Cash Rules Everything Around Me

Saudi Arabia’s investment conference, regarded as the “Davos in the desert”, presents a major opportunity for institutional investors and governments alike. It is a vital opportunity for Saudi Arabia to diversify its ‘petro-state’, as their oil dependent economy is in danger of depletion. Crown Prince Mohammed bin Salman (MBS) leads several annual initiatives like this with the hope of diversifying the Saudi economy and moving away from the Saudi state-driven model towards higher private sector employment.

MBS came to power in 2016 as a clear break from the octogenarians who had ruled the conservative party for decades. Some of his key initiatives include: allowing women to drive, issuing tourist visas, and liberalizing parts of the economy. At the core, many of these are steps towards achieving his most prized policy objective: ‘Vision 2030’. Vision 2030 aims to not only transition the Saudi economy away from oil but also to develop public service sectors such as tourism and education. Despite the killing of the Saudi journalist Jamal Khashoggi only days before, thousands attended “Davos in the desert”. This points towards several questions.  Will the international community punish Saudi Arabia for its actions? How will Wall Street react to the crisis? Will Wall Street turn a blind eye in hopes of high returns as they so often have in the past?

Capital Flight and Shaky Investor Confidence 

MBS’ penchant for authoritarian tendencies and  “capricious economic policy choices” have both contributed to international investors losing confidence in the Saudi economy. Given these concerns, it is not surprising that foreign direct investment plummeted by approximately 80% from 2016 to 2017. These figures illustrate a structurally weak economic and political machine. Concerns around Khashoggi’s assassination have further catalyzed  the downwards economic spiral in the kingdom.

Following MBS’s decision to take a portion of Aramco public, King Salman put a halt to the decision. It is believed that there were concerns that the IPO would undermine the Saudi monarchy. Others have suggested that King Salman wished to keep MBS’ power in check. This severely derailed MBS’ plans for Vision 2030. Aramco’s gross overvaluation at $2 trillion has further discredited MBS’ financial acumen.

The Saudi economy is facing a crisis whereby investor confidence, capital flight, and rising unemployment have created a bottleneck.  Investors continue to transfer their liquid assets to foreign assets fearing a further deterioration in the Saudi economy. This has shrunk foreign currency reserves, and in turn damaged the Saudi ‘rainy day fund’.  Capital outflows in 2017 were an astonishing 15% GDP. Despite this, official reserves have been held up by rebounds in oil prices. MBS will need to instill investor confidence in order to prevent the very vulnerable Saudi economy from collapsing.

Political Crackdown and the Raging War in Yemen

Saudi Arabia’s role in the Yemen Civil War has generated controversy regarding MBS’ foreign policy. Saudi efforts to crush dissent in Northern Yemen have devastated the Yemeni economy.  Their attempts to cut off Houthi rebels in the north of Yemen, through punitive economic measures continue to worsen the humanitarian crisis in the country. Yemen is in a rampant state of famine with millions in poverty and non-stop air strikes. Despite humanitarian concerns, the U.S. continues to support the Saudi regime. This should discourage bearish trends in the Saudi economy as investors will be less fearful of an American-led economic coalition against the kingdom. In essence MBS has become the diplomatic equivalent of big financial institutions such as Freddie Mae and Fannie Mac: too big too fail.  Support for the Saudi regime is not unique to the American government; executives from private companies attending the Davos in the Desert is proof enough that it is unlikely Western firms will cut commercial ties.

U.S. Saudi Interdependence 

A culmination of bad economic policy and poor diplomacy has undermined the stability of Saudi Arabia. The interdependence between the U.S. and Saudi Arabia proves as a vital variable that clearly undermines the susceptibility of Saudi Arabia from sanctions. The U.S. needs Saudi Arabia for oil and as a strategic Arab ally in order to isolate Iran from spreading revolutionary Islam. Actions against Saudi Arabia would limit American leverage over Tehran; a common enemy of both countries. American unease towards Iran concerns their ability to interrupt oil supplies passing through the strait of Hormuz. The risk of oil shortages and increased prices are too much of a burden for the U.S. to bear. This means they will continue the policy of blank cheque support for the Saudi kingdom vis-à-vis the rest of the region. Further, Saudi investors may be more attracted to dollar denominated assets as U.S. interest rates continue to rise, thus exacerbating capital flight. In essence, cash in this world may hold more value than international norms. The U.S. intends to uphold their arms deal with Saudi Arabia, estimated to be worth $110 billion. For major defense companies such as Lockheed Martin and Raytheon, business comes first invariably.

Wall Street Woes

The commitment to human rights and international law will ultimately determine the extent to which financial institutions and tech companies continue to do business with Saudi Arabia. Unanimous withdrawal by major financial institutions is necessary for Saudi Arabia to change its backwards regime. Again, this is unlikely considering the stake major institutions such as Uber, JP Morgan and Blackstone have invested in Saudi Arabia. Likewise, Silicon Valley remains at the forefront of technology and innovation. Countless venture capital firms (VC) and start-ups have raised capital from governments with questionable human rights track records. Top VC firms such as Sequoia Capital and Kleiner Perkins remain very secretive in terms of discussing their limited partners. It is extremely difficult to track the source of investments due to the extensive investment networks used by repressive regimes. Mr. Gutelius at the Data Guild has noted that the source of investment in the tech industry matters because “the profits you generate go directly back to supporting that regime and everything that it stands for”. Yet, misinformation prevails and loopholes make it very difficult to know where the money is coming from. This is especially concerning given Saudi Arabia’s increasing presence in the tech industry. Institutions will need to consider the repercussions to their corporate reputation if they continue to do business with Saudi Arabia. The costs to their corporate image may outweigh the benefits of condemning bad behavior.

Towards the Future

Saudi Arabia has already taken a major hit to its reputation. The war in Yemen and the death of Khashoggi will likely blow over in the near future. The massive arms contracts between major world powers and Saudi Arabia have proven to be worth the potential backlash from public opinion given the war crimes and human rights abuses. Black gold has been the lifeline of the Saudi Kingdom and has created inescapable ties to the West. Until the world takes a united stance to uphold international norms and behavior, cash will continue to rule the Saudi Kingdom and its regime.