Aamir A. Rehman (Staten Island, NY) is an expert in global strategy, the Gulf region, and Islamic finance. He is author of Dubai & Co.: Global Strategies for Doing Business in the Gulf States (McGraw-Hill, 2007), a strategic guide for global firms seeking to do business in one of the world’s most dynamic regions. He is also author of a Harvard Business Review article entitled “Islamic Finance: The New Global Player.” Mr. Rehman was formerly Global Head of Strategy for HSBC Amanah, a business unit of the world?s third-largest bank, offering Shariah-compliant financial services across nine major markets worldwide. He is currently Head of Strategy for Fajr Capital, a principal investment firm focusing on opportunities in key markets of the Middle East and Asia. Dubai & Co. and Mr. Rehman’s management commentary have been featured in the Wall Street Journal, the Financial Times, US News and World Reports, the Wharton Leadership Digest, and other media outlets. He has spoken at conferences and events in the US, the Middle East, and Asia.

Gulf Capital & Islamic Finance

The Rise of the New Global PlayersBy Aamir A. Rehman

The McGraw-Hill Companies, Inc.

Copyright © 2010 Aamir A. Rehman
All right reserved.
ISBN: 978-0-07-162198-4

Contents

Chapter One

Floating on Wealth: The Origins and Sources of Gulf Prosperity

We come from the desert, and we have been living on camel milk and dates … and we can easily go back and live in the desert again.

— King Faisal of Saudi Arabia (ruled 1964–1975)

Decades ago, when wealth in the Gulf was far scarcer, one prominent Gulf family subtly began sending a regular stipend to another leading family to help the latter meet its expenses. The recurring payment became standard practice, and continued for decades—even after successive oil booms had multiplied the wealth of each family manyfold. When a financial review by the benefactor family found that this small payment was still being paid regularly, the family stopped the practice for fear that the small gift—negligible compared to both families’ current incomes—could be a source of embarrassment for the recipient.

Shortly thereafter, the head of the recipient family placed a call to his former benefactor. While of course he was in no need of the stipend, he noted that the modest payment was something that he had deeply appreciated. He went on to explain the reason why: “because it used to remind me of the time when I was in need.” Judging from their current appearance, it would be easy to forget that the countries of the Gulf have long but modest histories. A look at the business centers of Dubai and Doha, with their sleek skyscrapers, slick roads, and fast cars, reveals hardly anything that looks more than 15 years old. The financial centers of Bahrain, Kuwait City, and Riyadh do feature edifices from the 1970s and 1980s, but these are fast being eclipsed by new icons such as Riyadh’s Kingdom Tower. Even the populations are strikingly young, with over 40 percent of the people in the Gulf being below the age of 15. All in all, the Gulf Cooperation Council (GCC) is a region in which one is overwhelmed by “newness” and signs of recent prosperity.

In truth, the countries that now make up the GCC have long histories of commerce and trade. For centuries, trade has been pivotal to sustaining the regional economy—the Gulf’s agricultural and livestock base is very modest, and therefore the trade of goods was always crucial to developing the Gulf’s wealth. In the area that is now the UAE, for example, the core economic sectors were historically pearl production, fishing, (modest) agriculture, and herding. Artisans produced some goods for local consumption, but the finest goods were imported from the Levant region of the Middle East (bilad al-Sham in Arabic, or what is today Syria, Iraq, Jordan, Lebanon, Palestine, and Israel), North Africa, and South Asia. The sparse agricultural endowments of the Arabian Peninsula and the reliance on trade were even mentioned in the Qur’an. Abraham, when leaving his family on the peninsula, prays, “O our Lord! I have made some of my offspring to dwell in an uncultivable valley by Your Sacred House”—with the last phrase being a reference to Makkah. Elsewhere, the Qur’an mentions “the journeys of the winter and the summer”—a reference to the trade routes that sustained the region for centuries.

The Gulf played an important role in the ancient trade route known as the Silk Road. The term refers to a longstanding trade pattern in which goods flowed between China, other parts of East Asia, India, Persia, the Arabian Peninsula, North Africa, and Europe. In this elaborate flow of trade, Gulf ports and the merchants therein were important intermediaries and enablers. Along with the exchange of goods came a mixing of cultures, ideas, and families, such that families with a broad range of ethnicities settled in the Gulf, and merchants from the Gulf settled elsewhere. Significant populations in Indonesia and Malaysia, for example, trace their roots back to Yemeni traders. In contemporary times, observers like BusinessWeek have discussed the rise of a “New Silk Road” as historical trade links between Asia and the Middle East have been revived. There is even an investment firm today by the name of New Silk Route (chaired by the former managing partner of McKinsey) that invests in businesses related to these growing economic flows.

Another key driver of the premodern Gulf economy—and one that remains important today—was the economic activity related to the Hajj. This pilgrimage to Mecca, required of all Muslims of means, now brings around 3 million pilgrims to Saudi Arabia each year. In premodern times, the numbers were far smaller, but the journeys were more elaborate. It was not uncommon for pilgrims to travel for several months and then to stay on the peninsula for several more months before returning home. The “Hajj economy”—in addition to pumping funds into the Saudi economy each year—has strategic implications for the development of key sectors. If fostered and applied more deeply, the capabilities and skills linked to the Hajj can be pivotal in developing and expanding world-class initiatives and companies in sectors such as infrastructure and logistics management, public health and safety management, and Shariah-compliant savings and financial services. Besides being an economic boon each year, the Hajj can also be—as it has been for centuries—a strategic component of the region’s economic development.

The discovery and export of oil—especially during the successive oil booms of the 1970s and 2000s—have, of course, transformed GCC economies. Nonetheless, modern versions of the premodern sectors that supported the Gulf for ages remain visible today: massive ports like Dubai’s Jebel Ali Free Zone facilitate trade between Asia and Europe; luxury goods inspired by the trade in gold and precious stones persist in modern form. Furthermore, the diversity of ethnicities integrated into Gulf society, especially in the western parts of Saudi Arabia, strongly reflects the heritage of the Silk Road and the Hajj economy.

A few decades ago, few would have imagined the massive wealth and rapid development that can now be seen in the Gulf. In a remarkably brief period of time, the countries of the GCC have made the transition from being minor economic actors (and often-overlooked markets for goods and services) to playing a meaningful role in the international economy. As discussed in length in Dubai & Co., this rapid growth has brought both benefits and challenges. One such challenge is a tremendous “backfill imperative to develop the social institutions—universities, cultural institutions, civic institutions, and the like—that are required for long-term economic competitiveness. Senior leaders in the Gulf remember a time when the region was in need. Today, the world recognizes Gulf capital—the fruits of GCC prosperity—as a new global player on the rise.

LARGE—AND GROWING—RESERVES

Over the past decades (but largely in the boom years of the 2000s), the economies of the Gulf have accumulated significant reserves. Consider the following figures:

* As of 2006, Gulf economies had about $1.9 trillion in foreign assets built up over the past decades.

* This pool of foreign wealth corresponds to over $47,000 per person living in the Gulf, and over $70,000 per GCC citizen.

* In contrast, the public debt of the United States in 2009 is over $11 trillion. This corresponds to over $37,000 in national debt per person living in America.

These figures are truly striking and reflect the changing topography of the global economy. For every Gulf citizen born in 2006, the Gulf economies had a pool of foreign assets more than three times the region’s annual GDP per capita. In the United States, however, for each baby born today, there is a national debt of about one year’s GDP per person. Put roughly, a GCC citizen is born with national assets over three years ahead of the game, whereas an American is born with a national debt about one year in the hole. Large national debts can also be seen in the United Kingdom and other leading economies of the Organisation for Economic Co-operation and Development (OECD) world, making the GCC’s accumulated wealth all the more remarkable.

Not only is Gulf wealth significant, but it’s also growing. Figure 1.1 envisions the potential growth of GCC foreign assets under three different scenarios.

If the oil price per barrel for the period 2007–2020 averages $70, the McKinsey Global Institute forecasts that the GCC will hold foreign assets of about $8.3 trillion by 2020. If the average price of oil is $100 per barrel—a scenario that appeared likely in early 2008 but now is in question—the foreign asset pool would be $10.3 trillion. Therefore, Gulf foreign assets may grow to three or four times their 2006 size in the decade ahead.

A third, intriguing scenario is one of “no new investments.” It is projected that, even if the GCC “never invested another penny,” the earnings on its existing investments would be about $1.6 trillion in the period through 2020. If all these earnings were reinvested abroad rather than being spent, foreign assets would end up being around $3.5 trillion—84 percent higher than they were in 2006. However, such reinvestment would require fiscal discipline on the part of public and private investors to preserve foreign asset returns rather than use them to fund consumption or local projects.

As is evident in these three scenarios, the pace of growth in Gulf assets is inherently linked to oil prices. The McKinsey forecasts cited here were developed at a time when oil markets were booming, leading McKinsey to assert that “in any plausible oil price scenario, Gulf nations’ wealth will continue to grow rapidly.” Today, the range of plausible oil prices seems wider. Nonetheless, it is fundamentally important for observers of the region to bear in mind that (1) the Gulf’s existing asset base is substantial and is able to generate significant income, and (2) this base is likely to grow through both the rein-vestment of returns and infusions of new capital. Just how much new capital will be available for investment depends heavily on the region’s ability to generate the kind of budget surpluses it has enjoyed in years past.

HEALTHY SURPLUSES

The large reserves that the Gulf enjoys today have been enabled by healthy budget surpluses over the past decades. Surpluses have varied greatly from year to year based on the market price of oil, and some years have seen deficits. In fact, Saudi Arabia—the core economy of the region—expects a deficit in 2009 as a result of an expansionary budget designed to stimulate the local economy. Nonetheless, sizable surpluses have been the norm in the wealthier Gulf states, especially in recent years.

Table 1.1 shows the budget surpluses of all GCC states and the GCC overall in 2008. It also includes the figures for a number of other countries for comparative perspective.

The key message from this chart is that in 2008 –(a year of remarkable volatility in oil prices), the GCC overall generated an estimated surplus of $161 billion. That’s about 14 percent of the total GCC economy and $4,000 per person living in the Gulf today. It’s also (at May 2009 valuations) more than the market capitalization of GE, Google, or Apple— and about eight times the market value of troubled Citigroup.

When examined further, this analysis of nations’ surpluses reveals a number of other interesting insights. Although China’s economy dwarfs that of the GCC (about seven times as large in PPP terms), China’s public-sector surplus in 2008 (in absolute terms) was only about half that of the UAE alone and around a third that of Saudi Arabia. China’s government-funded investment vehicles therefore had significantly less fresh capital to draw on for foreign investment than their counterparts in the GCC. At the same time, India, while having a large and fast-growing domestic market, experienced a deficit of 2 percent of its GDP.

Comparisons with the United States reveal that the Gulf, despite its growing significance, remains a relatively small economy when compared to that of the United States’. The US economy was about 13 times that of the GCC in total, and around 24 times the size of the Saudi economy. And although the Gulf surplus figures seem large, it would take about three times the GCC’s 2008 surplus to pay for the US deficit in that one year alone. The Gulf does have significant public-sector prosperity, but the scale of its economy is a fraction of that of the United States and about half that of the United Kingdom.

“HOT” ECONOMIC GROWTH …

In recent years, economic growth in the GCC region has significantly outpaced growth in other parts of the global economy. This fast growth has led to sustained prosperity in the region—a key component of the “opportunity formula” that is driving the Gulf’s attractiveness as a place to do business. In addition, the region’s favorable demographic trends—young populations, high literacy, increasing global connectivity, and the like—make its consumers a prime market for global firms. Finally, ongoing regulatory reform—with all GCC states now being members of the WTO, for example—has made Gulf markets more accessible than before. This opportunity formula of prosperity, demographics, and reform (discussed at length in Dubai & Co.) has made doing business in the region a key strategic initiative for many global firms.

Figure 1.2 shows the annualized growth rates of a range of international economies during the five-year period 2002–2006.

Over the period—boom times for the Gulf—economic growth in the GCC far outpaced growth globally and in the world’s developed markets. The cumulative annualized growth rate (CAGR) for the GCC economies (in aggregate) was 6.5 percent—more than 40 percent higher than the world average of 4.5 percent. In the same period, the world’s most developed economies grew at about one-third the Gulf’s pace: 2.3 percent. Kuwait, the UAE, and Qatar grew faster than India, although China outpaced them all with an astonishing annualized growth rate of 9.9 percent.

While this economic growth was fueled by natural resource income, it has enabled economic development across a wide range of industries. Major expansion in infrastructure, financial services, tourism and hospitality, retail, heavy industry, and a whole host of other sectors was achieved as wealth flowed into Gulf economies. GCC states have actively pursued economic diversification strategies supported by government initiatives such as projects, the establishment of government-linked companies, and deregulation through free zones in key sectors like financial services. As discussed in Dubai & Co., economic growth in the GCC has not been “all about oil”—oil has driven wealth creation, but this wealth has created booms in a wide range of economic sectors.

Were the Gulf to maintain the growth rate it experienced between 2002 and 2006, its economy would double every 11 years. By contrast, the core OECD markets would need more than 30 years to double in size were they to maintain their rate of expansion for the period. In reality, of course, the healthy growth period of the early to mid-2000s has been followed by a deep recession that has affected economies worldwide—including those of the Gulf.

… “COOLING” IN A GLOBAL RECESSION

The cooling effect of the global recession on the Gulf economies has been substantial. Figure 1.3, based on analysis and projections made by the Economist Intelligence Unit in 2009, illustrates expected real growth rates for each GCC economy and a number of other economic clusters for comparison.

While world economic growth generally slowed in 2008 relative to 2007, the major energy exporters of the Gulf—including the UAE, Kuwait, and Saudi Arabia—enjoyed stronger growth in 2008 than they had had the year before. While 2008 was a volatile year for oil prices and for the global economy overall, the average oil price was a strong $97. This enabled the GCC economies to outperform world averages significantly that year.

For 2009, however, far cooler economic growth is expected. Saudi Arabia (the region’s largest economy, with over half the Gulf’s total GDP) is forecasted to grow at only a 0.4 percent rate. For the UAE, the growth forecast is 1.3 percent—less than one-sixth of the 2008 figure of 7.7 percent. All six GCC economies are expected to see a slowdown in economic growth in 2009, followed by a return to higher growth in 2010. This 2010 rebound coincides with projections for a return to growth in the overall world economy, which is expected to grow 2.4 percent percent in 2010 compared with a mere 0.2 percent in 2009.

When compared to projections for the world’s most developed economies, however, the outlook for the GCC region appears relatively strong. The OECD and EU economies are both expected to experience negative growth (–1.9 percent and –2.0 percent, respectively) in the year 2009. In contrast, none of the GCC economies are expected to shrink for the year. When world growth returns in 2010, the countries of the Gulf are expected to again outpace other regions—the OECD is forecasted to expand by 0.5 percent, whereas all Gulf economies are forecasted to grow at about 3 percent or higher.

(Continues…)

Excerpted from Gulf Capital & Islamic Financeby Aamir A. Rehman Copyright © 2010 by Aamir A. Rehman. Excerpted by permission of The McGraw-Hill Companies, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.