Lebanon

The ABC Group does retail by the letter

by Executive Staff
written by Executive Staff

According to the latest figures in the retail real estatemarket, the sector is growing faster in the Gulf than in anyother region. The business website AME Info reports that by2010, nearly 50 million square meters of gross leasable area(GLA) will be available in the area, with the UAE and SaudiArabia taking up 44% and 30% of the pie, respectively. By2009, Dubai is also expected to have the highest retailspending in the GCC, beating out Saudi Arabia, despite itssmaller population. The city is gearing up for this increaseby building giant malls, such as the Dubai Mall, which isbeing hailed as the largest in the world. Hoping to cash inon this growing trend is the ABC Group—operators of the ABCdepartment stores and malls—which is scheduled to open two stores this year in Bahrainand Amman.

From the original store that was located in old Beirut onBab Idriss Street in 1936, the ABC Group has since morphedinto an expansive department store, with two shoppingcenters and a number of additional stores, including twonewly-added cosmetic and perfume outlets, under its belt.Despite the civil war that first claimed the Bab Idriss shopin 1976, followed by the 1982 destruction of the Hamra andTripoli stores, ABC has managed to become a member of theInternational Association of Department Stores (IADS),boasting retail spaces of over 60,000 m2.

Leader in Lebanon

According to figures provided by ABC, the Group enjoysone of the highest brand awareness rates in Lebanon,estimated at 97%, while 76% of consumers shop at one or moreof its locations. Within its first year of operation in2003, the ABC Mall in Ashrafieh was visited by five millionshoppers, with the number of visits to the Dbayeh mallamounting to 2.5 million per year. Branching out with ninedepartment stores into various Lebanese regions, such asBeirut, Zahleh, Kaslik and Tripoli, the company is supportedby a staff of over 600 employees.

The ABC concept as we know it today has shifted away fromits original exclusive focus on retail activities. “Thecompany started first as a regular retail business, addingat a later stage a real estate arm in charge of building,developing and leasing retail space, which resulted in ashopping center, comprising an inclusive ABC departmentstore,” said Robert Fadel, ABC’s director. This shift instrategy was marked by the construction of the Dbayehdepartment store, where for the first time, space was rentedto retail businesses. This move was subsequently followed bythe construction of the 42,000 m2 Ashrafieh mall. Otherservices, such as child daycare, information desks, weddinglists and a car wash were also added to the initial basketof products offered by the Group.

Expansion into foreign markets seemed like the naturalnext step. Prompted by booming Arab markets, Lebanese marketlimitations and a teetering political situation, variousfactors conspired to export the ABC concept to the MiddleEast. In the Jordanian and Bahraini markets, consideredstepping stones in the company’s overall expansion plan, thebusiness model adopted was either inspired from the Lebanonexperience or completely overhauled. “Occupying a 4,500 m2surface, the Amman department store will be similar to theBeirut one, although it will be developed on a smallerscale. The Bahrain 1,500 m2 concept store, however, focuseson women’s apparel, which includes accessories, shoes andlingerie,” added Fadel.

Positioned as mid- to high-end outlets, the ABC departmentstores offer various international brands, such as Carol,Tintoretto, A Priori, McGregor and Kookai, as well as luxuryitems from Chanel and various jewelry designers. The storesalso provide tableware and household items, shoes,accessories, cosmetics and perfumes, which are sold atcompetitive prices. With over 100 international, regionaland local brands holding sales stands at ABC, the group isthe largest retail developer in Lebanon, incorporating over200 tenants. Within the Middle East, the Bahrain and Jordanstores will also be positioned in the middle range of theretail spectrum, with Debenhams on the lower end and HarveyNichols on the higher end. “Besides these two contenders,basically anyone in the fashion industry is our competitor,”said Fadel.

Expansion plans

Collections on display in the Jordan and Bahrain storeswill also differ from the ones available in Lebanon, as aresult of differing store sizes as well as conflictingrepresentation and exclusivity contracts, a problemcurrently under examination by the ABC management. “TheAmman store will, however, include ‘shop-in-shops,’ such asKookaï or Chanel,” Fadel pointed out.

Despite expansion into foreign markets, ownership of thecompany will not be affected. “The company is owned up to80% by the founding family, with the remaining 20% dividedamong 100 shareholders,” explained Fadel. Owners also relyon a flexible structure based on three core activities:operation and services, leasing, and merchandising andmarketing.

Operation and services, the first sector of activity, isunderpinned by support services—including HR, purchasing,MIS, design and in-store marketing, maintenance,warehousing, finance and legal office departments. Store andmall operations are divided by area—including Dbayeh,Tripoli, Zahleh, Hamra, Ashrafieh, Kaslik and Furn elShebbak—and overall mall management. Leasing, the secondcore activity, is dependent on the company’s real estatearm. Lastly, the marketing activity involves events andpromotions, customer relationship management (CRM), marketresearch and communications. Purchasing is in charge ofregrouping ladies’ and men’s wear, shoes, lingerie,children’s wear, home items, appliances, toys andaccessories under one roof.

While the Group’s larger projects in Lebanon requiredmajor investments—the company’s total assets are currentlyestimated at over $100 million—the Bahrain and Jordanventures will require less capital. Including the cost ofmerchandise, the new ABC stores will fall within a bracketof $5 to $10 million and will be backed by staffs of 50 to200 employees. Fadel also expects sales revenue for the twonew outlets to vary between $4,000 and $7,000 per m2, afigure that can be put in perspective when compared to the$3,000 generated by local Lebanese stores. Considered one ofthe highest non-food ratios in Lebanon, ABC’s turnoverrepresents 13% of the $1.5 billion Beirut retail market.

Like any other company with an eye on attractive businessopportunities available in the Middle East, Fadel isconsidering ABC’s expansion into Kuwait, the UAE, Syria,Egypt or the KSA. As for going public, however, he has lessambitious plans. “It will eventually happen, sooner ratherthan later,” Fadel stated, “but there is no definite timeframe yet.”

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Lebanon

Parking meters Coming to Beirut

by Executive Staff
written by Executive Staff

This month will see 50 parking meters installed in one areaof the Beirut Central District. The pilot scheme, operatedby Near East Automatic Distributors (NEAD) in an $8 million,2.5-year, World Bank funded project, will then see a further10-20 on Charles Malik and Bliss streets and 50 more in thearea currently occupied by opposition campers. Althoughtargeting commercial areas, NEAD will eventually targetspecific residential zones to offer resident parking permitsin a system similar to that operated in London and othermajor cities.

“The number will eventually rise to 750 throughout Beirut,”says Chafic Sinno, NEAD’s managing director, “We will belocating them in the business districts, where we hope thecustomer will have the social wherewithal to understand andaccept the concept as something that is beneficial.”

The concept is simple. One main meter will dispense ticketsaccording to the “pay and display” system, with LL500 buying30 minutes and allowing a maximum stay period of twohours—perfect, Sinno believes, for the short-term parker.Customers who overstay their welcome will receive multiplefines—or citations—and further non-payment can result in a“booting” or immobilizing if the car is later spotted atother meter locations.

Drivers who think they can simply throw away the citationand disappear will be disappointed. Records are kept and,now that the mécanique renewal process is also under theauspices of the private sector, “wanted” drivers who haveoutstanding fines will not be able to renew their car papersuntil all debts have been cleared.

Handing out fines will be the responsibility of fieldoperators, all of whom will be accompanied by police, whosepresence—especially on the notoriously territorial BlissStreet running the length of the American University ofBeirut—will be welcome.

Those who have had run-ins with the often-threatening andintimidating parking attendants on Bliss might be skepticalabout NEAD’s chances of success on this busy,student-drenched thoroughfare. Even if they do contribute totraffic congestion, most businesses rely on double parkingfor their customers and, until now at least, the policehave, by and large, turned a blind eye.

Sinno is confident that the system will work and isrealistic about how people will react to the newrestrictions. “Listen, on Bliss Street, we will be flexible.We will not penalize very short term drivers if theyactivate their flashers, keep their windows down and ensuresomeone stays in the car,” he explains, adding that the jobwill become easier when the sidewalk is widened, a move thatshould make the street’s double parking culture impossible.He also insists that no one has been bought off in his bidto enforce parking.

“On Bliss, we are going head on,” he explains, “It will notbe easy. They [the shop keepers and restaurant owners] haveno idea we are coming and they will just have to deal withit. The police have been told that they too must cooperate.No one has been paid off. The orders have come from the verytop and we are receiving encouragement from all the seniormunicipal officials. In any case,” he laughs, “my marginsare too tight.”

Sinno confirmed that he had initially recruited 40 fieldoperators and that this number will rise to 150. He isconfident that if an operative is doing his job correctly,he should issue around 70 citations a day. In the firstyear, the government estimates it will generate revenues of$5 million, part of which will be given to NEAD—which hasbeen operating vending machines in universities, hospitalsand big offices for 12 years now—as its operating fee, andpart of which will be used to pay off the World Bank loan.

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Banking & Finance

Private equity booming

by Rami Bazzi
written by Rami Bazzi

The United Kingdom’s National Union of General andMunicipal Workers (GMB Union) has recently accused privateequity firms of evading tax payments on billions of poundsthat have been borrowed to fund their buyouts. The Union hasblamed the tax code for encouraging investors to overloadcompanies with debt in order to claim tax relief on theinterest payments.

However, evidence indicates that the private equity housesare delivering enviable results for investors and in factthe private equity industry has become a great Britishsuccess story.

The benefits are not simply the high rates of return oninvestment. There is evidence that takeovers by privateequity firms will, in the medium term, generate jobs, ratherthan destroy them. For instance, a study by NottinghamUniversity’s Center for Management Buyout Research studiedprivate equity deals over a five-year period, (1999-2004),and concluded that there was a significant increase inemployment, up by an average of 26%, after five years. Thatstriking figure suggests that private equity injectsefficiency and generates growth.

As a result, the private equity industry is booming inmany parts of the world and is highly regarded in the MiddleEast and other emerging markets including China, Sydney andthe US. According to Thomson Financial, private equity netreturns outperformed the S&P 500 19% to 9.7% for the 12months to last September and 14% to 9.7% for the past 20years. The firm predicts that new money will keep flowinginto private equity as long as the public market fails toallocate capital efficiently.

The immense benefits of private equity to the overalleconomy make it a vital cog in any market. Private equityhouses and activist fund managers of all kinds, includinghedge funds, play a much more valuable role than anygovernment or regulator in propelling the liquidity of ourcapital markets, in reducing the cost of capital, in drivingforward a country’s growth and in equipping the industry tosurvive and compete in the more challenging global marketsof today.

What we also need to remember is that private equity hasproven its potential in enabling the institutionalization offamily businesses and in the implementation of propercorporate governance, key to the sustained growth of today’senterprises.

Critics of private equity also highlight the limitedaccountability as one of the drawbacks. What they fail tounderstand is that in reality, when a private equity firmpurchases a company, ownership and control are much moreclosely aligned on the main shareholders. On the otherhand, in public companies, mechanisms of accountability haveto be developed because of the separation of ownership andcontrol.

The concentration of ownership in private equity meansthat formal accountability mechanisms become far lessimportant and the owners are actively engaged in thesupervision and management of the business.

If the importance of private equity has been wellestablished in developed markets, its role in supporting thedevelopment of emerging markets will be even moresignificant, especially in sectors such as IT and telecoms.For instance, in China, the total investment for 2005 was anincredible $1.057 billion invested over 233 enterprises in2005. As a result, hoards of foreign private equity firmshave rushed to quickly establish a physical presence in thecountry to take advantage of its huge domestic market, largepool of low cost engineering talent, technologicalinnovation and fast growing economy.

In the Middle East, the Islamic module of private equitypractices presents the optimum solution for many of thechallenges faced by private equity. The shariah law governsthe mechanics as well as the integrity of the investingoperations. For example, the shariah law prohibits investingin industries that are considered detrimental, such asalcohol, tobacco and weapons. The money invested also needsto be from permissible industries and cannot be from a fixedincome ROI whether it’s interest-based or interest-like.Another shariah investment requirement relates to acceptableleverage ratios. The ratio of the total debt of a targetcompany to its total assets must be less than 33%.

In Malaysia, such Islamic banking practices are popularamong non-Muslims and have proved to be a mainstreambusiness in many emerging markets, especially in the MiddleEast where the Islamic funds are mushrooming at anaccelerated rate. Those funds have proved to be lucrativeand trustworthy, as they can be a good alternative to theconventional funds whose integrity is in question.

Unfortunately however, the campaign against the privateequity industry is not tenuous. The growing use of“shareholder loans” in highly leveraged structures allowsprivate equity groups to disguise the equity as debts andobtain tax deductions. On the other hand, controversialquestions are being raised over jobs and working conditions,about private equity firms who made staff redundant andintimidate workers to maximize short term profits in firmsthey buy out.

The UK private equity industry continues to be the largestand most developed in Europe, and accounts for more thanhalf of the total annual European private equity investmentin 2005. Although private equity has been criticized by thelabor unions, wisdom dictates that the issue is actuallyrelated to tax policies and not necessarily to thefundamental characteristics of the private equity industry.We need to realize that exceptions cannot become the normsin free and open economic markets if economic progress isour underlying concern.

Rami Bazzi is principal fund manager at Injazat Capital

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Banking & Finance

Private Equity: A close look at a maturing asset class

by Executive Staff
written by Executive Staff

The Middle East and North Africa region has become apowerful magnet for private equity investment, as the totalnumber of capital raised reached $4.1 billion in 2006,according to insiders in this segment of the financialindustry. The experts expect private equity investments toincrease greatly in 2007, but also warn that the challengesfor the year ahead continue to be dominated by thedeployment of private equity cash into attractive companies.

By some measures, the region is poised to become the nextbig market in private equity, analysts say. “The privateequity industry globally is benefiting from enormous growthand the Middle East is no exception,” Colin Taylor, managingdirector and head of Credit Suisse’s Alternative CapitalDivision in Europe, told Executive. “There is a high levelof liquidity, enabling private equity players to raisesubstantial funds,” he added.

The region’s private equity evolution is trailing a fewyears behind the development of this industry in G7countries and is still small when compared with the region’seconomic engine and leading source of liquidity, the oilsector. OPEC is expected to generate close to half atrillion dollars this year, and the Middle East’s shareestimates are in the range of $320 billion in oil and gasexports revenues.

Despite a lot of buzz about private equity in conferencesand press statements, and despite the formation of aregional association for the industry, the real muscle ofprivate equity funding has not yet been shown to the curiouspublic. Numbers compiled by the international EmergingMarkets Private Equity Association (EMPEA), the regionalorganization Gulf Venture Capital Association andresearchers are several billion dollars apart in the amountsthey quote as results of Middle Eastern private equityfundraising for both the past decade and the past twoyears.

Moreover, if fundraising is the bulging biceps of PEmanagers, it has to work in productive interplay withinvestment activity as the triceps for distributing theaccumulated power into the corporate world. The fewavailable confirmed numbers on PE investments suggest thatit has been a challenge to turn collected funds intoprofit-making ventures.

A review of the funds that were active in 2006 or havebeen announced by the region’s PE firms shows that 20 fundswere in their fundraising phase with a cumulative targetamount of $4.15 billion. According to Zawya Private EquityMonitor, in total, 18 funds were in their investing phase.They had $5.76 billion in their war chests but did not sayhow much of that had already been invested into concreteprojects. For future funds, eight funds had been announcedwith combined target size of almost $3 billion, in additionto which market rumors knew of another seven fund projectsthat would be worth $1.54 billion.

Apart from the impact of the oil boom, analysts attributethis rapid growth in the private equity market, in both thenumber and size of funds, to reduced restrictions on foreigninvestment, the real estate boom—both in the GCC and Levant regions—substantial investmentsin infrastructure development and privatizations, familyconglomerates who are now interested in restructuring andgrowth strategies and favorable results for private equitymanagers from the recent high number of IPOs in the GCC.

“There is a fundamental reason why interest in emergingmarkets remains so strong: returns have not only beenimproving over the last three years, they are looking fairlyrobust on both an absolute basis and on a relative basiscompared to other PE markets,” said a report by EMPEA.

Big Deals

Private equity funds started to gain prominence in theregion in the mid-1990s, and by 1998, a small number offirms had over $300 million under management. Notsurprisingly, the overall industry picture has changeddramatically over the last three years. The private equityhas matured as an asset class with record fund raisings, asharp rise in average fund size and increasing acceptance ofprivate equity by leading institutional money managers.Today there are an estimated 83 firms with over 123 funds—announced, rumored, fund-raising, invested or closed—including those with multiple funds such as Abraaj Capital,Global Investment House, Swicorp Financial Advisory Servicesand EFG Hermes.

Although it’s growing fast, private equity in the MENAregion has yet to show the scale of returns and deal volumethat make PE a force in other global markets. Butnevertheless, there have been big deals in successfuloutbound investment, such as the $1.23 billion paid in 2006for UK’s Doncasters Group, an engineering firm, by DubaiInternational Capital for a majority stake, and Istithmar’sacquisition of billion-dollar stakes in Standard CharteredBank, pension insurance institutions, and properties in theUS and UK.

An example for a successful regional transaction was theDubai-based Abraaj Capital’s acquisition of a 25% stake inEFG Hermes, Egypt’s largest investment banking firm throughthe Abraaj Buyout Fund II in a deal valued at $501million.

And the big deals will continue to dominate in 2007, withDubai Islamic Bank and Dubai World’s announcement of a $5billion family of private equity funds to participate instrategic transactions on a global scale. Another rumoreddeal is from the US-based Carlyle Group MENA Fund, which isexpected to raise over $1.8 billion. Other substantial dealsinclude the $500 million Evolvence Private Equity GCC Fund,by Evolvence Capital, to invest in private companies invarious sectors in GCC.

The list also entails some international names that targetthe Middle East, with Credit Suisse and General Electriclaunching Global Infrastructure Partners, a $1 billion jointventure focused on energy, transportation and water projectsglobally. The fund is expected to take on infrastructureprojects in the GCC.

The need for regulation

The growth explosion in the industry and its economicimportance have not gone unnoticed by governments and themedia. This importance and the growing public awareness thatit brings have created a call for responsibility andaccountability to investors. Both in the United States andthe European Union, calls for increased regulation or for“tightening” the rules that govern private equity groups arenot new.

These same calls are now being echoed in the MENA region.Observers agree that the region should not fall in the sametrap as the US and EU, and should be prepared by developingmodern policies that would ensure the commercial climate isas supportive and competitive as possible, to protect bothsides on the private equity deal. “Regulatory changes willcontribute to growth by opening up investment opportunitiesfor PE, like the FDI rules for India, and by introducingplatforms like the DIFC to operate a PE business,” RodPalmer, a Dubai-based partner in international legal andmanagement firm Walkers Global told Executive.

Financial experts are suggesting a review of the industryin the region to promulgate new regulations that wouldensure market stability and create an oversight body forsupervision of registered firms. For example, the new bodywould look into the potential risk that PE activities mightpose to the broader financial system. Investigators shouldlook at the levels of debt in buyout deals and the growingprevalence of private equity backed bids for listedcompanies and the impact that this might have on the publicmarkets.

There has been another suggestion by experts in the EUthat call for moving away from a prescriptive mode ofregulation toward a more principles-based approach. Thisapproach places the burden on individual firms to spot therisks relevant to their businesses and to develop andimplement procedures to mitigate those risks. The biggestbenefit of this approach is that it provides a proportionateand flexible regulatory regime, allowing firms to have agreater hand in the way they implement policy. And finally,fund managers must provide more transparency by publishingdetails of their investments, investors, management andtrack record.

Some fund managers have suggested starting the wholeprocess by educating fund recipients and the public ingeneral in the dynamics and structures of the industry,thereby improving familiarity and clarifying the benefits ofprivate equity. “There needs to be a move towards educationon private equity, and then regulation should beconsidered,” Ashish Dave, partner and head of privateequity, Middle East and South Asia at KPMG, said. “PE willnot be hindered by appropriate regulation, but thegovernment and private equity firms should focus on adoptinga prudential approach to regulation,” he added.

What’s ahead for 2007?

Some experts argue that a historic shift from public toprivate equity is occurring and that the region has alreadywitnessed the birth of an asset class, which by all measuresseems to have a very bright future. “Clearly, private equityhas huge potential in the Middle East, and we expect stronggrowth in both the number and size of new private equityvehicles,” Rod Palmer of Walkers said.

Most fund managers agree that PE has an advantage overother alternatives (in particular, hedge funds), becauseit’s comparatively easier to launch a shariah-compliant PEfund, which will be acceptable to a wide range of investorsin the region. Other benefits include the important role ofprivate equity in financing and fostering innovative firms,and in reallocating capital to more productive sectors ofthe economy. “PE benefits from the fact that local investorsunderstand and are comfortable with the nature of PE andthat many of the PE funds in the region areshariah-compliant,” Palmer added.

Palmer said the industry will face some challenges in thenext two to three years that are unique to the region. Oneof the challenges will be managing investors’ expectationsof high returns, as more and larger PE funds are launchedthat are all chasing deals in the region.

Another challenge is the lack of solid and attractiveventures out there. “We expect that it might become a caseof too many dollars chasing too few deals, and funds whichout bid others will end up with a high cost associated totheir investment,” said Jamil Brair, vice president of PEfirm SHUAA Partners in Dubai. “Proprietary deals become keyand it is the fund with the best network that will be ableto keep its deals off the market and away from biddingprocesses,” he added.

According to Credit Suisse’s Taylor, the asset classesattractive to PE investors in the region are maturing interms of geographic and deal diversity. “In the Middle East,we see investment potential in the energy, infrastructure,financial services and real estate sectors. We also expectopportunities to emerge in healthcare, media, retail andservices,” Taylor said.

In order to take advantage of these opportunities, PEplayers will have to attract and retain qualified assetmanagement professionals, Palmer said, adding that fundsthen would also grow further outside of the region. “Iexpect that as the market continues to mature, we will seean increase in outward investment by regional managersexpanding their investment mandate. We are already seeingthat with the real estate PE market, where a number ofwell-established based investment houses with stellarperformance records in MENA real estate are now expandingthe mandate of their PE funds and operations into realestate in Europe,” Palmer said.

What does the future hold for private equity in the MENAregion? Experts predict that within three years, aconsolidation phase will have started to take shape, and2007 will be a year to write home about.

“2007 will continue to announce new records in privateequity in the region—largest fund announced or raised, newindustry-focused funds,” said Jamil Brair.

Private equity as an asset class has been so far successfulin the MENA region and is on its way to playing an evengreater role in building corporate and national wealth.Players in the industry have gained much and have addedvalue and leverage to small companies benefiting from theunexpected growth. However, it remains unclear how effectiveprivate equity funds will be at deploying capital in deals10 times larger than what’s available now. Most expertsagree that there is no question that private equity in theregion has the critical mass and the diversity to warrant alot of attention. According to Palmer, the trend ofincreasing size of the funds launched will continue,“particularly as size and experience of the asset managementteams within the PE houses grow and they can handle morecapital.”

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Banking & Finance

Global private equity has a long reach

by Imad Ghandour
written by Imad Ghandour

The Middle Eastern Private Equity Internationalconference, held each year in the third week of March inDubai, has become the annual hotspot for the region’s PEindustry. Heads of international PE funds, like Carlyle’sDavid Rubenstein and CD&R’s Joseph Rice, descended on Dubaito explore how to expand their sprawling reach to one of thefew remaining untapped markets. In addition, rising PE starsfrom the region lectured about their experiences and theirvisions, eyeing further international expansion, and aimingto attract the attention of global PE giants.

Carlyle’s Rubenstein, in his keynote speech, predictedthat the Middle East will be the fourth pillar in the globalPE industry after US, Europe and the Far East. The region,loosely defined from India to Morocco, has more than 2billion inhabitants, $1.5 trillion GDP, and is one of themain exporters of capital. Rubenstein is practicing what hepreached by setting up a $1.8 billion fund targeting theMiddle East and Turkey.

Sarah Alexander, President of Emerging Market PrivateEquity Association (EMPEA), noticed the remarkable evolutionbetween the first conference in 2005 and the 2007 edition. In 2005, the local presenters were inquiring if it can bedone, how it can be done, and how lucrative it will be ifdone well. Today, local PE champions are speaking withconfidence about deals closed, problems overcome, exits madeand real realized returns. Between 2005 and 2007, theprivate equity industry has quadrupled in size, and controlsnow more than $15 billion in assets under management.

Where to go from here?

Rubenstein and Rice’s appearance at the conferences onlyhighlight the increasing attractiveness of the region as atarget for global PE funds. Other PE heavyweights have beenscouting the region and assessing its potential. Secondtier global PE players, like 3i, Ripplewood, Actis, CVC,HSBC and Emerging Market Partnership, have already starteddeploying funds since 2003. By tying up the region to theglobal PE network, regional investment practices will besignificantly alleviated, and PE will rise further invisibility.

In 2007, the $2 billion fund benchmark will probably besurpassed with the closing of Abraaj’s Infrastructure fund.In 2005, PE practitioners could barely identify a dozensmall-size deals. Today, the prospects have improvedsignificantly. A multi-billion privatization program, a direneed for infrastructure investment, an active need forpre-IPO institutional investors and a relentless need forequity financing to support corporate growth are presentingfunds with a continuous stream of investment opportunities. Infrastructure funds will become larger and larger in orderto finance the privatization and infrastructure programs,but the mid-cap market targeting investments in the $25-150million range will remain very active as well.

Global private equity has been under scrutiny bygovernments and media in both US and Europe. However, localPE leaders have been from the onset more proactive,advocating the benefits of PE for the region’s economicdevelopment. PE is frequently prescribed as a remedy for the“unemployment bomb” threatening the social and politicalstability in the region and the institutionalization of theprivate sector.

Access to capital was definitely not an issue that cameacross the conference speakers’ minds. Unlike other parts ofthe emerging world, the GCC is one of the largest exportersof capital. This excess liquidity will fund PE investmentsand their IPO exits.

UAE as the fourth capital of private equity

UAE is already the regional capital for private equity:three quarters of all PE funds are managed out of UAE, andthe UAE is the largest recipient of PE investments. AbuDhabi Investment Authority (ADIA) is also rumored to be theworld’s largest investor in private equity funds.

But reaching global prominence over the next few years is,to a large extent, in the hands of the leading firms. Themacro environment is expected to remain favorable in themedium term and investment opportunities will be abundant. The biggest challenges for PE firms are to identify, train,attract and retain talented and experienced professionals,and build a competitive advantage through the development ofsystems and operations at par with international standards.

Imad Ghandour is head of strategy and research at Gulf Capital

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Iraq needs its own Ataturk

by Claude Salhani
written by Claude Salhani

Some months after the fall of Saddam Hussein, I found myselfin Kuwait sharing a taxi from the airport to my hotel withan Iraqi journalist who had just come from Baghdad to attendthe same conference. We talked about the situation in Iraq,the violence and how it should be dealt with.

One of the first questions I put to my Iraqi colleague waswhat he thought should be done to bring stability to Iraq.Without a moment’s hesitation he said, “Iraqis need a‘Saddam-lite,’ a benevolent dictator. Someone not as bad andpowerful as Saddam, but someone who can frighten the peopleinto accepting discipline.”

It was a strange but nonetheless realistic point of viewthat chaos in Iraq could only be contained by installing aleader who could rule with an iron fist, while working tobring democracy to the country—an Arab Atatürk if you will.(Mustafa Kemal, better known as Atatürk or “father of theTurks,” emerged as a military hero in the Dardanelles in1915. He led the founding of the modern Turkish republic in1923, after the collapse of the 600-year rule of the Ottoman Empire. After a three-year war ofindependence, Atatürk led Turkey into the 20th century andmodernization, and did so with a firm rule.)

Indeed, at a time when President George W. Bush had highhopes that Iraq would be the new shining light from whichdemocracy would spread throughout the Arab world, similarthoughts were being put forward by moderate Arab countries.One was King Abdullah II of Jordan.

Abdullah saw that a possible solution out of the Iraqiquagmire would be to install a strong military leader. Sucha leader, said the king, could instill law and order in thechaos that is Iraq today.

“I would say that the profile would be somebody from inside,somebody who’s very strong, has some sort of popularfeeling,” said the Hashemite monarch in the InternationalHerald Tribune, on his return from Washington where he metwith President Bush. “I would probably imagine—again this isoff the top of my head—someone with a military background who has the experience ofbeing a tough guy who could hold Iraq together for the nextyear.”

Today, four years on, Iraq is experiencing an unprecedentedcrime wave. Aside from the politically-related violence, which is claiming hundreds of lives on adaily basis, the country is being hit by organized and pettycrime and the contrast between Saddam Hussein’s 30-year rule as an absolute dictator who cracked down hard oncrime, and the sudden void of authority felt in the countryafter the dissolution of the army and the Baath Party couldnot have been greater.

I remember asking my traveling partner what he expectedwould happen when the US-led coalition handed over partialsovereignty to an Iraqi government. “I fear there will becivil war,” he replied. “Perhaps not immediately, butcertainly in due course.”

He was equally skeptical about democracy. “Forgetelections,” he said.

“They are simply not ready for it,” he said, and then,echoing King Abdullah’s sentiments, he went on, “Give them astrong army man who can pull it together. Someone who canrule with an iron fist and bring back law and order. Someonenot as bad as Saddam, but who has experience in themilitary, and in getting respect. That’s what we need.”

But there are two problems in putting such an idea intopractice. First, it would be in-your-face evidence that theBush Doctrine of freedom for the Middle East, with Iraq as ashowpiece, was a failure—something this White House wouldsavagely oppose. And second, the mechanism needed to realizesuch a venture—mainly a strong military—is no longer present in today’s Iraq. Alas, this means Iraqmay be destined to live through more years of instabilityuntil a strong figure can emerge to lead the country out ofthe darkness.

It wasn’t exactly what President Bush had in mind,especially as it would mean accepting that the democracyexperiment in Iraq has failed, at least for the moment, butamid the mounting chaos that is gripping Iraq today, theidea of a benevolent dictator—an Iraqi Atatürk—is beingtouted as a genuine option, one that was even debated—“Thishouse believes only a new dictator can end the violence inIraq”—recently on the BBC’s Doha debate.

Identifying an Iraqi “Atatürk” might not be all that simple—just think of the ethno-religious hurdles: a Sunni would be rejected by Shi’ites and vice versa. For sadly, Saddam’s over-inflated megalomaniac ego did not leave room for any Iraqi heroes—at least not any whose hands are not stained with Iraqi blood.

CLAUDE SALHANI is international editor and a political analyst with United Press International in Washington

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Banking & Finance

Regulating the shadows – Hawalas test global financial system

by Executive Staff
written by Executive Staff

During a recent conference at the Abu Dhabi Central Bankattended by members of the financial sector and experts fromthe region, Europe and the US, a focus was on how to betterregulate the informal money transfer system of hawala, whichhas been linked to money laundering, organized crime andterrorist financing.

Hawala, which can be traced back to the 8th century, is apopular, cheap and effective way to send money that isfrequently used by the Gulf’s massive expatriate Asianpopulation.

Money is transferred through a network of hawala brokers,or hawaladars. A customer approaches a broker in one cityand provides a sum of money to be transferred to a recipientin another country. The broker who has received the moneycalls his counterpart in the recipient’s city, providinginstructions on the disposal of the funds and promising tosettle the debt at a later date.

Although much of the money transferred is legitimate, adrug bust by the Italian police late last year connectedseveral Pakistanis with a Dubai-based Indian who receivedmoney through his informal bank to channel funds to drugcartels and arms dealers.

This incident is far from unique, with the UAE and Britishauthorities busting a drug network operating between the UKand Afghanistan only last month (March) that used the UAE asa ’cash pool’ to launder an estimated $194.7 million.

The ancient versus the modern

The problem facing central banks and regulatory bodies isthat the majority of hawala transactions are completelylegal and a primary source of income for many people aroundthe world. According to the UN, in 2005 there were 175million migrants worldwide sending remittances in excess of$300 billion, of which some $167 billion went to emergingeconomies and accounted for up to two-thirds of GDP incertain countries.

That trend is likely to increase, particularly as thedemand for young workers spikes in the aging populations ofEurope and North America.

The issue is of particular importance in Somalia, where upto 15% of the population lives abroad and remits $1.5billion annually to the Horn of Africa.

“The Somali economy is more dependent on remittances thanany other country on earth,” said Muhammed Djirdeh of theSomali Money Transmitters Association. Around 40% of theSomali population is reliant on remittances from relatives,and remittances are a source of finance for up to 80% of newbusinesses.

But with the recent clamp down on the hawala system,hawaladars are feeling the heat.

“We suffer, like all others in this business, from animage problem,” said Djirdeh, citing the example of theMogadishu-based Al Barakat money transmitter that was closeddown after 9-11 by the US authorities for connections toterrorism.

“Our problems are regulations, forcing some of us to quitthe business or work without compliance. The US is veryprohibitive for us to work in and with as we are the smallboy in the neighborhood—banks close our accounts, and wecannot do without working in the system. On top of that,transaction costs are going up. We charge 5% to send$100-$150, but have to pay agencies and commissions, so theoperator gets a small income,” added Djirdeh.

By comparison, a bank in Europe or the UAE will charge upto 20% for a transaction of the same amount.

But low costs are not the only reason for using the hawalasystem. In many developing countries, the banking system isso underdeveloped that informal money transmitters are theonly means to transfer money. In addition, hawala is highlyefficient, taking a maximum of two days to get to therecipient.

“What’s amazing is in today’s electronic world it takesfive days for a check to clear in the UK,” said ProfessorHannah Scobie of the European Economics and Financial Centerin London. “If there were hawala brokers between the UK andItaly, we would use them, as banks can take up to twoweeks,” she added.

Some observers also believe that hawala has been unfairlysingled out as a system abused by criminals and terrorists.As World-Check, a British company that runs an intelligencedatabase on financial risk, has pointed out, 60% of all bankfraud is internally driven. Equally, other forms oftransmitting funds are widely used but garner less attentionby regulators, the financial system or the press.

For instance, settlements can also be made via a cashcourier, as cargo, via diamond smuggling or through multi-country settlements.

“The latter is particularly popular as it is a way to cutcosts and make money on currency exchanges,” said NikosPassas, professor of criminal justice at NortheasternUniversity.

“The money of migrants wanting to send money goes into acash pool. The dollars go to an exporter of goods, and thenrupees go to the families—that’s how you minimizecross-border transactions and score tons of money,” headded.

As another example of avoiding cross-border transactions,Passas said Taiwanese boats going to meeting points ininternational waters to trade narcotics for commercial goodsthat will then enter Hong Kong, which acts as the financialhub to effectively launder the money.

“The other ways are through goods. The value of a good mayofficially be declared at $30, but only worth $1.20, whichis fraud,” said Passas.

Finding the right balance

The struggle for regulators is to find the right balancebetween over- and under-regulating informal moneytransmitters.

“It is difficult to regulate hawala without driving itunderground,” said Jean-Francois Thony, assistant generalcounsel of the financial integrity group at the IMF.“Regulations are not the panacea to avoid misuse,” he added.

If a regulatory body is particularly zealous, it will notonly be hawaladars and low-income workers that areaffected.

“Over-regulation can lead to capital flight,” saidProfessor Scobie. “But banks and regulators have gonecompletely wild following 9-11. Every time you turn around,there is a new form to fill in. This is very disturbing forcustomers, and on looking closer, these forms are for banksto get more information to sell more products.”

So what is the solution between excessive regulation thatcould drive informal transmitters underground and bankstrying to flog extra services?

In the UAE, the central bank has started encouraginghawaladars and exchange commissions over the last threeyears to come forward to register themselves.

“We realize hawala could be used to launder money andfinance terrorism, so we want to control—not end—hawala, asit is important for people in poor countries,” said AhmedIsmet of the UAE central bank

Initially expecting around 100 applicants, 215 dealershave been officially certified and 43 applications are stillpending.

“The first stage is registration [by hawaladars]. Morestringent and restrictive regulations will come in time asit could be counterproductive if done earlier,” said IbrahimAl Hosani of the UAE Central Bank.

Countering terrorist financing and money laundering is notconfined to reining in the hawala system, as such informalmoney transmitters also use official banking channels. Sothe financial community also needs to be brought onboard.

The issue is of major significance for banks, as evenallegations of being a channel for criminal activity couldhave long-lasting effects on a bank’s reputation and brandequity. Equally, Arab banks with branches in the US have tobe proactive in countering money laundering and terroristfinancing to comply with the USA Patriot Act’s InternationalMoney Laundering Abatement and Anti-Terrorist Financing Act of 2001.

But figuring out the bad transactions from the good is noeasy task.

“If every A4 paper transaction made by LloydsTSB worldwidewas piled up over a week, it would endanger a 747 jet flyingto the US—that’s 35,000 feet of paper. To single out one badtransaction is very difficult,” said Richard Stockdale, headof LloydsTSB Global Services.

Agreements between banks and central banks for automatedclearing houses to reduce the cost of money transfers inbanks was suggested as one way to wean customers off thehawala system.

Alex Cunningham, head of the New York-based Middle Eastand Balkans Program at the Financial Services VolunteerCorps, thought that one way out of the dilemma was a morerepresentative banking system.

“Banks need to become more focused on low-income bankingand offer different products, such as lottery tickets andphone cards in low-income branches,” he said.

Greater transparency between the private and public sectorwas also highlighted as necessary to make it easier to spotsuspicious activities.

“The whole financial control framework does nothing if tradeisn’t transparent,” said Passas. “Despite all thisinfrastructure for anti-money laundering and counter-terrorist financing, take a look at the business environmentand there are huge holes—not loop holes—but black holes thatany half-decent criminal entrepreneur can take advantageof.”

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Bush understands Lebanon

by Lee Smith
written by Lee Smith

The US’s former ambassador to the UN, John Bolton, recentlyconfirmed that Washington rejected calls for a ceasefirethis past summer and let Lebanon wither under Israeli attackfor several more weeks. An early cessation of hostilitieswould have been “dangerous and misguided,” said Bolton, whowas “damned proud of what we did.” So, maybe it’s worthwhileasking, with friends like the Bush administration, who needsenemies?

And yet strange as it may seem, certainly to thoseunfamiliar with the tangled relationships that constituteMiddle Eastern politics, this White House, having sponsoredor backed a series of UN resolutions supporting Lebaneseindependence and pledging almost $1 billion in foreign aid,is probably the most pro-Lebanese US administration inhistory. And that’s no small feat, since the US has had astake in Lebanese affairs ever since it became thepre-eminent Western power in the region shortly after theend of World War II.

The key date is 1956, after the Suez crisis, leaving the USwith the primary responsibility for containing Sovietinfluence in the Middle East. Eisenhower’s sending troops toBeirut to shore up the Chamoun government suggests that forWashington, clarity in Lebanon has tended to look like twosharply polarized sides, with one clearly pro-Western, andthe other decisively not. When the internal Lebanesesituation is muddier, as it was during the fifteen-year-long civil wars, US officials have had a much harder timefiguring out where American interests lie—and hence whataction to take. Indeed, when Ronald Reagan dispatched theMarines in 1982, the only clear divide was in theadministration itself, which debated the wisdom of gettinginvolved for as long as US troops were based here.

It was partly because American blood was shed in Lebanonduring the ’80s for no apparent reason, as well as placatingHafez al-Assad, that the current president’s father showedvirtually no interest in Lebanon, a state of affairs thatcontinued through the Clinton years. And without aremarkable chain of events these last seven years, thingsprobably would’ve remained the same during the tenure ofthis administration.

It may seem paradoxical in light of last summer’s war withIsrael, but as I was reminded recently during the annualAmerican-Israeli Public Affairs Committee (AIPAC) PolicyConference, it was largely the power of the Israeli lobbythat kept Lebanon a live issue here in Washington when noone else was paying attention. In 2003, the US House ofRepresentatives passed the Syria Accountability and LebaneseSovereignty Act, largely meant to force the Executive branchto reconsider its dubious policy of constructive engagementwith Damascus.

Still, it wasn’t until the Iraq war that Washington realizedwhat it had in Lebanon—not just a staging ground to rollback a confrontational Syrian regime and a fight aregion-wide Iranian agenda, but a high-profile showcase forthe keystone of the administration’s new national securitystrategy: Middle Eastern democracy. It is hardly lost onthe White House that to date, Lebanon, for all its problems,is the most successful part of its regional portfolio.

What’s bizarre is not Washington’s support of Lebanesedemocracy, but that so much of the rest of popular USopinion seems to have turned its back on Beirut. Ever sincethe formation of James Baker’s Iraq Study Group, there hasbeen intense domestic pressure on the White House tonegotiate with Damascus. Though seriously weakened with itsfailing position in Iraq, the Bush administration does notbelieve that solving Baghdad means acquiescing to Bashar in Beirut.

And then there’s the American media. Bush, explains theclueless Seymour Hersh in a recent New Yorker article, isbacking Al-Qaeda militants through the offices of theSeniora government. Other media reports also contend that USfunds used to shore up the Internal Security Forces areessentially being used to create Sunni death squads to waragainst the Shia.

Through it all, the Bush administration has brought Lebanoneven further within the fold. To date, in addition todiplomatic support and financial aid, Washington has devotedan unprecedented amount of White House prestige to Beirut. And as for Lebanese officials making their way toWashington, the State Department, Pentagon and White Househave all thrown open their doors to leaders from every sect,including a host of younger Shia hopefuls who seek anotheroption for their community other than that articulated bythe grim Islamic resistance.

And now with Bush having only a little more than a year leftin office, the natural question is, what happens to the Washington-Beirut relationship when the most pro-Lebanese president in the shared history of the twocountries leaves the White House? As today, Washington’sinterest will be determined by circumstances, and mostimportant among them, it is the will of the Lebanese peoplethat will decide if in, say, 20 years time, we will lookback on the beginning of the 21st century as the goldenyears of the US-Lebanon alliance, or as merely the start ofa beautiful friendship.

LEE SMITH is a Hudson Institute visiting fellow and reporter on Middle East affairs. 

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Banking & Finance

Nixing GCC monetary union, Oman charts own way

by Jason J. Nash
written by Jason J. Nash

Oman’s decision in early 2007 to opt out of the GCCmonetary union project has come as a blow to efforts by GCCstates to establish closer economic relations. However, thedecision was not necessarily based on a complete rejectionof the scheme. Rather, it is a reassertion of Oman’s need tofollow a different path until a more solid set of monetaryunion objectives is implemented by the other GCC states. Ithas also put under the microscope the GCC’s level ofpreparedness in dealing with its 2010 deadline for theproject.

Prime candidate to join… on paper

With the most conservative GDP growth of the GCC memberstates, Oman seemed likely to benefit from the much-vaunted ‘catch-up effect’ of monetary union, as seenfollowing the introduction of the euro. Oman was certainlynot struggling to meet the negotiated requirements in termsof fiscal policy: budget deficits are required to be cappedat 3%, while Oman had a fiscal surplus in 2005 of over 11%;public debt was well below the limit the GCC imposed onitself; and Oman’s foreign exchange reserves could easilyfinance four months of imports. Although Oman was meetingthe initial entry criteria, Ahmed bin Abdulnabi Macki, theminister of national economy, announced in January that thesultanate had decided to withdraw from the monetary unionproject.

He affirmed that Oman had reservations, both with the lackof progress made on obtaining prerequisites for successfulunion by 2010 (no agreed regional headquarters or commonmarket) and also cited Oman’s aversion to surrenderingeconomic sovereignty. He stated to Reuters that, “Thesultanate has its own economic and financial compulsionswhich do not offer room for meeting the criteria set for thesingle GCC currency.”

Oman has always sought to distinguish itself from its GCCpartners, both in its approach to oil and industry, and howit is now marketing itself as a tourism destination. Thegovernment is aware that the country does not have the samedepth of oil and gas reserves that most other GCC stateshave, and that the sultanate’s economic diversificationefforts could perhaps lose market competitiveness under aunified regional currency. The slowness of the other GCCstates to move on readjusting their currencies in step withone another to help fight dollar-inspired inflation wouldseem to validate its approach.

Interestingly, the other GCC state not flush with oil andgas reserves, Bahrain, is also now beginning to voice itsown concerns over the prospect of monetary union. Commonthemes of discontent include a lack of preparedness and theincomplete implementation of a common economic marketbetween the member states. At the same time, Kuwait ishoping its fellow GCC members will move faster onreadjusting the currency peg with the US dollar to helpstave off inflation.

Oman’s voice speaks strongly of independent economicconsiderations, and this is also reflected by itsindependent partnerships outside of the regional bloc.Recent bilateral developments have given Oman a new platformfor trade and investment. Whilst this may have not beenwell-received by some GCC member states, it has opened up anumber of opportunities for the sultanate’s economy.

The Oman-US FTA has so far generated large bilateral tradereturns for Oman (45% increase in export revenues from theUS over the last 12 months). This agreement also gives Omanunrestricted access to the US market, and eliminates the 5%tariffs previously in place. This is particularly useful asthe US is Oman’s fourth-largest import partner, responsiblefor $538.7 million worth of imported goods in 2005,according to the central bank of Oman.

Ties beyond the Gulf

The so-called “FTA effect” is evident across the region,with Bahrain also entering bilateral agreements earlier lastyear. FTA countries in the MENA region have experienced anaverage 33.5% increase in trade with the US during2005-2006. Although the FTA effect may well slow down incoming years, the extra trade created will remain. However,revenue is not the only factor to be considered in Oman’scase, as strategic partnerships with the US would stand tobenefit diversification options in the country.

Oman’s intra-regional trade ties should not be forgotten.The sultanate has significant trading interests with its GCCpartners, accounting for 18% total imports and 10.7% totalexports. The UAE is Oman’s fourth largest trading partnerand still a key part of the GCC market area. Should themonetary union continue without Omani membership, thesultanate may well find itself facing higher transactioncosts to deal with the Gulf Dinar.

Oman has managed to create new space for itself in theglobal trading network, establishing bilateral agreementsand partnerships promptly and efficiently which fulfill itsdevelopment criteria. Comparatively, the GCC as anorganization has repeatedly prolonged negotiations to forgeUS-GCC arrangements and has encountered many points ofcontention in aligning members’ independent economicpolicies. Bahrain was the first to observe that going italone on a trade deal with the US might better serve itseconomic need to generate growth and jobs, and Oman’s FTAreiterated the concern that the differing priorities of GCCmember states may be hampering the growth of the smallerplayers.

Oman also seems to be bearing its Asian priorities inmind, since its three major trading partners are Japan,China and Korea, who account for a collective 44.5% of totaltrade (21.5% total imports and 58.0% total exports). This isa regional alliance that Oman has successfully enticed andis continuing to pursue. Sinopec is the sultanate’s largestexporter of crude oil (30%) and has recently announced aproposal to increase term purchases by up to 20% for thisyear. China is also bidding on industrial contracts in thecountry and is seemingly paving the way for a longrelationship with Oman.

Asian loans have proved crucial to financing governmentprojects: the Japan Bank for International Cooperation(JBIC) loaned $150 million to Oman as contribution tofinancing part of the project of the second phase of Soharport, financing construction as well as infrastructure.Japan also participates in a “human resources transfer”program, dispatching ‘experts’ in response to requests madeby the government. The Omani-Asian links continue tostrengthen and Oman is taking care to ensure that thispartnership does not become neglected at the expense ofregional economic cooperation. The GCC priority is inestablishing a trade agreement with the EU, something whichhas moved very slowly since the opening of negotiations in1990. Despite the EU being Oman’s fifth-largest trading partner, the essential composition of theGCC presents many institutional barriers to trade alliances,and Oman’s branching out may indicate its lack ofwillingness to keep on waiting.

Although there has been criticism of Oman’s decision towithdraw from the monetary union process, the move may cometo be seen as very sensible regarding the sultanate’seconomic position. Oman has sent a clear message to the GCCthat it will not marginalize its domestic concerns for thesake of regional unity. This decision has already encouragedGCC scrutiny of what many now agree are unrealisticdeadlines and criteria. The concept of a fully operationalGulf Dinar by 2010 looks unlikely, though an ECU-styleaccounting unit used as a precursor is one course now leftopen for the GCC partners. As for Oman, it seems more intenton developing on its links with the US and Asia, increasingits competitiveness to benefit from more diverse foreigninvestment and partnerships. And just perhaps, through theOmani move, the other GCC states may take a long look at themonetary union plan and revise the steps needed to achieveit.

Jason J. Nash is Head of Research at the Oxford Business Group

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Syria not yet folding its cards

by Nicholas Blanford
written by Nicholas Blanford

Like it or not, Syria’s leaders have no desire it seems toimitate Longfellow’s “Arabs” and “fold up their tents andquietly steal away into the night.”

Two years of diplomatic isolation and unrelentinginternational pressure have failed to persuade Damascus tosignificantly alter its course regarding key regionalissues: Lebanon, the Palestinians and Iraq. On the contrary,marginalization by the international community has had theeffect of drawing Damascus closer to Tehran. TheSyrian-Iranian relationship, one of the most unlikely andenduring alliances in the Middle East, has only grownstronger since the election of Iranian President MahmoudAhmadinejad in August 2005.

Both countries need each other. Syria allows Iran a toeholdinto the Arab-Israeli arena and serves as a vital conduit toHizbullah. In exchange, Syria has a powerful military andfinancial ally in Iran with which to face the cold shoulderof the West and the unease of other Arab nations.

The US effectively severed relations with Syria in the wakeof the assassination of former Prime Minister Rafik Hariri.By February 2005, the Bush administration’s patience withDamascus had waned considerably over a number of issuesincluding Syria’s support for Palestinian militant groupsand foot-dragging over a troop withdrawal from Lebanon, butchiefly over its unrelenting opposition to theAnglo-American invasion and occupation of Iraq.

The European Union, following the US lead, also distanceditself from Damascus, influenced by French President JacquesChirac who does not even try to hide his antipathy towardthe regime of Syrian President Bashar al-Assad.

The US told Syria that it must change its behavior beforethe Bush administration would consider re-engaging with it.An uncowed Syria instead turned toward Iran and embraced animage of Arab steadfastness against the bullying dictats ofthe West, a stance that resonated among many Arabs.

But the cracks in the edifice of isolation began to emergeat the end of last year with the release of the Baker-Hamilton commission’s report on Iraq, which recommended aresumption of dialogue with Syria and Iran. The Bushadministration initially dismissed the commission’s advice,insisting on its demand that Syria must take the first stepby changing its behavior. But several US senators,emboldened by the Democrats’ success in the mid-term US elections in November and by the findings of theBaker-Hamilton commission, traveled to Damascus, the firstsuch visits in two years. In November, Syrian ForeignMinister Walid Muallem visited Baghdad, which paved the wayfor a restoration of formal diplomatic relations betweenSyria and Iraq in December and the signing of a jointsecurity agreement. In January, Jalal Talabani visitedDamascus for the first time in his capacity as president ofIraq. The biggest indication that Syria could be coming infrom the cold was its invitation in February to attend—alongwith Iraq’s other neighbors—a conference in Baghdad todiscuss how to help stabilize Iraq.

The Europeans also have begun retreading the path toDamascus, most notably Javier Solana, the EU’s foreignminister.

A general rapprochement between Damascus and the West stillseems a long way off and will probably depend on the outcomeof the United Nations investigation into Hariri’s murder.But the tentative steps toward re-engagement has revived thedebate between those that believe that jaw-jaw is alwaysbetter than war-war and those who argue that talking toDamascus is futile. Both arguments have somejustification.

Syria’s critics maintain that the Syrian leadership has ahistory of frustrating and infuriating its internationalinterlocutors by making promises that go unfulfilled.Recommencing a dialogue with the Syrians, they argue, willbe taken as a sign of Western weakness and suggest thatDamascus has no need to change its policies. Much better,they say, to at least maintain and possibly increase thepressure on Syria in a bid to break the will of the Syrianleadership.

Supporters of dialogue, however, argue that the policy ofisolation over the past two years has not only failed topersuade Syria to yield to Western demands, it has had theopposite effect of helping cement the Syrian-Iranianrelationship. That strengthened bond forms the backbone ofthe anti-Western alliance spanning the Middle East fromTehran to Beirut’s southern suburbs. The alliance isdetermined to check the regional ambitions of the US andlies at the root of mounting Sunni Arab alarm at Iran’sgrowing reach into the Middle East.

A serious re-engagement with Damascus, they argue, wouldhelp pry Syria away from Iran, breaking the anti-Westernalliance and weakening Tehran’s ability to influence theArab-Israeli conflict. The bottom line, they say, is thatSyria cannot be expected to dance to the Western tune ifnothing serious is offered in exchange.

The debate over how to handle Syria remains heated andunresolved. But there is little doubt that it is hard toignore a country that lies at the nexus of so many of theregion’s conundrums.

NICHOLAS BLANFORD is a Beirut-based journalist and author of “Killing Mr Lebanon: – The Assassination of Rafik Hariri and its impact on the Middle East

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