KUWAIT: In December 2011, an online version of The Wall Street Journal included the following report: "Index compiler MSCI Inc postponed a decision on whether to upgrade the status of stock markets in the United Arab Emirates and Qatar for another six months, a blow to local investors who saw a promotion to emerging-market status as a way to reinvigorate lackluster trading." As a resident of the UAE and observer of business in the region over the last two and a half years, I found this representation of the facts quite interesting.
As far as I understand finance, and I want to be careful to emphasize the limits of that comprehension, a change to the index might have such an effect for at least two reasons. The first is substantive and would result when an index upgrade reflects improvements in the underlying economic fundamentals; I have not seen the evidence to suggest that an upgrade in the MSCI index accurately tracks improvements in the underlying economic fundamentals.
The second reason why an upgrade might induce more investment would be the self-fulfilling dynamic where investors enter the market after the upgrade based on the belief that others will enter. Presuming the disappointment of local investors is based on the hope that it would trigger this herd dynamic, I would like to suggest that this expectation is not well founded. In short, I do not share their hope that this foreign certification would re-invigorate lackluster trading. To understand my skepticism on this issue, consider the following question: Can there be any serious hope of attracting foreign capital to financial markets that do not attract even a small portion of massive cash flows generated by energy exports? As you might guess, I believe the answer to this question is a resounding no.
At the same time, I do not wish to characterize hoping for MSCI certification as futile without suggesting what I believe to be a constructive alternative. In particular, I advocate a process for redesigning market architecture that resolves competing interests effectively. In laying out this idea and in the interest of full disclosure, I hereby confess that I am an American. As I have lived outside the US over the last years I have often been asked about the economic successes (and excesses, but I will ignore these for purposes of my essay) of my homeland. In talking about the successes, I have settled on a response that emphasizes a single factor, a clause in the original constitution of the country stating that interstate commerce can only be regulated by the federal government. It is my belief that this provision created the world's first mass market, triggering a process of economic integration that continues to this day and has expanded to global scale. Understanding the genesis of this provision brings me back to the value of a process that effectively resolves competing interests. Importantly, this clause was not enacted with foresight to create a large-scale market. Instead, it was enacted because New York refused to join a union where Pennsylvania could tax goods imported from New York, and Pennsylvania refused to join a union where New York could tax goods imported from Pennsylvania.
Apparently, equal participation by representatives of thirteen states in the context of a constitutional convention had some good outcomes as a process. I say this not as a suggestion that the UAE or any other country should mimic what happened elsewhere. This would hardly be more useful than trying to attract foreign investment by obtaining a particular rating of the domestic stock market from an outside ratings agency. Instead, I urge local investors to design an exchange platform that surfaces and resolves competing interests; this is the surest route to success in creating domestic capital markets that attract the attention and money of local (and foreign) investors.
© Kuwait Times 2012
