Capital is the lifeblood of free market economy 

Capital is the lifeblood of free market economy 

Capital is the lifeblood of free market economy 
In recent years, new types of funding vehicles have gained ground, whether REITs or funds set up with public sector participation. (Shutterstock)
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One of the hallmarks of the post-World War II oil-era development model of the Gulf countries was the importance of public sector investment in driving economic progress. This was almost inevitable. The government was the main recipient of oil income and the implementer-in-chief of economic strategies.

However, the unquestioned pre-eminence of government-funded investment has been evolving in recent years as, across the region, policymakers have committed themselves to fiscal consolidation while seeking to stimulate alternative mechanisms for pooling and allocating capital. 

Saudi Arabia has been one of the most proactive regional economies in this regard. It is home to the region’s largest, most diverse stock market, and various new vehicles, whether under the auspices of the Public Investment Fund or other entities, have been set up to drive thematically targeted investments.

These changes are both welcome and necessary. Capital is the lifeblood of the free market economy.

Development requires its efficient pooling and allocation. More than three decades ago, in 1988, Henry Azzam published a book “The Gulf Economies in Transition” where he described the adjustment of the regional countries to the realities of lower oil prices. 

One of his primary focus areas was the importance of pulling non-sovereign sources of capital into development.

He produced a cautious assessment of the prevailing realities: “To attract private capital into the development process, a more sophisticated financial market need(s) to be developed, including the creation of new financial intermediaries, new investment instruments, public efficient stock markets, investment funds, and venture capital companies.”

Much progress has materialized since Azzam’s verdict. Not only did Saudi banks successfully regroup and grow in the closing decades of the 20th century and beyond but the new millennium also saw brisk development in capital markets and insurance. The rise of Tadawul to a globally significant exchange ranks as a major success story. 

Fixed income markets have matured to a significant degree, not least thanks to substantial sovereign issuance. Standardized sukuk structures have contributed dramatically to the process. In recent years, new types of funding vehicles have gained ground, whether REITs or funds set up with public sector participation. The Shareek program is an innovative way for the government to facilitate greater private sector participation in funding development.

But financial markets do not stand still any more than does the broader economy. As the Gulf economies pursue the goals articulated in Saudi Vision 2030 and other comparable roadmaps, financial sector growth and diversification are only increasing in urgency and importance. In many areas, yet more proactive reform is needed to deliver on these ambitions.

For instance, the International Monetary Fund reviewing the Gulf financial markets in 2018 still found that “Institutionalization … is proceeding within the financial sector in many ways as a result of economic growth, rather than as a precursor or foundation of economic growth.” To wit, more prosperous economies are creating the demand for new financing needs while the role of financial market development in driving economic change is less. 

Encouragingly, the GCC regional financial sector is well-positioned to do more. The regional banks are well-capitalized and recent consolidation has beefed up balance sheets. The question is how to further build on this progress in enabling more lending to “new” businesses, especially SMEs, to ensure their growth potential is not constrained by limited access to credit. 

Gulf exchanges have started to see more IPOs but there is an opportunity to push more private companies and innovative funding vehicles to join their number, not least by creating more successful “exits” for startups.

Large businesses are reaping the benefits of fixed income markets but deeper, more diverse local currency issuance is needed to expand the reach further down the value chain. 

Private equity possesses obvious potential — and economic healing power — given the number of disruptions created by the economic challenges of recent years, not to mention the structural opportunity to create more productive businesses. The imposition of value-added tax and other changes are creating a stronger basis for valuations. But the private equity industry remains small.

Finally, there is a massive opportunity to boost the institutional investor universe by stimulating the development of collective saving vehicles. Pension funds, insurers, and mutual funds dominate capital markets in the West.

Gradual steps to diversify pension provision and drive the growth of insurance and personal savings can help their progress also in the Gulf.

These are entities motivated by a fiduciary duty and they have shown themselves to be potent tools of financial market diversification and efficient capital mobilization.

  • Jarmo Kotilaine is an economist and strategist focusing on the Gulf region. He writes on issues ranging from economic development to changes within the corporate sector.
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