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Countries: Saudi Arabia Defies Emerging Markets Blues

Saudi Arabia has embarked on a radical transformation of its economy, politics, and even society under the helm of its crown prince Mohammed Bin Salman (“MBS”). In our November 13, 2017 DIBs report, we gave an overview of the kingdom’s politics, economy, and regional complications, including MBS’ unprecedented consolidation of power. In today’s DIBs, we will look at some recent efforts to advance his economic agenda.

KSA Vision 2030 is at the core of MBS’ ambitious strategy to open up the Saudi economy, attract new business to the country, diversify away from oil, ease social restrictions, and establish a legacy for himself. As part of the Vision 2030 program, MBS has planned three giga-projects – Neom, Red Sea Project, and Qiddiya.

Neom, a 25,000 square kilometer (10,000 square miles) megacity extending into Egypt and Jordan, and covering three times the size of NYC, is meant to serve as an economic hub between Europe, Asia and Africa. The plan is for NEOM to be a business and industrial zone, with a focus on tech and manufacturing, which will run entirely on renewable energy.

With two-thirds of the population under age 35, and few local entertainment offerings, many Saudis have to flock to Bahrain or Dubai on weekends. The kingdom wants to secure up to a quarter of the $20 billion spent on entertainment overseas each year, and attract global tourists, hence the plans to launch the Red Sea and Qiddaya projects.

The Red Sea Project aims to transform Saudi Arabia’s Red Sea coastline into a global tourism destination. The project, which includes a nature reserve, diving in coral reefs and heritage sites on about 50 islands, will cover 34,000 square km – an area bigger than Belgium. This initiative could transform Saudi Arabia’s tourism industry which, right now, relies soley on Muslim pilgrims from around the world visiting holy shrines in Mecca and Medina. It is expected to contribute 15 billion riyals ($4 billion) to GDP once fully running. Initial ground breaking is planned for 2019, with first phase to be completed by 2022.

With the Qiddiya project, Saudi Arabia aims to become an entertainment, cultural and sports destination for local, regional, and international tourists. It is being built on a 334 square km site, making it 2.5 times the size of Disney World. Qiddaya will have theme parks, water parks, motor sports, cultural events, and vacation homes, with a goal to attract 1.5 million visitors annually when the first phase opens in 2022. By 2030, the number of annual visitors to Qiddiya is expected to reach 17 million in the entertainment sector, 12 million in the shopping sector and two million in the hospitality sector.

The idea is for the Saudi Sovereign Wealth Fund and the Public Investment Fund (PIF) to bankroll these projects, supplemented by financing from local and international sources through bonds, direct investment and other means. Saudi Arabia already has commitments from private investors such as Richard Branson, while SoftBank has signed a memorandum of understanding to build a $200B solar power project in the kingdom, calling it the single largest of its kind in the world.

During his meet & greet tour of the United States last month, MBS focused on the three specific areas he has targeted for American investment in his country: Entertainment, Technology, and Defense. He met with leaders in these industries including AMC, Walt Disney, Warner Brothers, and Universal Pictures in the entertainment sector; Google, Apple and Facebook in technology; and Lockheed Martin, Boeing and Raytheon in defense.

His objective was to woo these firms into becoming participants (i.e. investors) in the KSA Vision 2030 program. His selling points to America’s entertainment and technology titans is that they would benefit from the fact that Saudi Arabia is a new, untapped, and under-developed market with a young, highly educated demographic that’s craving entertainment and technological services. They would also share in the spoils of the giga-projects attracting tourists from all over the world.

There is no doubt that MBS’ Vision 2030 is super ambitious, and could fall well short of expectations. As it stands, the country’s private sector has been struggling, hit hard by government austerity steps and a recently imposed 5% value-added-tax to balance the budget. A survey shows that growth in the non-oil private sector slowed to a crawl in April, reaching its lowest level since the survey was launched in August 2009. The Saudi economy, which has been slowing since the oil price crash of 2014, slipped into a recession last year, compounding very weak growth in the non-oil sector in 2016.

But the government remains optimistic, with finance minister Mohammend al-Jadaan saying he expects GDP to rise “north of 2 per cent” in 2018, exceeding the IMF’s 1.7% growth forecast, thanks to the combination of an expansionary budget this year, higher oil prices, and more business friendly laws. He also estimates the budget deficit will fall to 7% of GDP, from almost 13% in 2016.

Investors seem equally optimistic about Saudi Arabia’s prospects, judging from the bond and stock markets.

Last month’s $11 billion bond issue was five times oversubscribed, and 15% of those investors were first-time buyers of Saudi debt. That this latest issuance follows the record breaking $17.5 billion debut sovereign bond in 2016 and $21.5 billion issuance in 2017, shows how strong investor appetite is for Saudi debt. Last month, 45 government-linked securities were launched on the Tadawul financial market in a move aimed at deepening the domestic credit markets. The Ministry of Finance has indicated that Saudi Arabia’s intent is to become the “regional benchmark and safe haven in fixed interest markets.”

Meanwhile, Saudi Arabia is number 2 among all global country stock market ETFs in 2018, boasting a gain of nearly 16% YTD. Egypt’s stock market is the only better performer at 20%. Inflows have been so strong that the Saudi Arabia ETF (KSA) is 14 times larger than at the beginning of 2018. The fund, which tracks a broad-based index of Saudi companies, began the year with $14 million in AUM and now has about $208 million in assets. Its top industry allocations are banks (38%), chemicals (24%), telecoms (7%), food (6.7%), and mining (3.9%). Energy represents less than 1% of the portfolio.

Although sentiment has soured towards emerging markets generally, given rising rates in the United States, idiosyncratic country-specific factors are helping Saudi Arabia stand out in the EM space, including structural reforms by MBS, rising oil prices, an upcoming IPO of Saudi Aramco, and the potential inclusion of Saudi stocks in the FTSE Russell and MSCI emerging markets indexes this year. 

These factors, combined, add up to the type of transformational change that we look for in our quest to identify change-driven thematic investment opportunities. As such, we are adding LONG SAUDI ARABIA to MRP’s list of themes effective today. Investors can gain exposure to Saudi Arabia via the iShares MSCI Saudi Arabia ETF (ticker KSA).


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