What is the future of the free zone model in the GCC?

Published July 18th, 2016 - 06:53 GMT
Jafza is now one of the world’s biggest free zones, accounting for almost 32 percent of total FDI (foreign direct investment) flow into the country. (Arabian Supply Chain)
Jafza is now one of the world’s biggest free zones, accounting for almost 32 percent of total FDI (foreign direct investment) flow into the country. (Arabian Supply Chain)

In 1959, when business leaders in the small Irish town of Shannon realised their tiny airport would soon no longer be needed as a refuelling stop for transatlantic aircraft heading for Europe, they quickly convinced the government to allow it to set up a small district outside the airport that would be isolated from the rest of the country’s economy, offering tempting tax breaks for foreign investors.

It was the world’s first free economic zone, beginning a trend that has been imported and developed to the benefit of countless global economies. Almost three decades later, the concept would land in the Middle East. Surrounding Jebel Ali Port, Jebel Ali Free Zone Authority (Jafza) became the flagship free zone for Dubai and the UAE, and the trade and logistics hub for the wider Middle East region, when it opened in 1985.

Jafza is now one of the world’s biggest free zones, accounting for almost 32 percent of total FDI (foreign direct investment) flow into the country. In 2015, it generated trade worth $87.6bn and recently announced that its total number of companies grew by 8 percent last year, with total workforce reaching 144,000 at the end of 2015.

But it is facing new competition from the region’s rising megaports. Saudi Arabia’s King Abdullah Economic City (KAEC) set out with the aim of taking business away from Jafza by offering a quicker and cheaper service, officials promised last year. The port handled 1.3 million TEUs (twenty-foot equivalent units) last year, compared with 500,000 TEUs in 2014, its first year in service. After the addition of a fourth berth, its capacity reached 3 million TEUs. It will add two more berths by the end of this year to reach a capacity of 4 million TEUs. By comparison, Jafza’s recently announced Terminal 4 is expected to add 3.1 million TEUs by 2018, taking Jebel Ali Port's total capacity to 22.1 million TEUs.

Saudi Arabia is proving to be an increasingly attractive hub, due in part to the continued growth of Chinese and Indian economies. In 2014, more than 6,000 vessels passed through the Red Sea, carrying more than 42 million TEUs.

In neighbouring Oman, Chinese investors recently signed an agreement to build an industrial park at the southern port of Duqm. The government is working to develop the area around Duqm, on a stretch of barren coast 550km (345 miles) south of the capital Muscat, into a major business zone as part of efforts to diversify the economy beyond oil. The park project is expected to attract billions of dollars of investment.

The CEO of Sohar Port and Free Zone on Oman's northern coast, Mark Geilenkirchen, says the rise of new megaports is positive.

“It allows space for unhindered industrial expansion and the provision of more efficient ‘hinterland’ infrastructure; it reduces congestion around the old ports and improves the quality of life for people living there; and it often leaves behind what I would call ‘legacy ports’ that have huge potential for tourism,” he says. 

The Sultan Qaboos Port in Muscat is being converted to accommodate tourist-carrying cruise ships that are expected to contribute to tourism and generate jobs.

Duqm Port, on the other hand, will focus on dry docks and oil exports for the time being.

Dubai’s premier free zone Jafza is capable of handling 15 million containers annually.

Competition also is growing in Qatar, with Doha’s New Port Project (NPP), expected to be completed by 2020. Located south of Doha, the $7.4bn project includes a new port, a new base for the Qatar Emiri Naval Forces and what will then be Qatar’s third special economic zone.

Geilenkirchen says each port will carve out its own advantages and uses. Doha, for example, will primarily serve Qatar.

“If you are shipping in construction materials for stadiums in the run up to the FIFA World Cup in 2022, you are going to ship them through Doha port. As such, we do not see this as head-on competition for Sohar," he says.

Jafza is also expanding to counter some of the competition. Deputy CEO and chief commercial officer Ibrahim Mohamed Aljanahi says it is well-positioned to take advantage of growth from economies in Asia and elsewhere.

Jebel Ali Free Zone launched last May a string of new projects that will continue to position Jafza as one of the world’s leading free zones, attracting leading businesses from around the world. In the next five years, we expect significant growth to come from Asia, Europe and Americas.”

The new projects include a 500-unit multi-storey warehouse near the World Expo 2020 site, a new complex for light industrial units catering for the supply chain and logistics sector, and a new 30-building onsite residence complex that will house almost 30,000 employees and will include restaurants, retail stores and recreational areas.

Jafza is one of more than 30 free zones in the UAE, hosting upwards of 25,000 companies, which represented 32 percent of the country’s total non-oil trade volume last year, to a value of $135bn, according to the Federal Customs Authority.

Yet some of the region’s free zone chiefs argue the model is becoming outdated and are planning for what they see as an inevitable decline in its importance.

“As the region continues to evolve and new legal and tax frameworks are introduced in the future, there is certainly the possibility that some of the many advantages that free zone companies have today, compared with their onshore competitors, may no longer be as significant,” Geilenkirchen says.

“However, all the GCC countries are diversifying their economies further and faster than ever before, and that will lead to more foreign direct investment into the region and more growth. Perhaps most important of all is that the ease of doing business in this region continues to improve, and that the GCC continues to build on its successes in helping to reduce bureaucracy and in attracting more international partnerships.”

Oman wants Port of Duqm to become one of the region’s largest ports over the long-term.

In a period of global economic uncertainty, benefits such as zero percent corporate tax, unrestricted repatriation of capital and profits and zero percent import and re-export duties certainly offer a reassuring layer of protection.

Dr Mohammed Al Zarooni, chairman of the Dubai-based World Free Zones Organisation, says: “While free zones cannot stay completely insulated from global growth dynamics, they are less insecure in the sense that the slowdown or stagnation is likely to impact free zones less severely given that free zones are often special enclaves and generally enjoy government’s policy support and fiscal support.”

And free zones will be at the heart of the UAE’s next mega economic project, the 2030 Dubai Industrial Strategy, which Sheikh Mohammed Bin Rashid Al Maktoum, Ruler of Dubai, launched in June to generate an extra $44bn for the emirate’s economy.

The strategy is being led by Jafza, Dubai Industrial Park and the Dubai government, to enhance the sustainability of the emirate’s industrial sector and its free zones, says Aljanahi.

“The Dubai Industrial Strategy has outlined policies to ensure a steady pace of growth in all sectors and has assigned specific tasks to every economic institution, whether free zones or industrial zones,” Aljanahi says, adding that it will contribute to a “quantum leap”.

Just as Saudi Arabia’s Vision 2030 is designed to remove the country’s dependence on oil, the Dubai Industrial Strategy is intended to help reduce the emirate’s dependence on imports and foreign trade — a huge boon for the country’s free zones and onshore companies.

So why are some free zone leaders in the GCC wondering aloud about the future of the model?

In May, Saudi Arabia issued a decree that will allow 100 percent foreign ownership in retail companies for the first time in the kingdom, albeit with tough conditions. Now some business leaders think the rest of the GCC will not be far behind.

At Dubai Science Park in Al Barsha South, discussions are already taking place on how potential changes in the status would impact free zones.

Executive director Marwan Abdalaziz says free zone status is “becoming less and less important” to foreign companies looking at the UAE. “If you are a local company that is doing business in Dubai, I don’t think it makes sense for you to be in a free zone. Most of the companies — 99 percent — operating in free zones are regional companies so they do business with the entire region, versus only Dubai, so if you are doing business only locally then it is a disadvantage, I would say.

The King Abdullah Port in KAEC is designed for quick and efficient handling of vessels and cargo.

“I think when we travel abroad, the free zone is probably the last point that we mention and I think the free zone status is diminishing. It is becoming less and less important, for a couple of factors.

“We had these discussion internally a long time ago saying that if the free zone status is taken away from us, how is that going to impact us? And this is why as a strategy we focused on the other activities that are more important for the companies, whether it is the community, the academic engagement, the regulatory engagement, so the free zone then becomes something good to have, but not the number one thing.”

Nevertheless, free zone growth is showing no signs of slowing, The UAE emirate of Sharjah announced in January its plan to emulate the success of Dubai Media City, just as Kuwait revealed it intends to develop business free zones on five islands off its coast. In Qatar, ministers recently approved a draft law setting out regulations for special economic zones aimed at attracting inward investment.

But Geilenkirchen warns that too many zones could result in a “shakedown” that would lead to consolidation.

 “Many of the region’s free zones have found their own niche to operate in, especially the highly specialised clusters in the UAE,” he says. “Our research tells us that there is still great opportunity with free zones in our region and our recent success in Sohar speaks for itself. However, if there ever are too many zones in this region, then you will surely see a general shakedown and consolidation within the sector. I don’t see that happening in the immediate future, but as markets evolve that is all part of a normal economic cycle.”

Geilenkirchen says it is no coincidence that the strongest free zones operate in countries with favourable macroeconomic policies.

 “We need to ask ourselves the question ‘do free zones actually work?’. From my perspective, some of the investments may have taken place anyway, though the existence of free zones in the MENA region certainly does spur governments to develop and consolidate their investment policies, satisfy investors and promote more opportunities for new business,” he says. “Free zones also create jobs; there are estimates that free zones account for just over 1.5 percent of national employment throughout MENA. But take a closer look and it is not hard to see how these zones can end up adding to the fiscal burden of governments or creating complacency in extending economy-wide reforms.

“The zones in the MENA region that have performed best over a long period tend to be in the countries where the enabling environment is relatively favourable, anyway, in terms of macroeconomic policies, investment laws, labour market regulations and the rule of law. Economic zones can only add to, but can never replace, a good enabling environment.

“Saudi Arabia is a case in point, but recent market reforms in the kingdom are already opening up the economy to outside investors, especially in the retail sector.”

So what is the future of the free zone model?

Sohar Port strategically lies at the centre of the Al Batinah Region — the sultanate’s maritime and commercial outlet to the Gulf and the Indian Ocean.

Most fall into one of two categories; the small specialist districts and the large industrial zones — and both of these tried and tested formats will continue to spring up in the region and beyond, while existing successful zones expand and attract more investment. However, Geilenkirchen says free zone operators must ensure their goals are of benefit to the wider economy if they are to sustain their success.  

“I think you will see two trends,” he says. “One that is already visible in the UAE where you have many small and highly specialised cluster zones for media, financial services, commodities trading, digital technology and so on. Those kinds of zones will continue to be set up and many are already very successful.

“On the other side, you will see industrial free zones that work in synergy with major ports and logistical hubs, such as Jafza, Salalah and Sohar, continue to attract very significant international investments and further expansion. I think over the next five to ten years, you may see some consolidation, with maybe five or six main players dominating the regional market.

A report by the World Free Zones Organisation, released this year, found free zones worldwide are not immune from the evolving global dynamics and policy imperatives, and they must acquire a competitive edge not only to survive, but to prosper.

“While technology adoption may be crucial for those who render leading edge services, location, say, near a port, and quick access to support services will help sharpen the competitive edge of those in goods trade, especially export-import trade,” chief knowledge officer Dr Mohan Guruswamy is quoted as saying in the report. “Additionally, at the micro level, strong product knowledge and market knowledge coupled with ability to foresee the emerging trends would foster increased competitiveness.”

Abdalaziz says operating in the vicinity of other companies can provide vital opportunities. “I see more and more companies wanting to be closer to smaller companies who they can either outsource some of their work to or companies they can actually even acquire,” he says.

“Today you are hearing large companies buying local companies and this is for many reasons. One is because those smaller companies have the talent that the other companies don't have or are quicker in coming up with solutions.”

As tax frameworks and ownership laws continue to evolve in the region, questions over the long-term future of free zones will remain. But with the Dubai Industrial Strategy plans, new free zones across the GCC and the continued expansion of flagship zones, free zone operators might be forgiven for putting aside any concerns over the decline of the model’s importance. Either way, smart firms both within these zones and onshore will be prepared for change.

By Jamie Goodwin


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