Investors
will finally have the opportunity to enter the largest stock exchange in the Middle East. At $590 billion USD (United States Dollar), Saudi Arabia will partially open up the market on June 15th. The new regulations will come into force on June 1st in time before the inaugural change that takes place two weeks later. Investment will be limited to qualified foreigners that have at least $5 billion USD in assets under management. This will give a distinct advantage to banks, brokerages, international fund managers, insurance companies and pension funds. It will exclude most individual investors at this time.
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The government of Saudi Arabia has taken this action to deal with two major issues in relation to their national stock exchange. The hope is that in allowing more participants, it will assist in the excessive volatility that exists in the market at present. It should also help with better corporate financial policies of companies that are traded in the exchange. A number of mostly family owned businesses are short on transparency and the best business practices.
An additional benefit to Saudi Arabia, will be the infusion of the equivalent of billions of American dollars to the domestic economy. This comes at a time when the Kingdom is dealing with the impact of low oil prices and the subsequent drawn down of foreign exchange reserves. This has become necessary in order to fully fund government appropriations. The Saudi government made the decision to maintain normal expenditures, despite the dramatic decline in revenues that are coming from crude oil exports.
Saudi Arabia made the decision in the second half of 2014, to maintain market share in the global oil market by maintaining a higher rate of production. This was despite declining prices in the face of rising world stockpiles of oil. The global economic slow down was reducing demand for oil.
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The drop in the foreign exchange reserves of Saudi Arabia has been dramatic. The total amount has declined by 5%, the equivalent of $36 billion USD in the last 2 months alone. The need for more investment is what finally prompted the government to move forward, with the planned opening of the Saudi markets.
In addition to who will be able to buy stocks, there are further restrictions imposed by the government. The Saudi Capital Market Authority known as the CMA, is the controlling agency that will structure and control the flow of foreign investment. They will determine the amount of the market that will be open to outside investment. It has been determined that no more than 10% of the value of the entire market can be owned by foreigners. Foreign ownership of an individual firm is restricted to at most 49%. Another prohibition limits single ownership to just 5% of any particular stock.
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An investor could expect that the opening up of the Saudi markets will be done in incremental steps. The expectation is that the stock market in the kingdom will be identified as an emerging market within the next couple of years. The time frame is now estimated to be mid 2017.
If one considers all the prescripts and regulations involving foreign participation in the Saudi exchange, why would an investor wish to make the effort? Not only is the country one of the most stable in the region, it is also one that is growing the fastest. So far this year, the Saudi Arabian stock exchange known locally as the Tadawul has grown in value by 19%.
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Saudi Arabia is the largest economy in the region. It has become a major goal of the next generation of leaders, that the country become far less dependent on oil revenues. Opening up the markets to foreign investment would be part of this process.
The Saudi Arabian stock exchange is among the most active in conducting initial public offerings known as IPO in the trading world. As early as 2008, the Saudis had permitted foreign investors access to their domestic market through what are known as swaps. The present effort is partly due to the previous steps taken by two much smaller markets in the region. Both Qatar and the United Arab Emirates were promoted as emerging markets, by the index compiler MSCI Inc, already in May of 2014.
Once the kingdom gains the emerging status the total global share of that market, would equate to about 4%. This would allow the flow of tens of billions of dollars into the previously insular economy and markets. This will dramatically change the present structure of business investment within the country.
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There will obviously be new opportunities as well as risks associated with an investment in the markets of Saudi Arabia. There is still some concern how regulated and free from government interference the Tadawul will be, once foreign investors are allowed to participate. The rewards are obvious in being permitted to purchase shares, in some of the fastest growing companies in the world. The risks are still not fully understood at the moment.
There is little worry about currency fluctuations since the Saudi riyal is pegged to the American dollar. The main commodity and export of the country oil which accounts for over 80% of government revenues, is already factored in USD. However, it is highly likely that much of the advance in share prices this year, is more due to the anticipation of foreign investment rather than an improving Saudi economy.
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Recent diversification efforts have focused on natural gas exploration, petrochemicals, power generation and telecommunications. Yet, oil still plays the dominant role. Saudi Arabia has 16% of the proven reserves in the world, second after Venezuela. It is still the largest exporter of oil in the world and as a result, plays a dominant role in OPEC (Organization of the Petroleum Exporting Countries). It is estimated that oil alone, accounts for 45% of the GDP (Gross Domestic Product) of the kingdom and 90% of export earnings.
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Saudi Arabia with a population of 30.8 million and a GDP of around $745 billion USD has great potential and relatively good economic growth. In PPP (purchasing power parity) GDP is in excess of $1 trillion USD. Although the economy has slowed somewhat with the dip in oil prices, the country is still in a good financial position. This is largely due to the immense foreign exchange reserves built up over the years. The kingdom does seem less secure with the chaos of the Middle East encroaching ever closer, but it is still overall a great opportunity for selective investors.