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GEMs Paper #26
Saudi Arabia: beyond oil but not so fast

Merrill Lynch

30 June 2016 Corrected

Transforming Saudi Arabia, but challenges abound
The Saudi National Transformation Plan (NTP) bodes well for comprehensive reform efforts to diversify the economy in line with Vision 2030. The NTP a) identifies key sectors with high growth potential; b) starts to articulate supportive public sector industrial strategies; and c) seeks to foster higher value-added through enhancements to processes, products and organizations. Still, ambitious targets in a number of sectors are unlikely to be reached and medium-term macro sustainability is not yet clear.

USD peg holds but NTP inconsistent with stable FX policy
Our view is still that the USD peg holds. However, the NTP provides a mixed message. On the one hand, it blurs policymaking incentives given the need for a competitive Fx if diversification progresses. On the other, unrealistic fiscal targets mean consolidation is likely to fall short of easing imbalances materially without oil price recovery. Energy policy thus likely needs to become less aggressive to support macro and FX policies.

Eurobond premium required for fiscal slippage risk
We expect large and regular sovereign Eurobond issuance to support FX reserves and domestic liquidity but to weigh on regional bond spreads if risk appetite does not hold up or fiscal balance slips. EMBIG index inclusion is unlikely, in our view. Saudi forwards, CDS and rates are likely to stay under pressure due to issuance and tight liquidity.

Commodities: NTP adds to medium-term oil tightness
The NTP suggestion that production capacity is maintained until 2020 reinforces our conviction of medium-term oil market tightness. The NTP gas production target that could displace domestic crude demand and boost export capacity is challenging.

Equity Strategy: six investible themes on the back of NTP
We see a number of investible themes emerging from the NTP which investors can use to identify potential beneficiaries. These themes include rising availability of affordable housing, increased access to healthcare, down-trading as the consumer comes under pressure, a surge in telecom infrastructure and significant opportunities in the downstream petrochemical arena. Buy-rated names with access to these themes include: Al Hammadi, Savola, Al Othaim, STC, Zain KSA and SABIC.

Partial NTP success & MSCI inclusion could drive rerating
The Saudi market trades on a 12m fwd P/E of c.13x, an 11% discount to the long-term average and its lowest premium to GEMs since 2010. We believe that with earnings momentum gradually reaching an inflection point a relatively negative outlook is already being priced in. Given our view that oil prices will gain strong momentum in 2017, even a partial success of the NTP along with CMA market reforms to expedite inclusion in the MSCI EM index could be sufficient to improve confidence and thus drive a rerating.

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Trading ideas and investment strategies discussed herein may give rise to significant risk and are not suitable for all investors. Investors should have experience in FX markets and the financial resources to absorb any losses arising from applying these ideas or strategies.
>> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under the FINRA rules.
Refer to "Other Important Disclosures" for information on certain BofA Merrill Lynch entities that take responsibility for this report in particular jurisdictions.
BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Refer to important disclosures on page 82 to 85. Analyst Certification on page 81. Price Objective Basis/Risk on page 77.
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Jean-Michel Saliba
MENA Economist
MLI (UK)
+44 20 7995 8568
jean-michel.saliba@baml.com

Hootan Yazhari, CFA >>
Research Analyst
Merrill Lynch (DIFC)
+971 4 4258218
hootan.yazhari@baml.com

Francisco Blanch
Commodity & Deriv Strategist
MLPF&S
+1 646 855 6212
francisco.blanch@baml.com

Faisal AlAzmeh, CFA >>
Research Analyst
Merrill Lynch KSA Company
+966 11 299 3741
faisal.alazmeh@baml.com

Abdelrali El Jattari >>
Research Analyst
Merrill Lynch (DIFC)
+971 4 4258231
abdelrali.eljattari@baml.com

Jamie Clark, CFA >>
Research Analyst
MLI (UK)
+44 20 7995 1300
jamie.clark@baml.com

Ali Dhaloomal
Research Analyst
MLI (UK)
+44 20 7996 9107
ali.dhaloomal@baml.com

Celine Fornaro >>
Research Analyst
MLI (UK)
+44 20 7996 5515
celine.fornaro@baml.com

See Team Page for Full List of Contributors

A Transforming World
[Diagram: People, Innovation, Markets, Government, Earth]
This report ties into the enterprise-wide Investment Themes recently introduced in A Transforming World. In particular, the Saudi National Transformation Plan is likely to span the themes of Markets (Frontier), Government (Reform) and Earth (Energy Efficiency)

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