Saudi Arabia Newsletter - Spring 2018

Saudi Arabia now in MSCI EM

 

MSCI announced the inclusion of Saudi Arabia into the MSCI EM Index, as expected, with a weight of 2.6%. MSCI, in its annual market classification review, on 20 June added Saudi Arabia to the MSCI Emerging Market (EM) Index. Saudi Arabia, on the other hand, gains a substantial lead in the Gulf Cooperation Council (GCC) region with a 2.6% weight, when compared to Qatar’s 0.8% and the UAE’s 0.6%.

 

The domestic Saudi equity market (Tadawul) is up 15% YTD (as of 19 June 2018). The upgrade news was largely expected but not fully priced in by markets. 

 

Saudi Arabia has now become the largest market in the GCC region and one of EEMEA’s largest too. The inclusion is important for several reasons. First, it is a great driver of exchange-traded fund (ETF) flows in the region, particularly because it is the biggest inclusion, in c.25 years, directly to the EM status. The growing importance of ETFs is a key contributor to the outperformance prior to announcement in more recent upgrades. Second, planned part-privatization of government companies could further boost Saudi Arabia’s weight to the top 10 in the EM index in coming years. Third, the inclusion should attract more foreign institutional investors (foreign investors currently own less than 5% of the Saudi market).

 

Inflows triggered by upgrade to emerging market status could drive the Saudi equity market 20% higher over 12 months.  Fundamentals remain weak, but should only weigh on performance and valuation once Saudi Arabia has been included in the emerging market index in 2019.

 

The government’s plans to grow the non-oil economy and engage in fiscal consolidation have resulted in long-overdue reforms being initiated but have weighed heavily on economic activity, with 2017 marking the kingdom’s first non-oil sector recession in more than three decades. Government spending (the key driver of economic growth) is more restrained than in the pre-2014 high oil price environment and further subsidy cuts are expected in the coming years. As a result, economic growth is likely to be muted in the foreseeable future. Consumer spending, which has come under significant pressure is therefore likely to remain weak for some time.

 

Once Saudi Arabia is officially included in the MSCI EM index, expect the macroeconomic environment to be more appropriately priced in and valuations to contract as a result.