SAUDI HOLDS THE KEY
Morgan Stanley Capital International's (MSCI) reclassification of UAE and Qatar from frontier to emerging markets was akin to these two countries winning a prize on the global stage.
The decision of Morgan Stanley Capital International (MSCI) to upgrade the status of the UAE and Qatar from frontier to emerging markets will pave the way for attracting foreign investments but Saudi Arabia's plans to open its bourse for foreign investments will accelerate the process.
“After years of anticipation, the UAE and Qatar have finally been reclassified from Frontier to Emerging Markets by MSCI. While local exchanges and regulators have done the heavy lifting so far, the onus will now be on listed companies to prove themselves to a more international audience.”
MSCI began consultations as long ago as July 2008 after which local investors watched the index provider's annual June updates with bated breath. In June 2013, MSCI finally announced that Qatar and the UAE were to be upgraded at the May 2014 reclassification.
Following the announcement last year, active investors began positioning themselves and helped Dubai's benchmark index rally 108% during the year, making it the second best-performing equity market in the world (after Venezuela). Abu Dhabi and Qatar were also among the top ten performers. In the first five months of 2014, Dubai continued its remarkable ascent, climbing 51% to claim top spot among global equity markets. Qatar was in second place, rallying 32%.
After tremendous excitement, extensive press coverage and billions of dollars of foreign inflows, the long-awaited upgrades are now behind us. But what happens next? How will MSCI's decision affect these markets and the region?
Some impacts from the upgrade are already visible while others will take years to emerge. Quick wins included the virtuous cycle fuelled by a jump in daily liquidity which squeezed bid-offer spreads, in turn attracting greater volumes and helping the cycle to continue.
In the first five months of 2013, average daily volumes were QR254.8 million ($70 million) on the Qatar Stock Exchange and QR655.2 million ($180 million) across both UAE exchanges. In the first five months of 2014, this had tripled to QR848.12 million ($233 million) in Qatar and quadrupled to over QR2.78 billion ($765 million) in the UAE.
Heightened international awareness of both countries is another positive, as increased press coverage will educate readers about inward investment opportunities. The narrative on Dubai will no longer just be a popular destination for tourists and real estate investors; Abu Dhabi's domestic spending plans will enjoy greater external attention; while Qatar will see articles about more than just its own investments abroad. Unfortunately for Qatar, the MSCI upgrade has coincided with negative press about the FIFA 2022 World Cup which has certainly reduced some of the active buying expected around the MSCI upgrade.
Local equity markets expand
Over time, increased capital inflows will expand local equity markets. Sustained high oil prices have meant regional banks are flush with cash and are looking to aggressively deploy their balance sheets. In addition, both corporate and sovereign borrowers took advantage of buoyant fixed income markets in 2012 and 2013, securing long-term funding. In this environment, equity raising has been very limited so adding another option to finance ambitious government plans and associated private sector expansion will be welcome.
There will also be a recalibration of
shareholders who – although will remain minorities because of foreign ownership limits – will gradually bring in change, both negative and positive. Many international funds have long invested in the GCC and higher correlation to global markets is evident in many of the stocks they favour. Foreign ownership will rise further but this may not always be desirable; UAE and Qatari equities will increasingly feel pain during times of sour global sentiment when top-down ‘de-risking' drives indiscriminate selling.
However, some of these new investors have considerably longer horizons versus local retail that dominates GCC equity markets. UAE and Qatari companies will be increasingly conscious of demands to improve transparency and come up the investor communication curve if they wish to benefit from the significant foreign capital available. Improvements to corporate governance will be positive but likely take several years to be felt.
The importance of Saudi Arabia
While attention has been on UAE and Qatar, the real prize in the GCC would be to add the Kingdom of Saudi Arabia (KSA) to the fold.
In early 2013, HE Mohammad Al-Sheikh was named Chairman of the Capital Markets Authority (CMA). His Western experience is notable as he studied at Havard Law School, worked at a major US law firm and held a senior position at the World Bank.
A few months after his appointment, the work-week was adjusted to the regionally conventional Sunday-Thursday, increasing overlap with international markets. In addition, the CMA held consultations with foreign brokers to discuss a framework allowing certain foreign investors access. Frenzied speculation of imminent change followed but unfortunately so did silence from the CMA. Anticipation of opening up the Kingdom's listed companies to direct foreign ownership has since waned, however, this is unlikely to be the end of the road. Regulatory change in Saudi Arabia is never rushed.
For Saudi to be eligible for a global equity index other changes are necessary, such as the T+0 settlement process. Although extremely popular with retail investors, which account for 90% of daily volumes, international investors may be less enthusiastic.
However, the country's size and potential are compelling. The QR2.73 trillion ($750 billion) economy should continue to grow in the mid-single digits and accounts for almost half of the GCC's GDP. KSA's 28 million people represent more than 60% of the region and Saudis make up 75% of their country's population; in stark contrast to Qatar and the UAE where just one person in every nine are citizens.
While Qatar boasts the greatest proportion of millionaire households in the world (at 14%) and Abu Dhabi's QR364,000+ ($100,000+) GDP per capita makes it one of the highest globally, Saudi's more modest GDP per capita of QR94,640 ($26,000) reflects a demographic closer to an average emerging economy.
Although the Kingdom has its fair share of ultra-wealthy, it also has a large proportion of middle class and lower income workers as well as the unemployed. This brings to bear familiar themes for global investors, such as urbanisation and industrialisation which are limited in the region. The Saudi stock market offers superior breadth and depth versus regional peers. One hundred and sixty four listed companies (versus UAE's 92 and 43 in Qatar) with an average daily volume in excess of QR8 billion ($2.2 billion) are more than double the UAE and Qatar combined. The Saudi Tadawul index boasts 50 stocks which trade more than QR36.4 million ($10 million) a day.
Saudi Arabia also offers superior diversification and is not just dominated by banks and real estate companies, allowing more nuanced investment. There are numerous listed petrochemical producers which benefit from some of the cheapest feedstock in the world, as well as dozens of consumer and industrial companies which are key beneficiaries of enhanced government spending. In terms of significance, the QR1.638 trillion ($450 billion market) capitalisation of MSCI Saudi Arabia compares to MSCI South Africa's QR1.53 trillion ($420 billion) (˜7.5% weight in MSCI EM) and QR1.31 trillion ($360 billion) for MSCI Mexico (˜5% weight). Implementing foreign ownership limits would lower Saudi's index weight, but with Qatar and the UAE already included, the Gulf's overall contribution would be significant.
So while the UAE and Qatari equity markets bask in their upgrade to MSCI EM, the true coming of age for the region will be if, or perhaps when, Saudi joins them
BY AKBER KHAN Director of Asset Management Al Rayan Investment