On The Right Path


By Gordon Platt


For the Gulf Cooperation Council (GCC), there have been setbacks on the road to a common currency, which now appears unlikely to be introduced anytime in the next five years, but progress in developing world-class capital markets in the Arab Gulf is happening at an accelerating pace. The eurozone crisis is reason enough for the GCC states to pause for reflection about the lessons to be learned from Europe’s debt problems before plunging ahead with plans to unify what has until now been a fairly loose economic and political bloc. Meanwhile, in the seven years since Saudi Arabia created its Capital Markets Authority, the kingdom has made significant advances in the way its markets operate and their accessibility to global investors. Bahrain, Qatar and the UAE have all made strides in creating modern financial centers. The Kuwaiti financial sector came under great stress during the global financial crisis, but it has recovered, and the country is moving ahead with plans to create a regional financial and trade center. Oman, which has hosted many annual summits of the GCC, is helping to link the region with the fast-growing markets of India and China.

The relatively young Islamic finance industry is benefiting from global demand for an ethical form of investing. After nearly three years of deliberations, the first globally standardized master agreement has been published for privately negotiated Islamic hedging products. It will take time for the agreement to be universally accepted, but it represents a major breakthrough in Islamic financing and risk management. Shariah, or literally “the path to the well,” is getting more crowded.

The economy of Dubai will continue to struggle due to overbuilding in the property sector and the initial mishandling of the Dubai World debt crisis. A recent restructuring agreement has helped to clear the air, and a new sense of realism and traditional Arab prudence is coming to the fore. A new legal and regulatory infrastructure is being put in place. It is exciting to contemplate how far the GCC financial markets will advance in the next three to five years.

Opening up

Frontier markets crack the door open for global investors.

The six member countries of the Global Cooperation Council (GCC) are opening up gradually to global investors and attracting growing amounts of foreign direct investment (FDI). However, the oil-rich countries of the Arab Gulf are still classified as frontier markets, and in the eyes of many institutional investors, this makes them more risky than emerging markets, despite their high GDP per capita ratios.

If any of the GCC countries—Saudi Arabia, Qatar, Bahrain, Kuwait, the United Arab Emirates (UAE) and Oman—were to be upgraded to emerging markets status by New York–based MSCI, they could attract significant new inflows from investors who benchmark the MSCI Global Emerging Markets Index. Qatar and the UAE were under review this year for a potential reclassification to emerging markets. Following discussions with the investment community, however, MSCI announced in June that these two countries would have to wait for at least another year, along with South Korea and Taiwan.

In the case of the UAE, the recent economic and financial turmoil may have slowed progress toward introducing a planned increase in foreign ownership limits and a true delivery-versus-payment (DVP) settlement model, MSCI said in a release announcing its decision. Investors are hopeful that there won’t be any further delay, it said. “Investors would also welcome a public road map from the regulator and the exchanges providing visibility on the timetable for implementation of these changes,” according to MSCI.

In Qatar, much as in the UAE, global investors need to create separate custody and trading accounts and shuttle assets between them because local brokers have unlimited access to the trading accounts. This issue needs to be addressed to meet emerging markets standards, MSCI says.

Most of the GCC markets meet the size and liquidity requirements to be upgraded. “However, the need to set up and operate with a dual-account structure is still a major concern to a number of international institutional investors and is incompatible with general emerging markets standards,” MSCI says.

Still, investors are eager to participate in the growth in the region, where oil and gas revenues are fueling government spending. “GCC governments have implemented a variety of measures to boost private-sector activity and encourage foreign investment, and their success in this has been recognized by a number of surveys that rank global business environments and competitiveness,” says Keith Savard, director of economic research at Riyadh-based Samba Financial Group. “More significantly, foreign direct investment into the region has surged over the past five years,” he says.

The World Investment Report 2009, published by the United Nations Conference on Trade and Development, measured Saudi Arabia’s FDI inflows to be the 14th largest in the world and the highest in the Middle East and North Africa (MENA) region.

The World Bank rates Saudi Arabia as the easiest place to do business in MENA, and number 13 in the world. Among Arab countries, Saudi Arabia is the easiest place to register property, get credit and start a business. It also offers the world’s most competitive energy prices to investment projects. All six GCC countries score in the top 50 of the World Economic Forum’s Global Competitiveness Index.

Qatar, the fastest-growing country in the GCC, could realize growth in real GDP of about 16% this year, says R. Seetharaman, CEO of Doha Bank. “Fiscal policy has played a critical role in cushioning the impact of the global crisis on the region and in supporting its recovery,” he says. Qatar, which has budgeted the price of oil at $55 per barrel in the current fiscal year, ending March 31, 2011, plans to increase spending by 25%.

Qatar’s real estate market has remained stable and reliable, Seetharaman says. “The government is spearheading efforts to create more opportunities beyond the oil and gas sector,” he adds. These include the Qatar Financial Center, Education City and Sidra Medical and Research Center, as well as free-trade areas, such as Qatar Science & Technology Park. Projects such as these can stimulate demand in the office market, Seetharaman says.

Economies on Steady Footing
Oil prices have adjusted to the possible impact of lower growth in European countries that have adopted austerity measures to reduce their budget deficits, says Ali Shareef Al-Emadi, group CEO of Qatar National Bank (QNB). “Thus, for the time being, unless Europe’s debt problems get worse, the economies of the GCC countries will not be affected should oil prices trade in the region of $60 to $70 per barrel,” Al-Emadi says.

QNB’s first-quarter 2010 earnings rose 25.3% from the same period a year earlier, with loans and customer deposits each growing by 44%. “The results reflect QNB’s strong ability to capture the rising demand for credit from large corporations and government agencies, which was evident from the last quarter of 2009,” Al-Emadi says. “The growth in the first quarter also reflects the somewhat moderate growth in the first quarter of 2009, when we were in the midst of the world financial crisis and risk averseness was high and loan demand was weaker.”

The big companies, government agencies and semi-government agencies that are the primary beneficiaries of record government spending are clients of QNB. “Given our leading position among Qatari banks in dealing with these institutions, we stand to benefit the most,” Al-Emadi says. “QNB is able to accomplish this given the strong capabilities of our corporate team, the fast turn-around time in structuring deals, along with our large funding capacity.”

QNB Capital, the bank’s investment banking arm, was established three years ago and offers a wide range of services. It was joint lead manager and bookrunner for Qatar’s successful sovereign bond issues last year, including a $7 billion offering in November. In addition, it was joint lead manager and financial adviser for the $1 billion initial public offering of Vodafone Qatar, the region’s largest IPO during 2009. QNB is also providing financial advisory services on the Shard of Glass project, which is constructing Europe’s tallest mixed-use building on the south bank of the Thames in London.

Meanwhile, the bank is continuing its international expansion. “The expansion plans for 2010 call for further solidifying our presence in key markets in which our operations are witnessing strong growth,” Al-Emadi says. “That includes Sudan, Syria and Oman, where additional branches are to be established during the year.”

The sovereign debt problems in Europe indicate that the road to a solid world economic recovery will be long and challenging, says Adel El-Labban, chief executive of AUB Group and managing director of Ahli United Bank, based in Bahrain. With oil prices still well above the levels factored into the budgets of GCC nations, and with the focus shifting slowly to government-sponsored infrastructure projects, the GCC economy is likely to consolidate in 2010, before reviving from 2011 onward, he says. Latin America and Asia are currently fueling global demand for oil, he adds. “However, if the European crisis turns uglier, the region will be impacted by the contagion effect of such a crisis,” El-Labban says.

“There is still a lot of dust in the air in the GCC, which makes it difficult to accurately value a company,” he says. There will be some deal activity as a result of reduced valuations, but extreme caution is required, particularly in relation to real estate assets, El-Labban says.