Impact of oil prices, political factors, and regulatory environment on Saudi Arabian stock market

Saudi Arabian Stock Market

The objective of this research study is to examine the influences of the Saudi Arabian stock market including such as prices of oil, political factors, regional events, financial crises and how these have impacted the Saudi Arabian market relative to other markets. This work will additionally examine regulatory authority as well as laws and regulations in the Saudi Arabian market including such as efficiency, transparency and the role of CMA in fraud.

The work of Arouri and Rault (2011) that the GCC was established in 1981 and includes the countries of Bhrain, Oman, Kuwait, Qatar, Saudi Arabia and the United Arab Emirates (UAE). GCC countries share several common patterns. In 2007, they produce together about 20% of all world oil, control 36% of world oil exports and possess 47% of proven reserves. Oil exports largely determine earnings, government budget revenues and expenditures and aggregate demand." (Arouri and Rault, 2011)

Arouri and Rault (2011) additionally report "The rationale for using oil price movements as a factor affecting stock valuations is that, in theory, the value of stock equals the discounted sum of expected future cash flows. These cash flows are affected by macroeconomic events that can be influenced by oil shocks. Indeed, oil price affects the main economic variables in GCC countries: earnings, government budget revenues and expenditures and aggregate demand. Thus, oil price changes should directly affect corporate output and earnings, and then stock returns in these countries. Moreover, oil prices may have indirect effect on stock prices. In fact, the effect of oil prices on the aggregate demand influences the expected inflation and money supply, which in turn affect the discount rate and therefore stock prices in GGC countries." (Arouri and Rault, 2011)

In addition, it is reported that GCC countries are also manufactured goods importers and this results in indirect oil price fluctuation impact on the GCC countries through having an influence in import prices and further through creation of inflationary pressure in GCC economies therefore, it is reported that "inflationary pressures, in turn, could dictate the future of interest rates and of investment in securities. Such strong effects of oil prices on GCC economies make these countries primary targets for investigating the relationships between oil price changes and stock market returns." (Arouri and Rault, 2011)

It is reported that while there have been studies that demonstrated that oil price shocks have significant effects on the economy "…relatively fewer works have looked into the relationship between oil prices and stock markets." (Arouri and Rault, 2011)

II. Overview of CMA in Saudi Arabia

Parties reported to be subject to CMA control and supervision include the following parties with accompanying definition:

(1) Tadawul Saudi Stock Exchange -- Tadawul is the sole entity authorized to carry out trading in Saudi Arabia in securities trading and responsible for all operation of the exchange.

(2) Authorized Persons: Legal entities authorized to carry on securities business and only persons holding a valid license issued by CMA are allowed to perform this function;

(3) Listed companies: companies whose securities are traded in the Saudi Capital Market Tadawul; and (4) Traders: Entities representing the public who trade in securities in the Saudi capital market. (CMA, 2009 cited in: Ramady, 2010)

III. CMA -- Range of Powers

The CMA is reported to have a wide range of powers that include those as follows:

(1) Ensuring transparency and fairness;

(2) Admission of new members for broking and clearing;

(3) Listing new companies;

(4) Promotion of high ethical standards amongst members, employees and market participants;

(5) Ensuring high standards of corporate governance;

(6) Ensuring timely and accurate market information;

(7) Establishing an efficient system of nationwide securities trading; and (8) Applying penalties on irregularities and insider trading. (Ramady, 2010)

IV. Foreign Direct Investment (FDI)

It is reported in the work of Al-Jasser and Banafe (nd) that Saudi Arabia "has been much less affected by external shocks and market volatility than have other emerging markets. This is because our policy preference has been to attract foreign direct investment, which serves both the investor and the domestic economy through joint ventures and transfer of technology." It is additionally reported that while gradually, Saudi Arabia is nevertheless "opening up its financial markets for portfolio investments." (Al-Jasser and Banafe, nd)

There are reported to be no restrictions on foreign investment government bonds although the stock market is "not yet fully deregulated. Foreign investors can, however, invest in the stock market through open-end funds." (Al-Jasser and Banafe, nd) Furthermore, the market's regulatory structure in Saudi Arabia has served as a shield from "disruptive capital flows." (Al-Jasser and Banafe, nd) In addition, the domestic banks are reported to be "…net suppliers of funds in the interbank market, and the country as a whole is a net capital exporter. Corporate borrowing needs are largely met from domestic sources. Against this background, the question of "sudden stops in capital flows" is not relevant to Saudi Arabia." (Al-Jasser and Banafe, nd) In the area of financial market functioning it is stated that the Saudi Arabian Monetary Authority "…believed in the free workings of the markets." (Al-Jasser and Banafe, nd)

It is interesting to note that there is a lack of a formal interest rate structure in the kingdom of Saudi Arabia with capital expenditure and corporate borrowing stated to be in response to the commercial lending rates of banks. (Al-Jasser and Banafe, nd) Two factors are stated to influence the interest rates in Saudi Arabia:

(1) Saudi Arabia is an open economy, with no restrictions on currency convertibility. The cross-border movement of funds responds to the differential between domestic and foreign returns;

(2) the kingdom has a pegged exchange rate system. Since June 1986, monetary policy has been directed towards keeping the exchange rate at USD 1 = SAR 3.75. The fixed exchange rate regime implies that Saudi Arabia's financial market is highly integrated with external financial markets, and in particular the U.S. market." (Al-Jasser and Banafe, nd)

Al-Jasser and Banafe state that in the domestic market the U.S. interest rates are the primary factor in the determination of the riyal interest rates due to the arbitrage mechanism. (paraphrased) Also reported in the work of Al-Jasser and Banafe is that a cross-border movement in funds is known to occur when there is a "…significant difference between the domestic and comparable U.S. interest rates." (Al-Jasser and Banafe, nd)

V. Political Factors

The work of Wiesenthal (2011) entitled "Art Cashin On The Saudi Connection To Tuesday's Big Market Plunge" writes that "…Some media commentators tried to blame the sell off on Bernanke's conceding that significantly higher oil prices could strain the economy if they lasted for an extended period. If you actually followed the testimony that was a bit of a reluctant and grudging concession by Mr. B. The bulk of the testimony tended to shrug off higher oil and food prices as temporary blips that would not hobble the economy in a meaningful way. Other pundits blamed the surge in oil for putting the stock market into the kamikaze style dive. That certainly was true as can be seen in the more severe pummeling suffered by the Transports." (Wiesenthal, 2011)

Wiesenthal states that what was missed was the reason that there was such a sharp spike in oil and that being "a series of rumors about Saudi Arabia." (2011) Traders were stated to be concerned about a & #8230;"sharp sell off in Saudi Arabian Indices. The sell off itself became the topic of one of the early rumors. Some suggested that the pronounced weakness was the result of wealthy Saudis pulling money out of the markets to secure it against potential looming unrest. Another rumor that popped up was that the Saudis were sending tanks into neighboring Bahrain to shore up a fellow Sunni monarchy. A somewhat lesser rumor on the same topic was that the alleged tanks had only been sent as far as the causeway that marks the border with Bahrain." (Wiesenthal, 2011)

It is reported that later a second rumor spread related that there had been a Shiite cleric imprisoned by the Saudis and who is reported to have called for a "shift to a limited constitutional monarchy to replace the current monarchy in Saudi Arabia." (Wiesenthal, 2011) Somewhat later another rumor said that the Saudis had imprisoned a noted Shiite cleric who had called for a shift to a limited constitutional monarchy to replace the current monarchy in Saudi Arabia. When the press seemed to confirm the arrest of the cleric, oil spiked higher still sending stocks even lower. By end of day, the Saudi rumors and concerns (and their effect on oil) trumped things like a better ISM number and the Bernanke testimony. The oil influence is most evident in the drubbing taken by the Transports and cyclical stocks. The result was another rather ugly Distribution Day." (Wiesenthal, 2011)

VII. Uneven Distribution of Investors Across Industries

The work of Samba in its report series of December 2009 entitled "The Saudi Stock Market: Structural Issues, Recent Performance and Outlook" report that the long-term volatility in the Arabian stock market is in part due to the "…long-standing dominance of retail investors has led to considerable volatility in the Saudi bourse. The middle part of this decade saw a vertiginous run-up in the TASI. This reflected a number of factors, but key among them was a huge influx of small first-time traders attracted by a number of under-priced IPOs. (Under-priced IPOs encourage investors to sell part of their existing holdings in order to raise capital to invest in the new issues, thereby fuelling volatility.) Between 2003 and its peak in February 2006 the index gained a staggering 700%, with market capitalization soaring to $800 billion -- around two-and-a-half times nominal GDP. At its peak, the Tadawul was the world's tenth largest stock market by value, despite having only 78 listed stocks, many with a limited free float." It is reported that there is no surprise in the knowledge that "…valuations became increasingly stretched with the average price-to-earnings ratio reaching a high of 47 in late February 2006 (the ratio exceeded 100 for a number of companies). Expected corporate profit growth began to run ahead of actual results; this was compounded by annual reporting showing that many companies had invested heavily in the stock exchange and booked unrealized stock market earnings." (Samba, 2011) When the correction occurred it is reported to be of a severe nature as the TASI lost fifty percent of its value in less than one quarter and ended the year 53% below where it began." (Samba, 2011)

VIII. Banking Industry Report 2007

The Saudi Arabia World Report for the year 2007 reports that the expectations for growth on the part of Saudi Banks has had to come down to reality following "an astonishing run of record profit-making in recent years, earnings are down and an air of normality has returned to banking." (Saudi Arabia World Report, 2007) It is additionally reported that industry analysts believe that banks are going to face additional challenge that medium- and long-term growth potential is extremely positive. Profit levels have been reported to have "gone through the roof" however, it is also stated to be such that would not and could not last as "the cold wind of reality began to blow in." (Saudi Arabia World Report, 2007)

The profits for banks were a derivation of the stock market and in the form of brokering activities which are stated to have "plunged" and this in combination with the regulatory changes effectuated by the Saudi Arabian Monetary Agency (SAMA) and the central bank in the kingdom, new restrictions were implemented that slowed the growth in consumer lending in Saudi Arabia. (Paraphrased) This resulted in a decline in earnings at the majority of Saudi Arabian banks and with the kingdom having joined the World Trade Association, SAMA responded by opening the sector to ten foreign and two local banks. The reported confidence in the Saudi banking future in terms of prospects and profitability in the current Saudi Arabian economy is stated to "rests in the banks continuing to benefit" from the banking environment business climate along with the high oil prices being sustained. It is reported that in the workings were such as number of bank customers, new mortgage regulations to open the residential mortgage market industry in the kingdom which will answer the large young population stated to be the largest group in the kingdom. Islamic financial products and services are also the target of bank exploitation in the banking industry in the kingdom. (Saudi Arabia World Report, 2007, paraphrased)