Moving Markets: How the Middle East Gets Beyond Oil


By Amanda Zeidan

Saudi Arabia, the world's largest oil-exporter, is kick starting non-oil growth by opening to foreign investment for the first time. Generational shifts in opinion on financial reform and regulation could lead Saudi Arabia to serve as the model for future-proofing the Middle East petro-state.

Political instability and economic volatility has often characterized the Middle East, but such characterizations downplay the resilience, albeit autocratic, the region has displayed to external shocks. Oil-exporting countries of the Middle East, with long-standing monarchies that often remain immovable to outside forces, are a reflection of a kind of resilience that necessitates home-grown transformation. The sharp decline in oil prices since 2014 has turned large surpluses in oil-exporting countries into growing deficits. MENA oil exporters were down $360 billion in export revenue in 2015. Concentrated credit allocation has compounded the effect of tumbling oil prices for governments with revenues almost completely dependent on oil exports.

In the past, several oil-exporting countries of the Middle East have enjoyed a degree of market integration with the global economy. Most members of the Gulf Cooperation Council (GCC), all of which are oil exporters, are relatively economically developed. Collectively, GCC countries make up over half of the world's oil reserves, closely tying MENA capital markets to the oil market. Though the banking sector in GCC countries is generally quite large, access to credit is often restricted to single borrowers or particular sectors, such as the oil industry and the state.

Crowding in new players into a developing financial economy requires encouraging competition within the financial sector. A supply glut for oil-exporting countries and a decrease in demand from China is pushing central governments in the Middle East to consider new options. The problems caused by inefficient capital allocation are exacerbated by investment constraints related to persistent political and social instability, lack of regulatory and legal frameworks, and financial restrictions that make MENA countries unattractive destinations for investors. Recently, the media has taken note of Saudi Arabia's reform efforts as it races to implement financial and economic reforms as commodity prices remain uncertain. Regulation and supervision, in a region where competing narratives of insider advantage and popular discontent often make front page news, offer a unique opportunity to rescript that narrative and promote financial and economic growth.

Regional dependence on oil, and the industry's highly concentrated benefits, has contributed to an inefficient allocation of capital. This has increased the reliance on the government for employment and subsidies. Capital and power is further concentrated in the bloated public sector through pervasive government control of large banking systems and productive industry, as well as underdevelopment of the non-bank financial sector in these investment constrained economies. In addition, MENA ranks among the lowest in protecting creditors' rights as measured by the World Bank's Doing Business indicators, further encouraging lenders to give credit to only a few, well-connected borrowers.

In an autocracy, the leadership panders to a "selectorate" rather than an electorate. This often results in a high concentration of lending to individual borrowers or specific sectors and, in turn, crowds out small and medium-size. Banks are characterized by their selective habits, providing loans to borrowers that reflect the interests of state-owned enterprises. Meanwhile, advanced financial systems promote diversifying investments, mobilizing savings, facilitating trade, and mitigating risk. This in turn ensures that capital is given to the most efficient user, resulting in growth. Paramount to the success of financial intermediation is macroeconomic stability, which can only be achieved through a credible institutional environment.

In order to increase efficient credit allocation in the MENA region, oil-exporters must pursue aggressive diversification of their financial sector. To reduce instability associated with increased global market participation, these reforms should be implemented gradually and accompanied by institutional reform. The Middle East is reaching an inflection point and a period of extraordinary politics may be around the corner.

Amanda Zeidan is pursuing a Master of Science in Foreign Service at Georgetown University, where she is pursuing a concentration in Global Business and Finance. She is currently an Allen W. and Allen M. Dulles Graduate Fellow at the Institute for the Study of Diplomacy and a Middle East Fellow at Young Professionals in Foreign Policy.

Image Credit: IMF