Potential Drivers For The Saudi Capital Market

Despite being one of the biggest economies in the region, Saudi Arabia has yet to fulfill its true potential within the Islamic economy. Dr Ahmed Al Ajlouni explores the opportunities and challenges facing the kingdom in its quest to develop a functional and accessible Islamic capital market.

The Saudi economy

The Kingdom of Saudi Arabia passed the time of the global financial crisis very smoothly, benefitting from a conservative and prudent economic policy in addition to the acceptable level of oil prices. It enjoyed historically high budgets for two successive years in 2012 and 2013. The kingdom has a very good ranking on the global ‘Ease of Doing Business’ scale in 2013. This assures its role as an economic pillar for the global economy, supported by a fact that it is the biggest oil exporter globally and a member of the G20, which has allowed it to take a leading role on the global economic stage as the world recovers from the financial crisis.

Saudi Arabian joint stock companies started in the mid-1930s. The market remained informal until the early 1980s when the government embarked on the formation of a regulated market for trading, coupled with the required systems. In 1984, the Saudi Arabian Monetary Agency (SAMA) became the government body charged with regulating and monitoring market activities: a role it kept until July 2003 when the Capital Market Authority (CMA) was established. CMA is now the sole regulator and supervisor of the capital market in Saudi Arabia and issues the required rules and regulations to protect investors and ensure fairness and efficiency in the market.

In spite of its relatively recent origins, the Saudi Arabian capital market has enjoyed rapid growth. It ranked 24th in global market value in 2009 and is the largest Arab financial market with a market value of US$373.4 billion. At the end of 2012, Saudi Arabia held 40.6% of the total value of all Arab financial markets and more than 80% of all share trading in terms of value in the GCC region.

Potential developments

In spite of the positive indicators for the Saudi Arabian economy; the capital market has yet to fulfill its true economic potential. In order to put the Saudi capital market on the right track to reflect the healthy economic status of the kingdom, there are key additional drivers to be considered that have not yet been utilised efficiently. These are likely to determine the development prospects of the equity market in Saudi Arabia in the short and long-term. These factors include:

1. The Islamic finance industry

In spite of the economic and spiritual stature of the kingdom and its important participation in the area of Islamic economics; other countries have taken the lead in the Islamic finance and banking industry. This means that potential capabilities in this regard have not been used efficiently and there is still considerable untapped potential for the Islamic financial industry in the kingdom. One of the most promising indicators states that the volume of money managed according to Shariah in Saudi Arabia is rising by as much as 21% annually. More than one index for ‘pure’ stocks (fully Shariah compliant companies) has been established in Saudi Arabia by Shariah scholars in recent years.

Adopting Islamic financial instruments will be an important market pillar. It will motivate the capital market through:

- Developing the financial market by broadening it with new instruments and deepening it by additional sums of cash flows.

- Retaining the surplus funds that are looking for Shariah compliant, Halal investment in the country and preventing them from being invested abroad.

- Participating in establishing an Islamic money market to deal with the liquidity dilemma for Islamic banks and other Islamic financial institutions.

2. Government and family-owned firms

Government-owned entities and family-owned firms are key investors in the Saudi economy. The government and its investment vehicles hold about 35% of total companies in the country, while family-owned companies account for 10% of the kingdom’s GDP. If a giant firm like Saudi Aramco (with an estimated value of up to US$10 trillion, making it the world’s most valuable  company) goes public and its shares are traded I   he capital market, we can imagine how much the market will be deepened.

3. Promoting an efficient corporate debt market

Mainstream Saudi companies have traditionally relied on bank loans and retained earnings to finance their expansion. These companies have become more familiar with bonds over the last two years, with a wide range of investors now demanding riyal-denominated bonds.

The issuance is entirely in the form of Islamic bonds, or sukuk. “Saudi Arabia had traditionally been considered the sleeping giant of regional debt capital markets, but this has certainly changed in the past 18 months as we have seen an upsurge in riyal sukuk issuance,” said Stuart Ure, a partner at law firm Clifford Chance in Dubai.

Sukuk issuance is now expanding much faster than traditional bonds. In 2012, about SAR27.2 billion (US$7.25 billion)-worth of riyal-denominated sukuk were issued, according to HSBC — up from SAR11.3 billion (US$3.01 billion) in 2011. In the first quarter of this year, SAR10.3 billion (US$2.74 billion) has already been issued.

However, bonds and sukuk are still not an essential component of investment portfolios for institutional and individual investors in Saudi Arabia.

4. Female empowerment in the capital market

The royal decree issued by King Abdullah to appoint 30 highly educated Saudi women to the Shura Council (consultative assembly) early this year crowned the kingdom’s efforts to empower women and recognise the key role of women in society.

Women make up 50% of the population and account for SAR100 billion (US$26.66 billion)-worth of bank deposits. Yet although in the last 15 years there has been a boom in female education, with women entering government jobs and even breaking into the private sector, the economic role of women is still weak and their role in the overall Saudi Arabian economy remains tiny. Women are usually active only within family-owned firms or as owners of very small enterprises; and their role in the capital market as active traders is insignificant, despite the fact that there are about 200,000 female stock holders.

I would suggest establishing an electronic trade market, benefiting from the experience of NASDAQ. This will boost the role of women as active investors rather than just as stockholders. This would also be compatible with the Islamic law and community traditions that prohibit direct physical interaction between male and female. An electronic trading platform would allow women to do business independently from their homes, conveniently without commuting outside. This initiative would be fueled by high education levels, enthusiasm for new experiences, surplus time and the personal hoarded funds of the Saudi Arabian women.

5. Non-Saudi investors

One of the problems facing the Saudi Arabian capital market is the limited access for foreign investors. The MSCI Global Market Accessibility Review of June 2012 defined the Saudi Arabian capital market as a ‘standalone market’ with a negative view, due to its limited accessibility for foreign investors. Although this can be considered as a hurdle, it should also be seen as an opportunity to stimulate the market. The focus should not be only on foreign investors from abroad, as the non-Saudi residents already in the country have potential in this regard, as they number over 9 million and have good savings capacity.

In addition to the above potential, Saudi Arabia can also advance by expanding outside the capital and establishing markets in other strategic cities: including Jeddah on the Red Sea and Dammam on the Arab Gulf. Developing an organised money market will play a significant role in solving liquidity problems.

A future external factor related to the GCC monetary union will be the introduction of a single currency, which could be the catalyst to unlock the comparative advantages and potentials of the Saudi Arabian economy. Through the elimination of bilateral exchange rates and the operation of a single monetary policy, all the GCC countries will derive benefit from the underlying efforts of creating a single financial market.

Future challenges

In spite of the governmental and business initiatives to develop the capital market, hurdles still exist preventing Saudi Arabia from reaching its full potential. The country has for decades followed highly conservative regulations towards foreign investment. It also struggles with deep-rooted traditions concerning dealing with women, and is held back by stagnant boards of family-owned firms who will not move easily towards the global financial markets. Above all, a lack of transparency and an unclear economic policy are major challenges.

To truly develop a functional capital market requires economic and structural changes and legislative amendments. In my own opinion, I think that it will take at least five to 10 years to see an international developed capital market in the kingdom.

Dr Ahmed Al Ajlouni is a faculty member of Finance & Banking at the Economics & Finance Department of College of Business and Economics at Qassim University.

This article first appeared in Islamic Finance News (8 May 2013, Volume 10, Issue 8, Page 21 - 22). For more information, please visit