Emerging markets get bigger with Saudi Arabia and Argentina

Buenos Aires

EMERGING market (EM) stocks are about to get a US$600 billion boost. That's how much the asset class will expand after MSCI Inc said on Wednesday it will add both Saudi Arabia and Argentina to its equity index of developing nations.

Neither decision was assured, and together, they could prompt a relief rally after a selloff knocked US$2.7 trillion from emerging economies since late January, amid threats of a global trade war and higher US rates.

Saudi Arabia - home to the Middle East's biggest bourse - and Argentina, pummelled by a currency rout that prompted it to seek help from the International Monetary Fund (IMF), join the likes of China, India and Brazil.

The change could attract billions of dollars of foreign-investment flows from index-tracking funds.

Geoff Dennis, head of global emerging-market strategy at UBS in Boston, said: "The news on Saudi and Argentina will boost inflows to those markets short-term, but the outlook for EM assets will depend more fundamentally on global conditions - notably the dollar, US yields and the risk of an escalating trade war.

"It's only a short-term lift to the asset class overall."

The potential for an MSCI inclusion made the market in Riyadh a magnet for foreign investors, turning it into the world's second-best performer this year.

By contrast, waning confidence in Argentina's economy, a currency slump and one of the world's highest inflation rates is shrinking the Buenos Aires market.

Sebastien Lieblich, MSCI's managing director and global head of equity solutions, said in a statement: "By supporting the inclusion of Saudi Arabia and Argentina in emerging markets, international institutional investors confirmed that they are now able and ready to access and operate in these markets."

The index provider did add a caveat, saying that it would reconsider the Argentine decision if the authorities introduce "any sort" of restrictions on market accessibility.

The index compiler also said that due to lower liquidity in the nation's local markets, only foreign listings such as American Depositary Receipts will be initially eligible to enter the index.

Exchange-traded funds tracking equities listed in both countries climbed in post-market trading. The Global X MSCI Argentina ETF spiked 7.4 per cent, while the iShares MSCI Saudi Arabia ETF jumped 2.4 per cent.

For Saudi Arabia, the upgrade will help improve liquidity after regulators implemented a series of changes aimed at adapting the bourse to international standards.

Argentina's benchmark index stands to rally by as much as 20 per cent, Morgan Stanley says, after a peso rout created one of the world's worst-performing stock markets in dollar terms.

Inclusion "is a game-changer for Saudi Arabia's capital markets", said Antoine Maurel, head of global markets for Middle East, North Africa and Turkey at HSBC Bank Middle East Ltd. He estimates it will lead to US$35 billion of inflows.

"This will create a much deeper and more liquid market." Mr Maurel's bank was among the first qualified foreign investors to trade Saudi stocks directly three years ago.

Saudi Arabia may see inflows of as much as US$40 billion in the coming year, Khalid Al Hussan, chief executive officer of the bourse, said in a phone interview.

Modernisation of the Saudi stock market is part of a broader plan spearheaded by Crown Prince Mohammed Bin Salman to steer the nation's economy away from oil and diversify the government's sources of revenue. That includes selling shares in government-owned Saudi Aramco, which is expected to stage an initial public offering in Riyadh that could be the world's biggest.

In Argentina, hopes for an upgrade had faltered as the peso tumbled, making the central bank jack up interest rates to a world-beating 40 per cent and leading the government to turn to the IMF for a record US$50 billion credit line.

Finance Minister Nicolas Dujovne welcomed the return to a status the nation last held nine years ago, saying Argentina will gain access to cheaper credit and bring more investment, growth and employment. It is a welcome outcome as well for investors, who had been pinning hopes on an upgrade as the nation's stocks head for the worst year in almost 10 years.

An upgrade will allow funds that track more than US$1 trillion to invest in the nation's stock market, leading to about US$3.5 billion of inflows, said Ernesto Allaria, the president of stock operator BYMA.

The inclusion, coupled with the IMF deal, is expected to lead to capital inflows into the country, helping to ease pressure over the central bank to stabilise the currency, Jim Barrineau, head of emerging-market debt at Schroders in New York, wrote in a note.

The recent selloff in stocks and an "attractive" exchange rate mean that Argentine stocks offer "interesting opportunities" for foreign investors, said BlackRock Inc.

Other analysts and investors were still a bit skeptical. Win Thin, the New York-based head of emerging markets at Brown Brothers Harriman & Co, said Argentine stocks may see some knee-jerk buying following the MSCI decision to upgrade the country to emerging-market status, but this doesn't solve the country's problems.

The Saudi market will probably face hurdles in retaining foreign money unless companies become more transparent, some traders said. Mark Mobius, who has gained a reputation for being optimistic more often than not on emerging markets prospects, said earlier this month he isn't completely bullish on Saudi Arabia because the range of offerings is limited and a number of curbs are still in place.

Akira Takei, a fund manager at Asset Management One Co in Tokyo, which oversees around US$500 billion, said: "It is very good to have more opportunities for investors to invest. But the MSCI inclusion doesn't mean they have become good in terms of quality of the economy. Argentina and Saudi Arabia still have hurdles to tackle." BLOOMBERG