Saudi Arabia was at the centre of two of the major market developments of the last week. Sensitive to investors, it won the approval of MSCI to be included in its Emerging Market index, while sensitive to consumers it led the Opec negotiations - which resulted in an agreement to raise oil output and thereby limit price rises. Together these outcomes illustrate Saudi Arabia’s determination to widen its global relevance to investors beyond the oil sector, while at the same time to not lose influence over the resource that still drives most of its economic activity.
The inclusion of Saudi Arabia in the MSCI EM index marks the culmination of a series of measures over the last few years to open up financial markets for foreign investors. MSCI said that the decision follows the implementation of a number of regulatory and operational enhancements that effectively increased the access to international institutional investors.
The desire to attract inward investment intensified after the sharp decline in oil prices from 2014 to 2017, which focused greater attention on the need to diversify the Kingdom’s economy away from oil and boost non-oil sector growth. Opening up financial markets for foreign portfolio investment is part of a broader plan to attract funding for economic diversification efforts.
The benefits of increased inflows from foreign institutional investors are obvious. In anticipation of this decision, the Tadawul has seen sustained inflows from foreign investors in 2018. The total year to date inflows from foreign institutional investors stands at US$3.4 billion, with $49 million last week alone - its third weekly record this year. This translates into roughly 8 per cent of total inflows seen into broad emerging market equity funds so far into 2018.
The inclusion of Saudi equities into the MSCI EM index could also trigger passive inflows of about $10bn. To put that into context, the average daily value traded on the Tadawul in 2018 in first five months of 2018 is $1.1bn. It is also worth highlighting that as of June 2017, nearly $1.7 trillion of assets / funds tracked the MSCI EM index.
However, the intangible benefits of attracting a newer set of sophisticated investors should result in improved standards of financial disclosures and corporate governance. It is also possible that there will be a positive impact of Saudi Arabia’s inclusion on the broader region given the increased weightage of the overall region in the broader EM index.
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The Opec decision was not exactly what the market had anticipated, but the meeting probably ended in a more constructive atmosphere than was widely predicted. The producers' bloc official statement called for members to return to 100 per cent compliance with the production cut agreement that has been in place since January 2017. As per the terms of the original deal Opec countries were meant to cut output by 1.2m barrels per day, topped up to 1.8m bpd with the addition of other countries like Russia.
In practice though, Opec has cut far deeper than that, achieving cuts of nearly 2 million bpd on its own. Over-cutting by Saudi and unplanned outages from countries like Venezuela and Angola have contributed to this shortage. So the ambition appears to be to increase output by 1 million barrels collectively but whether they can do that remains to be seen.
Only Saudi Arabia possesses significant spare capacity that it can bring onto markets quickly and for a sustained time. Most other members of Opec are producing close to capacity and thus will be constrained from hitting their allocated target.
Oil markets took the news of the Opec deal relatively positively as it has been widely interpreted as being enough to keep markets close to balance but not significant enough to cause stock builds again in the second half of the year.
Opec kept its statement intentionally vague as to the exact scale of production increase. This was likely a political compromise between Saudi Arabia and Iran as Iran is unwilling to voluntarily cede market share at a time when it faces US sanctions. All Opec members agreed to the original deal, making it the least bad option for all parties to endorse once again.
Tim Fox is group chief economist and head of research at Emirates NBD
