Saudi stock market cheers, but cannot take its eye off the ball

Wednesday was a good day all round for Saudi Arabia’s stock market. The Tadawul index surged to an 18-month high, 5.5 percent up on the day before, as investors reacted to the far-reaching changes in the Kingdom’s power structure, as well as the much-anticipated news that the country was being considered for inclusion on the MSCI “emerging market” (EM) index.

The MSCI news had been expected, and was mixed with some caveats. But overall it was a significant sign of global finance’s approval of the Kingdom’s dramatic transformation plans, under the banner of the Vision 2030 strategy.

The “masters of the universe” like what they see happening in Saudi Arabia and are waiting to get a slice of the action just as soon as they can.

The MSCI decision is also the perfect preparation for the gigantic privatization program under way in the Kingdom, not least the $100 billion initial public offering (IPO) of Saudi Aramco planned for late next year. Many of the entities lined up for sale by the state will end up on the Tadawul market in Riyadh, which under the EM banner would be a much more attractive proposition than it currently is. The word the international moneymen use is “investible,” and the Saudi market’s prospects have been enhanced significantly by the news that it is on the watchlist for EM status.

The Tadawul — as the exchange of the region’s biggest economy — has long been the most active market in the Middle East but needed greater exposure to foreign investors. That too will come with EM status.

Exactly how much money will pour in is still a matter for debate. Deutsche Bank analysts estimate that, if Saudi Arabia reaches the level of foreign-investor participation achieved by the EM-listed markets in Dubai, Abu Dhabi and Doha, it could mean an inflow of $43 billion to the market, mainly from passive investors. Capital Economics, the London-based consultancy, is rather more conservative with an estimate of $38 billion. Both are enormous amounts for a market currently capitalized at around $400 billion. 

For active investors, Deutsche has identified specific stocks that foreigners might want to buy. The Saudi Basic Industries Corporation (SABIC), the Saudi Telecom Company and Southern Province Cement are top of the list, while Al-Bilad Bank could also prove attractive, the German bank says.

But amid the euphoria, policymakers in the Kingdom must not take their eye off the ball just yet. Obviously, the earlier the country is included in the EM index, the better, especially with such significant liquidity events as the Aramco IPO and the privatization plan coming up. The Tadawul authorities appear confident it can be included by next year, but this is not a given. For example, MSCI also announced yesterday that Argentina would remain relegated to the “frontier markets” rank for at least another year. 

There are a number of things the Tadawul can do to ensure a speedy inclusion. MSCI noted the progress Saudi Arabia had made on such vital market areas as settlement, failed trading management, short selling and stock borrowing, but these will have to be kept up to scratch if the target of 2018 is to be met.

MSCI will be watching every move in Riyadh over the next year and grilling international investors on their level of customer satisfaction in the Kingdom. It must be made even more attractive for qualified financial institutions — still a comparatively low proportion of overall investment in the country — to do business there.

Some analysts were asking yesterday what effect the move to EM status would have on the Aramco IPO, but really the question should be put the other way round. The flotation is so huge — Aramco’s suggested market value of $2 trillion is five times the current capitalization of the Tadawul — that you should really ask what effect the IPO will have on the market.

For one thing, it will dramatically increase the weighting that Saudi Arabia has within the EM index. Currently, it is estimated that it would make up between 2 and 3 percent of the overall value of the index, but that could leap to around 5 percent once Aramco is included.

You might also ask why, if the Riyadh exchange is going to be so attractive to international investors under the EM status, Aramco has to look at foreign markets like New York and London for some of its IPO. Why not just put it all on Tadawul?

The answer is that however efficient the Saudi market could become, it would not be able to digest an IPO like Aramco on its own. If the $2 trillion target is to be achieved, Saudi Arabia will need the help of foreign exchanges and investors on those exchanges to enhance its value.

Finally, it is worth bearing in mind that, regardless of the positivity that came out of the MSCI news, there remains one fundamental factor that will determine market values far more than any international index: The oil price.

With Brent seemingly stuck at the $45 per barrel mark, getting it back up above the $50 level at which this year’s Saudi budget was calculated remains the top priority.