The Gulf economies come of Age

The oil-backed economic boom in the Gulf shows no sign of waning, as GCC governments harbor reserves for safeguarding long-term growth

It’s been a historic year for the region. Some are calling it the oil boom of the new millennium, others are recognizing it as the coming of age of the modern Arab economy, but the reality remains that the growth witnessed across all sectors in the Arab world in 2005, was nothing short of phenomenal.

Stock market indexes across the GCC have more than doubled in less than a year, liquidity is high and rising, and the money is beginning to overflow into neighboring regions, namely the Levant and North Africa.

However, as the year draws to a close, the question on most people’s lips is: with oil prices beginning to show signs of easing, what’s in store for the Arab world in 2006? Will stock markets continue to break records, will liquidity remain as high, and will economic growth across the region be enough to sustain such “irrational” market valuations? To answer such questions, one should look to the key factors that have driven regional markets to such a performance.

The economies

On one side, certain economic and financial fundamentals have played a key role: economic growth in Saudi Arabia and its neighbors continues to be very strong. Moreover, and against opinions outside the region, the economic growth is not purely oil-driven. The consensus among leading regional economists in the Middle East is that the true effect of incoming oil money has yet to be felt, as GCC governments are utilizing the oil money to build reserves as a means of intervention when the booming economic cycle in the region begins to show signs of receding. In other words, regional governments are just waiting for a sign of slowing economies to re-open the taps of oil-money and rekindle economic growth.

That being the case, it turns out that the economic drivers in the region are more “internal.” Domestic consumption is on the rise, manufacturing and exports are at historical highs, and stock markets are providing a wealth distribution mechanism that is spreading wealth more proportionately and thereby creating a wider consumer market, which in turns re-fuels the economy: it’s a self-energizing, self-fueling engine.

Nevertheless, the “in-direct” effect of the oil boom should not be ignored. Although the physical oil money may not have trickled down to the economies in full force yet, its psychological impact is strongly felt. With oil prices at record highs and oil companies announcing record profits, the general population is immersed in a very strong sense of optimism, greatly outweighing any socio-political related concerns. When people are more optimistic about the future, they are willing to spend more.

The obvious conclusion to this equation is that such rapid growth in the regional economies has a lot to do with consumption, which, when combined with strong exports, government spending on infrastructure (such as the railway project in Saudi Arabia and GCC power grid), and growing foreign direct investment in the region, provides a self-propelling economic growth system.

Therefore, and when it comes to economic growth, the outlook for 2006, and even beyond looks rosy. Even if oil prices begin to fall later in the year, regional governments have accumulated enough reserves to sustain economic growth for a long time. In addition, the same governments have realized the impact of market psychology on consumer behavior, and as such are utilizing media channels to communicate to the market their concrete support for economic growth, and thereby continue to fuel spending.

In addition, with more international investment coming to the region, underlined by the strong thrusts by global banks into the GCC (e.g. Goldman Sachs, Morgan Stanley, HSBC, JP Morgan, and others), one can see a continued positive slope for the growth of GCC economies. Such growth may be boosted by ongoing talks of inter-cooperation between oil-rich GCC countries and potential currency unification.

The capital markets

Driven by such economic growth and high oil prices, greater consumption and liquidity in the GCC continues to rise to unheard of levels. The only difference between today’s liquidity boom and that of the 1970s, is that today’s liquidity boom is falling more equitably into the hands of the population, as opposed to just a privileged few as seen in the 1970s.

Although the “common” populations have, in the past, enjoyed certain periods of high liquidity, they were rarely able to capitalize on that and obtain attractive returns on their money. Investment opportunities were rare and far apart. The only available liquid investment opportunities were in the “West,” and only a select few in the general population had access to them.
Following 9/11, and the large losses suffered by many regional investors, a growing sentiment arose in the region: why not create our own financial markets, which would be self-sufficient, profitable, and which would attract European and American monies for investment in the region, instead of the other way around? And as such, capital markets in Saudi Arabia, the UAE, and the rest of the GCC began to take the shape.

Regional governments did not withhold a penny on developing proper capital market infrastructures. Saudi Arabia’s Capital Markets Authority (CMA), and its listing rules have been established and drafted based on the best international standards. With such rules in place, and banks not hesitating to provide the requisite investment banking resources, companies big and small began to realize the benefits of going public. At the same time, the general population, which rarely benefited from the large profits of such companies, saw an opportunity to do so by becoming investors in such companies. And so the frenzy began.

Etihad Etisalat, Bank Al Bilad, Almarai, Sadafco, and now Yansab (a Sabic subsidiary) have floated in Saudi Arabia, and Dana Gas and Investcom on a more regional level. Such high profile companies began offering their shares to the public, which, in turn voraciously ate up anything the market offered. IPOs were vastly oversubscribed, valuations skyrocketed, and people began screaming for more investment opportunities.

Now, people are beginning to wonder what is going to happen in 2006. Many skeptics are already foretelling a crash in the regional equity markets. Their rationale: oil prices will drop in 2006, and the markets are overvalued. They are resembling the market boom in the GCC to that of the Nasdaq in 1999.

However, what such people don’t realize is the following: the Nasdaq bubble was fueled by rising valuations for dot-com companies with little or no earnings, no cash flows, and much weaker regulations. On the other hand, capital market authorities in the GCC and especially in Saudi Arabia, have been careful enough to learn from the Americans’ mistakes, and uphold the strictest financial performance rules for companies intending on hitting the public equity markets. As such, one would never find a company with little or no earnings going public in Saudi Arabia. In fact, companies going public in Saudi Arabia are so profitable and so high profile that investors were overflowing bank branches, and dealing applications forms in the black market for the chance to pick up a handful of shares. And the trend continues in 2006.

During my last trip to London as well as in Lebanon, I witnessed what most expatriates in the GCC are experiencing: I was flooded with offers from friends and family wanting to practically give me their life savings to invest in the Saudi stock market. Such behavior begs a question, however: now that Saudi Arabia is joining the World Trade Organization and might open the capital markets for foreign investors (which means an even higher level of demand for Saudi stocks), and DIFC is offering international access to GCC investments, will we ever see an end to this frenzy?