RIYADH - MSCI's move to add Saudi Arabia to its benchmark emerging markets index could help attract $40 billion from foreign funds and boost the appeal of oil giant Saudi Aramco's proposed initial public offering, a Saudi official said on Thursday.

Inflows are expected from both passive and active funds, Mohammed bin Abdullah Elkuwaiz, chairman of the Saudi Capital Market Authority (CMA), told Reuters in an interview, adding that around $10 billion would come from passive funds.

Investment inflows could be bolstered further by the listing of state-owned Saudi Aramco IPO-ARMO.SE , which is expected to become the world's largest publicly traded company.

Kuwaiz said Saudi Arabia's inclusion in benchmark indexes and the prospective Aramco IPO are mutually reinforcing, with one strengthening the case for the other.

"From a market liquidity standpoint, connecting the Saudi market to the rest of the world and having the free movement of capital from global investors to the Saudi market only helps a listing of the size and scale of Saudi Aramco," he said.

He added that the Saudi bourse operator and the CMA were "fully ready for the Aramco IPO", which Saudi officials have said could raise $100 billion.

The timing of the Aramco listing remains uncertain. Saudi Arabian Energy Minister Khalid al-Falih said on Thursday it would be "nice" to see Saudi Aramco floated next year, but added that the timing was not critical for the Saudi government. 

The Saudi bourse, or Tadawul, has a total market capitalization of around $520 billion, with a free float of about 40 percent, which Kuwaiz described as a "safe level in terms of leaving sufficient liquidity in the hands of public investors to allow appropriate price discovery".

Increasing the free float -- and probably the share of foreign ownership -- would be in the hands of institutional shareholders, who will decide when it is appropriate to sell, he said.

MSCI's move comes three months after another index provider, FTSE Russell, also gave Saudi Arabia emerging market status. The Saudi index is up nearly 14 percent this year, the best performing index in the Gulf region. 

Mazen al Sudairi, head of research at Al Rajhi Capital, said the index inclusions would encourage more companies to list on the region's largest stock market. More investment by institutions and declining retail ownership of shares would meanwhile improve the free float, he added.

Khalid al-Hussan, CEO of Tadawul, told a news conference in Riyadh that MSCI's move had created market capacity to absorb liquidity and would be the main element in feeding new IPOs.

He said passive investors tracking the MSCI index will only get access to the Saudi market next year, although active investors can participate in IPOs now.

The MSCI Saudi Arabia Index will have a weighting of approximately 2.6 percent in the emerging markets index, with 32 securities, following a two-step inclusion process in May and August next year.

Abhishek Kumar, sector head of emerging markets debt, fixed income beta at SSGA, said the "developments in equity world (are) likely to be closely watched by the fixed income index providers".

JP Morgan is likely to announce the results of a review of its Emerging Market indexes later this month, he added. Inclusion in benchmark bond indexes would similarly broaden the potential pool of investors in Saudi debt.

($1 = 3.7503 riyals)

(Reporting by Marwa Rashad; additional reporting by Davide Barbuscia; Writing by Saeed Azhar; Editing by Catherine Evans) ((Saeed.Azhar@thomsonreuters.com; +971 44536787; Reuters Messaging: saeed.azhar.reuters.com@reuters.net))