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Investment Potential in Saudi Arabia

January 09, 2012 | About:
Saudi Arabia could be hit or miss for emerging market investors. The country’s main strengths can easily be converted into weaknesses. Gaining direct exposure to the potential is a challenge for individual investors. Most investment opportunities come in the form of foreign direct investment. There is currently no ETF available with direct exposure to Saudi Arabia. There are the standard Middle Eastern ETFs such as the WisdomTree Middle East Dividend (GULF) and the Market Vectors Gulf States Index (MES), but even these provide very little exposure to the kingdom. A pegged ETF would go a long way toward providing leverage and exposure to the region for individual investors.

Saudi Arabia’s government is now increasing their public expenditure in the hopes of speeding up economic growth. It is also possible that they are trying to steer clear of the tensions that have led to uprisings amongst the kingdom’s neighbors. Saudi Arabia has so far managed to stay out of the spotlight where the Arab Spring is concerned. Recently state spending has been the sole driver of economic activity for the kingdom. This past year King Abdullah bin Abdul-Aziz announced two spending packages totaling SR500 billion. Still, these commitments could represent an expensive fiscal drain on the kingdom. Around SR195 billion will be spent of the package within one year. This move could push spending to a third higher than in previous years. However, over the long-term protests and political tension would cost the kingdom exponentially more.

Another major concern for Saudi Arabia is the rising domestic consumption of oil and gas, perhaps as a result of the increased public spending. This reduces the amount available for export. Domestic consumption is growing at approximately twice the rate of non-oil GDP growth. This is not surprising considering Saudi Arabia’s thriving population. The kingdom’s young adults are becoming far more educated and skilled than their predecessors. They are bringing new skill sets to the kingdom that will go a long way toward diversifying the economy away from just a trade hub. They will bring new products and services to contribute to the nation’s wealth.

Saudi Arabia is also facing external pressures in the form of the weakening US dollar. Though the US economy may be slowly recovering, the currency is still weak by comparison. The kingdom’s main export commodity, oil, is priced in dollars, upon which the riyal is firmly pegged. This policy is in place to enable low interest rate risk and maintain investor confidence. The majority of emerging market investors are still more at ease when investing in their home currency. The peg makes sense where stability and predictability are concerned. Removing the peg structure of the riyal and the dollar would bring about uncertainty which in turn breeds economic volatility. It is possible that such a move could also decrease foreign direct investment into the country.

Not ten years ago, Saudi Arabia required an oil price of just $24 per barrel in order to balance its budget. Now that price is closer to $84 per barrel. Oil prices under $60 per barrel would be a significant challenge for the kingdom. The government will be left with little room to maneuver if oil prices continue to drop. Saudi Arabia’s capacity to absorb oil price volatility is diminishing and the acceptable margin of error is shrinking.

Downward pressure on oil prices is serving to expose the economy’s vulnerability. Questions have also been raised about the viability of continued dependence on a single commodity that proves sensitive to the economic climate. After Standard & Poor’s downgraded the US credit rating oil prices dropped $10 - $15 per barrel. The impact was immediate on a country that pumps nearly 10 million barrels per day. The Saudi Arabia stock market, the Tadawul, was the first to register the impact, falling 6.5% in August. The global economic tension in emerging markets is proving to have an impact on oil demand from the region.

Even with these concerns, Saudi Arabia’s fundamentals remain solid. Bank lending in the private sector has increased. The kingdom boasts surging oil export revenues and real GDP growth. The kingdom anticipated revenues of $252 billion in 2011, which would produce a 6.4% budget surplus. The government also has substantial banking reserves along with a time tested fiscal cycle. Run a surplus in the good times to allow for deficit spending in the bad times. Oil production is close to an all-time high and price volatility should be limited in duration. Saudi Arabia still represents a great investment opportunity. If only there were an easier way to gain exposure to this market.

About the author:

Mary Posey
I am an avid fan of financials and investing. I regularly contribute to Seeking Alpha as well.

Visit Mary Posey's Website


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