Factors Affecting Entry of Foreign Multinationals in the Market of Saudi Arabia - Research Paper Example

Factors Affecting Entry of Foreign Multinationals in the Market of Saudi Arabia Table of Contents Table of Contents ii Chapter 1 1 1.0 Introduction 1 1.1 Rationale of the research 2 1.2 Research question 2 1.3 Aims and objectives of the research 2 Chapter 2 3 2.0 Literature review 3 2.1 Foreign Investment Regulatory Regime 3 2.2 Opportunities for Investors in the KSA 3 2.2.1 Negotiation processes 4 2.2.2 Language issues 4 2.2.3 Socio-political concerns 4 2.2.4 Foreign Investment Regulatory Regime 5 2.2.5 Legal issues in Saudi Arabia 5 2.2.6 The taxation system in Saudi Arabia 7 Chapterr 3 9 3.0 Research Design and Methodology 9 3.1 Introduction 9 3.2 Research Design 9 3.5 Data Collection Procedures 10 3.5.1 Type of Data 10 3.5.2 Data Collection Method 10 References 11 Chapter 1 1.0 Introduction Increased rate of economic globalization and integration of international production and the ease of sharing and transferring of key functions in modern organizations like innovations in technology has continued to create a conduce environment for the growth of multinational companies. Further reduction of international trade barriers by most countries has continued to be a catalyst of direct foreign investment in these countries as companies seek to take advantage of investment opportunities in foreign countries (Mataloni 2011). One of the advantages that a country gains by attracting foreign direct investment (FDI) is that the investors are able to unlock the potential of the country through provision of finances and technical expertise into sectors that would have otherwise remain untapped. Saudi Arabia has not been left behind in attracting direct foreign investment. According to National Competitiveness Center (2010), Saudi Arabia attracted an inflow in FDI to the tune of US $ 38.5 billion in the year 2009 the biggest contributors of the FDI being the United States followed by the Kuwait at US $ 5.8 billion and US $ 4.3.billion respectively. There has been a gradual increase in the FDI since the year 2005 the time at which the direct foreign investments stood at us $ 12.5 (NCC 2010). According to () the leading form of investment in Saudi Arabia is in the form of joint ventures that stretch from strategic alliances, international trade, consultancy among others( Mababaya 2002) According to NCC (2010 the direct foreign investments in Saudi Arabia however is far much below the expected level and does not actually correspond to the potential of the country to attract investors owing to its superior infrastructural development (NCC 2010). It is from this understanding that the researcher seek to unravel the factors that affect the entry and exit of foreign multinational firms in the market of Saudi Arabia. This research will have three broad chapters namely the introduction which seeks to introduce the subject and the scope of research, the literature review which details the previous research work done about the subject matter and the gaps in the previous research and finally the methodology which outlines the research design that the research will adopt, data collection procedures, data analysis and presentation. 1.1 Rationale of the research As highlighted earlier, Saudi Arabia’s infrastructure are relatively highly developed offering a good incentive for foreign investment. In addition, Saudi Arabia hold the largest proven oil reserves in the world besides the United States and the Soviet Union and with the country’s broad economic goals of transforming its oil driven economy in to a broadly based and privately owned industrial and service economy, opportunities for investment are wide open (Dr. M. Al Amri & co. N.d). This potential however remains untapped as the foreign direct investment in the country remains below expectations. In fact after a gradual growth in DFI from 2005 through to 2007, 2008 recorded a 7% decline which was a deviation from the target of doubling the FDI. The research will therefore seek to establish the factors that affect the entry and exit of multinational firms in the Saudi Market by identifying the reasons why the FDI remain low despite the numerous investment opportunities. 1.2 Research question Despite the numerous investment opportunities available in Saudi Arabia together with a number of incentives offered to foreign investors, why does foreign direct investment remain low in the Kingdom of Saudi Arabia? 1.3 Aims and objectives of the research The aims and objectives of this research are; 1. To determine whether the Islamic cultural factors do have any impact on the operation of multinationals in the Kingdom of Saudi Arabia. 2. To determine the impact of the legal system in establishing multinationals in Saudi Arabia. 3. To identify the taxation system on multinationals in Saudi Arabia and its impact on their competitiveness. 4. To examine the social-political environment under which the multinational operate and its impact on their stability. Chapter 2 2.0 Literature review 2.1 Foreign Investment Regulatory Regime Foreign Direct Investment (FDI) according to Maitena (2003) is whereby an investor gets a lasting interest in an enterprise in the foreign country. The lasting interest in this context means that the direct investor and the investment enterprise establish a lasting relationship with the direct investor influencing management of the foreign enterprise. Contessi and Weinberger, (2009) also argues that FDI is the process through which an investor obtains a lasting influence in managing another firm in the foreign country. Inflows from the FDI in the form of multinationals have helped countries increase their fiscal and financial schemes in their home countries (Artige and Nicolini, 2006). 2.2 Opportunities for Investors in the KSA According to the Discovery Business (2013) there has been a stable and considerable foreign investment in the Kingdom of Saudi Arabia. History has it that for the past two decades, the Kingdom received close to US$ 150 billion from Foreign Direct Investment. The most prominent investors in Saudi Arabia are Kuwait, France, Japan and the US. The inflows received from the FDI are distributed among the sectors in the country and the most beneficial sectors are the real estate, transport, contracting and petrochemicals. Below is a representation of the distribution of foreign investors and inflows among the sectors of the KSA economy. The body which is responsible for establishing an effective economy ground and regulations to attract foreign investment in Saudi Arabia is the Saudi Supreme Economic Council. The foreign investment systems in Saudi Arabia comprise of incentives like the founding of SAGIA, which is put in place to encourage foreign investment in the country. By 2008, approximately 2,000 projects amounting to US$ 15 billion had been licensed. This led to a reduction in number of activities that were not permitted to foreign investors and restrictions are now limited to land, transportation, oil and gas exploitation and investment in Medina and Mecca (Discovery Business, 2013). 2.2.1 Negotiation processes The process through which the foreign investors are supposed to negotiate in order for their business to be accepted could be time consuming compared to other jurisdictions and this normally discourages investors from investing their resources in the South Arabia (Herbert, 2010). To some extent, long negotiation process is caused by cultural differences and language barriers, which many foreign investors find hard to cope with. During the negotiations, foreign investors are required to commit themselves to technical support, training and even management expertise among others which provides unfavorable condition for investment by foreigners. At time negotiations are forced to come to an end during prayer times and during Ramadan, the holly month for fasting among the Muslim community. The negotiation requirement of getting consent from the local business partner before registration of any nature is done may prove to be a problem to the foreign investors especially when the Saudi party to the negotiation chooses to withhold the investors’ business name. 2.2.2 Language issues Most of the foreign investors in South Arabia understand English as the only language to communicate with. The most prominent language that is used in signing contracts in Saudi Arabia is Arabic and sometimes the language prevails in case a dispute arises during the interpretation. Arabic language is dominantly used to an extent that even if English language is used in theory, officials from the government may always read Arabic alone. In such a case, the foreigners will have to ensure that both languages communicate the same thing. Foreign investors will have a problem in meeting the demands of their customers due to barrier in communication. The investors are also limited on the type of expatriate to use in conducting their business and most of them would have to come from Saudi Arabia (Herbert, 2010). 2.2.3 Socio-political concerns According to Hammarlund (2012) Saudi Arabia experiences domestic and regional socio-political tensions which are likely to discourage more foreign investments. One of the important factors that are causing domestic dissatisfaction and the possibility of political instability in Saudi Arabia are the increased rate of unemployment, King Abdullah’s succession, unwillingness towards foreign involvement in the affairs of the country, religious intolerance, discrimination against gender and unavailability of democratic rights. For instance, King Abdullah’s gradual reforms that created room for women to participate in municipal elections was far from a meaningful political reform the country expected, but only created room for more tension in the country. Furthermore, Wahhabism does not support women involvement in economy and society and is making effort to stop their participation which causes more controversy. There is also increased competition and tensions between the Iran and Saudi Arabia and to some extent with Yemen, which is likely to be a threat to the stability and security in the Kingdom. As a result, potential foreign investors are discouraged from investing their resources in the Kingdom of Saudi Arabia. 2.2.4 Foreign Investment Regulatory Regime The changes in the regime created room for entry of foreign investment in Saudi Arabia but still some segments of the economy have been restricted from foreign investment. Saudi Arabia’s Foreign Investment Regulations set out clearly areas of investment which is commonly referred to as “negative list” (Herbert, 2010). Also, foreign investors are denied some operational licenses to conduct certain businesses and they are issued to Saudi nationals only. For instance, foreign investors are not allowed to conduct money changing business, which is limited to the nationals of the Kingdom. As much as Saudi Arabia avails investment vehicles to foreign investors, restrictions on the type of business foreign investors are supposed to engage into may force them to adjust their business model which causes financial stress. Restrictions and licensing requirements by the government of Saudi Arabia is likely to prevent foreign investors from offering their full potential in terms of goods and services the way they could provide in other jurisdictions. Therefore, despite the fact that the foreign investment guide that realized with the intention to improve foreign investment in Saudi Arabia, several investors are not ready to invest in the country. 2.2.5 Legal issues in Saudi Arabia There are several regulations that the Saudi Arabia government requires for any foreign company to do business in the country. The company’s regulations regulate the establishment and governance of corporate entities as well as the multinational corporations. The main forms of legal entities, as explained by (Watkins 2010), are the Limited Liability Company, Joint Stock Company and branch of a foreign company. Multinational corporations must abide by this rules and regulations in Saudi Arabia. A foreign company that opens a branch in Saud Arabia is obligatory (a condition for all overseas limited liability and joint stock corporations), to deposit an amount equivalent to the capital requisite by Saudi Arabia general investment authority with a home bank and such amount is blocked until issuance of the official document of registration for such local office by the Ministry of Commerce and Industry. This is a hindrance from doing business in this country. Subject to any statutory (for example the right of Saudi Arabians to purchase shares) or contractual preemption rights, as (McKenzie 2012) explains, the exit of a foreign shareholder is done by way of cancellation or transfer, as it may stand, of the Saudi Arabia general investment authority license. This dictatorial restriction is designed to control the foreign corporations venturing to the market in Saudi Arabia. Due to restrictions on foreign investment and pursuant to the Commercial Agencies Regulations, many foreign manufacturers and principals have generally appointed Saudi agents or distributors to trade and distribute their products in the local Saudi Arabian market. In addition to these restrictions a Saudi commercial agent or distributor must register with the Ministry of Commerce and Industry each time it enters into a distributorship or agency relationship with a multinational foreign company or corporations. As part of such registration process, the Saudi agent or distributor must submit its agreement with its non-Saudi principal to the Ministry of Commerce and Industry for registration within three months from the effective date of such agreement. This only adds to difficulties of doing business in Saudi Arabia as (Minkus-McKenna, 2003) explains. In December 2005, Saudi Arabia acceded to the World Trade Organization (WTO) and, accordingly, the Supreme Economic Council (SEC) opened definite economic sectors to foreign investment like the retail and wholesale trade businesses but leaving out multinational corporations as (Watkins 2010) continues to assert. Nevertheless, foreign investment in wholesale and retail trade business (including distribution activities) remains subject to, amongst other effects, a lowest amount foreign venture of SR two million and a maximum foreign equity chipping in of seventy five percent. However, commission based commercial agency arrangements remains on the Negative List. This has received a lot of criticisms from the world trade organization. Furthermore, as (McKenzie 2012) asserts, foreign companies cannot have complete control of companies working in Saudi Arabia as well as the employees working there. This means that the company should be run by Saudi Arabia citizens. They are also required to have initial capitalization, operating within the object for which they were approved by the Saudi Arabia general investment authority. These legal regulations combined with the Islamic culture make it had for multinational corporations to do business in Saudi Arabia. Some do penetrate through the local agents and distributors as mentioned above. 2.2.6 The taxation system in Saudi Arabia The multinational companies are subject to a number of tax implications and import barriers instigated to restrict their entry in the Saudi Arabian market. For instance, multinational corporations have to pay five percent tariff on importation of goods to Saudi Arabia (raw materials). This is even more to corporations which produce or import products which are similar to those made in Saudi Arabia by the local firms owned by the Saudi Arabians, they have to pay a whopping 12 percent on these products. As (Wu, 2008) describes, multinationals which work in Saudi Arabia have to pay the Islamic tax on wealth on top of the normal taxes companies are supposed to pay. Saudi enacted a broad tax law in year 2004. Under this tax laws, companies are subject to various taxes like residential capital company for non Saudi shares, a resident non-Saudi national that conducts business activities in Saudi Arabia, a resident non-Saudi natural person that conducts business activities in the Kingdom of Saudi Arabia, business that is engaged in oil and other hydrocarbon production and a corporation that is engaged in gas exploitation has to pay tax on the oil and or gas. Any corporation from outside the country operating in Saudi Arabia has to pay all this taxes besides the corporation tax rate on the profit of the company. Sparingly gas and oil exploitation companies have to pay taxes of up to eighty five percent as the tax laws are. Companies have also to pay Islamic tax which is levied on the capital resources of a company at a rate of 2.5 percent (excluding the fixed assets, long term investments and differed costs from the total capital resources but including profits from other investments). To add on this, corporations are required to register their employee’s contracts with the interior ministry before they can be given license to carry on their business operations. Each company is allowed a limited number of visas there by limiting the number of foreign experts who can work for the multinational corporations in Saudi Arabia. The employment laws require that foreign corporations must employ a minimum number of Saudi Arabia nationals. This means that multinational corporations are restricted in the choice of labour services even if there are no such. A foreign corporation may only obtain a temporary commercial registration after it has obtained a government contract and the license is limited to the capacity and period of the contract only. This hinders entry of multinational corporations in the Saudi Arabian market. (Watkins 2010) explains that the temporally commercial registration does not allow foreign corporations to establish actual presence with the reason of promoting business and monitoring market conditions as well as opportunities for the local companies. For multinational corporations therefore they must wait for opportunities brought about inform of government contracts and invitations. Chapterr 3 3.0 Research Design and Methodology 3.1 Introduction In an effort to determine the factors affecting the entry and exit of multinational firms in the market in Saudi Arabia both qualitative and quantitative research methodology. Qualitative research is employed in describing a number of non-statistical inquiry processes and techniques used in gathering social phenomena data (McNabb 2008). Quantitative research will be employed in this case in obtaining data relating to taxation of multinationals and analyzing it in comparison to the data relating to the locals Saudi Arabian companies in an effort to examine whether the tax system places the multinationals in a disadvantaged position in comparison to the local companies. 3.2 Research Design The researcher will employ descriptive research design which entails making observations or collecting data of the research subject and describing the behavior of the subject without influencing it in any way. Descriptive research relies heavily on questionnaires and interviews of respondents to collect the primary data as well as perusing through journals, newspapers and other reliable sources to obtain secondary data (Elahi & Dehdashti, 2011). The researcher will use questionnaires and either face to face or video conferencing interviews to obtain a good insight about the respondents understanding about the factors affecting the entry and exit of multinational firms in the market in Saudi Arabia. The questionnaires will be both closed ended as well as open ended so that in addition to respondents answering the guided questions, they will also give more important and relevant information that the researcher may have not been covered in the close ended questions. 3.5 Data Collection Procedures 3.5.1 Type of Data This study will use both primary and secondary data. Primary data will be collected through interviews and questionnaires while secondary data will involve other sources of materials such as newspapers, education journals among others. 3.5.2 Data Collection Method Questionnaires will be administered to the respondents through a drop and pick method. The researcher will leave the respondents to fill the questionnaire at their own time and collect the completed form within one week. This will avail the respondents enough time to read, understand and fill the forms with maximum concentration. On the other hand, as the respondents continue with the exercise of filling the forms, interviews which will be conducted with selected chief executive officers of multinationals will commence and will be conducted either in their offices or through video conferencing. The research will target to interview 30 chief executive officers and issue questioners to 100 multinationals. References Ali, A 2009 Conducting Business in Saudi Arabia a Brief for International Managers Global Business and Organizational Excellence Artige, L., & Nicolini, R 2006, Evidence on the determinants of foreign direct investment: the case of three European regions. 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