GULF COOPERATION COUNCIL STOCK MARKETS SINCE SEPTEMBER 11

Middle East Policy, Spring 2008 by Hakim, Sam R

Despite many economic and social features that bind their economies, the Middle Eastern countries are remarkably diverse. Their economic heterogeneity is a reflection of unequal natural-resource endowments, with a few economies in the region subject to enormous swings in growth resulting from commodity price shocks. In some countries, regional conflicts and instability pose significant challenges and exert tremendous pressure on the population and its welfare. In others, differing economic trends reflect the very divergent paths countries in the region have taken towards economic liberalization and integration. Other signs of disparity are evident in economic freedom, political rights and civil liberties.2

During the past five years, the rapid rise in oil prices has fundamentally changed the economics of countries in the Middle East. At the end of June 2007, oil prices continued to climb due to international tensions over Iran's nuclear program, instability in Iraq, and other geopolitical concerns amid a tight market with limited excess oil-production capacity. In December 2007, the price for crude oil broke through the psychological barrier of $100 per barrel, marking the third consecutive year that the average price for oil exceeded its previous all-time high.

In Saudi Arabia, the economic boom is in its fourth consecutive year, with 2006 registering record oil revenues, and record trade and budget surpluses in an environment marked by moderate but rising inflation. The economic cycle appears to be in its early stages. With the term structure of future oil prices relatively flat through 2015, Saudi oil revenues will continue to grow for many more years. Coupled with a government fiscal position that can support growth, and mega-projects just getting underway, there are clear signs that Saudi Arabia is at the beginning of an economic boom not seen since their golden age of the early 1980s. Table 1 provides the main economic indicators between 1999-2004.

Against this backdrop, the two most important themes for the region's financial markets are (1) the impact of the war on terror and (2) rising oil-export revenues and their impact on the local stock markets.

CAPITAL MOVEMENTS SINCE 9/11

Private capital inflows to the Middle East region remain very subdued compared with the strong capital inflows occurring worldwide. Middle East portfolio-equity flows were visibly affected by events following September 11, turning down markedly over 2001-02 before posting a moderate recovery in 2003. Net portfolio-equity flows for developing economies in the Middle East shifted from an average inflow of $365 million over 1998-2000 to an average net outflow of $175 million over 2001-02, recovering to net inflows again of about $100 million in 2003. As a share of total portfolio equity flows to developing countries, the proportion captured by Middle Eastern countries was significantly reduced, averaging about 0.4 percent of world equity flows in 2003, compared with 3.4 percent over 1998-2000.

Net foreign direct investment (FDI) inflows, in comparison, have remained largely stable, reflecting the longer-term nature of the investments. Although the share of world FDI toward developing economies captured by the Middle East region has weakened compared with its performance during the early 1990s, the region has exhibited a slight improvement in recent years. In 2003, the Middle East region captured approximately 3.1 percent of all FDI directed to developing countries, up from less than 2 percent over 1998-99.

REGIONAL IMPACT OF 9/11

Since September 11, an important development in the Middle East region has been the increased strengthening of intraregional ties, seen in financial flows and tourism, and, to a lesser extent, intraregional trade flows. Investment flows originating in the Middle East largely backed out of U.S. assets over 2001-03, in part as managers of burgeoning international reserve positions for the key Middle East oil exporters sought returns in alternative markets and currencies.

The largest overall shift in financial flows was the apparent withdrawal by the region's major oil exporters from investment in U.S. assets between 2001 and 2003 (Table 2). Prior to 2001, the Middle East oil exporters were investing between $18 billion and $25 billion per year in a mix of U.S. government securities (treasuries and agency bonds) and U.S. corporate securities (bonds and equities), while channeling substantial funds through the U.S. commercial banking system, as well as U.S. commercial concerns. However, 2001 saw a net withdrawal of some $4.3 billion in commercial and banking flows, followed in 2002 and 2003 by substantial sales of U.S. long-term securities. By 2004, the proportion of deposits held in dollars declined to 61.5 percent, from 75 percent in the third quarter of 2001.3

While some of these assets may have been shifted to other parts of the world, the Middle East region also appears to be a strong net beneficiary, experiencing a sharp rise in real estate and equity prices. In 2004, the stock markets in the Middle East began a long ascent, with strongest performance in Egypt and Saudi Arabia. Steeply rising markets have presented a lucrative opportunity for Gulf investors to diversify portfolios closer to home, creating a virtuous circle and fueling much of the stock-market rise. Gulf investment in the Jordanian stock market, for example, now accounts for over 20 percent of the traded volume. Gulf investors also have been active in the Cairo Stock Exchange, where the devaluation of the pound has made Egyptian stocks cheaper to acquire. Table 3 indicates GCC economic prowess in 2006.