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What does the Aramco IPO tell us about Saudi reforms?

The excitement was palpable as bankers, one group at a time, stepped on to buses that shuttled them from Riyadh’s Ritz-Carlton hotel to a meeting with Saudi officials.

Saudi Arabia, the most conservative of nations, had promised to do what no other Gulf state had dared: open the books of its state oil company Saudi Aramco, let the world peer inside and ultimately take a stake in the kingdom’s crown jewel.

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When the bankers arrived, they were greeted by Prince Mohammed bin Salman, then the deputy crown prince, and his “A-team” sitting around the “biggest table I’ve ever seen”, says one executive who attended the December 2016 meeting. The bankers were pitching for business from what was touted as the world’s largest initial public offering, with Riyadh seeking a valuation of $2tn and considering a global listing of 5 per cent of shares to raise $100bn.

“It was euphoric,” says the executive. “Some people were sceptical, but I would say, ‘What? Focus on the positives’. They were finally prepared to do it and bring socio-economic change [to the country].”

Three turbulent years later, Riyadh can lay claim to the world’s largest IPO. But it is on a far smaller scale than it had originally suggested. Saudi Aramco is to list 1.5 per cent of its shares on the local stock exchange on Wednesday, raising at least $25.6bn with minimal participation from foreign institutions that baulked at even the scaled-back valuation of $1.7tn.

In the kingdom, it is being hailed as a milestone for the world’s top crude exporter — proof that Prince Mohammed, elevated to crown prince in 2017, is forging ahead with his pledge to overhaul the oil-addicted economy and modernise his nation. But for many of the jaded financiers whose lives have been consumed by the on-off process since 2017, the mood is one of deflation — dazed by the downsizing and the realisation that the fees they dreamt of may never materialise.

“They aren’t doing what they were aiming to do, which is bring in foreign capital,” says a senior banker, who like most of those interviewed, asked not to be identified. “It’s not a real deal, it’s political.”

The story of the listing is a metaphor for the rollercoaster journey Saudi Arabia has been on as Prince Mohammed consolidated power and shook up the kingdom on a scale not witnessed since his grandfather, Abdulaziz, founded the modern state 87 years ago. It is a tale that began with audacious announcements and lofty ambitions that generated huge expectation but also scepticism. Now as the first phase of Prince Mohammed’s “Vision 2030” reform plan edges towards its close, it has become one of missed economic targets and shifting goalposts set against the paradox of unprecedented social reforms and increasing autocracy.

It is a combination that has fuelled contrasting narratives between optimists, resolutely supportive of the crown prince, and pessimists who fear his brash and aggressive leadership is doing more harm than good.

“Right aspirations, wrong approach,” says an executive familiar with the royal court. “When you are trying to do too much, you end up doing nothing much. There’s a hundred things that have to go up to his highness; it creates an environment of overwork and gridlock.”

The lack of economic progress helps explain why Prince Mohammed was so keen to complete the Saudi Aramco listing this year — the need for a win.

“Before the IPO, there was some disillusionment that none of the big projects have yielded anything and the economy is doing badly. People were asking, ‘What has happened to Vision 2030?’” says a foreign executive with Saudi clients. “With the IPO, they can say they have done something they said they were going to do.”

There has been some progress. Prince Mohammed has ushered in social reforms few believed they would see. A ban on women driving has been lifted; cinemas have opened; rules that prevented women travelling abroad without the consent of male guardians have been eased; and the once-feared religious police have been muzzled.

New laws on bankruptcy, foreign ownership and mortgages have been signed off.

Riyadh took the politically sensitive decision to slash energy and fuel subsidies to ease the fiscal burden. And when Saudi Aramco provided intimate details to investors on a roadshow to market its debut bond this year, it was seen as “an amazing period” in a region where disclosure has been anathema, says a veteran Gulf banker.

But, for many, the positives have been drowned out by negatives, including the shocking murder of Jamal Khashoggi, whose dismembered body has not been recovered a year after his killing. Many Saudi businesses were already reeling from an anti-corruption operation conducted 11 months before the journalist’s murder in Istanbul in October 2018. That purge saw more than 300 princes and tycoons locked up in the Ritz-Carlton — the same hotel the excited bankers had stayed in 11 months earlier — shattering the fragile confidence of a business community already buckling under the weight of austerity measures and the state’s failure to pay bills.

Separate crackdowns targeting bloggers, female activists, journalists, clerics and academics have reinforced the belief that Riyadh has become more repressive under Prince Mohammed. His actions have quashed debate, whether it is about the merits of the IPO or the pace of reform and highlighted the risks of investing in the kingdom.

Crucially, the flood of foreign direct investment Prince Mohammed was betting on to support his plans has yet to materialise. Instead, it fell to $1.4bn in 2017. And even though it picked up to $3.2bn last year, according to UN data, that is less than half the FDI secured in 2016. Meanwhile, outward investment trebled between 2017 and 2018 to $21.2bn, a reflection of spending by state entities, notably the Public Investment Fund, the sovereign wealth fund, as well as private investors shifting money offshore.

“He could have used the energy of hope instead of the energy of fear . . .
and not just been surrounded by yes men. The Saudi private sector could mobilise $200bn to $300bn — the shortage is not capital, it’s trust,” says the executive familiar with the royal court.

Repeating Saudi businessmen’s concerns, he adds: “‘We saw our friends go to the Ritz, we saw our bills not being paid [by the government] and now they say we should come and invest?’”

Saudi officials acknowledge mistakes. But there is also frustration that Prince Mohammed is not, in their view, given sufficient credit for taking on an unsustainable economic system built on petrodollars and patronage.

“There’s no question we’ve had a tough time getting to where we are and it’s been more difficult than we would have hoped,” says a senior Saudi official. But he adds, “You can’t underplay what we’ve managed to achieve. We are going through an evolution and everyone is judging us while it’s happening.”

It was, however, Prince Mohammed who set such high goals just at the moment when the oil-rich region was grappling with a prolonged fall in crude prices that turned abundant surpluses into yawning deficits. The crown prince was clear about his prime objectives: reining in the domineering role of the state and creating private-sector jobs for the youthful population.

A National Transformation Plan, unveiled in 2016, was to cut unemployment from 11.6 per cent to 9 per cent, create more than 450,000 private-sector jobs and increase non-oil revenues, while also lowering public sector wages from 45 per cent to 40 per cent of total government spending — all by 2020. But it became clear that many goals were unrealistic and the next year Riyadh revised the NTP, with targets removed or pushed out by five to 10 years.

It was an early sign of the magnitude of the task. Today, many of the metrics paint a very different picture and the state’s role is as dominant as ever. Unemployment sits at 12.2 per cent, after surging to a record high of 12.9 per cent last year. The public sector wage bill has increased to 50 per cent of expenditure, while the budget deficit is expected to widen to $50bn next year — almost twice the proceeds of the Saudi Aramco IPO. The government has boosted non-oil revenue by introducing value-added tax and tariffs on foreign workers, who dominate the private sector.

But the latter move has been debilitating for businesses dependent on cheaper foreign labour. The cuts to energy subsidies were welcomed by economists but have added to companies’ costs and damped demand. The IMF has downgraded its forecast for growth in gross domestic product this year to 0.2 per cent because of lower oil prices and cuts to production, even as there is a pick-up in non-oil activity.

One success officials point to is the visible increase in women working, particularly in shopping malls as the government has pushed retailers to hire Saudis. Yet, there has been little movement in the goal of raising the number of women in the labour force from 23 per cent to 28 per cent by next year.

“We rushed into quite a lot early on,” says the Saudi official. “We had energy, we had success, we had confidence, and everything was going really well. But then you start saying, ‘Let’s shift here, let’s do this here’. [And then] there is a bandwidth issue. Do we have enough people to manage this process? No, but we’re still going to give it a shot.”

Other factors created “blind spots”, says the executive familiar with the royal court. “Prince Mohammed’s mistake was that every time someone like Larry Fink [BlackRock’s chairman and chief executive] visited, he believed the Kool-Aid and that they were ready to pour hundreds of billions of dollars in, when in reality they just wanted a piece of the action,” he says.

The obsequious behaviour continued through the IPO process, which was revived after Saudi Aramco’s $12bn bond issue attracted significant foreign interest in April. Bankers and advisers jumped through hoops to lay out a plan to achieve the $2tn valuation. When Khalid al-Falih, the energy minister, was deemed resistant to the IPO, he was replaced.

At London pitches to the company in September, bank executives proposed aggressive marketing strategies, some saying a valuation of more than $2tn was eminently possible. But arguments flared, say people close to the process.

Prince Mohammed’s circle tried to push back against the inclusion of sensitive political topics in the risks section of the IPO prospectus. Officials were also furious when banks reported that international demand was dependent on valuations below $1.5tn.

Still, the fact that for all the doubts it is finally happening has proved to some that nothing is off-limits in the Mohammed bin Salman era.

“Saudi Arabia does not have to sell a single Saudi Aramco share, but the idea itself reflects a different approach to state administration,” wrote Abdulrahman al-Rashed, a Saudi columnist. “That is something that any visitor who knows Saudi Arabia will verify — the country is changing in all aspects of life.”

The jury is still out on the tangible impact of the downsized listing.

“They are juggling [Saudi] money from one place to another, and my concern is that it will be used for investments outside, like [Japan’s] SoftBank, when it’s supposed to be used to create sectors domestically,” says a Gulf-based executive.

Much is likely to hinge on the PIF, which will receive the proceeds of the IPO and has undergone a radical transformation to in effect become the personal tool of Prince Mohammed to drive the reform process.

Headed by Yasir al-Rumayyan, one of Prince Mohammed’s closest aides who replaced Mr Falih as chair of Saudi Aramco, the sovereign wealth fund is tasked with establishing new industries at home as well as leading projects such as Neom, a $500bn futuristic city. It made its mark on the global stage with high-profile investments, including pumping $45bn into SoftBank’s Vision Fund.

But its role is controversial. Proponents argue it is needed to spearhead projects the private sector would not, and use its financial and political muscle to develop new sectors. Critics complain it is crowding out the private sector, reinforcing the state’s dominance and making risky bets. Some are concerned that its omnipresence will now stretch to control of Saudi Aramco, with the risk that it uses the oil firm as a cash cow.

“The PIF is sucking all the air out,” says a Saudi businessman.

There is one issue that unites sceptics and optimists: with the IPO completed, the ultimate test of Prince Mohammed’s abilities will be delivering the next phase of building a strong economy.

“Urban, young Saudis are extremely happy and feel they owe the leadership a lot of credit,” says Steffen Hertog, a Gulf expert at the London School of Economics. But he warns that “social reforms are low-hanging fruit”. Creating sufficient jobs to tackle 30 per cent youth unemployment is a bigger task.

“What can the next big thing be? The megaprojects will take a lot of time and some locals think the PIF might be creating white elephants.”

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