Renaissance Capital: Saudi Arabia – the next emerging market?


On 20 June, MSCI announced the results of its 2017 market classification review. MSCI has decided to include China ‘A’ shares in MSCI Emerging Markets; not to transition Argentina from MSCI Frontier Markets to MSCI Emerging Markets; to delay the decision on whether to remove Nigeria from MSCI Frontier until November 2017 (so the new investors’ and exporters’ [I&E] FX window can be monitored); and to add Saudi Arabia to the upcoming (June 2017-June 2018) review cycle for potential inclusion in MSCI Emerging Markets.

Saudi Arabia joins the 2018 cycle

Saudi Arabia has been added to the upcoming (June 2017-June 2018) annual review cycle for potential inclusion in MSCI Emerging Markets. If successful, this could see Saudi Arabia added to MSCI Emerging Markets at end-May 2019 (in time for the Saudi Aramco IPO). Using the provisional list of constituents and latest prices, we estimate that Saudi Arabia could have a weight of 2.5% in MSCI EM, making it the ninth-largest country in the index and the third-largest in EMEA. MSCI’s decision will rest on whether foreign investors feel the current level of opening is sufficient, given the 49% foreign ownership limits and investor qualification requirements (which have admittedly become less strict); in addition, some of the market framework changes (such as stock lending and short-selling) have yet to be tested.

What could this mean for the market?

Foreign ownership of Saudi equities is currently very low at just 4%. We estimate that inclusion in EM would trigger at least $2.3bn (or seven days of trading for the basket of stocks that are expected to make the cut) of inflows from passive funds (based on c. $94bn of EM-dedicated passive AuM), with a further $9.3bn of inflows should active funds move to neutral (or 26 days of trading) – see Figure 3 for more details. Currently, active GEM funds in aggregate hold a small (0.15%) amount of Saudi Arabia in their portfolios, down from a peak of 0.3% in August 2015.

Argentina’s upgrade on hold for now

Argentina is to remain in MSCI Frontier Markets for now, and not transition to MSCI Emerging Markets. Investor feedback was that recent improvements and an easing of capital controls and foreign exchange restrictions need to be in place for longer to be deemed irreversible. Argentina is to stay under review for potential transition to MSCI Emerging Markets in the upcoming (June 2017-June 2018) annual review cycle. The news may be seen as a disappointment by investors given the recent run in the market (up 43% YtD in dollar terms).

Nigeria earns a reprieve

The decision on potentially removing Nigeria from MSCI Frontier as a result of foreign exchange shortages has been delayed until November 2017, in order to give more time to monitor the new I&E foreign exchange trading window introduced by the Central Bank. MSCI said that investors seem “cautiously optimistic on the new window”.