Questions Loom For Saudi Arabia’s Economy
The Gulf region awaits Saudi Arabia’s ‘opening up’ of the Tadawul to foreign investors.
If Saudi Arabia’s intention to open up its stock market (Tadawul) to foreign institutions has been well flagged in recent months, the only outstanding issues needing confirmation have been when and to what degree the doors would be opened up to them.
With newly-published rules and a start date of 15 June, both of those questions are answered.
While the Tadawul, looming large over the rest of the region, given its market cap north of $570-M is one of the last major exchanges to liberalize, the doors are not yet fully open as regulators continue to exercise caution.
A measure of this can be seen in the requirement that Qualified Foreign Investors must have assets under management of at least $5-B in order to be even considered. And while the Kingdom’s Capital Market Authority has the discretion to lower this to $3-B AUM, the $5-B rule will remain in force for now to pre-empt the possibility of a sudden rush of foreign money flooding the market leading to instability.
Unsurprisingly, smaller niche players who have previously shown strong interest in investing in the Kingdom have cried foul – especially those investment houses geared towards emerging markets. They have been left disappointed; not least because the final rules are very similar to draft measures published by the CMA in 2014.
The new rules mean that foreign investors will no longer be restricted to indirect investments through Exchange Traded Funds (ETFs) and swaps both of which come with associated higher costs.
Other rules include a 5% tax on dividend income paid by listed companies.
Meanwhile, no single investor will be allowed to own more than 5% of a company by stock market value, while overall foreign ownership of listed shares in a company will be set at a maximum of 49%.
Likely to be less enforceable is the rule that QFIs will only be allowed to comprise a maximum 10% of the Tadawul by market value, especially in view of the fact that foreign participation in other emerging markets can often be double this.
Though criticism of the 10 per cent rule has come from a number of quarters, regulators have been quick to point out that long-standing indirect investment channels, such as ETFs, remain available and are not subject to such a limit. Therefore foreigners may still use these avenues to increase their ownership.
Despite budget strains caused by lower oil prices in recent months, the Kingdom is not opening up its market to foreigners because it needs the cash. GCC citizens and resident foreigners can already buy stocks directly. However, the new rules are part of a long-term strategy to diversify the Kingdom’s economy away from Crude Oil, promote improved corporate governance, create additional jobs and lessen the influence of retail investors who historically have taken a short term market view when it comes to trading often leading to price volatility.
Self-evidently, Crude Oil and Nat Gas remains the ‘elephant in the room’, given that roughly 87% of government revenues came from them in Y 2014.
This is not fully reflected on the Tadawul where not only large-cap petrochemical companies feature, but also those in the retail as well as the banking and financial services sectors.
Other prominent sectors represented include insurance, telecoms, construction and building materials as well as real estate.
Major listed companies that are not energy related include the likes of National Commercial Bank, Saudi Telecom, Kingdom Holding, Al Rajhi Bank and Saudi Electricity among others.
Current best guesstimates from the investment funds industry suggest the liberalisation of the Saudi market could attract upwards of $50-B from foreign institutional investors over the next few years.
This in turn should help Saudi companies become stronger players in their respective markets, given the fresh sources of capital set to be made available.
Another benefit of market liberalisation is the likelihood it will improve domestic corporate governance practices since foreign shareholders will be taking a keen interest in how companies, in which they have invested, are being run.
In addition, investment will be attracted to the Kingdom if, as expected, Saudi Arabia is eventually re-classified as an emerging market by global stock index compiler MSCI. This is a long term prospect, however, as any re-classification, for logistical reasons, would be unlikely before Y 2017.
Addressing a recent investment conference Adel Al-Ghamdi, CEO of the noted that Saudi Arabia’s debt market needed to become more efficient by allowing easier structuring of bonds that comply with Islam’s prohibition on interest.
It remains to be seen whether more companies will be issuing sukuk or will continue taking out Shariah-compliant loans available at competitive lending rates from local banks.
Ironically, it is the Saudi banks themselves that have been issuing bonds and bonus shares over the last couple of years to bolster their capital reserves after strong lending to companies.
Riyad Bank, for example, confirmed in early May plans to issue a SAR4bn bond to boost its capital base. The bond is set to a 10-yr term with the option to be repaid after 5 yrs. Also rumoured to be coming to the market is Saudi British Bank, which had previously raised SAR1.5-B in December 2013, its latest bond reportedly set to have a term of 7 yrs, but with the option to redeem after 5 yrs.
Developing the domestic sukuk market further will also provide an alternative source of capital for companies in the private sector; many of whom were caught out during the financial crisis when banks curbed their lending and boosted margins as they sought to bolster their capital reserves. A number of companies seeking long-term project finance consequently saw this source of capital drying up, forcing them in some instances to reschedule or even abandon investment plans.
Against this backdrop, the establishment in January of the Council of Economic and Development Affairs could lead to an accelerated program of state-owned companies being privatised.
In an April note, ratings agency Moody’s said the government’s very low level of debt, at 1.6% of GDP as of Y 2014’s end, gave it the needed flexibility to issue domestic debt to finance its deficits over the next 1 to 2 yrs.
Yet, following a deficit of approximately 0.6% of GDP in Y 2014, the agency forecasts the government’s budget deficit to increase to 12% or more during 2015, mainly the result of the steep fall in Crude Oil prices that occurred during the last 6 months.
While financing this deficit should be manageable over the short to medium term, because the Saudi Arabian Monetary Agency has Forex reserves equivalent to roughly 100% of GDP as well as substantial domestic financial assets, the need to promote additional liquidity in domestic markets has arguably never been greater.
In a separate report: Saudi Arabian Insurance Market Update, the agency noted the Kingdom’s insurance market had premiums worth $8.1-B in Y 2014, the 2nd largest in the GCC.
It was also the GCC’s 2nd-fastest growing insurance market in Y 2014, with an 8-yr Compound Annual Growth Rate of 20.3%, insurance premiums growing by more than 20% in Y 2014; helped by premium rate increases in the medical and motor sectors. Yet, Saudi Arabia’s insurance penetration levels (1.1%) are still significantly below those of most advanced economies.
“Despite this significant growth, Saudi Arabia has the lowest insurance density in the GCC and one of the region’s lowest penetration levels,” according to Mohammed Ali Londe, analyst and author of the report. “This suggests that there is a high degree of untapped potential in the market,” he added.
In many ways the Kingdom’s insurance industry provides the subtext to a much bigger narrative of increasingly competitive markets having to satiate the growing needs of a young and prosperous population of middle class consumers.
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Liberalization also provides companies with fresh sources of capital either in terms of returning for additional funding or looking to raise capital via the IPO (initial public offering) route.
National Commercial Bank’s $6bn IPO last year, for example, which saw the bank offer 25% of its shares at SAR45/share (15%earmarked for Saudi investors, 10% for the Kingdom’s Public Pension Agency) and ended up being 23X oversubscribed, confirmed strong domestic retail interest.
Yet, with short-term minded retail investors often accounting for 80% of daily turnover on the Tadawul, the need for re-balancing, by lessening their influence has long been apparent.
Allowing for the entry of foreign institutional investors will address this issue, how quickly remains to be seen.
Being reclassified by the MSCI as an emerging market, and by implication confirming the market’s depth and stability, will help. But that too will take time.
By Martin Morris
Paul Ebeling,
Editor HeffX-LTN
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