Research Proposal

For:Stock Market Development and Economic Growth in Saudi ArabiaIntroductionSaudi Arabia’s joint stock companies had their beginnings in the mid 1930’s, whenthe first such company, the Arab Automobile Company was established. By 1975there were 14 public companies. The rapid economic expansion and Saudisation of foreign banks in the 1970’s led to the establishment of a number of large corporationsand joint venture banks. Major share offerings were made to the public during thisperiod. The market remained informal, until the early 1980’s when the Governmentembarked on a rapid development program. In 1984, a Ministerial Committeeconsisting of Ministry of Finance and National Economy, Ministry of Commerce andSaudi Arabian Monetary Agency, SAMA, was formed to regulate and develop themarket.With the aim of improving the regulatory framework, share-trading intermediationwas restricted to commercial banks. In 1984, the Saudi Share Registration Company(SSRC) was established by the commercial banks. The company provides centralregistration facilities for joint stock companies and settles and clears all equitytransactions. Automated clearing and settlement was introduced in 1989. TheElectronic Securities Information System (ESIS), developed and operated by SAMA,was introduced in 1990. Tadawul, the new securities trading, clearing and settlementswas launched in October 2001.And on 31/7/2003, The Capital Market Authority was established pursuant to the "Capital Market Law". The authority represents the government apparatus which ismainly entrusted with management and organization of the Saudi Capital Market, and

which reports directly to the chairman of the Council of Ministers. The authority isfinancially and administratively dependant, it is main objective is envisaged inorganization and development of the capital market in the Kingdom, throughenactment and enforcement of the rules and regulations for protection of investors andfairness and integrity of the capital market.The Stock Market index has grown from 690 points to more than 13000 points, agrowth of more than 17000%, between 1985 to 2005Q2, and the number of transactions, volume and value traded increased dramatically.Goal of the ThesisThe goal of the thesis is to empirically investigate the linkage between stock marketdevelopment and economic growth using Saudi Arabia as a country case study. Thestudy will intend to answer the following questions:1.

How can the development of the Saudi Stock Market be explained?2.

What factors are behind the Market’s recent high growth?3.

What is the nature of the relationship between stock market size, liquidity, andthe economic performance?4.

What is the direction of this relationship? Is it going from stock market toeconomic growth or the other way around?Such questions are important to address because stock markets has been widelyconsidered as an important tool for economic development, investment mobilization,and lowering firm’s cost of capital. In addition, understanding what account for stock market growth may help identifying the tools by which policy makers can motivatetheir activities.

Literature ReviewEconomists have long held the belief that the financial structure of an economy is acrucial determinant of the level and rate of growth and its wealth. The economicrelationship between financial development and economic growth has beenextensively tested. There are three views explaining the relationship between financialdevelopment and economic growth. The first view suggests that financialdevelopment is a consequence of high growth that demands more and better financialdevelopment (Partick 1966). Robinson (1952) contended that financial developmentsimply follows economic growth. The need for financial intermediation depends onthe variance in growth rates among different sectors of the economy. Arestis,Demeriades and Luintel (2001) suggest that stock market development may actuallyhamper rather than help economic growth.The second view suggests that the supply of financial institutions and servicesstimulates investments in more productive resources. The financial developmentwould then lead to economic growth. Shaw (1973) argued that a country’s financialsector does matter for economic development. Financial liberalization can moreefficiently allocate savings by widening and diversifying the financial market withinwhich investment opportunities compete for the savings flow. Mickinnon (1973)showed that the role of capital markets is crucial in the economic developmentprocess. The last decade has produced several important contributions (e.g.,Bencivenga and Smith (1991), Atje and Jovanovic (1993), Gaytan and Ranciere(2003, 2004) etc.) in support of the view that financial structure is a crucial vehicle inthe development process.