Middle East – The Reform and Index Upgrade Story
Following on from a piece written in December 2017 called “Is this the Riyal Deal?”, economic and stock market reforms have continued at pace in Saudi Arabia and there are very significant positive events going on in the rest of the region as well, specifically in Kuwait which we will examine in this report.
Starting with Saudi, we will examine both the impact of economic reforms, and the impact of associated stock market reforms and their potential to continue to drive stock market performance.
Saudi has, for the last 18 months, gone through some of the most radical economic and cultural reforms in the country’s history. I think we can safely say that three years ago the overwhelming majority of Saudi citizens would not have forecast (or even dreamt in most cases) that three years later women would be able to drive, men and women would be eating at the same restaurant tables, cinemas would exist and foreign workers would be leaving in their millions. From the depths of the oil price fall in 2015, the Saudi budget deficit has been cut to below 5% of GDP from above 15%, with a reduction in subsidies such as fuel and electricity and reduced expense allowances for government workers leading the way. With very low government debt levels and a now strong oil price environment the budget deficit can be taken back into balance in a controlled manner and the focus can be returned to economic growth.
Any major economic reform process will create severe economic dislocations in the short term, the key is having the political will and power to see them through and therefore propel the economy into the upswing of the J –curve. The impact of 1.5 million expats leaving the country has certainly caused many consumer companies to suffer, particularly those that cater to the less affluent parts of the population, but this “Saudization” has resulted in huge market share gains for the strongest companies in their sectors. Healthcare companies are benefiting from a government push to increase private participation in the industry, entertainment and leisure companies are enjoying much greater cultural freedoms (we have invested in the largest private gym company in Saudi) and insurance companies look set to benefit from both the proposed enforcement of mandatory motor insurance and the move towards private medical cover.
In the banking sector we have witnessed very low or non-existent loan growth for the last three years, due both to an uncertain outlook for corporates (imposition of VAT, anti-corruption process, removal of subsidies and impact on disposable incomes) and a lack of government capital spending due to the focus on other more urgent reforms. We now expect banking loan growth to accelerate over the next two years as companies become confident in the new economic environment. For example, the Purchasing Managers’ Index, a gauge of the performance of the non-oil private sector, rose to its highest level in more than a year in January 2019, reflecting rising output and new orders. More tellingly, business optimism about future output was the highest in more than five years. In addition we believe the government will start to actually develop many of the proposed major infrastructure projects (airports, railway lines, roads, tourist resorts, both religious and entertainment), and the rapid growth of the nascent mortgage and consumer lending markets will start to become significant.
The fourth quarter of 2018 showed the first tangible signs of these economic policies as GDP grew by 3.6% versus the fourth quarter of 2017(the quarter most impacted by economic change) and credit growth to the private sector started to rise after two years of stagnation. To highlight the change in economic behaviour of the consumer due largely to the cultural reforms, point of sale transaction numbers in the restaurant and hotel sector increased by 68% in February 2019 versus February 2018!
To add to the economic story in Saudi, one of the key pillars of the National Transformation programme has been reform of the Saudi stock market. The result of the progress being made regarding foreign ownership allowance, settlement cycles and custody requirements all being elevated to international market norms is that Saudi has been upgraded by both FTSE and MSCI to Emerging Market status. The actual inclusion into these indices is ongoing. The following chart shows the expected inflows into the market this year.
