The “Halo Effect” of Saudi Arabia’s Emerging Markets Arrival

Saudi Arabia’s inclusion in the MSCI Emerging Market Index marks a significant milestone for the MENA region, according to Salah Shamma, Franklin Templeton Emerging Markets Equity’s Head of Investment, MENA. He explains the “halo effect” from this move that mirrors that of other prominent index providers, and shares why the region is becoming much harder for global investors to ignore.

Saudi Arabia’s inclusion in the MSCI Emerging Markets (EM) Index1 is another huge win for the Kingdom’s capital markets and a significant milestone for the entire Middle East and North Africa (MENA) region. The “halo effect” of MSCI’s move, following similar upgrades by index providers FTSE Russell and S&P Dow Jones earlier this year, will be felt on trading floors across the region as MENA becomes an investment destination that global investors can no longer ignore.

In many ways, Saudi Arabia’s new emerging market (EM) status should be viewed as another important step in the evolution of its equity market. We expect further economic expansion and increasing levels of foreign investment to support its ambitions of a deeper and more dynamic stock market.

Saudi Arabia’s elevation to EM status resulted from a number of capital market modifications and improvements made to its equity market infrastructure. On top of this, we’re impressed at the pace of domestic reforms unfolding inside the Kingdom. Like other small EMs, we’ve seen a host of significant social and economic changes.

While Saudi Arabia’s economic fundamentals remain strong, there have also been numerous developments since the beginning of 2019 that lead us to believe the Kingdom is in the middle of a recovery. For example, the success of both Saudi Aramco and the government’s recent international bond issues highlight the ability of Saudi Arabia to attract capital, and with that rising levels of foreign investors. Government projects inside Saudi Arabia have been reinstated and consumption numbers such as electronic point-of-sales data, as well as total credit card transactions, are also on the rise. All of these factors have helped alleviate investors’ concerns and support overall market performance.

Promotion to the MSCI EM Index, in our view, is the next transformative liquidity event for Saudi Arabia. With this in mind, we continue to like sectors that are exposed to the Kingdom’s exciting recovery story, including banks and companies within the consumer discretionary sector.

We anticipate a likely significant increase in foreign flows resulting from Saudi Arabia’s inclusion in the MSCI EM index. More than US $8.6 billion has already found a home in the market this year from international institutional investors, including passive flows through exchange-traded funds (ETFs) of over US $2.5 billion. In total, we anticipate US $6.5 billion in flows are likely to initially come into the market on MSCI’s first inclusion date on May 28, and US $40 billion overall (because of Saudi Arabia’s 2.7% inclusion weighting in the MSCI EM Index).2