Stock Market and Financial Sector in Saudi Arabia

The key purpose of this report is to analyze those factors that can impact the stock market in Saudi Arabia. Furthermore, it is necessary to forecast market conditions in this country on 3-month and 1-year timeframes. Finally, this report will explain the benefits of investing capital into the Saudi economy. The findings of this report will help the team to make better investment recommendations. These are the key issues that are going to be scrutinized in this paper.

Economic factors influencing Saudi stock market performance

There are several factors that shape Saudi stock market performance; the majority of them are connected with the global environment, for example, the growth rates of the world economy, the demand for oil, economic development of GCC countries, exchange rates, the government’s participation in free trade agreements, unemployment and so forth (Saudi Arabian Monetary Agency, 2010). These are the key forces that influence Saudi stock market. It should also be mentioned that some of these forces, especially the growth rates of the world economy and demand for oil are closely intertwined with one another. These are question are going to be scrutinized in the first section of this report.

The first and arguably the most crucial factor is the development of the global economy. Over the last several years, the economy of several advanced countries such as the United States, the United Kingdom, Australia or Germany passed through a long recession and these countries are the largest consumers of oil in the world. Many companies that are based in this region have to slow down their production tempos and this subsequently decreased the global demand for oil. This example shows how the development of global economy can impact the performance of Saudi stock market. Another issue which one should bear in mind is that many countries are now trying to reduce their oil dependency (Morgenstem & Portney, 2004). The governments of many nations invest money in the development of alternative energy sources, and in the long term, these undertakings may adversely influence Saudi Stock market. The findings of International Energy Agency suggest that the level of oil demand is relatively unstable; for instance, in 2008 it declined by 1.4 percent, while in 2009 it increased by 1,9 percent (Saudi Arabian Monetary Agency, 2010, p 17). These facts suggest that the stock market of Saudi Arabia is influenced by external rather than internal forces. The inner policies of the government also should not be underestimated but they do not play such an important role.

We should not overlook such factor as the level of oil supply. At this moment, there are seventeen countries that export oil and Saudi Arabia occupies the leading position among them. More than that, the majority of oil supplies are located in the Middle East. However, the findings of OPEC (Organization of Petroleum Exporting Countries) suggest oil supply has grown and will grow especially in those countries that are non-members of OPEC (Opec, 2010, p 135). Therefore, there is some probability that in the near future, Saudi Arabia will not be able to dictate pricing policies in this market. The critical issue is that the majority of oil reserves in these countries have yet to be discovered and it is likely that in the near future, they can actively compete with Saudi oil exporters. Special attention should be given to Russian oil reserves, which remain relatively unexplored at this point, but this situation may change in the future.

Such factor as exchange rate is also relevant to the performance of Saudi stock market. Saudi Riyal has a fixed exchange rate to the US dollar, 3.75 (Saudi Arabian Monetary Agency, 2010, p 17). This means that the value of Saudi Riyal is dependent on the value of dollar. Provided that the value of dollar diminishes in relation to other currencies such as Euro or Yen, the price of Saudi stock may significantly drop. The most important thing is that a great number of Saudi companies have dollar-assets and the weakening of this currency may turn out a very severe strike for them. In this regard, we need to point out that the performance of Saudi capital market is closely related with the economy of the United States.

The economic performance of GCC countries is also a powerful force that may impact Saudi stock market; in particular, we need to speak about the inflation rates in such neighboring countries as Kuwait, UAE, and Qatar. The thing is that many Saudi companies such as SABIC (Saudi Arabian Industry Corporation) operate in these countries and inflation can negatively impact their stock performance. Another factor that is also relevant to the performance of Saudi stock is the government’s participation in free trade agreements. At this point the negotiations with the representatives of the European Union are at a deadlock, and Western companies cannot fully access Saudi markets. Therefore, local companies face very little competition. However, if the government of Saudi Arabia chooses to join WTO World Trade Organization, their financial performance may deteriorate. It should be mentioned that the government of Saudi Arabia has long pursued the policy of protectionism toward local businesses, and they have been shielded from external competition but sooner or later, the policy-makers may adopt a new attitude toward free trade agreements and this will present domestic companies with many difficulties and their market share may decline.

When speaking about economic factors, one also should not forget about the impact of unemployment. At the moment, unemployment rate in Saudi Arabia constitutes 5,4 per cent, which is very high (Saudi Arabian Monetary Agency, 2010, p 226). The increase of unemployment will have a detrimental effect on the performance of Saudi stock market because unemployment diminishes the purchasing power of the population and the profits of many companies may drop. Those, companies that are engaged in the production of oil may not be able to generate the expected profits. Thus, we have enumerated economic factors that may influence the stock market of Saudi Arabia. To some degree, each of factors can shape the market conditions in the country. This information should be taken into account by analysts who attempt to forecast market conditions.

The forecast of capital market conditions

The forecast of capital market conditions has to be based on the analysis of historical records that show how the value of stock changed over a certain period of time. In this part of report, we need predict the market conditions for the next three months and the next year. The first and most crucial parameter to which one has to pay attention is Tadawul All Share Index or TASI as it is also known. Over the last fifty-two weeks, its value ranged from 6,929.40 to 5,760.33, while the average percent change was 3,37 (Tadawul, 2010, unpaged). On the basis of this information, we can say in the next three months, its approximate value will be 6,344. In turn, the average fluctuation will be 0.2391688. The prediction about the value of Tadawul All Share Index is much more difficult to make. The thing is that over the last four years, it significantly varied, for instance, in 2007 the value was 11,175.96, while in 2008 it was 4,802.99 (Tadawul, 2010, unpaged). In part, this discrepancy can be explained by the fact that during these years the world economy passed through deep recession, and the level of oil demand dropped. Now, when the global economic situation has been stabilized by the joint efforts of many governments, the financial performance of Saudi will improve slowly, but surely.

Provided that there will be no dramatic changes in domestic and local economies, the value of Tawadul All Share Index will remain at the level of 6,344. It should be noted that making these estimation we did not divide Saudi capital market into various segments such as banks and financial services, petrochemical industries, energy and utilities because such approach would not give a full picture of Saudi economy. Still, even despite this limitation, we can assume that the economy of this country and its capital market are now regaining its former strength after the collapse that occurred in 2007 and 2008. More importantly, in the near future the investments in this stock market will be more or less risk-free. It has to be acknowledged that the financial performance of Saudi economy has yet to reach its former level, especially in comparison with 2006, it has become more stable.

Given the fact that the economy of Saudi Arabia strongly relies on the production of oil and exportation, one can argue that oil demand will be one of the most important capital market conditions. According to the information released by OPEC, in 2011 the average level of oil demand will be 85,5 million barrels per day (OPEC, 2010, p 60). This is approximately a two percent increase, in comparison with this year. In addition to that, the representatives of OPEC believe that in the next three months, the level of oil demand will rise. This can be partially ascribed to the fact that the governments of many countries have chosen to weaken gas emission standards as they often lead to the stagnation of local economies (OPEC, 2010). One of the largest consumers of petroleum is automotive industry. Such corporations as Ford or Toyota attempt to manufacture vehicles that would use biofuels rather than petroleum. However, at this point the proportion of such vehicles is very small.

While estimating the price for oil, one has to take into consideration such factors as the recovery of global economy from recession, intensification of production, the peculiarities of manufacturing process (OPEC, 2010). According to Saudi Arabian Monetary Agency, in 2010 oil prices were at the level of $ 80 per barrel (2010, p 17). More importantly, the situation is not going to change in the next three months. Nonetheless, OPEC expects that during the next year, the prices will go above that mark (OPEC, 2010, p 6). The representatives of this organization explain this assumption by the fact the industrial enterprises are slowly but surely regaining their former production rates, and therefore, their demand for petroleum will only increase. These data indicate that the performance of Saudi capital market is heavily influenced by the trends in global economy.

Nevertheless, one of the major concerns is the devaluation of the US dollar. In October the value of this currency weakened against Euro and Yen. It should be borne in mind that due to this devaluation can strongly impact the financial performance of many Saudi companies as the proportion of their dollar assets is very high (OPEC, 2010). One of the major challenges is that it is very difficult to predict dollar’s exchange rate for the next year or even for three months. It is expected that it will remain at the level 1. 3895 per one Euro throughout the next year (OPEC, 2010, p 22). However, such estimations are based on subjective assumption rather than facts.

The advantages of Saudi economy

Overall, there are several reasons why the team has chosen the economy of Saudi Arabia. First of all, the capital market of this country is regulated and closely monitored by the state, and this helps to protect actual and potential investors from fraud and manipulation and minimizes risks, connected with investment. Secondly, the information about capital market conditions is available to the public, which means that people can make informed decision as to which sector they should invest or what the returns from investment will be. In this case, none of investors can gain an unfair advantage over others. This is one of the attributes of Saudi stock market that attracts investors throughout the world.

Furthermore, the analysis of various economic factors indicates that Saudi Arabia capital market is less exposed to external threats as any state-driven economy. It has to be admitted that the country is strongly dependent on the global demand for oil and currently the governments of many advanced countries attempt to decrease their oil dependency. However, there is very little likelihood that the demand will drop significantly because modern industrial companies rely on continuous oil consumption, and there is very little likelihood that they will be able to deliver themselves from this bondage, as it will radical changes in the production process. As it has been mentioned earlier, oil demand is expected only to increase in the years to come. These are the main reasons why it is quite prudent to invest into the economy of this country.

The performance of the Saudi stock market is strongly shaped such forces as 1) the level of global demand and supply for oil; 2) the economic development of GCC countries, in particular by the level of inflation; 3) exchange rates; 4) the willingness of Saudi Government to participate in free trade negotiations. It is quite possible for us to make favorable prognosis as to the performance of Saudi capital market. The economy of many countries have already partially recovered over the global crisis, demand for petroleum is gradually increasing. The same can be said about oil prices. So, people, willing to invest into Saudi capital market, can feel relatively safe.

The factors, affecting the performance of Saudi financial sector

This section of the report aims to examine the factors that shape the performance of Saudi financial sector, in particular, banking institutions. Overall, these forces are closely connected with the macro and microeconomic environment of the country as well as with the policies, pursued by the management of each bank. The first and probably most important factor is the level of trust that people put in the banking institutions. In other words, one has to understand whether people are willing to deposit money in the banks of this country. The findings of Saudi Arabian Monetary Agency (SAMA,) indicate the number and amount of deposits rose by 11, 2 percent (SAMA, 2010, p 29). People have become more confident in the efficiency of Saudi Arabian banks. In turn, this means that the level of money supply, available to the banks has risen over the last two years.

Another factor is also crucial for the development of financial sector is the demand for banking services, particularly for credit. To better explain the importance of this factor, we need mention that the business world of Saudi Arabia is dominated primarily by industrial enterprises, for example, the manufacturers of petrochemicals, construction companies, food industries, commercial businesses and so forth (Tadawul, 2010, unpaged). Their need for credit is larger than in service sector (hotels, restaurants). This is why it is possible for us to argue that at the given moment, Saudi Banking institutions are in more or less safe position, and their services will enjoy considerable demand in the near future.

At this point, it is important for us to determine what kind or organizations are the largest loaners in Saudi Arabia. According to the report, published by Saudi Arabian Monetary Agency, over 25 per cent of all loans were made by commercial organizations, manufacturing and processing companies received 10 per cent, while building and construction companies made 6.7 per cent of all loans (SAMA, 2010, p 54). The most critical issue is the ability of these businesses to return this money. Normally, this factor is called credit capacity or borrowing power of the loaner. This is why the management of banking institutions has to pay special attention to the performance of these organizations, the competitiveness in these particular sectors, the demand for the products of these companies. So, prior to giving a loan to an enterprise, the management of the bank has to make sure that the borrower will be profitable enough to return this money. In this case, the most noticeable detail is that the share loans, given petrochemical industries has diminished, whereas other companies, unrelated to oil-production, demand credit more often that it was in at the beginning of this decade. These data indicates that the economy of Saudi Arabia is less vulnerable to the fluctuations in oil prices, and this is very beneficial for the banking institutions.

Such factor as fiscal policies of the state should not be disregarded by the person who analyzes the performance of the banking sector. Currently the government of Saudi Arabia adheres to expansionary fiscal policy (SAMA, 2010, p 104). This means that they attempt to cut taxes in order to stimulate economic development of the country and provide entrepreneurs with an opportunity to better sustain their business. In turn, such attitude of the state increases the borrowing power of local companies.

The investor, who evaluates the performance of Saudi banking sector, should pay special attention to the external competition, especially the attempts of foreign banks to enter Saudi markets. In the previous section of this paper, we have already mentioned that the government of the country is rather reluctant to allow foreign companies to gain access to domestic markets. However, due to the increasing influence of the World Trade Organization, SAMA officials permitted foreign banks to compete with the local ones (Scholars International Academy, 2006, unpaged). For instance, Deutsche Bank has already launched its operations in Saudi Arabia, and there is great likelihood that other foreign banks will follow this example.

Finally, it is vital to take into account the trends in global economy; this group of factors includes such elements as 1) global demand and supply of petrochemical products; 2) the value of US dollar; 3) environmental policies of the foreign governments concerning oil and gas consumption; 4) the political situation in the Middle East. These forces do not influence the banking sector directly, but they have a profound effect on the organizations that cooperate with banks. Overall, this analysis shows that the factors, affecting the performance of Saudi financial sector, are closely intertwined with another, and one cannot discuss them separately. More likely, they can be viewed as a web or network, whose threads are much entangled. While forecasting capital market conditions, one has to understand the relations between these factors and the ways they impact one another.

The forecast of capital market conditions

In order to forecast the performance of the Saudi financial sector, one should first refer to the data, provided by Tadawul. Such sector as Banks & Financial Services has the highest value in Tadawul All Share Index. It’s present value is 15,860.64 (Tadawul, 2010, unpaged). It should be noted that over the last years, there have been numerous fluctuations. The average percent change was 0.88 during this year. To predict capital market conditions for the next three months, one has to take into account the highest value of this sector (17,997.40) and the lowest one¹ – 15,244.00 (Tadawul, 2010, unpaged). On the basis of these data, we can assume that the approximate value of these stocks will be 16,6207. This prognosis can be accurate only under the condition that there will be no drastic changes in the economy of Saudi Arabia.

The forecast of financial performance for the next year is much more difficult to make, as one has to examine financial data, collected over a longer period of time, for instance three years². The maximum decline of this sector was in June 2009, at that time the value of 11, 361. 11; this meltdown can be explained by the fact that at that time the effects of global economic crisis finally manifested themselves in Saudi Arabia. In turn, the highest value was registered in July 2009; at that point, it constituted 32. 141.11. (Tadawul, 2010, unpaged). Given the fact, that the majority of advanced economies are slowly but surely overcoming the aftereffects of recession, we can argue that the value of this stock will not drop below the level of 15,244.00.

Apart from that, we need to focus on such a measurement as the level of money supply. It has been continuously rising over the last 12 years even despite the global economic recession. In 2010, it increased almost by 10 percent in comparison with the previous year (SAMA, 2010, p 241). It should be kept in mind that we have excluded demand deposits from this statistics because a person can withdraw money from them without having to notify the bank. Currently, Saudi banks hold 542, 010 million Riyals, while the total amount of money is 1.010, 511 (SAMA, 2010, p 241). Considering the fact that the average percent change is approximately 7 per cent, we can assume that at the end of the next year, Saudi banks will have approximately 1.070. 511 Riyals, while at the end of March this number will constitute, 1.030. 511 Riyals. Apart from that, the amount of currency outside banks has increased only at 2.1 percent in comparison with 2009.

These results show that people of Saudi Arabia tend to trust the banking institutions of this country. More importantly, it is quite safe to invest into the stocks of these institutions. Still, a potential investor should also remember that the performance of the banking sector is strongly dependent on many outside factors: 1) the performance of domestic and foreign businesses; 2) economic policies of the state; 3) trends in global economy. Therefore, it is necessary to determine how these market conditions will evolve over the next year. In the first part of this report, we examined both internal and external economic environment of Saudi Arabia, and we can say that banking sector will be least exposed to economic and financial risks. The advantages of investing capital in the financial sector.

At this stage, it is vital for us to explain why the banking sector has been selected for this project. The first and most important reason is that over recent years it has become less dependent on oil production. Banking institutions collaborate with building and construction companies, IT developers, food manufacturers, hospitality industry, commercial enterprises and so forth. The fluctuations in oil demand will not be so dangerous to these organizations. The economy of Saudi Arabia is becoming more diversified, which means that oil production is no longer the only source of revenue for the country. A large number of new businesses have recently come onto the stage, and under such circumstances, banking institutions will prosper. Another reason why we should give preference to this particular sector is the predictability of its financial performance. The person, who analyzes the changes in the value of its stock, will inevitably notice that the average percent is 0,88 % (Tawadul, 2010, unpaged). This means that there will be no sudden downturn in the value of a stock, and a person will be able to withdraw his assets, if he/she realizes that the performance of the banking sector deteriorates. Finally, one should not fort that over the last twenty years the management of Saudi banks has become much more experienced, and their risk assessment practices improved. From investor’s point of view this is also a form of insurance. So, we can argue that the investment into the banking sector is a relatively safe option that enables a shareholder to minimize his/her losses.

Reference List

Anonymous. (2006) “Foreign banks launch into Saudi financial market”.. Scholars International Academy. Web.

Morgenstem. R. & Portney P. (2004). New approaches on energy and the environment: policy advice for the president. NY: Resources for the Future.

Saudi Arabian Monetary Agency (2010). Forty Sixth Annual Report. The latest economic developments. Web.

OPEC. (2010). World Oil Outlook: Annual Report. Web.

OPEC. (2010). Monthly Oil Market Report. Web.

Tadawul. (2010). The official Website. Web.

Footnotes

1. These are the records for the last 52 weeks
2. The official website of Tadawul provides records only for the last three years.