Ranking the Gulf in the Global Financial League

Vanessa ROSSI
The Gulf Cooperation Council (GCC) is made up of Saudi Arabia, Kuwait, Bahrain, Oman, Qatar and the United Arab Emirates. In economic terms, this free trade zone is not dissimilar in style from the European Union. While there is no common currency among them, most of the economies in the bloc are pegged to the U.S. dollar, functionally creating a single currency with a fixed exchange rate. Discussions are underway to set up common monetary institutions, such as a central bank, with the aim of considering a single currency regime in the near future, and allowing this currency to float freely on international markets in the more distant future.

Looking at the current international economic situation, it must be kept in mind that this environment presents opportunities as well as risks. Parts of the Asian and Gulf region, in particular, are showing opportunities in terms of prospects for future growth. Currently, opportunities exist in the form of better access to skilled labor, expertise in building financial centers, and entry points for M&A activity due to low asset prices.

Regions must begin focusing on their own regional development rather than investing in other parts of the world economy, but they do not have the appropriate assets to invest in at the present time. One such example is the flow of money from Asia and the Gulf into U.S. bond markets because there is little opportunity for this wealth to be invested in similar bond markets within the Middle East and Asian regions themselves. This must be changed to a more balanced approach to the portfolio of wealth and assets in the world economy. Within Asia some financial centers are already well-developed, including Tokyo, Hong Kong, and Singapore, but the Gulf is still emerging in this regard. All of the financial centers in these regions lack an international bond market of the stature of the United States and the EU.

What is significant about the current world economic situation is that there has very rarely been such a simultaneous deterioration of conditions in the beginning of recent recessions, even in the early 1980s. Different economies generally slow down at different times, unlike now, where all economies are seeing a near simultaneous drop. The fact that all the major economies are moving into recession at the same time creates much sharper momentum and greater downside risk.

A common factor in many major economies is the slump in property markets. The U.S. is not alone in its boom-and-bust property market. In recent surveys of major property markets, two thirds of the countries surveyed had already seen prices declining sharply in the property sector. This type of problem spreads difficulties into every country. Property being a prime engine of labor in each of these economies creates difficulties in labor markets, as well as for asset values and quality of loans. Such a coordinated shock in property markets has not been seen since the 1970s, but even that shock lacked the highly global character of the current crisis.

Eastern Europe's problems are a new element to this crisis. Eastern Europe has become part of the problem of the banking sector in Europe. European banks were very active in providing financing to Eastern European countries and are now finding problems due to the poor quality of that debt. There is a fear that Eastern Europe will see a similar debt crisis as Latin America did in the 1980s.

The global nature of the crisis is another new feature of this recession. The notion that one region's stock market can move in a different direction than another region's has been discredited by the synchronous nature of world stock market downturns. A major shock to companies' profitability and financial conditions will affect markets worldwide. One market cannot continue to perform as if it did not belong to the world system. Even if some economies are resilient, like China's, it does not mean that stock markets or other financial markets can remain immune to problems that are being seen outside of those economies.

Given these difficulties it is also understandable that oil prices have fallen sharply in the last few months. The volatility in commodity prices also reflects volatility in areas such as exchange rates. That being said, none of this can have a firm relationship to fundamentals. The swing in the dollar-euro rate is an enormous change in a very short space of time. It is impossible that the fundamentals of these currencies and economies have changed as radically as the price of these currencies.

These large volatilities create problems for economies on a whole as well as for decision-making in companies. Speculation in financial markets has played a bigger role and has created much greater volatility than was believed possible when liberalization was undertaken in the 1970s. There was much debate on the possible volatility, but the expected volatility was low-level and was not expected to generate the kind of swings that have been seen in the current crisis. One of the changes that is likely to occur in the wake of the crisis is the way in which the international financial system is regulated to protect firms and consumers from the kinds of damaging fluctuations that are caused by liberalized financial markets. The fundamental question up for debate will be, "How do you create a system that is open and free, but at the same time has some kind of limits?"

Fluctuations in commodity prices, particularly oil, have led to questions about the viability of the Gulf economies. The high prices seen over the summer caused expectations of further growth to veer away from realistic growth potential. Low commodity prices are one of the manifestations of the current financial crisis. When the current recession eases, the tightness in global resource markets will produce a new upswing in commodity prices.

It would be unwise to assume that low commodity prices brought on by the economic downturn will last very long. The same mistake was made in the mid-1990s when oil prices fell below $20 a barrel and oil analysts believed that oil prices would never reach above $30 a barrel. When the economy does speed up again, increasing demand will push prices of commodities higher. This must be taken into consideration for longer term investment planning, so as not to plan for an unrealistic future.

In the last 5-10 years most of the world's growth has come from the emerging market economies, particularly in Asia and the Middle East. Chances are that when the global economy recovers from its current malaise, it will return to this pattern of growth. China may even weather the crisis without a very sharp downturn in growth. This is more important now since Asian and Middle Eastern economies have become a much larger part of the world economy than they were in the last decade. Still, a sharp pullback can be expected from the emerging market economies in 2009, not dissimilar to the problems seen in the Asian Financial Crisis.

As for the Gulf economies, considered as a whole, they stand apart from developing countries. Their lack of development in the non-oil and financial sectors keeps them from any other classification, though their high average GDP per capita and combined GDP of around $1 trillion are certainly not on developing country standards. As a bloc, the GCC countries have the tenth-largest economy in the world by GDP. Significantly, the region is the world's fifth largest exporter and eighth largest importer. These kinds of economic fundamentals already give the Gulf region a strong position in global finance.

Both GDP size and the GCC's world trade position places it among some of the most important economies in the world. The GCC ranks between Japan and Canada in terms of exported goods. The non-oil sector has been growing extremely rapidly in recent years and accounts for 50% of GDP. Service sector development, in particular, has seen very high growth and has been generating more and more jobs. In terms of imports, the GCC ranks between Japan and India with an increasing position forecast till 2011. While Dubai's rank as an international financial center among other cities is 23rd, when compared nationally Dubai ranks 14th. If the US and Europe are removed from the survey, Dubai ranks 6th, with Bahrain and Qatar standing at 12th and 14th, respectively.

Even with recent shocks to the financial system that damaged the sector and jobs in the short run, wealth and financial services remain an important area of specialization for both developed and developing economies. Without opportunities in agriculture or manufacturing in the GCC region, the financial services sector provides higher income and higher value-added activities that produce the kinds of jobs younger members of the labor market wish to move into. This is not the case in Asia, whose strength clearly lies in manufacturing more than services. The Gulf area cannot compete in this regard, so efforts must be made to capitalize on competitiveness in service provision and trading hub concepts. These skills have grown naturally from management of trade and the wealth generated from oil over the years.

Compared to the region's GDP, trade, and wealth rankings, the GCC still has not attained a position in world finance commensurate with its capacity. Reasons for this include a lack of scale and sophistication of market trading activities, and a rudimentary banking system. Currently, the banking system in the Gulf area is experiencing difficulties because of a lack of skills and a tradition of unsophisticated banking methods. Banks in the Gulf have unusually high proportions of foreign assets and foreign liabilities on their balance sheets. This has created some enormous risks given the current changes in the global financial system.

The value of foreign assets held by the banks has been damaged by the problems in the financial system in recent months, and at the same time foreign liabilities have not been immune from the effects of the global credit crunch. While this system operated quite successfully in the past, money flowed out of the Gulf into European and U.S. banks, which then acted as intermediaries for the deals and project financing operations within the Gulf area. But as the problems of this system become more apparent, there will be an increasing amount of pressure on banks in the Gulf region to undertake their own intermediation and manage their own finance operations from within the banking system. Additionally, because of the wealth present in the Gulf and consistent government budget surpluses, the potential to finance a bailout or assistance package is present, and money has been earmarked to help resolve these problems in the banking system.

One difficulty in the Gulf and across Asia is the lack of a large, liquid debt market. While this may not be labeled a bond market in the Gulf due to Shariah-compliance and Islamic finance rules, it ends up being essentially the same as a bond market. Regardless of religious regulations, this is where much more growth needs to be seen. The Asia and Middle East region contains a large hinterland that requires the development of its debt market to raise capital and finance projects for lesser-developed regions and countries. While the Gulf region is currently helping to provide financing across Northern Africa, there is a much larger hinterland region to exploit in the Middle East and Asian regions.

With the U.S. and Europe being the majority of the world's bond market, there is great imbalance in debt markets. Savers in Japan, China and the Middle East have no choice but to heavily invest in the U.S. and the EU, which creates flow problems in the world economy that need to be addressed. By both addressing these problems and increasing financial opportunities for people in Middle Eastern and Asian financial markets to hone their expertise in the field, the development of a pan Asia-Middle East bond market could be one of the most important issues for the coming years. The world, discounting the U.S. and the EU, currently has high demand and growth potential in bond markets. If a comparison of scale is made between the economy and the bond market, based on the U.S., EU and Japan, the rest of the world's bond markets could practically double in size compared to current levels, offering significant opportunities for new issues.

In summary, the Gulf's rise as an emerging market region, continued oil revenues and increasing long-term demand will help growth and development in the future. As Gulf area governments budget for $50-60 oil prices, the recent drop in revenue has not led to serious damage to budget structures. Surpluses have gone into sovereign wealth funds and growth in these funds may be slowed down as oil prices are low but in general these savings have led to greater economic stability. Development in non-oil sectors, like financial services, continues in spite of the economic downturn. These are centers of high net worth, a quality that must be taken advantage of to develop the financial services sector.

Martin TIDESTROM
Dubai, as some other representatives of the region, has been taking an active approach to developing our financial services markets and we have placed ourselves in increasingly high positions in various rankings. The economies in the region have been diversifying and there are, as a result, many large and successful Gulf companies competing on various regional and international markets. Ownership of such companies is held by governments, influential family groups and a fast growing community of ultra-high net worth individuals. Similarly, there is a large inflow of foreign companies, capital and professionals to the Gulf markets. Another important trend in this context is 9/11 and the difficulties for Middle East investors to travel to certain parts of the world and invest abroad. These factors have fed the need in the market for financial services in the region.

Dubai was, historically, a small economy based on trade, fishing and pearling. Over the last 10-15 years, Dubai has strived to broaden its scope into tourism, trade, construction, communications and a range of services, and to becoming a center of a highly cosmopolitan lifestyle. Dubai built a foundation to position itself as the Middle Eastern hub in a number of different industries.

This has been done by building industry clusters. Starting a little over 10 years ago with Dubai Media City and Internet City, over 20 different industry clusters, set up as free zones, have followed. Each zone targets the best companies in different industries to set up their regional headquarters in Dubai and do business all over the Middle East, North Africa, the Indian Subcontinent and parts of Central Asia. Within each free zone, companies within the targeted industries were offered state-of-the-art infrastructure, swift and transparent incorporation processes, tax incentives and a range of other services aimed at facilitating their business in the region.

An important challenge for the financial services industry across the Gulf region and beyond has been the lack of internationally recognized legal standards. For example, the legal framwork of the United Arab Emirates is based on the French system, which long ago was implemented in Egypt and then spread across the region, and has since been merged with Islamic principles. Legal and regulatory frameworks of the region are generally not aligned with those of international financial centers, and this deterred the development of the financial services industry.

In response to such issues, the Dubai International Financial Centre (DIFC) was set up as a regulatory free zone with a completely separate legal jurisdiction. Based on the British common law system, a new set of laws and regulations for financial services were put in place and administered by a new financial supervisory authority, and a separate Courts organization. The aim is that business can be done with transparency, integrity and confidence within DIFC, making it easier and safer for foreign and local institutions to conduct their business.

DIFC is a well-regulated on-shore industry zone with certain off-shore advantages. DIFC guarantees a zero percent tax regime and allows for full foreign ownership and free repatriation of capital. We offer infrastructure and a range of services to facilitate the growth of firms located within our jurisdiction, and we drive a number of initiatives across the region to help the industry. An international stock exchange has been set up, we support corporate governance across the region as well as improvement of education and other areas of human resource development to sustain the competitiveness of the industry and our region.

The Dubai International Financial Centre has been open for five years. Currently, over 750 companies have been registered with DIFC, including investment banks, asset management firms, insurance captives, Islamic finance providers and many related service providers. While this endeavor is not yet on the scale of older international financial centers like Tokyo, we have created the foundation to become a successful international financial center in the Middle East.

Q: Given Dubai's increased use of debt compared to other GCC members and the Financial Times' report stating that Dubai is suffering in the global financial crisis, what is your opinion on Dubai's economy? How do you feel about reports that the GCC lost over 25% of its sovereign wealth funds in the financial crisis? What attitude do you think the GCC will take at the upcoming economic summit toward British Prime Minister Gordon Brown's comment that the GCC should assist the IMF?

Vanessa ROSSI
As for the Dubai economy, there are not many oil-related problems in terms of budget and government finance as a very small proportion of the economy is driven by oil. However, the areas that Dubai relies on - trade, property development, tourism and travel, among others - will be very severely hit by the coming recession. There may be a decrease in world trade of about 5%-10%, which will directly impact Dubai in an extremely negative way.

In regards to support of the IMF, the first thing that must be considered by economies in crisis is how to secure one's own economy. During global financial crises, capital begins to flow back into the home country and this is currently being felt in Japan. Gordon Brown's fund request was not large and is feasible for emerging economies. This opens up an opportunity for countries that were previously not at the highest tier to gain influence in the IMF. The Gulf region may have some financing available to go into the IMF, though it may not come from areas with greater problems like the Dubai economy.

Large-scale losses have been seen in stock markets with the disappearance of banks in the U.S., and sovereign wealth funds have not been immune to negative effects. That being said, for most of 2008, excess oil revenue should almost completely cover the losses sovereign wealth funds suffered during the crisis. The inflow of new money has probably helped cover much of the loss on the assets that they had previously been holding. There will be a reasonably stable position for sovereign wealth funds next year, although it is much less likely that there will be high revenue inflows into sovereign wealth funds in 2009.

In terms of the differences between the Gulf economies, Dubai may have more of the difficulties given current global economic conditions, but Qatar's focus on natural gas gives it a more stable business outlook.

Q: To what degree can the GCC be viewed as a region versus looking at the individual emirates and states as separate actors? Also, how do other Middle East nations view the development of the GCC in relation to Islamic law and culture?

Vanessa ROSSI
In the report released by Chatham House on this issue, it was clearly stated that the report was not intended to make comments on the political systems or geopolitical risks in the area. There is so much history behind issues of Islamic law and culture that it is difficult to come to a concise understanding of the issue. Such discussions might not focus sufficiently on how economic development in the region is progressing and can ultimately change some of these conditions.

Interestingly, there are fewer problems with Shariah compliance in the Middle East than people in the UK and the U.S. seem to think, and where there is serious concern over issues of Islamic finance. In most Gulf countries, some 80%-90% of financial products are not held to Shariah compliance. Still, this is a high-growth segment that has become increasingly popular in the region. It must be understood that this is not the only way in which these countries operate their financial systems, nor is it the way westerners always need to approach dialogue on financial systems in the GCC.

This relates to changing views on how the economies will be managed in the future. Saudi Arabia is already active in setting up its own financial system, although it is behind the curve. The fact that the intention to proceed exists is an indicator that there is not disagreement amongst Gulf countries on the development of these sectors and the changes that come along with that development.

Shashank SRIVASTAVA
Over the last five years there has been a very clear decoupling of the economic system and the political system. Economically, the region is moving in the direction of an EU-style economic bloc. For example, Qatar's finance minister stated that the economic crisis has strengthened the case for a GCC united currency. The political system has become completely separated from the economic system in regards to reform and forward movement.

That being said, profit-making is definitely Shariah-compliant. As such, Middle Eastern people see the acquisition of profit as important and take a very practical view toward economic matters. To develop their economic systems, the GCC members are beginning to understand the need to provide first-world infrastructure as far as financial regulations are concerned. Several different countries in the region have been upgrading their legal and regulatory infrastructure to allow for a modern financial services industry.

The focus is not only on attracting foreign companies into the region; an important aspect is for the economies in the Middle East to develop their own, home-grown national champions. These domestic institutions are keen on adopting international standard financial regulations so that they can be recognized as world-class by business partners and competitors abroad.

Q: What are your feelings on the discrepancy between the treatment of early-coming or British-related investors versus the treatment of late-comers, including Japanese banks in Gulf economies, specifically in regards to restrictions on use of the local currency?

Vanessa ROSSI
In Saudi Arabia, there has been a very determined effort to create more jobs for Saudi Arabians in the oil sector. This has been rather successful, but it is essential to bring in outside experts if rapid growth of the financial services sector is desired. The Gulf economies have been active and open in recruiting people in this regard.

Martin TIDESTROM
To clarify, the DIFC is a separate part of the Dubai regulatory infrastructure focused on whole-sale activities, not retail, and as a result certain financial activities are allowed while others are not.. Further, each individual company is operating with the specific financial services categories it has applied and been licensed for. Each bank, for example, that is licensed to operate from and within DIFC within the same category of license has the right to conduct the same business, provided of course that all regulatory requirements are complied with. Some banks and other institutions who have been in the region for a long time have locally regulated operations, in addition to their DIFC-licensed businesses, and these local operations may be allowed to conduct other activities than what is approved within the DIFC.

Shashank SRIVASTAVA
The discrepancy you mention is one of the reasons I was part of the forming team of the Qatar Financial Centre. One of the decisions we took very clearly from the beginning was that we will not have a free zone concept. If a firm is licensed by the Qatar Financial Centre Authority, it is allowed to do business in the local currency, do business with the local economy, and conduct retail business. This was intended to get rid of discrepancies between different firms.

Q: When mentioning London in the presentation, were those references in regard to central London, or the greater London area? What is your opinion on the cancellation by Hamas leaders of peace talks in Palestine?

Vanessa ROSSI
The presentation referred to the City of London, the central part of the London area where financial institutions are based. The City of London survey is undertaken by the City of London government to gauge the competition for London's financial institutions in the world. I believe they should also publish rankings for countries rather than only for individual cities. That would allow a more accurate picture of national strength in international finance by taking into account the strength of countries with many small financial centers rather than a few large cities anchoring an entire country.

As for the Middle East peace process, many other types of issues become the victims of such cancellations. Especially in the midst of the economic crisis where there is very little time to look at issues of peace and reconciliation in that part of the world. Apart from this region, many countries are pushing other agenda items to the side to deal with the economic crisis, including climate change and energy policy.

Shashank SRIVASTAVA
In regards to the numerous surveys, including the City of London survey, they survey around 600-700 people from in and around London. These numbers do not allow them to attain a sufficient sample size to be truly accurate. Moreover, the methodology of recording results is inaccurate. If a form is only partially completed, the software registers answers to the blank questions based on what it thinks the answers would be. The Qatar International Financial Centre is not focused on rising up in such rankings. All that needs to be done to rise in those rankings is mount a publicity campaign amongst the 600 people in London who are surveyed, but that does not help in creating a financial center. The focus for the Qatar International Financial Centre is on doing the right things; creating the right infrastructure, creating the right regulations, helping companies do business on the ground, getting them involved in the local economy, etc.

Vanessa ROSSI
The latest surveys currently poll around 2,000 participants, though there is still a need to be careful about using rankings to judge international financial centers. What is being gauged is how other people view potential, and while it must be treated in the report, it is not necessary to focus on that in terms of marketing work as it would distract from the development process.