DUBAI  - International equity index compiler MSCI said it expected to include Saudi Aramco in its Saudi Arabia Index from the time of the oil giant's IPO, potentially triggering a big flow of funds into the shares as soon as they list in Riyadh.

"Saudi Aramco will be included in the MSCI Saudi Arabia Index at the time of the IPO as long as it fulfils all eligibility criteria, including the listing of the company's shares on an eligible stock exchange and related market segment e.g. Tadawul's Main Market," MSCI said late on Thursday.

The Saudi government plans to raise tens of billions of dollars by selling about 5 percent of Aramco during the second half of this year, in what could be the world's largest-ever initial public offer of shares.

"Passive" funds tracking the MSCI Saudi Arabia Index would flow into Aramco shares as soon as the company became part of that index.

This could potentially cause instability in the stock price and make it hard for some investors to obtain the shares, given the company's limited float and the Saudi market's relatively small capitalisation of about $450 billion at present.

In addition to listing Aramco in Riyadh, authorities have said they aim to list it in at least one foreign market, which could make it easier for the Saudi bourse to absorb the shares. But MSCI said on Thursday that it was still not clear whether any secondary exchange outside Saudi Arabia would host Aramco.

Meanwhile, MSCI plans to decide in June this year whether it will upgrade Saudi Arabia to emerging market status - a step that would trigger fresh inflows of foreign money into Aramco and other Saudi stocks. A positive decision this June would probably mean the upgrade taking place from mid-2019.

This week Saudi regulators announced market reforms designed to convince MSCI to make the upgrade. Requirements for foreign institutions to qualify as investors will be eased, custody rules changed and the method of determining closing stock prices reformed. urn:newsml:reuters.com:*:nL8N1P52US

MSCI welcomed the changes on Thursday, saying they "should be an important step toward increasing the efficiency of the Saudi Arabian equity market".

But it added that given the size of the Saudi market, it would need more feedback from market participants to decide whether to upgrade Riyadh.

"MSCI encourages market participants to review these enhancements of the Saudi Arabian equity market and to share feedback on the reclassification proposal. MSCI will also continue to engage directly with its clients on this topic," it said.

(Reporting by Andrew Torchia; Editing by Stephen Coates) ((andrew.torchia@thomsonreuters.com; +9715 6681 7277; Reuters Messaging: andrew.torchia.thomsonreuters.com@reuters.net))