Saudi Arabia has taken inspiration from the east as it prepares to open up. The oil producing kingdom is copying China's cautious approach as it prepares to grant foreigners direct access to its $523-billion stock market in the first half of this year. China's experience over the past decade suggests the opening of West Asia's biggest market will be a whimper rather than a big bang.
China has fifty times as many people as Saudi Arabia and its economy is almost 13 times as large. Yet the desert kingdom's draft rules on foreign investment resemble those introduced by the People's Republic in 2002. To limit hot money flows, eligible investors must have at least $5 billion of assets under management. In aggregate, foreigners will be able to own no more than 20 per cent of any single stock and a maximum of 10 per cent of the value of the total stock market.
Those limits are unlikely to be tested in the near-term. China has only very gradually increased its allocated quota to qualified foreign institutional investors. Even now, the total sum of foreign capital invested under the scheme amounts to more than $72 billion - or less than two per cent of the country's $4-trillion market capitalisation. The Shanghai stock market only opened to Hong Kong investors last November.
Demand may be soft too. Saudi Arabia may join MSCI's emerging markets index more swiftly than China, which is still waiting for inclusion more than a decade after it began opening up its market. For now, however, both remain "off benchmark" bets, making any losses fund managers incur from investing there are harder to defend. Besides, large sovereign wealth funds in the Gulf are already able to tap the kingdom's market directly with no limits as they are considered local investors.
High valuations will be the ultimate brake, however. Saudi stocks now trade at 16.2 times earnings. That's on the high side when compared with most other large emerging markets. The benchmark Tadawul index has risen 7 per cent in the past three months - despite a 3 per cent decline in the crude oil price. That's partly due to a big cash handout by the new king but also hopes that a flood of foreign money will soon hit the market. China's experience suggests that Saudi Arabian investors should temper their expectations.
