Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors

aranca.com Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors 2014

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors Report Prepared by: Prahlad Bhanushali, Rishiraj Agrawal, Ati Ranjan 2 // www.aranca.com

Contents Multi-billion dollar investment opportunity in KSA 03 Importance of Saudi Arabia as an investment destination 07 Tadawul providing a level playing field among many G-20 economies 13 Other markets performed well after liberalization 19 Conclusion: Opening of market to lure huge foreign investments 23

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An Aranca Special Report 2014 1 Multi-billion dollar investment opportunity in KSA In July 2014, authorities approved plans to fully open the Saudi stock exchange (Tadawul) to foreign direct investments (expected by 1H 2015). The move is believed to be a precursor to the much-coveted inclusion of Tadawul in the MSCI EM Index (likely to take place in 2017). Following the recent upgrade of the UAE and Qatar to emerging-market status, this could enhance MENA s visibility among global investors, increasing its weightage to 5.35% (including Saudi Arabia s 4%) vis-à-vis 1.35% currently. Given the scenario, global portfolio managers are expected to allocate around USD40bn to Saudi Arabia. In addition to passive investment, we expect a lot of active money to begin flowing into the Kingdom, given the fundamental strength of KSA s economy and stock market. www.aranca.com // 5

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors Saudi Arabia, the last G-20 country to open doors to foreign investors Saudi Arabia, the largest country in MENA by market capitalization and GDP, is the last of the G-20 countries to open its stock market to full foreign participation. Except China, where there is a cap on investments for Qualified Foreign Institutional Investor (QFII), all other G-20 markets are fully open to foreign direct investments. Saudi Arabia s market cap to GDP ratio currently stands at 0.71, lower than the G-20 average of 0.79 and significantly below that of the US (1.14), Japan (0.94), the UK (1.34), Canada (1.28), Australia (0.97), South Korea (1.07) and South Africa (2.93). We believe opening doors to foreign investors would bring the ratio closer to 1; our back of the envelope calculation indicates that deepening of the market would mean more than USD150bn addition to market capitalization if the MCap/GDP ratio improves by just 10 basis points. Figure 1: MCap to GDP ratio of just few G-20 countries greater than 1 20,000 10,000 USD bn 3,000 0 Source: World Exchanges, IMF World Economic Outlook Database, April 2014 Inclusion in MSCI EM Index to attract significant inflows Based on our preliminary calculations using funds benchmarked to the MSCI EM Index and weightage based on market cap, we expect global portfolio managers to eventually allocate about USD40bn to Saudi Arabia. According to the July 2014 MSCI EM factsheet, funds aligned to MSCI indices totaled USD9trn. Considering the market cap approach to calculate weightage, the MSCI EM has 12% weightage on MSCI; this translates to an allocation of USD1trn. The MSCI Saudi Arabia Domestic Index has a free float market cap of USD194bn from 45 constituents. Based on our calculation, this indicates roughly 4.7% weightage on the EM Index; however, going by the market s estimate, even if weightage is around 4%, it represent a potential investment of around USD40bn. Once included, Saudi Arabia would be among the top ten countries in the MSCI EM list of 23 nations, which is currently dominated by China (19.44%), South Korea (15.62%), Taiwan (11.84%), Brazil (10.92%) and South Africa (7.51%). 6 // www.aranca.com

An Aranca Special Report 2014 Figure 2: Expected structure of MSCI EM after inclusion of Saudi Arabia FUND BENCH- MARKED Corpus allocation to MSCI Funds: USD9.0trn Corpus to MSCI EM aligned based on weightage i.e. 12% INVESTMENT OPPORTUNITY IN SAUDI ARABIA Corpus allocation to EM Funds : USD1.0trn Weightage allocated to KSA in MSCI EM Index 4% USD40bn WEIGHTAGE ASSIGNED MSCI Index Market Cap: USD33.6trn MSCI EM Index Market Cap: USD4.0trn Top country weightage in MSCI EM: China 19.44% India 6.84% South Korea 15.62% Russia 5.40% Taiwan 11.84% Mexico 5.12% Brazil 10.92% Saudi Arabia 4% (expected) South Africa 7.51% Source: MSCI, Aranca research Rapid strides toward inclusion in MSCI EM; likely by 2017 The three major criteria to enlist in the EM Index are economic development; having the requisite size and liquidity; and market accessibility. Saudi Arabia is currently at par with developed markets with regard to the first two parameters. However, it lags in terms of market accessibility, particularly openness to foreign ownership and efficiency of operational framework. In line with the aim to fully liberalize the Saudi market by 1H 2015 and bring it at par with international standards, authorities in KSA are taking steps aimed at effective governance of market and building a trading technology framework, among others. Therefore, we believe Saudi Arabia would be a part of the MSCI EM Index in 2-3 years, taking much lesser time than the UAE and Qatar (5 6 years). Figure 3: Saudi Arabia standing on par with the developed markets requirements on several parameters CRITERIA FRONTIER EMERGING DEVELOPED SAUDI ARABIA A. Economic development Sustainability of Economic development No requirement No requirement GNI per Capita 25% > above World Bank High Income threshold B. Size and Liquidity Requirements DEVELOPED No of companies meeting the below criteria:- 2 3 5 DEVELOPED Company size USD 449 mn USD 898 mn USD 1796 mn DEVELOPED Security size USD 33 mn USD 449 mn USD 898 mn DEVELOPED Security Liquidity 2.5% ATVR 15% ATVR 20% ATVR DEVELOPED C. Market Accessibility Criteria Openness to foreign ownership At least some Significant Very high FRONTIER Ease of capital inflows/outflows At least partial Significant Very high DEVELOPED Efficiency of operational framework Modest Good and tested Very high FRONTIER Stability of institutional framework Modest Modest Very high EMERGING 2008: UAE and Qatar first sought for inclusion in MSCI EM 2013: Announced approval 2014: Finally included Opening up of the market illustrates its commitment to attract foreign investors Source: MSCI, Aranca research www.aranca.com // 7

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An Aranca Special Report 2014 2 Importance of Saudi Arabia as an investment destination Saudi Arabia has come a long way in terms of developing its stock market, a crucial determinant to achieving an ambitious target. The country began to develop its stock market more than a decade ago, focusing on fundamentals such as transparency, disclosures, insider trading, and credit control, and recently switched gears focusing on raising it to international standards. On the economic front, Saudi Arabia remains the favorite among the G-20 nations, with stable GDP growth, high fiscal surplus and low debt levels, among others. The Kingdom scores high on other development parameters such as ease of doing business, investor protection and raising credit. Moreover, given its sovereign rating of AA- with positive outlook, the country is better than many developed and emerging economies. Another interesting aspect is that KSA is insusceptible to political crisis in the MENA region, as seen during the Arab Spring. www.aranca.com // 9

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors Evolution of investment regime in Tadawul indicates strong commitment to attract foreign capital Robust institutional and regulatory framework and a proactive policy make Saudi Arabia one of the most attractive markets for global investors. Since the handing over of Tadawul s supervision to a separate body (Capital Market Authority) in 2003, the operational structure of the capital market has become robust, governance/transparency has improved, and policymaking has become effective. The Capital Market Authority s strategy to transform the stock market, as it looks to gradually open the capital market to foreign investments, can be summarized in three broad steps:»» Removing irregularities in procedure and operations of the stock market, and focusing on the size and depth of the market»» Paving way for foreign investments, albeit indirectly»» Undertaking initiatives to complete the liberalization of Tadawul Figure 4: Development of Tadawul FIIs allowed to participate directly through ETFs CMA starts working on regulation to allow QFII Authority of supervising the stock market handed over to CMA(Capital Market Authority) from SAMA IB licenses issued to foreign banks SAMA introduced measures to reduce personal loan leverage A lot of structural rigidities saw the index reaching an all time high Major retail participation contributed to increased volatility Increasingly stretched valuations led to a severe correction with TASI losing half its value 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Change in working days to Sunday-Thursday, brings it closer to international standards Tightening regulations on loss-making companies to reduce speculations Introduction of VWAP mechanism increases institutional participation Full liberalization of Saudi Market and opening up for foreigners Going forward 2014 1H2015 2016 1H2017 Post correction, CMA adopted 3-pronged strategy; increasing market size & depth, improving transparency and rooting out insider trading New corporate governance code launched Direct market access for foreign participation Potential inclusion in MSCI Emerging Markets Index Foreigners allowed entry through swaps Earnings disclosures made mandatory FIIs allowed entry through swaps Source: Capital Market Authority, KSA, Aranca research 10 // www.aranca.com

An Aranca Special Report 2014 Market begins to stabilize with the pick-up in reforms from 2009 The Tadawul witnessed two major instances of volatility during FY03 09. A number of structural rigidities led to a run-up in prices which saw the Tadawul All Share Index (TASI) reach a record high of 20,635, with heavy retail participation cited as one of the reasons for the considerable volatility. Following the crash that wiped out nearly USD480bn and reduced the TASI to less than half its value, the CMA wasted no time in adopting a threepronged strategy: increasing size and depth of the market, improving transparency and rooting out insider trading. Having identified the need for foreign institutional participation to reduce volatility, the authorities turned their focus on removing imbalances in the market and attracting FIIs. Some of the steps included permitting foreign participation through swaps, ETFs and changes in regulations to allow QFII. The second instance was smaller in magnitude and related more to the global financial crisis of 2008. The reforms that began with the partial opening of the market in 2009 decreased volatility and culminated recently with the full liberalization of the Saudi market. Figure 5: Reduction in volatility from 2003 with the partial opening of the market in 2009 25,000 3,000 20,000 2,500 2,000 15,000 1,500 10,000 1,000 5,000 500 0 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 0 SASEIDX Index - Volume (unit) SASEIDX Index - Last Price Source: Tadawul, Bloomberg Saudi Arabia has sound economic fundamentals Expected to continue growing at a decent pace Saudi Arabia s economy has grown at an impressive rate over the past few years. Moreover, KSA is among the few countries that remained relatively immune to the global financial crisis, clocking an average GDP growth of 6%, third only to India and China. The IMF expects KSA s real GDP to continue growing at a modest (4 4.3%) but higher rate than advanced economies (2.3%). Figure 6: Nominal GDP (USD bn) and Real GDP Growth % growth (2007 19E) 6.0% 8.4% 7.4% 8.6% 670 734 745 773 791 816 850 889 932 416 520 429 527 5.8% 3.8% 4.1% 4.2% 4.2% 4.2% 4.2% 4.3% 1.8% 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E Nominal GDP (USD bn) Real GDP % growth Source: IMF World Economic Outlook Database, April 2014 www.aranca.com // 11

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors Favorable demographics key to sustained economic growth With 65% of its total population below 34 years old (median age: 26 years), strong demographics is an important underlying strength of Saudi Arabia; this, we believe, is the key to sustained economic growth. Over the last few years, the Saudi government has laid emphasis on tapping the potential of its burgeoning youth population by spending on education and related areas (expenditure on education accounted for nearly 25% of 2013 budget; highest in the world) and simultaneously taking steps to boost employment in the private sector through various labor reforms. Figure 7: Favorable demographics for sustained economic growth Population in Mn 2.6 3.5 4.7 6.0 6.8 2.0 1.4 3.9 5.1 6.4 7.0 7.4 7.7 8.1 1.0 0.8 3.1 2.3 5.8 7.0 7.6 7.9 8.2 8.6 8.8 9.1 9.4 10.2 10.6 11.3 12.0 12.1 12.3 12.2 11.7 11.5 8.3 8.8 8.9 8.5 8.3 8.1 7.9 7.7 7.4 2010 2015E 2020E 2025E 2030E 2035E 2040E 2045E 2050E 0 to 14 15 to 34 35 to 49 50 to 64 65 & Above Source: World Bank Database Fiscal surplus, despite expansionary spending policy, led by influx of petrodollars Saudi Arabia is expected to record a fiscal surplus for the fifth consecutive year in 2014 due to high oil prices and growth in oil production oil revenues are expected to total USD329bn. This has enabled the Saudi government to maintain an expansionary fiscal policy to diversify the economy from oil. Therefore, despite the economy s heavy dependence on oil revenues, the non-oil sector s contribution to GDP has risen steadily, standing at 53% currently from 44% in 2008. Figure 8: Government revenue and expenditure Figure 9: Budgeted vis-à-vis actual spending 194 131 315 151 172 154 219 208 318 238 369 331 329 262 269 274 131 101 109 151 127 172 144 208 155 238 184 262 219 269 2007 2008 2009 2010 2011 2012 2013 2014E 2007 2008 2009 2010 2011 2012 2013 Government Revenue (USD bn) Government Expenditure (USD bn) Budgeted (USD bn) Actual (USD bn) Source: IMF World Economic Outlook Database, April 2014 12 // www.aranca.com

An Aranca Special Report 2014 Saudi Arabia s current account balance (CAB) is one of the largest in the world due to its dominance in oil export. The country s CAB, as a percentage of GDP, of 17% is well above that of developed economies such as the US (-2.7%) and UK (-3.8%) as well as emerging markets such as Brazil (-2.4%), China (2.3%) and India (-4.9%). Saudi Arabia has also brought down its debt to low single digit over the years; it currently stands at just 3% of GDP. Figure 10: KSA s CAB one of the highest in the world Figure 11: KSA s debt levels reduced drastically 365 388 376 313 251 233 211 192 132 115 90 96 107 70 156 168 2007 2008 2009 2010 2011 2012 2013 2014E Exports (USD Bn) Imports (USD Bn) CAB (% of GDP) 30% 25% 20% 15% 10% 5% 0% 71 17% 63 60 14% 12% 45 36 8% 26 20 20 5% 4% 3% 3% 2007 2008 2009 2010 2011 2012 2013 2014E Public Debt (USD bn) As % of GDP Source: IMF World Economic Outlook Database, April 2014 Investor-friendly environment enhancing competitive strength Saudi Arabia has a higher sovereign rating than most emerging markets; this reflects its strong fundamentals. S&P has given Saudi Arabia an AA- rating with a positive outlook, just three notches below the maximum possible rating of AAA. Moreover, KSA scores better in terms of ease of doing business, with strong investor protection laws and high availability of credit, among a host of parameters. The raising credit parameter reflects the collateral and bankruptcy laws that support lending and borrowing, whereas the investor protection parameter indicates strength in three areas: extent of disclosure, extent of director liability and ease of shareholder suits. Figure 12: KSA s sovereign rating just two notches below highest Figure 13: KSA among the most business-friendly economies in EM Prime High Grade (AAA to AA-) Medium Grade (A- to BB-) Speculative Grade (B+ to CCC-) 92 96 109 116 126 134 71 6 7 16 23 26 41 48 53 Figure 14: Getting credit in KSA easiest in MENA (rank 133) Figure 15: KSA offers strong investor protection 109 109 130 115 128 1 13 28 28 42 55 73 73 73 83 83 86 4 10 22 34 34 52 68 70 80 82 98 98 98 Source: S&P, World Bank, Rankings taken from Ease of Doing Business Report 2014 www.aranca.com // 13

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors Unaffected by social unrest in MENA Saudi Arabia was largely unaffected by the Arab uprisings that swept the MENA region. This was mainly due to the Saudi government s ability to satisfy the needs of its population. The Government of KSA implemented major labor reforms in 2011 that led to an increase in employment as well as salaries of nationals, ensuring stability. Factors such as economic development, satisfaction with the system of governance and emerging nationalism have held the nation together during turmoil and otherwise; consequently, investors are more confident about stability in the Kingdom. Figure 16: Impact of Arab Spring in MENA (Saudi Arabia vis-à-vis other countries) Morocco Jordan Bahrain Iraq Iran Algeria Lebanon Kuwait Oman UAE Saudi Arabia Source: Aranca research Regime dethrone Civil war Major protests Governmental reforms Minor Protest No Impact Syria Yemen Egypt Libya Tunisia 14 // www.aranca.com

An Aranca Special Report 2014 3 Tadawul providing a level playing field among many G-20 economies Despite Saudi Arabia being an oil export economy, it offers investment opportunities across several non-oil sectors such as petrochemical, banking, telecom, food, retail, among others. We believe these opportunities would continue to increase as the country diversifies its economy further. The Saudi stock market (Tadawul) is fairly liquid and the most active IPO market in the MENA region, both in terms of value and listings. With just 169 listings, the market has an average monthly turnover of USD49.5bn over 68 stocks (or 40% of total) have a market cap of more than USD1bn (and around 100 stocks with market cap of USD0.5bn or more); this places it above the stock markets in several G-20 nations. Furthermore, due to its low correlation with emerging countries, the Saudi stock market provides investors with diverse options. Therefore, we expect it to continue trading at a premium to the advanced and emerging market group averages. www.aranca.com // 15

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors Economic diversification creating investment opportunities across sectors Saudi Arabia is an oil-driven economy, with the oil segment contributing more than 85% to total revenues and approximately 47% to the Kingdom s GDP. However, all companies in this space are unlisted. Hence, the Saudi stock market provides investors exposure to only non-oil companies across diverse sectors such as petrochemicals, financial, food, retail, among others. There are 169 listed companies in the Saudi stock market, with the financial sector having the highest free flow weightage, followed by petrochemicals and telecom. We believe further diversification of the economy would unlock more growth potential in the non-oil segment and benefit investors. Figure 17: Non-oil segment provides ample opportunities for investors KSA Oil and Non-oil GDP No of Listed Cos. Free Float Wt. Avg. Turnover Financial Services Food & Retail Oil Non-oil Industrial Construction Cement Petrochemicals Telecom/IT Metrics of Key Sectors in TASI Banking Petrochemical Food & Retail Construction & Cement Telecom Sector Revenue (USD bn) 14.7 80.9 19.2 9.9 20.7 MCap as % of GDP 15% 21% 7% 5% 3% Free Float MCap (USD bn) 61.4 51.1 28.7 25.1 10 No of Listed Cos 11 14 30 30 5 Daily Turnover (USD mn) 247 373 352 211 160 Volume as % of Total TASI 13% 16% 9% 8% 12% Source: Tadawul, Bloomberg Saudi stock market above several G-20 peers With an average monthly turnover of USD49.5bn, the Tadawul is at par with most G-20 peers; in fact, it is competitively placed with the likes of Brazil, South Africa and Russia. The Saudi stock market s share turnover velocity ratio is 1.1 vis-à-vis Brazil s 0.57 and South Africa s 0.23. Furthermore, the Saudi stock market is fairly deep, with over 100 companies (or 59%) and more than 68 companies (or 40%) of the total 169 having a market cap above USD0.5bn and USD1bn, respectively. This is higher than the peer group average of 34% and 24%, respectively. Therefore, attractive blue-chip offerings and market depth make Saudi Arabia a lucrative destination for investments. 16 // www.aranca.com

An Aranca Special Report 2014 Figure 18: Tadawul Provides an excellent depth to investors Country Stock Exchange MCap (USD bn) Avg turnover (USD bn) Share turnover velocity ratio No of Listed Cos No of Cos MCap>USD 1 bn No of Cos MCap>USD 500 mn Italy Borsa Italiana 698 83.3 1.25 360 80 101 Brazil BM&F Bovespa 1,100 55.7 0.57 369 117 160 Saudi Arabia Tadawul SE 530 49.5 1.1 169 68 100 Turkey Borsa Istanbul 223 31.4 1.8 231 40 72 South Africa Johannesburg SE 1,028 28.3 0.23 375 86 118 Russia Moscow Exchange 735 23.3 0.33 251 52 71 Mexico Mexican Exchange 530 13.1 0.3 142 68 84 Indonesia Indonesia SE 408 8.3 0.19 496 75 124 Argentina Buenos Aires SE 56 0.3 0.09 104 11 20 Average 590 32.6 0.65 277 66 94 Source: Bloomberg, Aranca research Robust IPO activity Saudi Arabia is the largest IPO market in MENA, with 37 listings over the last five years (2009 13), followed by Tunisia (23) and Oman (8). It is also the biggest in terms of proceeds raised (USD5bn vis-à-vis USD0.5bn in Tunisia and USD1.2bn in Oman). Al Hammadi Company for Development and Investment (in the retail sector) was the last of the four IPOs in 2014 raising a total USD533mn (higher than USD523mn last year). We believe the potential remains strong, with more than 35 family-owned businesses in discussions with advisors for IPOs, and National Commercial Bank (NCB), the largest Saudi bank, likely to go public later this year. Al Rajhi, the second largest bank after NCB, has a market capitalization of USD30bn. Figure 19: Saudi Arabia, largest IPO market in MENA (2008 14 YTD) 13 9,705 11 9 7 5 5 4 1,035 1,022 460 1,420 523 533 2008 2009 2010 2011 2012 2013 YTD 2014 Size of Offerings (USD mn) No. of IPOs 2008 2009 2010 2011 2012 2013 YTD 2014 Construction Consumer Goods Financial Services Food and Beverages Health Care Industrial Manufacturing Leisure and Tourism Mining and Metals Petrochemical Real Estate Retail Telecommunications Transport Source: Zawya, Aranca research www.aranca.com // 17

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors An attractive alternative to riskier emerging markets Saudi Arabia s stock exchange provides significant diversification-related benefits to global investors due to its low correlation of 27% and 47% (1-year and 3-year) with the MSCI EM Index. Separately, Tadawul has a negative to low correlation with Russia, China, Brazil and South Korea. However, its correlation with the US market is high at 87 94%, given the dollar peg; we believe this bodes well for investors willing to bet on safe-haven dollar-denominated investments, as seen during the emerging market currency turmoil. Figure 20: Diversification benefits due to low correlation with MSCI EM 96.8% 96.1% 94.6% 95.9% 93.9% 93.7% 91.3% 92.8% 90.9% 86.7% 83.1% 90.0% 93.4% 90.8% 92.5% 61.6% 47.3% 54.2% 26.8% 13.7% 22.3% -53.6% -60.5% -43.2% -62.0% -53.4% Qatar Dubai Abu Dhabi S&P DJIA FTSE MSCI EM Russia China Brazil Korea Taiwan South Africa 1 Yr Correlation 3 Yr Correlation Source: Bloomberg, Aranca research 18 // www.aranca.com

An Aranca Special Report 2014 Strong fundamentals, growth potential warrant premium valuation The Saudi stock market s return on equity (ROE) currently stands at 13%, higher than that of MSCI EM and MSCI ACWI (12% each). Furthermore, according to the consensus estimate, the earnings of listed Saudi firms would grow 13% in 2015, at a higher pace than the expected 11% average for both emerging as well as advanced economies. Also, at 3%, the Tadawul s dividend yield is higher than the 2.5 2.7% range for both MSCI EM and MSCI ACWI. We believe these factors, coupled with strong macroeconomic fundamentals, justify the premium valuation of 20x for the Saudi stock market versus 17x for MSCI ACWI. Figure 21: Saudi Arabia s position among key developed and emerging countries 18% Argentina India UK Size of the bubble represents MCap 15% US China 12% Russia Turkey South Africa Indonesia Saudi Arabia Mexico ROE Germany Australia 9% Brazil Canada Japan 6% Korea France 3% 3.0x 6.0x 9.0x 12.0x 15.0x 18.0x 21.0x 24.0x 27.0x P/E multiple Source: Bloomberg, Aranca research www.aranca.com // 19

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An Aranca Special Report 2014 4 Other markets performed well after liberalization Emerging markets such as India, Dubai and Qatar have witnessed positive results in the form of increase in market capitalization, investments and market activity after being opened to foreign institutional investors (FIIs). While the Indian market benefited from improved trading infrastructure and better corporate governance, which attracted a lot of FIIs, trading activity across the UAE and Qatar indices surged following their inclusion in the MSCI EM Index. Nine UAE and Ten Qatari stocks were included in the MSCI EM Index, which witnessed higher foreign participation in related sectors as well as increased foreign ownership in these stocks. The Government of Qatar raised the FOL to 49%; this is expected to result in higher foreign inflows and increase the weightage of Qatari stocks on the MSCI EM Index. www.aranca.com // 21

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors India: Stock market mainly driven by FIIs Like Saudi Arabia, other emerging markets witnessed a boom in investments and market capitalization after opening their doors to FIIs. India s Sensex moved up to 26,000 from merely 2,000 in two decades due to huge foreign participation. The Indian market rose significantly after 2003 owing to the massive inflow of FII money following the development of trading infrastructure and improvement in corporate governance. Figure 22: India: FII driving movement in index and volumes 4-Jan-93 3-Mar-95 29-Apr-97 26-Jun-99 22-Aug-01 19-Oct-03 15-Dec-05 11-Feb-08 9-Apr-10 5-Jun-12 2-Aug-14 Volume (mn) Sensex 1993-94 1995-96 1997-98 1999-00 2001-02 2003-04 2005-06 2007-08 2009-10 2011-12 2013-14 Turnover (INR cr) FII stake (%) Source: Bloomberg, Bombay Stock Exchange, National Stock Exchange, Aranca research UAE and Qatar: Included in MSCI EM Index in May 2014 Trading activity surges, foreign ownership rises in selected stocks in UAE The UAE index rose significantly, while trading activity increased nearly fourfold after the country was included in the MSCI EM Index, the process for which began a year earlier in June 2013. Notably, Dubai Financial Market (DFM) reached a five-year high in May following the news of inclusion. In June 2014, four stocks of the Abu Dhabi Securities Exchange (ADX) First Gulf Bank, National Bank of Abu Dhabi, Abu Dhabi Commercial Bank and Aldar Properties and five stocks of DFM Arabtec, DP World, Dubai Financial Market, Dubai Islamic Bank, and Emaar Properties were included in the MSCI EM Index; this led to higher foreign participation in banking, financial services and real estate sectors. 22 // www.aranca.com

An Aranca Special Report 2014 Figure 23: UAE: Trading improves significantly after MSCI EM inclusion Jan-12 Apr-12 Jul-12 Oct-12 Jul-14 ADSMI DFMGI Volume in mn Volumes quadrupled after including in MSCI EM 01-Jan-12 01-Apr-12 01-Jul-12 01-Oct-12 01-01- 01-01- 01-01- 01-Jul-14 Source: Bloomberg, UAE Stock Exchange websites, Aranca research Figure 24: UAE: Increase in foreign shareholding in companies included in the MSCI EM Index 7.32% 7.04% 7.39% 7.71% 8.79% 8.76% 9.00% 9.19% 14.73% 14.90% 15.18% 15.19% 15.06% 14.65% 14.64% 14.96% 11.96% 10.72% 13.09% 12.25% 13.67% 14.53% 17.35% 17.98% Abu Dhabi Commercial Bank First Gulf Bank Aldar Properties 2.35% 3.10% 3.02% 3.03% 3.05% 3.03% 3.61% 3.68% National Bank of Abu Dhabi Arabtec 8.66% 7.91% 9.62% 9.07% 8.78% 9.23% 11.07% 10.57% 5.54% 5.73% 5.02% 4.96% 3.72% 3.66% 5.40% 5.31% Dubai Financial Market 2.76% 2.74% 4.26% 6.33% 6.89% 8.49% 8.98% 9.90% 13.96% 15.41% 16.02% 15.88% 16.54% 20.52% 20.82% 21.13% Dubai Islamic Bank Emaar Properties Source: Bloomberg, Stock Exchange website, Aranca research Qatar performs on similar lines The Qatar Exchange (QE) index reached a lifetime high of 13,910 after inclusion of 10 stocks in the MSCI EM Index in June 2014. Furthermore, foreign ownership grew significantly in selected stocks. Recently, the government s decision to raise the foreign ownership limit (FOL) to 49% from 25% for listed companies strengthened investor sentiment. The rise in FOL is expected to not only help the country witness foreign inflow of approximately USD440mn but also increase the weightage of the index from 0.47% to 0.62% (higher than the UAE s 0.58%) on the MSCI EM Index in the near future. www.aranca.com // 23

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors Figure 25: Qatar: Rise in trading value and volume after inclusion in MSCI EM Jan-12 Apr-12 Jul-12 Oct-12 Jul-14 DSM After the announcement, volumes surged to 201mn Volume in mn Before the announcement, volumes averaged 90mn Jan/12 Apr/12 Jul/12 Oct/12 Jan/13 Apr/13 Jul/13 Oct/13 Jan/14 Apr/14 Jul/14 Source: Bloomberg, Stock Exchange website, Aranca research Figure 26: Qatar: Foreign shareholding in companies following inclusion in MSCI EM Index 6.05% 6.79% 7.40% 8.81% 10.61% 13.32% 12.00% 12.51% 3.78% 3.73% 3.98% 4.08% 4.76% 4.33% 6.82% 6.91% 7.23% 7.20% 7.08% 7.10% 7.37% 8.21% 9.33% 9.62% Doha Bank Vodafone Qatar Qatar Electricity & Water 3.94% 3.75% 3.56% 3.46% 3.71% 4.35% 5.61% 6.06% 7.04% 8.46% 8.65% 9.08% 8.92% 8.58% 8.79% 8.48% 4.24% 4.52% 5.17% 5.22% 6.00% 6.53% 6.51% 6.58% Qatar Islamic bank Qatar Industries Qatar National Bank 14.33% 14.67% 14.22% 14.06% 14.10% 13.07% 12.86% 12.72% 13.96% 13.43% 14.75% 15.22% 16.11% 16.05% 14.72% 15.00% Al Rayan Bank Commerical Bank of Qatar Source: Bloomberg, Stock Exchange website, Aranca research 4.31% 5.39% 5.26% 5.44% 5.82% 5.73% 7.44% 7.87% Barwa Real Estate 24 // www.aranca.com

An Aranca Special Report 2014 5 Conclusion: Opening of market to lure huge foreign investments Saudi Arabia took a landmark decision in July 2014 to allow direct foreign investment in Tadawul, the largest exchange so far restricted to outsiders. The Tadawul has a market cap of USD530bn, but a relatively lower MCap to GDP ratio of 0.71. On one hand, we expect the country s solid fundamentals to continue advancing on high oil prices, aided by the government s plan to diversify into the lucrative non-oil avenues. Capital Market Authority, on the other hand, is laying emphasis on bringing up its stock market reforms/policies/infrastructure at par with international standards. The Tadawul s high credit rating, low correlation with peers in emerging markets, and relatively higher earnings have made it a favorite among investors. With monthly turnover averaging USD49.5bn and a velocity ratio of 1.1, the Tadawul is at par with exchanges in several G-20 countries. Moreover, more than 40% of companies listed on the Tadawul have a market cap of above USD1bn (59%+ with MCap > USD0.5bn). It is, in fact, the most active IPO market in the MENA region. The Saudi stock market www.aranca.com // 25

Market Liberalization in Saudi Arabia: Opportunities Galore for Foreign Investors is also fairly diversified across non-oil sectors, and this is expected to grow as it continues to focus on economic diversification. Capital Market Authority expects the new rule to take effect some time in 1H 2015; our back of the envelope calculations suggest that the market cap could increase by USD150bn if MCap/GDP ratio improves by just 10bps. In our opinion, this is very significant, especially given that the Saudi market is likely to be included in the MSCI EM Index in 2017. A quick analysis of India, UAE and Qatar reveals that these nations significantly benefited in terms of market activity (volumes, turnover, index movement) as well as rise in foreign ownership after opening their stock market to foreign investors. We foresee the same results for Saudi Arabia. 26 // www.aranca.com

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