to extend longer-term credit, but this is changing. Whereas demand for longer-term facilities is high, banks have large proportions of their liabilities in the form of non-interest-bearing consumer deposits. These deposits are available on demand and thus carry no �maturity�. Exposure to longer-term, fixed-rate credit would mismatch a bank�s balance sheet, exposing it to substantial interest-rate risk. Without a bond or certificate-of-deposit market, or other longer-term sources of funds, banks generally cannot make long-term loans to any but the bluest of blue-chip projects.

Before the liquidity glut of the past several years, Saudi banks were generally incapable of extending credit for amounts larger than SR100m, preferring instead to syndicate their credit with other Saudi or Gulf banks. However, this is no longer the case, and as of end-January 2008, Saudi banks appeared more comfortable offering larger credit terms without a partner. Banque Saudi Fransi acted as lead arranger and financial adviser for a US$400m loan to the

Intercompany borrowing

Overview

Saudi Arabia 47


National Industrial Gases Company, an affiliate of SABIC, in May 2007. Other banks participating in the deal included National Commercial Bank, Samba Financial Group, Arab Petroleum Investments Corporation, Saudi Hollandi Bank, Riyad Bank, Arab National Bank and Gulf International Bank (Bahrain). The funding will go towards the company�s expansion plans for its facilities at Yanbu and Jubail.

In the past, industrial companies seeking three- to seven-year loans for amounts up to SR100m could arrange financing with major domestic commercial banks. However, as the build-operate-transfer (BOT) method of infrastructure financing gains ground as part of government policy, industrial borrowers have to compete for credit with parastatal (wholly or partially government-owned) companies, such as the electricity and telecommunications companies.

In response, several major state companies and nearly all industrial joint ventures�including the national oil company, Saudi Aramco�have extended their search for financing to outside the kingdom, where the range, availability and costs of credit are more attractive and more easily secured. Large facilities are usually led by a major Saudi or US bank and may have participation from Japanese, British, German or French institutions. According to figures published by HSBC (UK), the debt market in the Gulf Co-operation Council (GCC) countries topped US$120bn in the 1994�2005 period. Saudi Arabia led the share of the syndicated-loan market in the Gulf, with 36% of the total.

Tax consequences. Interest paid to foreign financial institutions is not subject to withholding tax. Interest paid to foreign affiliates or non-resident third parties is usually taxed at a minimum 15% of deemed profit.

Equipment leasing in nearly all forms is available via banks and vendors. Islamic finance houses, in particular, have a strong appetite for fixed-asset finance. Islamic leasing is a common technique to obtain the equivalent of a medium-term bank loan when there is an underlying fixed asset, such as plant, equipment or inventory. Under this arrangement, the Islamic bank becomes the actual owner of a new factory for its start-up period, and the company running the factory gradually redeems its possession with lease payments.

Tax consequences. There are no direct taxes on leasing contracts.

Corporate bonds�typically issued in the form of sukuk, or Islamic investment instruments�are rapidly gaining in popularity as an accessible, inexpensive and religiously acceptable form of finance. Unlike bonds or commercial paper, which generally rest on the reputation of the company and not fixed collateral, sukuk must have a revenue-generating asset supporting it. Before the advent of sukuk, bond issuance was rare, and managers many times had to go offshore for debt financing, if they pursued it at all. With the Capital Market Authority in place and new regulations governing the issuance of debt, banks and companies are increasingly viewing debt financing as another option alongside traditional equity financing. The kingdom�s first corporate bond issue, by Saudi Orix Leasing Company during the first quarter of 2003, laid the groundwork

Bank loans

Financial leasing

Corporate bond issues

48 Saudi Arabia


for a future bond market, despite the absence of official guidelines regarding debt issuance.

The success of the separate international debt offerings in 2005 of Saudi British Bank (SABB) and Saudi Hollandi Bank probably persuaded other banks and companies to use debt financing, sukuk or traditional. When SABB issued an international bond in March 2005, it became the first Saudi bank ever to do so. SABB�s US$600m bond was issued as a floating-rate note with a five-year maturity�the inaugural issue under the bank�s new Euro Medium-Term Note (EMTN) programme. Other corporate debt offerings�conventional and Islamic�followed in subsequent years, making bond issuance a ready option for finance.

In July 2006 Saudi Arabian Basic Industries Corporation (SABIC) launched a SR3bn sukuk, the kingdom�s largest at the time. A year later, in July 2007 the Saudi Electricity Company (SEC) surpassed it with a SR5bn issue, the largest sukuk ever issued by a Saudi entity. HSBC Saudi Arabia was the sole lead manager and bookrunner. The company completed a ten-day roadshow (that is, it went around the world looking for potential buyers and explained the offer and terms to gain publicity for the offer) during which the order book built up quickly to almost SR7bn, nearly three times the company�s issuance target of SR2.5bn, allowing the company to issue a sukuk worth SR5bn, the maximum permitted by the Saudi regulatory authorities. This sukuk issuance followed a recent ratings assigned by Fitch and Standard & Poor�s at the sovereign ceiling. The sukuk is due in 2025 but investors can exercise their purchase rights in 2012.

Launching a true sukuk typically requires some tangible assets upon which to base the issue. Unlike bonds or commercial paper, which generally rest on the reputation of the company and not fixed collateral, sukuk must have a revenue-generating asset supporting it. But SABIC, which is the world�s tenth-largest petrochemicals company, launched the sukuk as a holding company and has few tangible assets. SABIC�s net income from marketing agreements with its many subsidiary companies, however, allows SABIC to give quarterly payments to the holders of the sukuk, up to a certain amount. Any surplus income is kept in reserve to compensate sukuk holders in case income falls below expectations. SABIC issued the sukuk in these marketing services. The maturity is set for 2026.

A significant hindrance to a fully developed bond market, however, is the absence of a secondary market for government securities. This has hampered the development of corporate bonds by not providing a benchmark for their pricing. Although no date has been set, the government announced in October 2005 its intention to establish a secondary market. In addition, companies have traditionally not looked to issue bonds since they have been able to turn to the specialised credit institutions for long-term financing.

Saudi satellite operator opts for Islamic finance

Arabsat, the world�s ninth-largest satellite operator and the leading provider in the Middle East and North Africa, signed a US$300m financing agreement with Saudi Hollandi Bank in December 2007 for an Islamic facility that will aid Arabsat�s expansion over the next five years. The facility will be in accordance with the murabaha principles of Islamic financing�where a bank purchases the specified goods from a third party, then sells them to the client at an agreed profit after a

Saudi Arabia 49


transfer of ownership. Arabsat, which is headquartered in Saudi Arabia, plans to develop and launch a satellite every year from 2008 to 2011 to cater to growing regional demand in broadcast, telecommunications and broadband services as well as to launch high-definition television in the Middle East and North Africa region. Saudi Hollandi Bank will fully fund Arabsat�s murabaha facility, which will be repaid over a period of five years, and the bank�s corporate banking and Islamic finance departments will manage the facility. Saudi Telecom is the largest shareholder in Arabsat, with 36.7% of ownership, followed by a number of Arab government stakes.

Privately placed debt instruments are rare, but not unknown. The concept of companies and individuals purchasing privately issued and placed notes in the domestic market is still somewhat alien because of historical reservations concerning earning interest and a strong preference for privately placed equity.

The government discontinued its special bond programme to securitise its obligations to the private sector in 2000, when authorities were able to pay their obligations in cash. It could be reinstated if the state again falls under liquidity shortages. Under the programme, the government sold special bonds to contractors in exchange for their aged government receivables, thereby replacing a non-interest-earning asset with one carrying fixed interest and maturity. These notes could then be discounted into a secondary market. The programme was generally well received and created quasi-market conditions for an instrument that was not a government bond, but not quite a corporate obligation.


The trend towards purchasing consumer receivables from customer balance sheets has been established among banks�most notably larger, universal-type banks�such as Saudi British, Samba Financial Group and National Commercial. Development of the concept was led by automobile dealers and Saudi banks in the early 1990s to improve the liquidity of dealers with long-term receivables. Other retail sectors, especially those involved in leasing, have since made use of such financing.

Such arrangements could serve as precursors to securitisation of income streams in the form of bond issues. As a next step, banks would have to package the �asset pools� and resell them to third parties�such as other banks, pension funds and the public (through mutual funds). Islamic banks in particular are well suited to this type of asset securitisation.

By and large, sharia-compliant structured finance transactions centre around special-purpose vehicles (SPVs), which are used as legal conduits to restructure conventional interest-bearing debt to replace interest payments with price mark-up (murabahah), rent (ijarah) or profit (musharakah or mudarabah). The introduction of SPVs and the legal agreements that are normally set around it will result in hurdles, inefficiencies and additional costs that are normally passed on to the subscriber or to the originator. When foreign SPVs are utilised, such vehicles must seek a licence for foreign investment from the Saudi Arabian General Investment Authority (SAGIA), which normally grants it in an efficient process.

No formal market yet exists for the sale of notes against pools of assets consisting of consumer receivables. The spreads available on high-quality asset

Private placement of notes

Structured finance

50 Saudi Arabia


pools are too great to pass on to a secondary market. Moreover, banks have not yet reached their saturation point in terms of holding these assets on their books. The lack of dynamism in the secondary markets for equities and debt also impedes the development of these techniques. But Saudi banks are pursuing securitisation deals (mostly in the form of sharia-compliant finance) for greater variation on their balance sheets.

The Capital Market Law passed in July 2003 may foster greater securitisation of assets, such as the expanding mortgage sector, which is booming because of the rapidly growing population and greater regulatory transparency. One example of this was the landmark securitisation in July 2006 conducted by Bahrain-based Unicorn Investment Bank (UIB) and South Africa�s Standard Bank on behalf of Riyadh-based Kingdom Instalment Company, a specialist in housing finance. Capital Intelligence, an international credit-rating agency, rated the underlying sukuk�or Islamic bond structure and assets�at A−. The sukuk transaction was the first true-sale securitisation in the Gulf Co-operation Council, and was backed by US$23m of Islamic leasing contracts. The sukuk was priced at a fixed rate of 6.55%, with a maturity of 2020.

A few players, in particular Saudi British Bank, HSBC Saudi Arabia, Riyad Bank and Al Rajhi Bank, have introduced mortgage products. Consequently, there are significant opportunities in setting up specialised funds (mortgage and real-estate funds) through securitisation, thus creating space for more mortgage funding and also valuable investment vehicles that work well for Islamic investors.

There are no special incentives to encourage non-recourse project financing. The government traditionally has not distinguished project financing from infrastructure projects since, typically, all such financing is arranged through local, regional and international banks. However, the build-operate-transfer (BOT) method of infrastructure financing is gaining ground as part of government policy.

The Saudi Arabian General Investment Authority (SAGIA) is developing six economic cities in Saudi Arabia. King Abdullah Economic City (KAEC) is one of the major economic cities being developed on the Red Sea between Jeddah and Rabigh. The new economic city will be developed over a 168m square meter site. The project will be carried out in several stages and it will include development of a seaport, industrial district, residential district, financial island, education zone and a waterside resort. In July 2006, Emaar the Economic City (EEC) announced it had started land and site work operations, and in the same month EEC undertook an IPO offering 30% of its shares on the Saudi Stock Exchange. EEC said the IPO reached more than US$1.3bn. HSBC (UK) is the financial advisor and the Saudi British Bank (SABB) is the IPO lead manager.

Trade financing and insurance

More than 90% of Saudi exports consist of oil, downstream refined petroleum or petrochemical products, but the government is eager to continue with diversification and is making an effort to promote non-oil exports. Payment for

Infrastructure financing

Overview

Saudi Arabia 51


exports is made in various ways: on a spot basis, on long-term contract or on credit arranged under bilateral government agreements. Sales to many customers must be backed by confirmed letters of credit.

There is no official export-credit programme. The majority of Saudi imports are financed through traditional letter-of-credit financing, although some importers still use working-capital lines of credit to purchase goods.

The government has traditionally used grants to promote oil exports to less-developed countries and has often used oil rather than direct funds to repay some allies that fought for the liberation of Kuwait. In addition, the private sector continues to urge the government to tie more of its foreign assistance to the purchase of Saudi non-oil exports.

Despite non-oil exports reaching an estimated US$22.8bn in 2006, according to the Saudi Arabian Monetary Agency (the central bank), and an explicit government policy encouraging development in the export sector, there is no official export-insurance programme. The government has raised the prospect of allowing the formation of private-sector-led export-insurance and credit programmes, but no progress had been seen as of early February 2008.

Saudi Arabia is a member of the World Bank�s Multilateral Investment Guarantee Agency (MIGA). Saudi exports, especially to developing countries, may qualify for MIGA insurance.

In July 2005 the deputy prime minister and Abdullah bin Abdul-Aziz, then the crown prince, approved the allocation of SR15bn for underwriting credit facilities for non-oil exports. Ibrahim bin Abdel-Aziz bin Abdullah al-Asaf, the minister of finance, stated this move would help the national economy, and he urged all concerned to register with the new facility, named the Saudi Export Programme. The Saudi Export Programme is actively funding a variety of exports across several sectors to promote non-oil exports. Petrochemicals account for the bulk of these exports, although other manufacturing and metals exports are increasing in value.

Saudi companies can also access the trade facilities of the Jeddah-based Islamic Development Bank (IDB), the Kuwait-based Inter-Arab Investment Guarantee Corp and the Abu Dhabi�based Arab Monetary Fund (AMF). These facilities aim to promote intra-Arab trade, though some companies have called for the expansion of coverage to non-Arab countries.

The promotion of �non-traditional� exports is supported by the IDB�s long-term financing programmes, and many of the local banks act as agents for the IDB. Partial financing is available for smaller transactions (US$4m and less), up to 80% of the value of exported goods may be covered, and financing for up to 40% of transactions over US$4m may be available. Repayment periods range from six months to five years, depending on the type of goods. Goods originating from IDB-member countries, including those with at least 40% value-added from Arab countries, are eligible for coverage.

The Inter-Arab Investment Guarantee Corp offers export-credit guarantees against commercial and non-commercial risk. The programme covers trade

Export-insurance programmes

Official export-creditprogrammes

52 Saudi Arabia


between Arab countries in goods with at least 40% value-added from Arab countries. The terms of payment may not exceed 180 days for commercial and non-commercial risk coverage.

In addition, some institutions, notably Samba and the Arab Investment Co of Riyadh, are shareholders in a US$500m facility known as the Arab Trade Financing Programme. This facility, which promotes exports and trade among members of the League of Arab States, began extending intra-Arab credit lines in 1992 under the sponsorship of the Abu Dhabi�based and funded Arab Monetary Fund. The Arab Trade Financing Programme of the AMF has short-term facilities providing secondary finance. Six-month revolving lines of credit are available, and up to 85% of the value of the transaction may be financed.

Since Saudi exports are mainly some form of petroleum, there is no special private-export financing. Small exports of wheat and petrochemicals are sold on the basis of cash against documents. A small market has developed for discounting non-oil export trade bills.

Imports are financed through various instruments. The most common of these are letters of credit, cash against documents and�in the case of the government (which insists on it)�open account. The latter is also used for well-known distributors and agents who have an established record with their suppliers. Banks usually require a 25% cash margin for opening letters of credit, as negotiated between importer and supplier.

Suppliers watch credit lines more closely and may stop shipment if payments are repeatedly delayed. Some companies sell only against confirmed irrevocable letters of credit�the safer, but more expensive to organise, payment method.

Countertrade is limited mainly to the hydrocarbon sector (where the best-known examples are the Boeing and Tornado aeroplanes-for-oil swaps of the 1980s) and the base-chemicals sector. The Saudi Arabian Basic Industries Corporation has in the past arranged petrochemicals-for-rice deals and may be open to other similar arrangements as it seeks to expand its market positions in South-east Asia, Africa and the states of the former Soviet Union.

Some Saudi companies consider barter agreements with their foreign joint-venture partners, either to ensure marketing outlets or to pay for plant expansion. Saudi Cable is an example of a firm engaged in bartering.

As Islamic financing instruments increase in number and sophistication, countertrade, in conformity with Islamic practice, will continue to increase. Smaller Saudi firms will also use it to seek to expand their exports abroad, especially to countries in Eastern Europe and other less-developed countries. Al Rajhi Bank, the Islamic Development Bank, and other Islamic financing institutions promote countertrade agreements on both the local and international level.

Private export-financingtechniques

Import credit

Countertrade

Saudi Arabia 53


In general, forfait finance is not available, though the Arab Investment Company may be able to arrange it. This form of trade finance may be arranged through the normal forfaiting centres in the UK and Switzerland.

Key contacts

• Arab Monetary Fund (AMF), PO Box 2818, Abu Dhabi, UAE; Tel: (971.2) 617-1400; Fax: (971.2) 632-6454; Internet: http://www.amf.org.ae/vEnglish.

• Capital Market Authority (CMA), PO Box 220022, Al Faisaliah Tower, Riyadh 11311; Fax: (966.1) 218-1220; Internet: http://www.cma.org.sa.

• Directorate General of Zakat and Income Tax (DZIT), Off Airport Rd, behind Ministry of Finance Bldg, Riyadh 11187; Tel: (966.1) 401-0182/404-1537; Fax: (966.1) 404-1495.

• General Organisation for Social Insurance (GOSI), PO Box 2963, Riyadh 11461; Tel: (966.1) 478-5721/477-7735; Fax: (966.1) 477-9958; Internet: http://www.gosi.com.sa.

• Inter-Arab Investment Guarantee Corp, Arab Organisation Bldg, Al Matar Rd, Jamal Abdelnasser St, Al Shuwaikh, Kuwait (PO Box 23568, Al Safat 13096, Kuwait); Tel: (96.5) 484-4500; Fax: (96.5) 481-5741; Internet: http://www.iaigc.org/index_e.html.

• Islamic Development Bank (IDB), PO Box 5925, Jeddah 21432; Tel: (966.2) 636-1400; Fax: (966.2) 636-6871; Internet: http://www.isdb.org.

• Ministry of Commerce and Industry, PO Box 1774, Airport Rd, Riyadh 11162; Tel: (966.1) 401-2222; Fax: (966.1) 402-6640; Internet: http://www.commerce.gov.sa/English.

• Ministry of Finance, PO Box 6902, Riyadh 11452; Tel: (966.1) 404-3945; Fax: (966.1) 402-5659; Internet: http://www.mof.gov.sa.

• National Company for Co-operative Insurance (NCCI), PO Box 86959, Riyadh 11632; Tel: (966.1) 218-0100; Fax: (966.1) 218-0102; Internet: http://www.ncci.com.sa.

• Public Investment Fund, PO Box 6847, Riyadh 11452; Tel: (966.1) 461-0432; Fax: (966.1) 461-0432. • Real Estate Development Fund, PO Box 5591, Riyadh 11433; Tel: (966.1) 477-5066; Fax: (966.1) 479-0148/477-5093. • Saudi Arabian General Investment Authority (SAGIA), PO Box 5927, Riyadh 11432; Tel: (966.1) 448-4533; Fax: (966.1) 448-

1234; Internet: http://www.sagia.gov.sa. • Saudi Arabian Agricultural Bank, PO Box 1811, Riyadh 11126; Tel: (966.1) 402-3911/3934; Fax: (966.1) 402-2359; Internet:

http://www.saab.gov.sa. • Saudi Arabian Monetary Agency (SAMA), PO Box 2992, Riyadh 11169; Tel: (966.1) 463-3000; Fax: (966.1) 466-2936;

Internet: http://www.sama-ksa.org. • Saudi Arabian Stock Exchange, PO Box 60612, NCCI building, North Tower, King Fahd Rd, Riyadh 11555; Tel: (966.1) 218-

1999; Internet: http://www.tadawul.com.sa. • Saudi Credit Bank, PO Box 1319, Damman; Tel: (966.3) 826-6091; Fax (966.3) 826-7225. • Saudi Industrial Development Fund (SIDF), PO Box 4143, Riyadh 11149; Tel: (966.1) 477-4002; Fax: (966.1) 479-0165. • Saudi Industrial Investment Group, PO Box 99833, Riyadh 11625; Tel: (966.1) 462-6909/465-7870; Fax: (966.1) 464-3473;

Internet: http://www.siig.com.sa.

Forfaiting

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Saudi Arabia - WikiLeaks · 2014-01-13 · Saudi Arabia 3 Country Finance 2008 ' The Economist Intelligence Unit Limited 2008 Market assessment • All commercial banks had to spin