Belatedly, Gulf states are realizing that a financial revolution is required - involving governments, regulatory authorities and banks - if the region is to be competitive in a market-driven global economy. There are signs of a readiness to create a regional capital market and to examine the size and role of Arab banks in a world increasingly dominated by massively capitalized financial institutions.
The traditional approach of protected trading markets and closed financial markets is becoming unsustainable because of the revolution in international business. The most recent General Agreement on Tariffs and Trade (Gatt) settlement dealt a blow to those bodies, including the European Union and the Gulf Cooperation Council (GCC), that wanted to establish protected markets. Local bankers say that if the Gulf states wish to diversify their economies away from oil by selling downstream products and industrial goods, they will eventually have to offer reciprocal access to products imported from Europe, the US and Asia.
The GCC states (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE) are no longer capital exporters. The first phase of the region's financial evolution in the late 1970s involved the recycling of petrodollars by international banks; in the next decade this process was increasingly taken over by Arab financial institutions. The challenge now is to attract money into the region.
As Bahrain's finance and national economy minister, Ibrahim Abdul-Karim, notes: "New regional financing needs arise from GCC industrial diversification policies designed to reduce reliance on the energy sector, from GCC budget deficits, from GCC and other Middle East privatization, from Middle East economies undergoing major reconstruction and from rapid growth prospects in the neighbouring subcontinent."
There is no shortage of Arab capital abroad. Arab bankers estimate that Gulf nationals, at least 180,000 of whom are reckoned to be millionaires, hold more than $350 billion in assets overseas. There is also more liquidity in the local market as states, particularly Saudi Arabia, have recently released more funds for government contract payments. But the lack of a developed capital market and tradeable instruments means that private money is either moved rapidly overseas or invested in property. As a result, companies looking to expand have to borrow from international financial institutions rather than through a local market.
Investment by example
Nor will foreign investment fill the gap. According to Abdullah Saudi, now chief executive of ASA Consultants and in the 1980s the creator of Arab Banking Corporation, foreign investors "look at how domestic private - as opposed to public - capital is behaving and, for sure, if they see that local private investors are reluctant to place funds in local markets, then they are hardly going to do so either. Until we can persuade Gulf nationals to invest more locally, we shall have difficulties in attracting foreign capital as well".
There is growing acceptance that the Gulf must create its own market in which shares and other financial instruments, such as bonds, can be traded, and that there must be a more flexible approach to foreign participation. That will require a break with present practice whereby regulatory authorities, particularly in Saudi Arabia, have been reluctant to allow local companies to be controlled by outside investors or become vulnerable to stock markets outside the country.
"The trouble with the Saudis is that they are control freaks," says one Arab banker. Another says that "the Saudis must start to accept that security does not come from 100% ownership".
Abdullah Saudi, a long-time critic of the Arab world's slowness in coming to terms with global change, says that despite having established modern industrial states by investing oil money, the Gulf states' economies have not been able to cope with rapid change in international markets.
Says Saudi: "The state still has a prominent role in the provision of basic services (power, telephones, transport, housing); privatization has barely had an impact; VAT [value-added tax] and income tax do not figure as the major contributors to state revenue; economic activity in the private sector continues in large part to be generated by subsidized inputs; and the labour force is still heavily distorted in favour of cheap foreign labour (which spends little locally) while increasingly young nationals find it difficult to find jobs."
That assessment is possibly too bleak, say regional and expatriate bankers in Bahrain. There are signs of a willingness to confront the new challenges, particularly in Bahrain, whose future prosperity depends on greater Gulf cooperation.
Even in Saudi Arabia, there is a readiness to open up the market - the region's most closed. Bankers consider it significant that the government has decided to approve a closed-end fund to be established for investment in the still unofficial Saudi stock market. Further liberalization could be proposed by a committee consisting of the Saudi Arabian Monetary Agency (Sama), the commerce ministry and the finance ministry that is looking at the operation of the financial market.
In addition, says a Saudi Arabian banker: "Attitudes in Riyadh are changing. But they have to make up their minds whether to ask a company like Saudi Arabian Basic Industries (Sabic) to go for bonds. This would benefit them as it is a cheaper and more flexible instrument and would help create a regional market. The world is hungry for this type of paper."
One western offshore banker says: "The Saudi government is concerned about the lack of general liquidity in the corporate market, the lack of stock market instruments and the lack of development of their stock exchange. Everyone is telling them they have to deregulate and allow foreign ownership if they really want the boost to industrial growth that will bring jobs."
The ambition of Fawzi Behzad, director of the Bahrain Stock Exchange, is to have Saudi shares - potentially worth $60 billion - quoted on a Gulf-wide exchange. He has agreements to link the exchange with those of Egypt, Jordan, Kuwait and Oman, creating a Gulf market of 70 companies with a $25 billion capitalization. But Saudi involvement would be the jewel in the crown. "We want to bring all the markets together and create one large regional one. That will encourage local investment and persuade foreign investors to come in," he says.