Middle East Series: Finance and Investments 0 comments

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SM Goh was quoted recently as stating that he was disappointed at Singapore's inability to gain a larger share of the investment funds coming out of the Middle East..... and when you consider that this segment of the local banking industry has been growing at 20-30% per year, it gives a hint of how prodigiously the liquidity in the Middle East must be growing.

This segment centres around three main themes (in my view), which will be outlined below. It is worth noting that the liquidity relating to these themes mainly relate to the six richer GCC (Gulf Cooperation Council) countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, which are relatively more stable politically, foreigner-friendly, and boast strong services industries due to their affluence and consequent strong soft capital --- all necessary ingredients for a strong financial industry infrastructure. Equally importantly, they are strong direct beneficiaries of high oil prices --- with the probable exception of Bahrain.

The first thread is the development of the domestic financial markets. The booming regional economy has boosted the profits of banks, with tailwinds in the form of huge and growing business volumes and a low cost of funds and labor (due to high liquidity as a result of easy oil money) providing the momentum. Given the excellent demographics (one of the fastest growing regional populations) and oil money, foreign banks have been fast getting into the act by setting up branches in the region, leading to rapid growth of assets under management, a phenomenal increase in debt issuance; and accelerated innovation of new products, especially in the area of Islamic finance, with the creation of new Islamic banks. In the capital markets, the stock exchanges in Saudi Arabia and the UAE grew >100% in 2005, and that in Kuwait and Qatar grew >60%; this was due to high oil prices, entry of foreign funds (private equity, hedge funds) as well as a private sector investment boom in areas such as real estate, financial services, industrials and telco infrastructure. In recognition of global interest coming into the region, the UAE launched the Dubai International Financial Exchange (DIFX), the first exchange in its region created to list securities from many different countries, targeted to attract large numbers of international brokers and investment banks and hence establish the city as a regional financial hub. The first theme is one of expanding and liberalising local capital markets and financial services industries in the region.

In particular, Islamic finance has become the largest growth sector within banking globally - growing by 10 to 15 per cent a year. It is worth US$300-500B as of September 2006. This is the second major theme. This banking concept is based on interpretations from the Qur'an, and its two central tenets are that no interest can be earned on loans, and socially responsible investing. The first is self-explanatory, the second means investing responsibly to assure that the money does not go for "bad" purposes, such as investments in drugs, weapons, alcohol, pornography, and terrorism --- not much different from the Western concepts of ethical investing. Islamic financial instruments are not only available within the Middle East bond markets; they are increasingly being made available in foreign markets eager to attract Arab money. There are now Sukuk (Islamic) bonds listed on the London Stock Exchange, and Islamic countries like Malaysia, with decade-long experience in Islamic funds and with legal infrastructure in place, are looking to capture the market with their Islamic credentials. Key Islamic finance instruments include Sukok bonds (Islamic bonds, mentioned above), takaful insurance (cooperative insurance compliant with Islamic beliefs), and Islamic investment funds. Given the need to raise foreign capital (through infrastructure bonds) to invest in new infrastructure projects in the Middle East (oil money not enough) as well as offshore banking services to manage their burgeoning petrodollar assets, Middle East demand for Islamic banking services are expected to grow further.

The third theme relates to the overseas investments being made by the Middle East nations, especially the GCC member states. This is mainly done through their cash-rich state investment agencies, and also partly by corporates looking at other markets outside the GCC region to diversify and hedge market risk (of operating in a single market facing increasing foreign competition). Generally, their investment markets may be divided into several categories: stable Western markets, including the US (less so since Sep 11) and Europe (their old colonial masters and also in close proximity), moderate/relatively stable Muslim countries like Pakistan, Malaysia and Indonesia, high-potential/hotspots such as China (especially their banks) and India, and neighbouring countries like Jordan, Egypt and North Africa. Investments can be portfolio-type (ie. no controlling interest) or direct investments, which tend to be strategic (eg. Dubai Ports' port acquisitions in Hong Kong and P&O in Europe); real estate is a major preference, especially Asian property. Again, the rules apply: no companies that traffic in alcohol, pork, pornography or gambling, and also Islamic financing is typically used to avoid violating religious rules. This trend also partly explains the growth in Islamic financing.

In the Singapore stock market, the most obvious beneficiary from growth in the Middle East financial and investments sector are not banks, but real estate. The former has not achieved any significant penetration into the Middle East nor developed any strong exposure to outflowing Middle Eastern funds, while the latter fit the profile for the investment preferences of Middle East investors: Asian, prime real estate, key regional hub, friendly population and Muslim neighbours. One may note the ease with which large placements by Ho Bee and SC Global were taken up as evidence of interest in the local real estate sector.

References:
(1) Arab News Sep 06: Prospects Are Good for Banks in Gulf
(2) Bahrain Tribune: Islamic finance set to continue prodigious growth - Bahrain
(3) Arab News Aug 06: Sukuk Assumes Greater Complexity
(4) BusinessWeek Oct 05: A Bourse Is Born In Dubai
(5) Washington Post Aug 06: The Real 'New Middle East'
(6) Washington Post Mar 06: Mideast Investment Up in U.S.
(7) Wikipedia entry: Islamic finance
(8) RUSD Investment Bank presentation: Accelerating Investment Funds from the Middle East