NEW DIRECTIONS IN THE FINANCIAL MARKET OF SAUDI ARABIA

 NEW DIRECTIONS IN THE FINANCIAL MARKET

OF SAUDI ARABIA

DR. ABDULAZIZ M. AL-DUKHEIL

      

Economic growth of a country is generally accompanied by a simultaneous growth of its financial market. However, in Saudi Arabia, and also in Other Gulf Countries, growth of financial market has lagged far behind the growth of other sectors of the economy. Following the oil boom of 1970s, Saudi economy achieved a high rate of economic growth, except in a brief period of downturn in mid-1980s. The economy has made long strides in agriculture, industry, trade, commerce, power, transport and communication, and social and economic infrastructure. The financial sector has however failed to keep pace with the growth in other sectors.

The slow growth of the financial sector in general and capital market in particular can be attributed to the abundance of liquidity brought about by the oil boom, huge amounts of interest-free loans made available by the government credit institutions, lack of awareness to modern credit instruments, investors' high preference for traditional investment portfolios (eg., real estate) and the absence of proper commercial laws conducive to growth of the financial market. These factors constrained the market forces that ordinarily lead to innovations in the financial market and credit instruments.

* Dr. Al-Dukheil is President of the Consulting Center for Finance and Investment (CCFI), Riyadh, Saudi Arabia, and former Deputy Minister of Finance - Saudi Arabia.

RECENT TRENDS IN FINANCIAL SECTOR

The financial sector of Saudi Arabia is undergoing rapid changes. Gone are the days when individual or family funds dominated the business finance. Most modern industrial ventures are now being financed through market borrowings from banks, government credit institutions, investment companies, and equity participation. Small scale, family -owned industries are being replaced by giant-size industrial ventures necessitating huge investments. Inefficient industrial units which had come up and could survive only under buoyant market conditions have been either eliminated by the economic downturn of mid-1980s or forced to merge with others for gaining strength through the economies of scale. These recent changes in the economy have led to rise in demand for venture capital in bulk.

Besides, Saudi economy is treading on the path of steady growth. It is maturing, though slowly, into a modern industrial nation. In pursuance of its laissez-faire policy, the government is creating conditions for private sector to take on some of its economic functions. Privatization of some of the government establishment is expected to be accorded a higher priority in the Fifth Development Plan. Numerous new investment opportunities are being opened up for private investment. The private sector will therefore have a far greater role to play in the economy than ever before. These developments are bound to increase the demand for venture capital in future.

However, in face of the growing demand for venture capital, the flow of credit from the financial institutions has slowed down considerably. For instance, the net loans and advances made by the commercial banks, the most import organ of the capital market, has considerably slowed down due to heavy losses incurred by them during 1986 and 1987. The

Total claims of the banks against the private sector has declined between 1987 and 1988 by SR 460 million. Although loans and advances made by banks are somewhat rising, most of them are chasing the few big industrialists of to country who possess high creditworthiness.

The flow of credit from the Specialised Credit Institutions (SCI) funded by the government - a major source of private sector finance - has drastically reduced due to budgetary constraints consequent upon the oil price collapse in 1986. The total disbursement by SCIs has gone down from SR 23.6 billion in 1983/84 to SR 5.8 billion in 1987/88. The total net disbursement has turned to be negative in the past year.

Non-banking     financial     institutions,    eg.    investment

companies, insurance companies, and money exchange companies have yet to make any significant contribution to the financial structure of the Kingdom.

ISSUE OF TREASURY BONDS - A RECENT PHENOMENON

Experiencing financial squeeze and increasing budgetary deficits, the government of Saudi Arabia issued treasury bonds in its 1987-budget as a means of additional revenue to the treasury. The issuance of government bonds for the public subscription is a new phenomenon expected to prove a milestone in the fiscal policy of the government. It represents also a new thinking in the formation of monetary and fiscal policies of the government. Apart from being an instrument of raising revenue, government bonds would be an effective instrument of siphoning private liquidity into the productive ventures provided returns on such bonds are compatible with international rates of returns on such investments. Government bonds have already gained popularity as a safe investment. Trading of government bond

however remains confined mainly to the commercial banks.

REVIVAL OF THE STOCK MARKET

The most significant development in the financial sector of the Kingdom in the past two years is the revival of the stock market. The recent economic downturn had rendered a severe blow to the Saudi Stock market which was shaping well the formation of many joint stock companies. During the period of economic downturn, industrial activity had slumped; formation of joint stock companies had almost halted; stock market activity had become dull and share trading with fewer deals was sluggish. Share price index (1983=100) had fallen in October 1986 to around 55, the lowest ever, recording a fall of about 45%.

With the revival of the industrial activities in the Kingdom, the Stock market has exihibited a good deal of buoyancy since January 1987. Share prices show a strong tendency to go up. The CCFI monthly share price index has moved up from 60.8 in January 1987 to 77.5 in May 1989. Four new joint stock companies floated in 1988 were heavily oversubscribed within a short period of their flotation. Furthermore, the number of traded shares increased by 58% between February (1st week) and August (4th week) 1988, and by 47% between August (4th week) and June (3rd week) 1989. The recent trends in the Saudi stock market clearly indicate the rapid revival of the share market.

* Share flotation of all the four companies was handled by the Consulting Center for Finance and Investment (CCFI), Riyadh.

The renewed buoyancy of the Stock market reveals some other developments in the Kingdom's financial market. One, people's interest in investing in stock has grown tremendously as a large segment of the business community is getting involved in share trading. Two, there is a perceptible shift in the investors' choice of portfolio from the traditional assets to equities and credit instruments, perhaps, because investment in real estates and precious metals has turned out to be less attractive. Three, investors' awareness to the new channels of investment and to the developments in the financial market has considerably improved due to improving system of market information.

Four,    those who preferred to invest abroad are now

disillusioned   about the attractiveness of foreign

investment,      particularly after the collapse of the

international stock market in October 1987, and are seeking portfolio diversification between local and foreign assets. This has apparently led to rise in demand for local equities. These developments, along the rapid recovery of the economy, have activated the stock market.

DRAWBACKS OF STOCK MARKET

Since Saudi financial market is still underdeveloped, most of the private sector debts are raised through banks and public loans. The stock and bond markets are, by and large, unorganised, fragmented and small considering the financial needs of the country. The unofficial stock market lacks

depth due to short supply of shares compared to the growing demand therefor. Although the number of traded shares has rapidly increased during the past 18 months, the proportion of traded shares to the total remains still very small -less than 0.1%. This is mainly because of the absence of an official stock market, efficient information system and experienced stock brokers who could play the role of market makers.

Another important drawback holding the growth of Saudi stock market is the dominance of government share holding in the joint stock companies. There are at present 65 joint stock companies of which only 52 companies are tradable. The government and its agencies hold shares in 23 of the traded companies. The shares held by the government agencies account for 66.6 percent shares of the companies in which it holds the shares and 54.1% of the total number of shares issued. Government held shares are generally not traded. This is one reason why the percentage of shares traded each week is very small. The large share holding by the public agencies not only limits the number of shares available for trading but also holds the growth of activity in the share market.

REGULATION OF STOCK MARKET

Prior to 1984, share trading used to take place through the stockbrokers who were not required to have license, capital or credentials. Such a system had not only failed to instill public confidence in stocks but had also left investors interest unprotected. In December 1984, however, a new system was introduced under the supervision and regulation of the Saudi Arabian Monetary Agency (SAMA). In the new system, the unregistered stockbrokers were eliminated and stockbroking was made the sole domain of the 11 commercial banks and Al-Rajhi company for currency and exchange (then not a recognised bank). The objective was to curb speculation and reduce volatibility of the stock market.

The new system however proved to be arduous, time-consuming

and led to market segmentation. Banks had only a passive

role to play, and were concerned mainly about their

commission. The elimination of stockbrokers led to the elimination of market-makers. Since the new system proved to be inefficient, it was modified in May 1987. A Central Trading Hall was created in which all the banks assembled and auctioned the shares. Across-the-floor share trading, undoubtedly, reduced the time lost in executing transactions and curbed the big variations in the share prices. But this is not sufficient to develop a capital market to cope with the rising financial needs of the country.

The efforts which have been made so far to organise and regulate the stock market have fallen short of developing the market and promoting stock market activities.

A DEVELOPED STOCK MARKET IS A NECESSITY

In view of the post-recession developments in the Saudi economy and the pressing need for channelling private savings into productive ventures, a developed stock market has become an unavoidable necessity. It is no more a luxury as some used to feel it to be some years ago.

For long term stable growth of the economy, dependence on public expenditure has got to be reduced. Under the existing conditions, this can be achieved by making private savings to flow into productive activities. Opening up new investment apportunities in the industrial sector, essential though, is not enough as entrepreneurship is still confined to a small section (business families) of the society. What is more important is to mobilize private savings - big and small - for investment. Saudi Arabia's problem is not one of the underdeveloped countries, i.e., lack of savings. Her problem is lack of channels through which savings move to

the capital market and are converted into investment. A developed stock market would not only mobilize private savings and idle cash balances but would also encourage people to save at least a part of the income frittered away on conspicuous consumption, perhaps for lack of investment channels.

Besides,    the government is seriously considering to

privatize some of its industrial establishments. An important aspect of privatization would be the transfer of government shares to the private sector. A development stock market would make such transfers a great deal easier and efficient.

Finally, Saudi stock market has to be viewed also in the context of increasing cooperation between the GCC countries and its implications on their financial markets. Important changes are expected to take place in the stock markets of the GCC countries in the years to come. Baharain has established a stock market for the first time. It is dealing currently only in local stocks but will later open to the Gulf companies. Oman has also set up a small scale stock market open to GCC nations Kuwait is reactivating again its unofficial Al-Manakh after its collapse in 1982. These developments in the neighbouring countries are expected to influence public opinion in favour of establishing an official stock market in Saudi Arabia. It is greatly desirable that Saudi Stock market is linked to the Stock markets in other Gulf countries. It will expand its areas of operation, promote share trading and will help its growth.

 

-   Source : Wall Street Journal, U.S.A, August 1989.