It is a widely held myth that Gulf businessmen accumulated their fabulous wealth by using traditional commercial acumen and guile refined over generations. Undoubtedly in a few cases this is true, but most businessmen in the modern, post-oil Gulf made their money less glamorously. For some, the vehicle was land speculation, assisted in no small part by government land sales. Others won government contracts or benefited from government subsidies or cheap loans. Still others developed strong ties with a member of the local royal family and were able to skim off sizable commissions on large contracts. Income distribution programs — government salaries, perks, grants and subsidies — have benefited the majority of Gulf citizens. In most cases of serious individual wealth accumulation, the state budget or ruling family largesse was the source.
Some attribute the frailty of this bourgeois class to its virtual total dependence on the government for income. Forever insecure and knowing no other way to perpetuate its wealth, these pitiable rich languish in what amounts to a form of privileged slavery. Others attribute this condition to a historic compromise made between the royal families and the pre-oil merchant classes, whose original wealth came from pearling and entrepot/caravan trade: The merchants would forgo political participation in exchange for wealth beyond their wildest imagination.
Disempowered it may be, but the historical bargain has left the Gulf business sector splendidly well off. What may be less obvious is that the class is fantastically “liquid” and this liquidity is stored away in the securest of financial centers. The Kuwaitis, for example, would never have survived a day in exile without their overseas private and government accounts. It is precisely for such eventualities that these sums were accumulated overseas.
In the past, Gulf ruling families did not worry much about this overseas asset accumulation by the private sector — they, in fact, adopted the same savings habits. Government planners and technocrats, however, bemoaned the fact that private capital outflows constituted a steady drain on their countries’ balance of payments, precluded any serious long-term domestic private investment and therefore undermined efforts to diversify economies away from oil. But their pronouncements and suggestions for attracting private capital bank into the Gulf emirates were largely ignored in the environment of high oil prices and large financial surpluses of the early 1980s.
The situation became more serious after the 1986 oil price crash, when private outflows accelerated in the face of worsening domestic economic conditions and heightened fears of an Iranian victory on the battlefield against Iraq. The outflows only compounded the effects of the sharp decline in oil export earnings. The respective central banks stepped in to bolster their external accounts, by reducing their own holdings of foreign assets. By 1988, although the deficit in the balance of payments had been reduced, the hemorrhage persisted, and in time threatened to make a serious dent in the various foreign reserves. Saudi Arabia, Bahrain, Oman and Kuwait all attempted to use indirect means to attract private capital back, almost exclusively through the sale of domestic government bonds or treasury instruments. For the most part, this attempt at attracting private capital back home was a failure. Saudi Arabia, for example, ended up selling the bulk of its government bonds to itself (more precisely to autonomous government entities such as the Public Investment Fund and the Social Security Fund). Only a small share went to private commercial banks. This amounted to further depletion of foreign assets. Although the methods differed in the other Gulf emirates, the result was the same: For security reasons the private sector simply did not want to repatriate its foreign funds and hold domestic assets.
Crisis Management
Interestingly enough, the situation improved slightly during 1989 and 1990. Three important factors precipitated a tentative repatriation of private capital: First, the Iran-Iraq war ended, and Iran was no longer perceived as the threat it once was; second, a modest recovery in oil prices and government spending, combined with the need to replace aging buildings and equipment, helped improve business confidence; and third, some of the problems that the domestic financial sector faced in the early 1980s had become less acute. None of the capital flows back into the Gulf fundamentally changed the domestic economies, but they reduced pressures on the balance of payments. This trend came to an abrupt halt in August 1990, when Iraqi forces invaded Kuwait.
In the wake of the invasion, central banks and financial authorities in the Gulf were charged with stemming massive capital flight and stabilizing the banking system. Regional central bankers quickly restored confidence in their currency and banking systems; the arrival of US troops in Saudi Arabia naturally had a lot to do with dampening fears. Private capital did not return in those first months, but businessmen ceased to panic and, in fact, found meeting the material needs of the newly arrived foreign troops, not to mention the numerous civil defense contracts, quite lucrative. Nonetheless, an estimated $15-20 billion (roughly 15 percent of the assets of the collective Gulf monetary system) flowed out of the region in the third quarter of 1990, a fairly sizable hit on government and commercial bank foreign reserves.
The second crisis management task — paying for the war — fell mainly to Saudi Arabia and Kuwait. Including payments to the US and other countries and arms purchases, the Gulf crisis cost the region’s governments well over $50 billion in hard currency, forcing the governments to borrow on the international capital markets and further reduce their external assets. This round of asset depletion appears, at least for now, to be the last one possible, since foreign reserve levels have reached the “bare minimums” required to maintain international confidence in the countries’ currencies. The situation differs from country to country — this is least true in the UAE and Qatar — but generally describes the financial state of the net creditors, Saudi Arabia and Kuwait.
These governments must now tackle the underlying twin economic problems — structural budget deficits and the current account deficits in the balance of payments. To make matters worse, there are domestic pressures to reflate the economies through public spending; domestic (mainly royal family) and foreign pressure to increase arms purchases; and the need to maintain international oil market shares, which necessitates greater expenditures on oil sector expansion plans. Kuwait is additionally burdened with rebuilding the country’s infrastructure.
With all these demands for spending, and given that oil revenues are expected to stay relatively unchanged during the next several years, the governments of the region will continue to face serious budgetary deficits and parallel shortfalls in the external accounts. To finance these deficits, Gulf governments have three choices: Borrow from abroad, borrow from the domestic private sector, or relinquish lucrative sectors of the domestic economy which remain the preserve of the states or the royal family.
Credit Limits
Borrowing from foreign banks has already started. In 1991, the governments of Saudi Arabia and Kuwait together arranged to borrow close to $11 billion from international banks. In 1992, several petrochemical joint ventures owned by the state-controlled oil giant, Saudi Arabian Basic Industries Corporation (SABIC), ARAMCO and its shipping subsidiary, VELA, all tapped international capital markets for medium-term credits totaling about $4 billion. For now international bankers have been willing to lend to such borrowers, but they have a limited appetite for this form of sovereign lending. Most Gulf governments will hit their credit limits fairly rapidly if this magnitude of borrowing continues.
Gulf governments also have the choice of borrowing from the domestic private sector, directly or from commercial banks, depending on the extent to which private companies and individuals repatriate sums and deposit them in banks. Repatriated investments would also reduce pressure on the state budgets to pump-prime the economy.
The age-old problem of how to attract private capital back persists. In Kuwait, the private sector has given a total thumbs down, preferring to keep its money overseas despite the government’s $20 billion private debt write-off. Bahrain is trying everything to attract foreign direct investment from the rest of the Gulf or beyond: from upgrading local infrastructure — including building a new airport and setting up an economic development bank — to allowing 24 hour-a-day broadcasts of CNN and training the local police to smile and say “have a nice day.”
The two countries where private capital has returned in substantial quantities are Saudi Arabia and the UAE. Three factors are responsible. First, a perception that there is little to fear from external or internal threats to political stability — if the US protected Saudis once, the argument goes, it will do so again. Second, with most of the industrialized world in recession, relative rates of return appear to have improved markedly at home. Third, where else can business people find state-of-the-art “first world” infrastructure, access to massive government subsidies (which in Saudi Arabia were recently increased), and access to cheap Third World labor over which the governments maintain strict discipline?
For Saudi Arabia, the return of private capital has gone a long way toward reviving the local construction, retail, trade and financial services industries. In fact, banking shares have fared so well that they have attracted the attention of both the religious police (the mutawwa‘in) and Sheikh bin Baz, chief of the ‘ulama’ in the kingdom, but local investors have largely ignored religious pronouncements against investments in banking shares.
The return of this liquidity has allowed the Saudis to finance yet another large government budget deficit (estimated at 30 billion Saudi riyals), not to mention several large off-budget items such as the 10,000 riyal ($2.7 million) loan to finance the purchase of Tornado fighter planes from the UK. It has also allowed the Saudi Arabian Monetary Agency to rebuild modestly some of its foreign exchange assets.
There are indications, however, that these inflows may not prove sufficient to sustain current income and future rates of growth. It may be necessary for the government to strike partnerships with certain business families to engage them directly in the financing of major projects. Pressure to get involved in these lucrative projects may also be coming from the private sector, which has not had access to mega-projects (and mega-profits) for nearly half a decade.
Some potential for this lies in that most lucrative of all sectors, namely oil, where the government is currently engaged in three expansion plans. ARAMCO intends to increase upstream oil capacity to 10 million barrels a day; SAMAREC intends to upgrade its refining capacity; and ARAMCO has plans to increase captive refining and marketing capacity overseas. Conceivably some portion of these could be opened to the private sector. Recently a company was floated on the Saudi stock exchange which purchased 50 percent of Belgian-Fina’s refinery assets in the US and reportedly received a dedicated crude supply contract from ARAMCO. The government has also been instrumental in gaining access for Nimr Petroleum, owned by the Bin Mahfouz family, in Yemen. Two tentative observations can be made about these developments.
First, the Gulf governments are becoming more dependent on the private sector for financing their operations, and have expanded areas open for investment. Second, elements of the business families are taking a more open interest in the politics of their countries and are acting self-consciously (at least tentatively) as a class. The recent petition to the king signed by Saudi businessmen, technocrats and intellectuals was partly in response to the growing strength of the religious fundamentalists, but it was primarily a call for some opening of the closed political system and some curbs on the excesses of the royal family. Kuwaiti businessmen have been vociferous in their demands for democracy because they feel the royal family is incompetent and has lost its political credibility. Even politically meek Bahraini businessmen recently demanded lower government fees and duties and less royal meddling in their affairs.
Does this mean an end to the historic compromise? It seems unlikely that businessmen really want to see an end to the monarchies (with the possible exception of Kuwait). The royal families and their secret police do control the serious dissidents in their countries (radical Shi‘a in Bahrain and Kuwait, and lower middle-class fundamentalists in Saudi Arabia), and play a fairly effective political brokerage role between the various constituent groups — tribe, clergyman, bureaucrat and so on. But while they may not want to end the deal, if the business class is to provide the funds for future growth in the economy, they want more “rational” economic policies that promote their business interests and, possibly, a say in the budget’s design. More importantly, business wants a curb on royal excesses, whether personal enrichment of individual princes or arbitrary expenditures on pet projects (primarily arms procurement), and less princely meddling in local business.
