Saudi Arabia Business Spat Threatens Riyadh Bid to Be Middle East Boomtown

By MARGARET COKER

RIYADH -- Eight months ago this sprawling desert capital seemed poised to take on the mantle of new Middle East boomtown.

Flush with $450 billion in foreign-exchange reserves, the Saudi government kicked off a massive spending program to mitigate effects of the global economic downturn and loss of oil revenues.

Officials knew 2009 would be a tough year but unlike neighboring Dubai at least they could boast of healthy banks. Bankers were touting Riyadh as the next financial frontier.

But a speedy economic recovery is threatened by a multibillion-dollar battle between two of the kingdom's biggest business groups. The ugly brawl between Ahmad Hamad Al Gosaibi & Brothers Co. and the Saad Group has left the fate of as much as $20 billion in debt in question and almost paralyzed lending to the private sector.

Ahmad Hamad Al Gosaibi & Brothers, or AHAB, is one of the region's largest conglomerates. It is controlled by a group of siblings, cousins and partners and owns one of the country's Pepsi bottling plants among other industrial assets.

The Saad Group focuses mainly on financial services. One of its owners, Maan al Sanea is one of HSBC Holdings PLC's largest individual investors. The two families that run both companies are related by marriage and have been listed among the world's richest people.

In May, however, both groups started defaulting on their debt and blaming each other for their problems. Together they owe around 100 Saudi and international banks between $10 billion and $20 billion, analysts estimate. Both companies have started debt restructuring talks that have been complicated by allegations of foul play.

AHAB, in a lawsuit filed in New York federal court, contend that Mr. al Sanea misappropriated close to $10 billion of its money by forging documents for loans. In a separate suit filed by the group in the Cayman Islands, a judge froze Mr. al Sanea's global assets. Mr. al Sanea denies the charges.

It's uncertain how far the fallout of this feud could spread. Saudi banks haven't reported their exposure to the two family businesses, and the Saudi central bank has declined to answer questions about the issue. The Saudi government has set up a special committee to help schedule repayments from the two firms to Saudi banks.

Uncertainty about the situation has taken a toll on the banking sector as well as the country's economic outlook. Saudi banks aren't expected to fail, but they also aren't expected to open the taps to cash-hungry private businesses anytime soon. Bank lending to the private sector has declined in five of the last seven months.

Approximately 90% of Saudi Arabia's private-sector activity comes from family-owned businesses which run everything from large industrial concerns to contracting firms, banks and retail businesses.

The expected slowdown in private-sector growth caused Saudi economists to cut their economic growth forecasts last month. They expect the economy to contract by 1% this year, wider than the earlier forecast of a 0.5% contraction.

"It is a difficult year for Saudi because of what is happening globally and problems of credit locally," triggered by these two troubled business groups, says Paul Gamble, head of research at Jadwa Investment in Riyadh.

The kingdom, the world's largest oil producer, was already taking a hit from the sliding prices and demand for oil that accounts for a third of its gross national product. Saudi Arabia is expected to produce 10% less oil this year than in 2008. Average price is around $63 a barrel so far this year, less than half of last summer's high of around $145.

To make up for lost oil earnings, the government announced a stimulus package in November. It even plans to run its first deficit in more than a decade. Those plans had many observers expecting investment bankers, lawyers and consultants to gravitate to Riyadh from places like Dubai, where the financial crisis has triggered retrenchment.

For now, however, the financial landscape around Riyadh appears as parched as its sun-baked plains shimmering in the August sun.

The Tadawul All Stock Index has underperformed other emerging markets this year and average volumes have declined. The country's IPO market, the second-most-active in the world in 2008, remains sluggish.

Saudi economists say the economy should return to growth next year. As debt concerns sap energy from private sector, they say the only bright line on the horizon is giant government projects.

From January to July, Saudi Arabia awarded nearly $21 billion in petrochemical-sector deals and $70 billion in nonoil-related contracts for everything from power plants and railways to schools.

Among those benefiting from the government spending are international engineering and construction companies that have been looking to the kingdom to make up for falling orders elsewhere.

In February, General Electric Co. sealed a $912 million deal with the Saudi Electric Co. to supply gas turbines for new power plants. In July, China Railway Construction Corp. signed a $533 million contract with the Saudi Ministry of Education to build 200 schools over a period of 14 months.

Write to Margaret Coker at margaret.coker@wsj.com