Gulf States: Opacity blights outlook for economy

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An Oxford Analytica In-depth Analysis
Subject: Transparency deficits in Gulf public and private sectors.  

Significance: In terms of fiscal resources and the government's role in the economy, the Gulf monarchies have been better equipped to ride out the crisis than most other developed economies. However, to the extent that the region has been affected by the crisis, this has most of all been due to institutional weaknesses and a dearth of market and regulatory information that has been much more significant in the Gulf than in other comparably rich economies. 

Analysis: International investors have cast a critical eye not only on Dubai, but also on its neighbours, where the global financial crisis has revealed less spectacular, but nonetheless substantive issues of weak regulation and lack of transparency.

This has triggered a number of efforts to improve governance in both public and private sectors. The track record thus far is uneven: the informal and patriarchal management culture of the region has undermined attempts to improve transparency on a sustained basis. However, lack of transparency will have long-term consequences for the Gulf Cooperation Council (GCC) diversification process and the quality and stability of investments in the region.

GCC data. Transparency implies regular and reliable disclosure of information on decision-making mechanisms, administrative procedures, and resource allocation within organisations, whether public or private. There is no direct measure of government and business transparency per se, and other measures that have at least some bearing on it are at least in part based on subjective assessments. Nonetheless, available indicators allow for some useful broad-brush comparisons that situate the GCC in the global context:

Corruption. The corruption perceptions index of Transparency International ranks countries according to how corrupt their governments are perceived to be by expert interviewees. The GCC monarchies score fairly well among the total set of 180 countries included in the survey, and constitute the leading sub-region in the wider Middle East. However, higher GDP per capita usually correlates with lower levels of corruption; so the GCC states should mostly rank together with advanced OECD economies. In fact, they trail most of the OECD. Their corruption problems might be less severe than those of many other countries in the world, but are bigger than one would expect given their economic resources.

Efficiency. The World Bank's measure for 'government efficiency', another indicator that is closely correlated with GDP per capita, shows a similar picture. In contrast to most other oil-rich rentier countries, most of the GCC scores clearly above the median level of efficiency. Yet Gulf monarchies score considerably below the average correlation of efficiency and per capita income. While their bureaucracies function reasonably well in international comparison, they are not in very good shape relative to the public resources they have to administer and the size of the private economies they need to regulate.

Transparency. More specific indicators that bear directly on information availability are provided in the World Economic Forum's Global Competitiveness Report, which ranks "transparency of government policymaking" and "strength of auditing and reporting standards", the latter of which is best seen as an indicator for private sector transparency. Both are based on subjective expert assessments. Although the indicators do not pick up all aspects of transparency, the general pattern is repeated here: overall, transparency scorings are lower than the scores for the general competitiveness of GCC economies.

Observable traits. Beyond generic grades and rankings, whose validity and interpretation can be questioned, a number of concrete governance deficits compared to more mature markets can be observed:

Budget and performance data. National budget data, as well as other data on government performance and internal structure, are shared only to a limited extent, particularly in more authoritarian countries such as Saudi Arabia, Qatar and the United Arab Emirates (UAE). International ratings agencies explicitly refuse to give GCC countries the highest sovereign grades due to unavailability of crucial financial information. While contracting procedures have become more open and competitive at some public agencies, opacity remains severe in the security realm and in institutions controlled by ruling family members.

Decision-making. Political decision-making is opaque, with sheikhs and their private advisers making most major policy decisions, often cutting even the majority of ministers out of the picture. While such centralisation can make for swift decision-making, it can also lead to badly informed decisions and sudden policy reversals. The technocracy in most GCC countries has matured and more consultation on economic regulation is taking place, but last-minute policy shifts still happen.

Laws and regulations. Ministerial and administrative decisions that affect the concrete application of national laws are often badly communicated. Interpretations of bylaws can change when the bureaucrat in charge is replaced, and ministerial circulars defining documentation and other requirements for licensing and permit procedures often remain unpublished. A well-functioning central depository for official rules and regulations does not exist in any of the GCC countries.

Disclosure. In the private sector, traditions of financial disclosure are still weak. Many companies are unwilling to share their books even with their own banks, book-keeping standards are often sloppy and the (relatively few) companies that are publicly listed usually disclose only the minimal financial data strictly required by stock market regulators. Dozens of them regularly submit their quarterly and annual reports too late. Insider trading is still rampant on GCC bourses, and foreign institutional investors -- usually the strongest lobbyists for disclosure and accountability -- largely avoid the region. More generally, company strategies and governance structures are often opaque, with the function and competence of boards as well as the business-owning families' precise managerial role unclear.

These transparency issues are not unlike those in many other emerging markets. Yet the latter tend to be generally poorer economies that also suffer from other issues -- in terms of infrastructure, the depth of local capital resources, political and economic stability and so on -- that are less acute in the Gulf. In the GCC, institutional and transparency issues stand out as an economic development challenge of an otherwise fairly advanced region.

Low pressure for disclosure. Modern economic development in the GCC set in during the 1970s, giving the region limited time to catch up with global standards of management and governance. By default, the organisational culture in both public and private sectors remains secretive and, in many ways, family-oriented.

The primary political cause for lack of transparency is that there has been little bottom-up pressure for accountability. Gulf governments have been built by elites endowed with externally provided rents, considerable amounts of which are deployed to build networks of patronage.

These elites have also used a good share of resources to build effective technocratic bodies to lead local industrialisation and financial market development, but even those pockets of efficiency are often very cagey in their information policies, as they remain oriented towards their patrons rather than business or the public. Saudi Arabia's industrial and oil sector champions SABIC and Saudi Aramco for example are by most accounts well managed, but pursue a highly defensive information policy.

GCC businesses have on occasion pressured for more accountable governance and disclosure of government data. However, generally, business organisations such as chambers of commerce remain reactive rather than proactive players and their lobbying ad hoc in nature. Civil society itself more broadly remains weak or, where it is organised, not primarily interested in transparency issues; a recent parliamentary bill in Bahrain that will force senior government officials to declare their assets is an exception. Trust between bureaucracy and society remains fairly low and both sides are reluctant to share information with each other.

Moreover, the general shareholding culture on financial markets is weak and much investment remains short-term and speculative; research capacities of local investment firms are limited. Stock exchanges in the region are young, most of them only created during the last two decades, and only recently has there been a stronger top-down push towards capital markets governance.

These political and institutional factors are unlikely to change fundamentally after the crisis. The most dynamic area, in relative terms, probably will be private business governance, where pressure from investors and banks will gradually impose more systematic standards of disclosure.

Private sector crisis impact. The controversy surrounding the Saad and Al-Gosaibi family groups in Saudi Arabia has demonstrated the problems of private sector opacity in the GCC. After an inter-family fallout last year, the two groups have defaulted on large local and international loans, remain entangled in mutual lawsuits, and have not even been capable of clarifying who was the managing director of a (now defunct) major Al-Gosaibi-related bank in Bahrain. GCC banks' practice of 'name lending' -- giving loans on the basis of family reputation rather than an examination of company books -- has led to defaults and solvency problems for other large GCC businesses.

Non-performing loans of Gulf lenders have increased from less than 3% to more than 5% of total loans in 2009. They will be considerably more prudent for many years to come, requiring access to company books and the presentation of clear business plans. Many GCC businesses with an interest in expansion will hence have to become more transparent at least vis-a-vis their lenders. Not all will be willing to do so, which could lead to a gradual emergence of two tiers in the private sector: traditional family-based conglomerates on the one hand and more modern, outward-looking companies with more clearly defined governance structures and a clearer sectoral focus on the other.

On Gulf stock markets, an increase in new listings is expected this year and next, exposing more businesses to the scrutiny of investors. Although the latter are often still fairly undiscerning, stock market regulators have increased the pressure for timely and complete disclosure and against insider trading. In Saudi Arabia, numerous companies and traders have been sanctioned for infractions, including at least one member of the royal family. However, as long as broad pressure for better disclosure remains weak, regulators by themselves will be hard put to change the GCC corporate culture.

Public sector crisis impact. Although the crisis has exposed major governance and transparency problems in GCC governments, attempts to improve the quality of disclosure procedures in the public sector have been somewhat desultory.

Dubai is currently reorganising its troubled state-owned enterprises through reshuffles of senior management and consolidation of its fragmented holding structures. However, decision-making on the process remains opaque, and financial information on public assets in Dubai remains largely unavailable -- with a few well-established exceptions such as Emirates Airlines or Emaar, whose accounts have been published and audited for many years.

Information on national budgets has hardly improved thus far; in Saudi Arabia, the only data on actual national spending that is available are two gross figures on total capital and current spending issued towards the end of the budget year in December. The country shares last place with Rwanda and Sao Tome in the Open Budget Initiative's ranking of 88 countries on budgetary transparency.

GCC sovereign wealth funds (SWFs) have made modest attempts to increase their transparency, most notably the Abu Dhabi Investment Authority, which this year disclosed information on its general strategy, asset composition and returns but without revealing its total holdings or details on specific assets. In an apparent attempt to gain international investors' confidence, Abu Dhabi state holding company Mubadala issued its first detailed audited accounts in spring 2009. However, the only major SWF giving a precise figure for its total holdings is the Saudi Arabian Monetary Agency, a practice that again predates the crisis.

GCC public sectors have seen a number of well-publicised anti-corruption moves, but the investigations have mostly involved bureaucrats rather than political actors -- most recently a number of public notary officials in Saudi Arabia involved with falsifying property deeds. Investigations themselves remain shrouded in secrecy. Meanwhile, GCC governments are trying to enhance the capacity of their financial market and real estate regulators, creating new licensing mechanisms for market actors and new mechanisms to gather and disclose information about market transactions and price developments. It is probably in these areas that the most progress has been made since the onset of the crisis.

Outlook. In the GCC, pressure towards transparency and disclosure is often international rather than local in origin; and on the domestic level, it is often financial institutions rather than civil society which press for more information. On the business side, many merchant families are likely to prefer limited growth over increased disclosure during coming years. A relatively opaque regulatory and financial environment will continue to privilege established players and cautious business strategies.

For many international investors, the richness of the region will compensate for its opacity once the crisis is forgotten. Yet there will be long-term consequences for the GCC's diversification process and the quality of investments in the region. Investment is likely to be less diffuse, and steer clear of innovative but risky projects in new sectors. Instead, capital will focus on established sectors and large-scale ventures, often in partnership with public sector players. This pattern of investment has in the past had few positive spill-over effects on other local industries or on employment.

The technology and skills transfers that the region would require for large-scale employment generation is unlikely to happen in an environment whose opacity discourages innovation and risk-taking. Low transparency is a major barrier to entry for new players in GCC markets, reflected in the domination of GCC markets by long-established names.

Conclusion: Decision-making in public and private sectors in the GCC remains informal at its core, and this culture of secrecy will dissipate only slowly. In business, a two-tier system could emerge in which a limited number of national champions follow international standards of disclosure and governance, while the rest of the sector stays behind. In government, improvements will be limited to specific agencies, in many cases those which already had a strong institutional track record before the crisis. Lack of transparency will remain one of the main factors limiting economic diversification in the GCC.

© Oxford Analytica 2010