Saudi Arabia and Argentina have been promoted to emerging market status. MSCI has also announced that it will include the MSCI Kuwait Index in its 2019 Annual Market Classification Review, for a potential reclassification from frontier markets to emerging markets status.
Saudi Arabia will have an index weight of 2.6%, making it the ninth largest country in the Emerging Markets (EM) Index and similar in size to Mexico and Malaysia. Implementation will take place in two tranches in May 2019 and August 2019.
The Saudi Arabian stock market, known as Tadawul, is the largest and most liquid in the Middle East. It hosts 185 companies, with a total market capitalization of USD 522 billion, and has an average daily volume of over USD 1 billion. Tadawul is dominated by a few sectors. Financials constitute 43% of the market, materials around 28%, real estate close to 7% and consumer-related stocks just over 9%.
Interestingly for a country dominated by oil, no oil and gas exploration and production companies are listed. This is however expected to change if the Kingdom lists a stake in state oil company Saudi Aramco, the world’s largest oil company. This is expected to happen in the next 12 to 18 months, as the MSCI reclassification was seen as one of the major prerequisites. If Saudi Aramco is included in the MSCI Emerging Markets Index, the company could potentially significantly increase the Saudi Arabian weighting in the index.
At just over 5%, foreign ownership of the market is relatively low, and over two thirds of this are strategic partners. The reason for the low participation is that previously foreign investors were not allowed to directly own stakes in listed Saudi Arabian companies. This has recently changed with the introduction of a Qualified Foreign Investors system allowing foreign ownership of up to 49%.
Valuation is more challenging as the market currently trades at a Price/Earnings multiple of just over 15x, making it more expensive than the emerging markets average. Dividend yield is 3.2%, well above the average.
Under the leadership of King Salman and Crown Prince Mohammad bin Salman, Saudi Arabia is modernizing, strengthening and diversifying its economy away from oil. Numerous social and economic reforms have been made and we expect more to come. There is a genuine push to increase employment of Saudi nationals and stimulate participation of Saudi women in the workforce. Furthermore, there is a drive to attract investments. A clear example is the announcement of the development of NEOM, a USD 500 billion industrial megacity on the shores of the Red Sea, which aims to be fully automated and entirely powered by wind and solar energy.
We expect the Kingdom to come out of recession in 2018 and accelerate its economic growth to between 2% and 3% in the coming years. Given the peg of the Saudi riyal to the US dollar, monetary policy will follow that of the US Federal Reserve. The country has a large deficit (9% of GDP in 2017), but the government is addressing this by reducing expenses and increasing non-hydrocarbon revenues, which is expected to lead to a balanced budget by 2023. Elevated oil prices combined with relatively low public debt and large sovereign wealth funds are supportive.
Argentina comes back to the EM Index ten years after it was downgraded to frontier market status due to capital controls. The positive conclusion of the review reflects the efforts of local policy makers to improve market accessibility.
At the end of May 2019, about ten Argentine companies will be added to the EM Index. The resulting weight of Argentina is expected to be around 0.4%, similar to local peers Peru and Colombia. The upgrade will however only take place as long as the market remains free of capital or foreign exchange controls. As of the end of May 2018, the three largest sectors in MSCI’s Argentina Index were financials (45%), energy (20%), and utilities (14%).
Argentina, a G20 member, has the third largest economy in Latin America, and its GDP is larger than a number of long-time MSCI Emerging Markets members, such as Poland (1.1% of the index), Thailand (2.2%) or South Africa (6.3%). The inclusion of Argentina in the investible universe of emerging markets funds is likely to stimulate more local companies to tap the equity market, which over time could lead to a much higher weight. This should be welcomed by investors, as Argentine companies have access to fertile lands, natural resources, and a well-educated and relatively affluent base of workers and consumers.
Argentina’s upgrade from frontier status might raise a few eyebrows, as the announcement comes after the Argentine peso lost a third of its value year-to-date. Since the end of 2015, the government of President Mauricio Macri has been implementing a gradual fiscal consolidation program, combined with a free floating currency regime and reduced trade restrictions – all significant changes after 12 years of more interventionist governments. While markets remained supportive of the structural reforms for a while, the currency recently came under pressure as severe drought and the surge of oil prices and the US dollar worsened Argentina’s fiscal and trade balances.
MSCI’s announcement came on the day when the International Monetary Fund approved a record USD 50 billion credit line to Argentina – a strong vote of confidence with hardly any conditions beyond the fiscal consolidation program that the Argentine government brought to the table. The Argentine Central Bank will also become more independent in setting monetary policy – an important credibility boost for an institution that is set to battle stubborn inflation.
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