Regional equities fare well as they look to attract foreign investors

Including Saudi stocks into popular indices, such as the FTSE Emerging Market index, is a boon for the economy

The Tadawul is up 10 per cent so far this year. Simon Dawson / Bloomberg

At a time when the headlines are dominated by talk of global protectionism, it is a welcome development that this region appears to be opening itself up to foreign capital. While US equities that rallied on the arrival of Donald Trump are now turning lower as trade tensions heat up, regional equities are largely holding up on account of reforms designed to attract foreign investors into them. The Tadawul is up 10 per cent year-to-date while the Abu Dhabi Securities exchange is up 6.5 per cent and the Kuwait index by 3.5 per cent. The major global indices, however, are recording losses with the S&P 500 down 2.5 per cent and the DAX and the Nikkei having lost around 5 per cent so far this year.

Late last month, the Financial Times Stock Exchange decided to include Saudi Arabian equities in its EM indices. According to the index compiler, the country is expected to have an index weight of 2.7 per cent within the FTSE Emerging Market index. The decision will be implemented in five tranches starting in March 2019 and could lead to passive inflows of as much as $5 billion. MSCI, another index provider, is expected to take a call in June 2018 on including Saudi equities in its EM index. If the MSCI follows in the FTSE’s footsteps, that could lead into an additional passive inflows of as much as $10bn.

______

Read more from Tim Fox:

Equity markets suffer steep losses amid trade and security instability 

Global markets rattled by the prospect of a trade war

Why the Eibor is trading below the Libor

A healthy correction may not be the end result of the global market rout

______

An entry into broadly tracked indices would mark the culmination of a series of capital market reforms initiated in Saudi Arabia over 2016 to 2018. These included the simplification of the qualified foreign institutional investor registration process and changes to the settlement and custody model. Perhaps, the most important change was the shift in attitude and a greater desire to draw foreign capital into the economy. The first three months of 2018 saw foreign investors as the net buyers of Saudi equities every week since the start of the year. On an aggregate basis, they have bought equities to the tune of 7.3bn Saudi riyals in the first quarter of this year.

Saudi Arabia is not alone in chasing foreign capital inflows. Kuwait, which was classified as secondary emerging market status in September by the FTSE, has made several changes to gain the same status from the MSCI since the start of the year. The FTSE decision is likely to result in passive inflows of about $800 million into Kuwaiti stocks. As part of the reforms, the stock market in Kuwait was divided into three segments with the Premier Market composed of the largest and most liquid companies. Additionally, all indices were market-capitalisation weighted to better reflect market performance.

It is worth noting here that the period between announcement and actual implementation is generally positive for equity markets given flows from active investors. For the record, Qatar and the UAE received inflows of $2.7bn combined in the year leading up to their inclusion in the MSCI EM index in 2013.

The benefits of such inclusions into broadly tracked indices go beyond immediate short-term inflows. They also attract a new set of investors into the economy, the majority of whom are relatively sophisticated financial institutions. Once invested, these institutions tend to progressively drive positive changes in terms of transparency, corporate governance and financial reporting standards, which often translate into reduced risk premiums and enhanced valuations over longer periods of time.

While the authorities in the region were largely driven into many of these reforms by the need to diversify their energy-dependent economies, the pace and intensity of the steps taken to date suggest the majority of the region’s countries are now on irreversible paths towards opening up their economies to a wider set of reforms and international investors. At a time when other countries touted as beacons of free trade are retreating into themselves, the initiatives in the Mena region are a welcome development that should ultimately be a positive for their markets as well as for the investors in them.

With input from Aditya Pugalia, director of financial markets research at Emirates NBD

Tim Fox is group chief economist and head of research at Emirates NBD