The idea of privatizing Saudi Aramco, the national hydrocarbons giant in Saudi Arabia, appears to have re-kindled the privatization fire in the Middle East. While the announcement of what could theoretically be the largest initial public offering (IPO) ever envisaged startled even seasoned market observers, its modalities and timeline remain unclear, as confirmed by the company’s chairman in a recent interview.
Indeed, privatization was not on the agenda of regional governments until a few months ago, when the fiscal situation of some Gulf Cooperation Council (GCC) countries started to deteriorate due to falling oil prices. Elsewhere in the region, the reduction of state ownership anticipated by some observers of the Arab Spring failed to materialize as populations of such countries as Egypt and Tunisia grew disenchanted with previous experiments. The perception of corruption and insider dealings in previous transactions doubtless contributed to the discontent.
As a result, the last few years have witnessed a virtual halt in privatization activity across the Arab world. This was equally true in post-revolutionary countries like Egypt, those with longstanding fiscal deficits like Lebanon, and those with a large government sector like Kuwait. Privatization has remained a politically unpopular option both in the Gulf monarchies and in transition economies, both in governments led by Islamist and by secular parties.
This Is Changing by Necessity
Privatization appears to be slowly rearing its head in the region again, mostly in the economic plans of the GCC countries and in Egypt. To be clear, this is not because attitudes have changed. Divestment from state-owned enterprises (SOEs) is seen as a last resort in the Gulf countries in light of the fiscal tightening, especially in Bahrain, Oman, and Saudi Arabia.
Subsidies, which were previously thought to be an untouchable pillar of the social contract, have already been rolled back. In the last six months, all GCC countries butQatar and Kuwait announced specific measures to banish fuel subsidies. Even the latter two nations, which have the highest per-capita GDP in the Gulf, have considered the idea.
The United Arab Emirates (UAE) moved first, abolishing its US $7 billion annual petrol subsidy in July 2015. In December 2015, Saudi Arabia increased its gasoline prices by over 50%; Bahrain and Oman followed in early 2016. At first glance, these measures appear reasonable considering that a number of the region’s countries have the highest hydrocarbon subsidies in the world.
Yet, the rapid death of subsidized petrol was unexpected, especially in the patriarchal GCC economies, where they have been an intrinsic part of the social contract. Demolishing the long-entrenched subsidies system and even discussing the introduction of value-added and corporate taxes appears preferable to the GCC governments than further privatization, even of unprofitable companies. While some of the national SOEs have emerged as extremely successful companies, not all SOEs in the Gulf, and far fewer in other parts of the region, are performing.
Transactions to Replenish Coffers
Today, GCC governments are contemplating privatization in an entirely different context than in the days when transactions were designed to redistribute wealth to citizens through stock exchange sales. Already, previous privatizations have shown the limits of this redistribution logic: In Saudi Arabia, for example, shares of listed government companies settled in the hands of high-net-worth individuals as opposed to benefiting the general public.
Though there will be no redistribution logic in privatizations this time around, governments still want to retain high — if not controlling — stakes in any listed SOEs, as golden shares are not used in the region. It is likely that any further sales will be conducted through capital markets that can benefit from additional liquidity generated from the listing of large blue-chip companies, especially as family-controlled companies continue to be reluctant to open their capital to the public.
Governments in the region are already important shareholders in public equity markets as a result of previous privatizations and active investments made by a range of sovereign investors (such as social security and sovereign wealth funds). According to a GOVERN analysis, sovereign investors own over 40% of overall MENA markets’ total capitalization, and these figures are even higher in the Gulf. Of the 100 largest listed firms in the MENA region, 89 have government stakes, and over a third of the largest listed firms have the state as a shareholder.1
Previously closed to foreign investment, some companies — especially those listed in the UAE and Qatar — are now considering secondary public offerings to attract foreign investment. A number have raised their foreign ownership limits. In 2014, the emir of Qatar mandated that all listed companies raise their foreign ownership limit from 25% to 49%. In a widely anticipated economic announcement, the Saudi Capital Market Authority issued new rules in 2015 opening the market to foreign investment.
In this new socioeconomic backdrop to privatization in the Gulf, one important question remains unresolved: Considering that the state is already the largest shareholder of listed companies, to whom will new companies be sold? If domestic institutional investors subscribe shares, this will effectively mean passing the money from one government pocket to another, as domestic institutional capital is also often sovereign.
One potential group of buyers of state-owned enterprise shares are family offices, which are the second-largest investors in public equity markets in the region. Whether foreign institutional investors — to which Gulf markets are being increasingly opened — might be interested in Gulf state-owned enterprises is an open question.
Though sovereign investors certainly provide the stability of institutional investment, which is elusive even in developed markets, foreign investors may be skeptical of the quality of governance of newly privatized companies that — even though partially privatized — will likely remain under state control.
Although the listing of SOEs in the region has generally brought governance in line with other listed companies, there is still a gap between foreign investor expectations and existing governance practices. As the sale of government companies will likely result in the largest IPOs in the region, better corporate governance will become sine qua non in an attempt to bring much needed foreign investment to MENA capital markets.
Assuming foreign investors do find the value proposition of planned sales of SOEs attractive, their interests will need to be aligned with the objectives of Gulf governments. This is likely to prove a delicate balancing act.