October | 2008 | World Finance

Gateway to growth

Posted on October 14, 2008 by

Saudi Arabia is one of the world’s top 10 emerging and developing countries, and the largest Arab economy, with 10 percent of the total GDP of the Middle East.

It has more than 25 percent of the world’s oil reserves and a current estimated revenue surplus of €34bn. Private investors are developing €54bn of energy sector specific projects. The country’s resources go beyond oil, however – it has known gold deposits totalling 20 million tonnes, and an estimated 60 million tonnes of copper deposits that have not yet been exploited.

It also has one of the world’s fastest growing IPO markets, and the largest equity market in the Middle East, with approximately 120 listed companies, which is also ranked as the 11th largest stock market in the world. However, investors outside the GCC – the Gulf Cooperation Council, covering Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – have been barred until now from participating in the Tadawul, the Saudi stock market, which was founded in the 1930s, although the Tadawul All Share index has a market capitalisation of about €305bn. Indeed, it was only in 1997 that investors from the other GCC states were allowed to participate in the exchange, and even then they were barred from buying shares in banks and insurance companies, a rule that was dropped just a year ago. The result is that around 90 percent of all business on the Tadawul is by individual Saudi investors. The only way Western investors have been able to access the bourse has been through the under-developed mutual funds sector.

Further investment
On August 20, however, the Capital Market Authority of Saudi Arabia (CMA) announced it would be allowing the entry of non-resident foreign investors on the Saudi bourse through a “swap agreement” with what will be termed “authorised persons”.

The “authorised persons” will retain the legal ownership of the shares and agree to transfer the economic benefits of the Saudi companies listed on the Tadawul to non-resident foreigners. Both institutional as well as individual investors from abroad will be allowed to invest, the CMA said.

Bankers operating in Saudi Arabia, which has a population of about 25 million and it is ruled by the Al Saud dynasty, have been pushing for greater liberalisation to allow foreign participation, not only because their overseas customers want to participate in the growth of the Saudi economy, but also, they say, because having foreign retail and institutional investors involved would reduce some of the volatility found in the Saudi stock exchange, which is dominated by retail investors who, it is claimed, buy and sell too much on rumours and emotion rather than market-based analysis.

The Saudi authorities must also be hoping that allowing foreign investors in at last will also help lift the Tadawul, which has been one of the worst-performing markets in the region this year. In 2006, the market fell by more than 50 percent. Although it rose 43 percent in the final quarter of 2007 it has been down about 24 percent this year.

Expanding expertise
However, the CMA is undoubtedly aware that the country’s stock market could be damaged by a flood of fresh liquidity, something that, because of high oil prices, the whole of the GCC area is suffering from an excess of, which threatens to accelerate already rising inflation. For this reason the liberalisation of the Saudi bourse is progressing slowly and cautiously, step by step. One analyst commented after the announcement on August 20: “It is a step towards further liberalisation of the market, but more importantly it shows that the Saudis want to do this very gradually and very slowly for two reasons. One is that opening up the market to foreign investors brings up more liquidity and that’s the last thing they need right now. But what they [the Saudis] are interested in is bringing in expertise, hoping that the presence of foreign investors will slowly force local investors to adopt much more transparent rules of doing business.”

Commentators certainly see big benefits from the liberalisation, however. Another said: “This development will undoubtedly increase foreign capital inflows to the Kingdom’s stock market, promote greater transparency, reduce volatility associated with dominance of the retail investors in the Saudi market, and encourage more comprehensive equity research on listed companies.” The aim, observers believe, is that by gradually opening up the Tadawul, the CMA can encourage Saudi Arabia to become a major competitor with the UAE and Qatar for the title of the region’s financial centre. Just before the announcement that foreigners would finally be allowed to participate in the market, the CMA also issued new regulations saying that investors with stakes of five percent or higher had to disclose their positions, a move intended to increase transparency and reassure other potential investors.

Taking the right steps
One company that has already set up arrangements to act as an “authorised person” for foreign investors, both retail and institutional, looking to take advantage of the new regulations announced by the CMA on August 20 is FALCOM, based in Riyadh, with branches in Jeddah and Khubar. FALCOM, which was established in 2005, provides Islamic investment banking services including asset management, brokerage services, investment advice and treasury products. It now has 150 employees and a capital base of one billion Saudi riyals (€185m), and runs an internet trading service for customers called Tadawuly, and a suite of tools for stock market technical analysis through www.falcomwatch.com. FALCOM Financial Services was recently awarded the “Best New Investment Bank 2008’ award by Global Finance & Arabian Business, and it is about to open its doors to investors in the GCC region with a licence to operate in Oman.

FALCOM’s Chief Executive, Adib Al Suwailim, said the move by the Saudi Capital Markets Authority to allow non-resident foreign investors access to the stock market through “benefits swap agreements” with authorised licensed intermediaries who would legally own the shares is “a clear sign of liberalisation of the equity markets in the near term. With this move, the CMA has taken yet another investor-friendly step.”

The scale of interest “is likely to be tremendous across the board, and the Saudi market is currently performing well below its historic levels,” Mr al Suwailim said. “The initiative comes at the right time, when sentiments in the local market are down and valuations are attractive. This measure will cheer up the investors who witnessed the meltdown of the bull run in 2006 and fluctuating fortunes over the next two years. The Tadawul All Share Index, the market benchmark, has lost 23.3 percent to date in 2008. Over the longer term, the entry of sophisticated and deep-pocketed investors will lead to reduced volatility.”

FALCOM is now inviting institutional and retail investors to open accounts with it through which they can invest in a total benefits swap and thus gain access to the Saudi Arabian stock exchange. “FALCOM, being a member of the exchange, will execute the transactions, and buy and hold shares in the investor’s name, with an undertaking to transfer unconditionally the economic benefits of the holding to the ultimate beneficiary, the foreign investor, through the counter party broker,” the company said.

The company backs up its services with what it describes as “innovative financial products and wealth maximising solutions, ably assisted by a highly tech-savvy and dedicated professional team committed to support our client needs with benchmark standards of integrity, proficiency and commitment.”

It also provides a report service called FALCOM MarketToday, which covers valuable information such as valuation parameters, TASI support/resistance levels, last 10 days coverage, average prices on the day, money movers, 52-week high/lows and so on, much of it information not covered by any other investment banker, it says, and released by 4.30pm every day. Another of the company’s services, FALCOM MarketWeek, covers not just fundamental information but also stock volatility, weekly performance of stocks, company research, stock market research, strategy reports, and economic research are also regular feature.

Overall, FALCOM says, it believes that the announcement by the CMA will attract huge interest from foreign investors looking to diversify their portfolios. The Saudi stock market is “the most lucrative in the region because of its size and liquidity”, the company says, and the IPO market has been “abuzz with activity over the past two years. In 2007, 25 new companies were listed whereas so far in 2008, 15 new companies have been listed.”

Observers say they expect public companies in Saudi Arabia to open up to foreign investors gradually, albeit on a limited basis, over the next few year, probably under a system like the one in operation in Qatar, where foreigners are restricted to 25 percent ownership in all stock, or the UAE, where foreigners cannot own controlling stakes. All the same, the agreement on all sides is that the CMA’s move is good news for everybody, from Saudis to outsiders.

For further information shankar.biswas@falcom.com.sa

A waiting game

Posted on October 8, 2008February 9, 2012 by itsupport

The OECD sounded cautiously optimistic when it published its latest economic outlook in the middle of September. “Banks appear to have recognised most of the losses and write-downs related to sub-prime based securities,” it said. Yet within days, Lehman Brothers had slumped into bankruptcy protection, Bank of America had stepped in to bail our Merrill Lynch – buying it for about €35bn, half its value a year ago – and AIG was asking the Federal Reserve for a €28bn bridging loan.

That, of course, is the risk of making forecasts in such turbulent times. No doubt the irony of the timing was clear in Nice, France, where the EU’s finance ministers just happened to be holding a get together. At the top of their agenda: how to respond to financial turmoil and economic downturn.

The ministers decided to provide extra lending for small firms but ruled out public spending on the large scale seen in the US, which has spent €70bn on tax rebates in an effort to spur economic growth. The EU’s public lending arm, the European Investment Bank, is going to double the loans it makes available to small and medium-sized companies, which, because of the credit crunch, are finding it harder to secure finance from commercial banks. It will lend around €30bn over the next three years.

“We’re not simply adopting a ‘wait and see’ policy, we are not going to sit on our hands,” said French Economy Minister Christine Lagarde, who was hosting the event. “We need to make sure that our economies perform well.” Indeed they do, as the economic outlook for the Eurozone is bleak.

Inflation remains the policy priority, as ECB President Jean-Claude Trichet pointed at after the meeting. Soaring oil and food prices have pushed inflation up in the past year. The annual rate of Eurozone inflation hit a record four percent in July but has since eased a little after oil prices retreated from a high of more than €103 a barrel. The ECB has refused to reduce interest rates – which would encourage growth, but could also push up inflation. Its last move was to increase rates to 4.25 percent from four percent, on the grounds that inflation had to be tamed.

It’ll be interesting to see whether the ECB sticks to its strict line on rates. In April, the consensus view among policymakers was that Europe was not at risk of recession. With hindsight, that was hopelessly optimistic. Three days before the ministers got together in Nice, the European Commission cut its Eurozone growth forecast for this year to 1.3 percent from the 1.7 percent it predicted in April. It forecast growth of 1.4 percent for the broader EU group – including those, like the UK, that do not have the euro. That’s a big drop on the two percent it predicted in April. One reason for the change of heart is that, since April, gross domestic product in the Eurozone has shrunk – the first time the eurozone has experienced a quarter of GDP contraction since it was created in 1999.

Recession recession recession
That means the Eurozone is on the brink of a recession – it just needs another quarter of GDP shrinkage to fulfill the technical definition. However, the Commission is clinging to its optimism. It still forecasts that the overall Eurozone economy will stagnate rather than contract in the third quarter – although at national level it predicts that Germany will dip into a brief recession, followed by Spain and the UK.

Indeed, recession for some EU states seems now inevitable, even if its politicians refuse to use the word, for fear of making things worse (“Germany is not in a recession but in a downturn,” German Finance Minister Peer Steinbrueck told journalists in Nice).

Elsewhere, there is a willingness to face reality. Before setting off to Nice, the UK delegation had to digest a new economic forecast from the Confederation of British Industry, an influential lobby group. It said the UK would slip into recession in the second half of 2008 – albeit a “shallow” one – and that growth in the economy in 2009 will be the lowest since 1992.

It downgraded its growth forecast for 2008 from 1.7 percent to 1.1 percent and said economic output would shrink by 0.2 percent quarter-on-quarter between July and September, followed by a further 0.1 percent decline in the fourth quarter.

Its good news was that GDP should stabilise early in 2009 ahead of a gradual and growing recovery, with quarter-on-quarter GDP growth reaching a near-trend rate of 0.6 percent by the end of next year. Nevertheless, for 2009 as a whole, the GDP growth forecast has been cut from 1.3 percent to 0.3 percent.

Better news is that it expects inflation to peak at 4.8 percent this quarter, and thanks to an easing in commodity prices and the weaker economy, to fall back rapidly over 2009, reaching close to the Bank of England’s two percent target by the fourth quarter (2.3 percent). There is even a significant risk that, into 2010, inflation will undershoot the bank’s target.

This cheery view of the inflationary outlook should allow the Bank of England to make a series of rate cuts, bring the base rate down to four percent by next spring. “The bank should have leeway to cut interest rates and, as inflation falls, we should be well placed to move beyond this difficult stage in the business cycle,” said CBI director general Richard Lambert. “If all goes well there should be room for a half point cut in November to help restore confidence in the beleaguered economy.”

That’s if all goes well. “Over the past year our forecasts for economic growth have been shaved lower and lower as the UK economy continues to struggle with the twin impact of higher energy and commodity prices and the credit crunch,” Lambert added. “Having experienced a rapid loss of momentum in the economy over the first half of 2008, the UK may have entered a mild recession that will hopefully prove short lived. This is not a return to the 1990s, when job cuts and a slump in demand were far more prolonged. The squeeze on household incomes and company profit margins from higher costs will begin to ease as the price of oil moves downwards and, although the credit crunch will be with us for some time, conditions are set to improve later in 2009.”

Dark outlook
The CBI believes that UK unemployment will break the two million mark in 2009, reaching 2.01 million and a jobless rate of 6.5 percent. Average earnings growth is expected to remain subdued, which will aid the improving inflation outlook. Sharp rises in fuel and food costs, the resulting decline in real incomes and the troubled housing market have undermined consumer confidence and dampened household spending, and the CBI predicts that household consumption will contract by 0.3 percent in 2009.

Forecasts for investment have been downgraded, with fixed investment now expected to shrink by 3.5 percent in 2008 and by four percent next year, compared with flat growth predictions in the last CBI forecast. Much of this decline comes from the weak outlook for investment in buildings, as both residential and commercial property markets continue to struggle.

Is this relative optimism justified? The OECD’s global headline trends seem to be improving, but its forecasters are very cautious about making predictions right now. “Limited experience with some of the main drivers of the current conjuncture as well as uncertainty about some specific influences make for a particularly unclear picture,” it says, which roughly translated means: we haven’t seen anything like this before and we don’t want to come out of it looking like idiots.

Nevertheless, the OECD does venture that in the euro area and its three largest economies, as well as in the UK, economic activity is foreseen to remain broadly flat. More widely, Japan will see only a partial bounce-back and the situation in the US is still tough to call.

Globally, the OECD says financial market turmoil, housing market downturns and high commodity prices continue will continue to bear down on growth. “Continued financial turmoil appears to reflect increasingly signs of weakness in the real economy, itself partly a product of lower credit supply and asset prices,” it said. “The eventual depth and extent of financial disruption is still uncertain, however, with potential further losses on housing and construction finance being one source of concern.”

The downturn in housing markets is still unfolding, with reduced credit supply likely to add to the pressure. US house prices continue to fall, threatening further defaults and foreclosures that may again depress prices and boost credit losses. As regards construction, however, there are some hints of eventual stabilisation with permits and sales of new homes having ceased to fall and inventories of unsold houses coming down. In Europe, downturns in prices and construction activity appear to be spreading beyond Denmark, Ireland, Spain and the UK, with sharply lower transaction volumes a precursor of downturns elsewhere.

On commodities, the OECD notes that the price of oil has fallen from peaks reached around the middle of the year in response to slower demand growth and record production from OPEC. Oil supply conditions remain tight, however, contributing to volatile prices. Prices of other commodities – notably food – appear to have steadied at high levels. Food commodity prices may ease in the period ahead as droughts end in some food-exporting countries and as higher food production comes on stream.

On inflation, the OECD says that sharp increases in energy and food prices have boosted headline rates and sapped real incomes of consumers across the OECD area. Statistical measures of underlying inflation have also drifted up in most large OECD economies, partly reflecting the ongoing feed through of higher commodity prices. Wage increases have been broadly contained, so far. Its prediction: “If commodity prices are sustained at their recent, and in cases such as oil, lower levels some moderation of both headline and underlying inflation is to be expected.”

What should policymakers do in this tough climate? Pretty much what they are doing now, according to the OECD. In the US, underlying inflation is high but appears not to have drifted up further. The continuing credit crunch justifies Washington’s efforts to boost the economy with tax cuts. In the eurozone, underlying inflation has been rising steadily for some time, suggesting that capacity pressures need to be reduced, says the OECD. A recession would achieve that nicely, so there is no need to change policy. If action were needed, the OECD would rather see interest rate cuts than higher spending or tax reductions.

The message seems to be this: politicians and policymakers in the US, the eurozone and elsewhere have done all they can to avoid a deeper economic crisis. Now we just have to cross our fingers and wait.