Reality check for Gulf capital markets

27 October 2008
Fund managers believed GCC stock exchanges were not correlated with Western bourses. The drop in the indices of Gulf markets, as the financial crisis in the US and Europe spread, shows just how wrong they were.

Since 10 September, practically every assumption made by those buying and selling shares for a living has been shattered. One is the belief that GCC equity markets are not correlated to Western ones. Since then, the indices of every market in the region have fallen in line with trends in New York and London.

The wild volatility of the region's markets had already been accepted by champions of Gulf equities. It is best expressed in trends in the Saudi Arabian Stock Exchange (Tadawul), the largest in the region.

The Tadawul All Share Index (Tasi) rose to about 20,000 at the start of 2006 but was below 7,000 at the end of January 2007. Twelve months later it rebounded by more than 60 per cent to 11,900. The index is now more than 44 per cent below where it began the year.

Volatility is a characteristic of emerging or frontier equity markets. It goes with the territory. But if the trend mirrors that in Western exchanges, why should anyone bother investing in them? It is a question for which the GCC has no immediate answer.

Insane volatility

Almost 20 years since GCC countries opened stock exchanges as part of the process of promoting private investment, the region's capital markets have behaved exactly the way critics said they would. Insane volatility and share price levels not remotely related to sensible valuations have turned them into cockpits for speculators.

MEED's Middle East Capital Markets 2008 conference in Dubai last week was a time to take stock of how wrong things had gone for global finance and GCC stock exchanges in the past six weeks. Delegates were searching for answers, a glimpse of certainty in a world that no longer made sense.

There was, perhaps, comfort in numbers. Asked whether they thought the worst was over for GCC equities, only 60 per cent said no. Three-quarters said more pain was coming in other markets.

There are two reasons why the gloom is less intense in the Gulf.

Looking east

One is that the GCC is largely decoupled from the international banking system. The UAE (formally) and Saudi Arabia (in effect) have guaranteed the liabilities of their banking systems.

The second is that the GCC as a whole, and Kuwait, Qatar, Saudi Arabia and the UAE in particular, has huge savings and reassuringly high current account and balance of payments surpluses. Investors desperate for places to generate returns are looking to China and India. But the GCC is probably their favourite place because of its robust financial condition.

This may be welcome news to those in GCC markets who have lost their shirts in 2008. They hope that foreign money leaving advanced economies will now start flowing into the Middle East. This, sadly, is one reason why a sustained GCC equity rally is unlikely in the short term. Every time prices are bid up, existing investors are dumping their holdings and sending the market immediately down again.

So it may be time for a profound reappraisal of the role that stock exchanges play in GCC economies. They exist to serve two purposes, neither of which is being achieved. One is to provide an alternative source of long-term capital for GCC companies. The other is to spread wealth to the wider community. Companies going public priced their shares at low levels to allow small investors quick capital gains.

Losing value

But no company would choose to float in a market that can slash its market value for no good reason. And most of the distributional benefits flowing from early low price share sales have dissipated. Small investors tend to lose more often than big ones. Large investors, consequently, are cornering the equity markets of the GCC and getting relatively richer at the same time.

There are better ways of spreading income than through initial public offerings (IPOs). But stock markets serve a broad economic purpose. They should now get back to basics. It is time to get the irrational retail investor out of Gulf exchanges.

Small investors should be obliged to sell their holdings to authorised large ones at an incentive price. The large investors should be obliged to act responsibly as market-makers, buying and selling shares to ensure price stability. Retail investor access to the market would be restricted to investing in collective saving vehicles, for five years at least.

Reversing the direction of GCC stock exchanges might appear shocking. But nothing could be worse for the reputation of the region's capital markets than yet more of what has happened in the past three years.

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