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Saudi Arabia Sets Regional Pace

Weekly Equity Comment – 04 July 2017

It has been an eventful fortnight in the region with a number of market moving announcements, Saudi Arabia saw the elevation of Mohammed Bin Salman (MBS) as the Crown Prince and MSCI announced its decision to include Saudi Arabia in the EM index watch list. In the meanwhile Qatar received a set of demands from a Saudi led GCC coalition together with a deadline to respond.

The announcement of changes at the helm in KSA came along with a retroactive reinstatement of allowances for civil service employees that were curtailed in Q416 and an extension of Eid holidays for an additional week. These steps could indicate pre-emptive management of dissent even though the transition appeared to have gone smoothly with MBS getting 31 out of 34 votes in the allegiance council. The move has implications for austerity, reforms and geo-politics in Saudi Arabia. Austerity could now take a back seat as power is consolidated and social considerations are prioritised. The relaxation of austerity is likely to be positive for near term growth given that earlier plans had envisaged an income squeeze together with higher costs from lower subsidies on utilities and fuel. Post recent rollbacks, cost increases for consumers are likely to be compartmentalised through the Citizen's account program. MBS has already signaled that privatisations and asset sales are a preferred, if not necessary, way of raising capital and as such markets will keep a close watch on FDI flow and upcoming IPOs. From the market perspective considering the recent turn of events in KSA, incremental positives are skewed toward the banking and consumer sectors. The former is anchored on valuations, MSCI watch list inclusion, potentially higher interest rates as the government borrows from local institutions and the implications of growth being preferred over austerity, whilst the latter is due to the removal of wage pressures on the largest consuming class in Saudi.

Saudi Arabia’s inclusion in the MSCI EM watch list was widely expected considering the measures taken by the CMA in terms of trade settlement, short selling and changes in QFI rules. The actual implementation is scheduled for 2019 and as of today Saudi would have a theoretical weight of 2.4% in the EM index. The Saudi market reacted positively to the MSCI watch list inclusion moving up 8% since the announcement, driven to a large degree by the banking sector. Experience from other regional and international markets indicates that the Saudi market should perform well until the index inclusion date, even as patchy growth expectations and oil fundamentals suggest that the move is not likely to be linear as was witnessed during Qatar and UAE inclusions.

The Qatar stand-off continues, the 10-day deadline to address the KSA-UAE demands has been extended by 2 days, neither party appears to be relenting which could prolong or inflame the situation.

Fund Positioning
Overall, we continue to favor Saudi and UAE. In Saudi, portfolios are skewed towards solid blue chip large cap names that are seeing traction due to MSCI news flow, at the same time we are also focusing on names that will benefit from NTP reforms. In the banking sector we remain focused on size and quality. We see the petrochemical space as a decent diversification from domestic cyclical risk and have chosen names with earnings traction and sustainable dividend yields. Consumer names are being added especially those that will benefit from higher consumer spend on the back of reversal of earlier salary and bonus cuts.In UAE, we favor large cap real estate names and banks.

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