Ten years ago, a recommendation to invest in the Middle East would have produced more laughter than money. At that time, the Amman Financial Market (AFM) was the only effectively-constituted equity market in the Arab world. In the region as whole only Turkey was open to foreign investors.

A similar recommendation this time last year should have been taken much more seriously. For Middle East equity markets generally performed as well as any in the world in 1997. In some instances, the appreciation in equity values and growth in turnover was startling.

The 17 markets monitored weekly by meedmoney recorded an average dollar- adjusted gain, weighted by market capitalisation, of more than 43 per cent in the year. Share trading rose sharply across the region to about $150,000 million, more than 70 per cent above the figure recorded in 1996. This gives an average daily trading figure of more than $600 million.

These figures suggest that Middle East markets should be attracting growing attention from market-makers and investors. The returns have been handsome and the security trading business is growing rapidly. These trends should persist.

Yet, the region continues to tantalise investors rather than encourage serious capital inflows. There are several reasons why. The Middle East does not constitute a single market, not even to the limited extent that the bourses of South America do. Israel, Pakistan and Turkey are often not even considered to be part of the Middle East by many investors. Most of the other countries in the region are influenced by oil market trends, but not uniformly. Trading regulations vary considerably, while some Middle East markets are closed to non-national investors.

Attitudes to the region are still influenced by politics. Investors either invest in Israel or in the Arab world, rarely both. Egypt, which has developed dramatically in the past three years, frightens some because of the activities of violent Islamist groups. Iran, the most heavily populated Middle East country, is ruled out by investors as a matter of principle.

For some adventurous investors, these factors make the region even more attractive. Because the companies of the region are little-known and difficult to track, let alone invest in, determined early buyers have been able to build up positions in Middle East markets ahead of the competition.

But this offers small comfort to the countries of the region which desperately need to be taken seriously by mainstream portfolio investors - not just the adventurers. It is estimated that the Middle East will need at least $250,000 million to finance infrastructure projects alone in the next 25 years. This figure is well beyond what domestic investors will be able to raise. The Middle East will have to look outside for finance and at least a portion of this will have to come from equity investors.

Image problem

To optimise foreign portfolio flows, a host of factors will have to change. The most difficult to tackle will be the region's international image. There is little prospect of dramatic progress in the Arab-Israeli peace process; Iraq will continue to be seen as a threat while President Saddam Hussein remains in power and it will take years for US investors to overcome their distaste for Iran.

In these circumstances, any negative political developments will be nothing short of disastrous for local share markets. The challenge for national governments is to convey to the outside world that the real dangers are minimal, and to advertise the considerable progress made in stabilising and modernising the economies of the region.

At a more detailed level, stock exchange authorities will have to press ahead with greater conviction with appropriate market reforms to make it easier for foreigners to buy equities. Leading this process are Egypt, Morocco and Oman. All three markets have tangibly benefited from foreign portfolio flows and set an example that is encouraging a process of deregulation across the region.

Attitudes will also have to change within quoted companies. Many are now better at issuing regular financial statements, but in most countries there are still far too many firms that hesitate to publish timely and complete balance sheets and profit and loss figures. Inconsistencies in the way financial statements are presented do little to encourage long- term investors, while favouring those with access to insider information. Part of the solution is the development of credible intermediaries who can secure accurate information and briefings, enabling them to analyse quoted companies intelligently. This is happening, but too slowly.

The number and range of quoted companies needs to grow. In the GCC, where the most valuable firms are listed and share trading more than doubled in 1997, banks are still massively over-represented on stock exchanges. Service companies tend to be weak. Manufacturing firms, with the exception of cement companies, are few and far between. That explains why advocates of economic and financial reform are pressing for an acceleration of Middle East privatisation programmes. A high proportion of the more attractive firms in the region are still state-owned.

Attitudes will also have to change within private firms. In the West, going public is seen as the culmination of years of careful development which allows owners to access the wealth they have built up in their firms. In the Middle East, and particularly in the Gulf, selling shares in private firms is seen as a defeat - evidence that the owners, often tight-knit families, are incapable of running their own businesses.

Not ready to cope

At times, it seems the Middle East is seeking cost-free access to long- term economic development. Governments and the business elite are intellectually convinced by the case for developing more active equity markets, but fear some of the consequences. They seek quicker private sector development, growth in employment and productivity, sounder government finances and greater dynamism in the economy as a whole.

However, the shift to free capital markets will also open the door to hostile take-over bids, speculative arbitraging, job cuts and greater foreign involvement in domestic affairs. Many in government and at the top of business are simply not ready to cope with the full implications of lively equity markets.

And yet the trend towards equity market reform in the Middle East seems inexorable. Ten years from now, stock market turnover across the region will be several times larger. A growing proportion of domestic savers will consider equities as a way of storing up wealth for the future. And foreigners will have been able to acquire major stakes in most if not all the economies of the region.

So the question to be answered is not whether a stock market revolution will sweep across the Middle East. The question is how long it will take to be completed and how the people of the region will cope with the new world it creates.

IMPROVED investor sentiment helped the Bahrain Stock Exchange (BSE) all- share index rise by 49 per cent in 1997. Total turnover for the year increased by 170 per cent to BD 177 million ($480 million), with a weekly average of BD 3.4 million ($9.1 million) worth of shares changing hands.

Offshore banks lead the market, logging solid gains on the back of strong earnings growth. Shares in Bahrain Middle East Bank and United Gulf Bank appreciated by more than 100 per cent in 1997.

A new director and board at the BSE, appointed in May 1997, have begun to introduce reforms aimed at improving efficiency and transparency. The development of a computerised trading system to replace the existing manual one is also under study.

In December, the bourse signed a cross-trading agreement with the Kuwait Stock Exchange (KSE), enabling Bahraini investors to trade in Kuwaiti stocks through their local brokers and vice versa. The BSE is expected to benefit from the greater level of activity on the KSE. Non-resident foreign investors are allowed access to only five banking stocks and Arab Insurance Group, although a relaxation of these regulations is expected in the near future.

THE past 18 months have seen a dramatic change of fortune for the Egyptian Stock Exchange (ESE), the fourth largest bourse in the Arab world. A bull- run that began in the summer of 1996, ending in February last year, pushed the market up 150 per cent.

However, the correction over the last 12 months, exacerbated by the massacre of 58 tourists in Luxor last November, has tarnished Egypt's image and dragged the ESE down to its lowest level for about a year. The ESE index rose 23.3 per cent in 1997.

The market is fully open to foreign investors, who are estimated to have bought shares worth $1,300 million in 1997 - 6 per cent of market capitalisation. Net foreign portfolio inflows are put at about $700 million following a wave of selling in the wake of Luxor. Only about 60 of the 650 companies listed are actively traded.

The slump in prices means that the ESE is now cheaper than most Middle East markets, trading at a prospective price-earnings (PE) ratio of about 11.

The sale by the government this February of a stake in Egyptian Aluminium Company - which will be the fourth largest company

on the ESE with a market capitalisation

of £E 3,000 million ($882 million) - is

evidence of the government's continuing

commitment to privatisation and should lend support to the country's primary market.

MOST of the 255 stocks listed on the Tehran Stock Exchange (TSE) are either industrial companies or investment companies with significant holdings in the industrial sector. Turnover is relatively subdued, with average weekly trading in shares worth IR 20,765 million ($6.9 million).

The TSE was the best-performing Middle East stock market in 1995, but began a gradual decline in late 1996 and ended 1997 down 17 per cent on the year. The slide was accentuated by a tight monetary policy which obliged cash-strapped companies to raise capital on the TSE, leading to an oversupply of stocks. Investors deserted the market in favour of the higher returns to be had from the money markets and property.

The TSE management, under a recently appointed director, is developing reforms to tighten regulations and improve transparency, which should help restore investor confidence. Meanwhile, analysts are optimistic that the economic policy of President Khatami's government will favour the industrial sector, which should have a positive knock-on effect on the TSE.

While foreign investors are officially permitted access to the TSE, the repatriation of any gains is difficult. However, some international institutional investors are understood to have begun to invest in the bourse in anticipation of a relaxation of the restrictions and an upturn in the market.

THE Kuwait Stock Exchange (KSE) is the second largest bourse in the Arab world after Saudi Arabia with a market capitalisation of more than $28,000 million. It has 75 stocks, 10 of which are from other GCC countries. The market's eight banks dominate the market in terms of value, accounting for more than 10 per cent of total market capitalisation.

The KSE was the third best-performing market in the GCC in 1997 with a gain of 39.2 per cent. Historically, it has been the most active bourse in the Arab region, with daily turnover averaging $136 million in 1997. GCC investors are allowed to trade on the KSE and other outside investors are expected to be allowed to start investing from this year, possibly through a specially designed fund along the lines of those launched in Saudi Arabia and the UAE.

Kuwaitis have shown remarkable zest for equities trading, so much so that in 1997 the central bank was forced to act to stop margin lending for fear that the market would overheat. Excessive enthusiasm has caused difficulty before, most spectacularly in the collapse in 1982 of a parallel share market, the Suq al-Manakh, with losses totalling billions of dollars. There is talk that margin loans could be reintroduced this year to boost uncharacteristically low volumes.

Prices have also been depressed this year as real estate companies and banks, which led the rise in 1997, have begun to soften.

THE Beirut Stock Exchange (BSE) reopened in January 1996 after a 13-year closure and now lists eight banks and companies with a total market capitalisation of $3,511 million. The majority of the stocks traded on the bourse before its closure have yet to conform to the new listing requirements.

Trading volume has risen rapidly since the listing of three banks in late 1996 and early 1997, and the two indexes that track the market made strong gains in 1997 on the back of the sharp appreciation of the new listings. Several other companies and banks are expected to list early this year.

The market is dominated by Solidere, the real estate company which is redeveloping the Beirut Central District. Solidere shares alone account for 72 per cent of total market capitalisation. Since October 1997, the company's shares have been open to all investors, although a single shareholder may own no more than 10 per cent of the stock. The issue of global depository receipts by Solidere and a number of local banks has helped draw attention to Lebanese equities, analysts say.

THE Casablanca Stock Exchange (CSE) has come on in leaps and bounds over the last two years, due largely to the activity of local mutual funds which have pumped cash into the 48 shares listed on the bourse. However, most stocks are now overvalued as a result and earnings growth, while good, has some catching up to do.

For foreign investors - who are free to invest in the CSE - there are more attractive pickings to be made elsewhere in the region and most are content to hold their positions without putting any new money into the bourse.

The market suffers from a lack of liquidity, another deterrent to international investors, which has exacerbated the pressure on share prices. But a nationwide roadshow, launched by the bourse at the end of last year to encourage more private companies to offer shares to the public. is expected to lead to a significant improvement in the availability of paper.

The bourse is also in the process of moving to fully automated trading and setting up a central depositary to increase efficiency and transparency.

THE fourth largest exchange in the GCC, the Muscat Securities Market (MSM) had a market capitalisation of $8,736 million at the end of 1997. Established in 1989, the MSM boasts 121 stocks on the regular market, which lists established companies, and the parallel market, where new companies are listed.

Although the MSM is the most open market in the GCC, the holdings of non-Omani investors are negligible. Most companies allow non-nationals to own up to 49 per cent of their capital, but only about 15 companies currently have foreign participation of more than 10 per cent.

Local investors are the driving force behind the market and have shown an insatiable appetite for equities, pushing the general index up 141 per cent last year. This ranks the MSM as the best-performing emerging market in the world in 1997.

The primary market is one of the most active anywhere in the developing world, with public offerings by new companies worth $468 million in 1997. Banking and investment stocks led the rise last year, but some industrial and services companies are expected to perform well in 1998.

The market is considered expensive in comparison to its Middle East peers, trading at a price-earnings (PE) ratio of about 16, based on 1997 earnings.

THE Doha Securities Market (DSM) was launched in May 1997. It lists 18 banks and companies, most of which were previously traded on the informal over- the-counter market. Qatar National Bank is the most valuable stock, accounting for more than 40 per cent of the total market capitalisation of

QR 9,902 million ($2,720 million). Weekly turnover averages QR 8.4 million ($2.3 million).

The market is open only to Qatari nationals, but brokers expect a mutual fund to be launched this year or early in 1999 that will offer non-Qataris indirect access to the bourse.

Direct investment by non-Qatari GCC investors is expected to be permitted within a few years, followed ultimately by non-GCC nationals.

The DSM is located in the Al-Khaleej Insurance Company building. The second phase of the development of the bourse, due to be implemented by 2000, will involve the relocation of the market to a purpose-built exchange and the replacement of the current floor-based trading system with a computerised system.

WITH a capitalisation of about SR 218,750 million ($58,300 million), the Saudi Arabian share market is by far the most valuable in the Middle East. Trade is conducted through 11 local banks via the Electronic Securities Information System (ESIS), which is regulated by the Saudi Arabian Monetary Agency (SAMA - central bank). Analysts say the market is efficient, transparent and well-regulated.

Turnover is increasing, with shares worth SR 62,060 million ($16,549 million) changing hands in 1997, an increase of 144 per cent on 1996. But this is low in relation to the size of the market. Analysts say this is due in part to the extent of government ownership of quoted shares, which is estimated to account for about 25 per cent.

Bank stocks dominate trade, with Riyad Bank accounting for the highest percentage of turnover. Saudi Basic Industries Corporation (Sabic) is the most heavily capitalised entity, accounting for 21 per cent of the total market.

While GCC nationals are allowed limited direct access to Saudi equities, the only means for non-GCC investors to participate is through the closed- end Saudi Arabia Investment Fund (SAIF), launched in June 1997 by Saudi American Bank. The launch of similar funds is expected in 1998 as the government takes further cautious steps towards liberalising the market.

THE Tunis bourse has had a tough two years. The market has failed to find direction since the end of 1995, when a remarkable rise made it one of the region's star

performers.

Behind the decline is an electronic trading system introduced in late 1996 which makes it impossible for the broking subsidiaries of the big banks to continue to prop up share prices.

Many stocks are now trading 50 per cent below their 1995 levels, causing a slump in market capitalisation to around only $2,600 million. Local investors who fuelled the earlier rise in the market have since abandoned it in droves. Without them, a serious recovery of the market is not expected.

Although prices are now low and the foreign ownership ceiling of listed stocks, at 50 per cent, is relatively high, international investors are not flooding in. They want to see an active base of local investors who will sustain any upward price moves.

The market suffers from another structural weakness - being small and offering only a limited choice of stocks. Thirteen of the 33 listed companies are banks and many of them are in poor financial health.

Hopes for the months ahead are riding on a new privatisation drive by the government and a number of listings by privately-owned firms. If they materialise, these new launches could stir domestic retail investors back into action.

THE Istanbul Stock Exchange (ISE) is one of the most active and efficient bourses in the region, but also one of the most volatile. Foreign investors have to be fully prepared for the risks.

Market performance is heavily influenced by Turkey's unstable politics and erratic economic progress. Daily gains or losses of as much as 10 per cent are not uncommon.

Privatisation expectations also play a big role in driving the market. The impending sale of a 12.3 per cent stake in Is Bankasi, a leading bank, has led to gains of 400 per cent in the bank's shares. Hopes for the divestment of giant enterprises such as Petkim, Tupras and Erdemir have had a

similar effect on their stocks.

Despite the machinations of the country's political leaders, businesses have continued to thrive. Many of the 200 companies listed on the exchange have excellent fundamentals, particularly banks, manufacturers of consumer durables and holding companies.

The primary market is also active, with some 29 initial public offerings in 1997. This year, a number of firms are expected to launch international equity issues, Garanti Bankasi and Finansbank among them.

THE UAE is now the only GCC state without a formal stock exchange, and the over-the-counter market remains handicapped by a lack of transparency and inadequate trading regulations. The share prices quoted by brokers tend to be inconsistent, and accurate trading data is hard to come by.

The market is tracked by two indexes. The Emirates Bank Group (EBG) EMNEX, launched in 1997, covers 34 stocks with a market capitalisation of AED 95,560 million ($260,017 million). The rival National Bank of Abu Dhabi (NBAD) index covers 27 stocks. Emirates Telecommunications Corporation (Etisalat) is the most valuable traded stock, with a market capitalisation of AED 33,267 million ($9,057 million).

Foreign investors are not permitted to invest directly in UAE equities, but can gain indirect access through the Emirates Equity Fund, which was launched by EBG in June 1997.

Four well-received initial public offerings in 1997 were heavily oversubscribed and at least eight more are expected in 1998. However, the lack of a formal stock exchange is deterring family-owned enterprises from going public, and the situation is unlikely to change until late 1998 at the earliest.