RegionsMiddle EastChallenges Facing Corporate Treasurers When Doing Business in the Middle East

Challenges Facing Corporate Treasurers When Doing Business in the Middle East

The role of a corporate treasury department has developed a great deal in recent years. Financial markets continue to evolve yet grow increasingly volatile. The treasurer’s responsibility, and the challenges with which they are presented, have grown accordingly.

These days, a treasurer is not simply there to ensure a company can meet its payment obligations. It is a complex role involving the management of a range of assets and liabilities, with particular emphasis on risk management.

In order to look at the challenges faced by corporate treasurers in the Middle East, we need to look first at the wider global picture. We then need to look at the regional picture, keeping the two in context.

Impact of Globalisation

The Middle East is about globalisation. The region positions itself as at the business crossroads of Asia, Europe and the North America and therefore benefits from, but at the same time is at risk from, the different elements of globalisation.

In finance terms, globalisation promotes diversification, and presents opportunities to save costs and channel these savings into other investments. Spreading risks makes actions easier to bear and, in theory at least, reduces a company’s exposure. However, globalisation also presents serious challenges to the treasurer. As a company grows and deals in more jurisdictions, its exposure to currency, operational and political risk grows.

The Middle East is not, in its own right, a large enough region to withstand global economic events. The worldwide downturn and credit crunch are impacting on the key economies of North America and Europe and these markets are facing recession. Interest rate and currency exchange volatility are two obvious areas of risk arising out of this and are affecting Middle East markets.

Inflation and Oil

Oil has reached an unprecedented US$140 per barrel, which represents an increase of 100% in little over a year. The Gulf Co-operation Council (GCC) countries of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates produce 23% of the world’s oil and control more than 40% of the world’s oil reserves. It is clear to see why those economies have seen staggering growth over the past decade.

With many Gulf countries having their currencies pegged to the US dollar, the monetary policies of those governments must follow the policies of the US Federal Reserve. Given the huge difference in the current economic climate of the Gulf and North America, adoption of an identical fiscal policy poses some clear issues.

Inflation rates have soared across the GCC countries over the past two years. This threatens to destabilise economies that would otherwise be booming. The soaring price of oil, together with the continuing poor performance of the US dollar, will keep inflationary risks high for some time yet.

Currency-related Risks

Another localised issue is the proposed move to a unified currency across the GCC countries. The move to a single currency holds many clear benefits. It will significantly aid trading between GCC countries and external parties. It will also give greater collective bargaining power in trading relationships. The success of the euro demonstrates this.

From a treasurer’s perspective the unified currency poses a number of challenges, particularly in the short- to medium-term. Will the new currency be pegged to the US dollar or an alternative currency? Where will the central bank be based? How will the legal framework be constituted – on which jurisdiction will it be based? Many questions still remain unanswered.

Common Theme – Basic Uncertainty

The original agreed target for circulation of the new currency was 2010, which now looks impossible to meet. The level of inflation is causing a real threat. In 2006, Oman declared it no longer wished to join the currency. Then in 2007 the proposal was further damaged by Kuwait’s decision to de-peg from the US dollar.

Speculation remains that other GCC states will shortly de-peg from the US dollar. A recent report by Merrill Lynch stated that the US had effectively given its support to the GCC to de-peg. The report suggested that the US government was confident about the strength of the US dollar and was no longer as dependent on GCC currency support.

In the event that GCC currencies were to de-peg, given economic conditions in the Middle East as opposed to the US, the currencies would appreciate rapidly in the short term. It is clear to see why companies might be tempted to acquire and retain significant sums of GCC currency with a view to profiting from such appreciation.

However, the message from the GCC countries is very different. Both Qatar and the UAE have strongly dismissed these claims. Political constraints continue to exert their influence over the economic climate in the Middle East.

The Role of Islamic Finance

Islamic finance continues to grow at an impressive rate, both in terms of financing and investing. Increasingly, more corporates are moving their financial operations to Islamic banking across the Middle East.

Dedicated Islamic banks and investment vehicles are emerging and flourishing. Many international banks have looked at the success of these investment and are now offering Islamic banking services and setting up dedicated Islamic finance operations.

The main challenge now lies in the development of products that are compliant with Shariah law, while at the same time offering treasurers as competitive and effective an option as non-Islamic options. There is a lot of debate over what products are and are not compliant, which depend on the advice being given by key Islamic scholars. This has led to a mixed and differing range of products, which has put off some investors.

One example that highlights this better than any other is the overdraft. The importance and effectiveness of an overdraft to any business needs no explanation. However, there is a differing opinion amongst scholars on the acceptance of a product which serves as a universal equivalent of an overdraft facility. Islamic finance does not yet offer a universally accepted product.

Shariah law prohibits gambling or betting, among other forbidden activities. This will, of course, impact upon the type of financial products and instruments available and the type of customer who may take up such products.

There is a distinct lack of a liquid local currency derivative market across the Middle East. Corporates do not have anywhere near as many options in this part of the world. With so many currencies here pegged to the dollar there has not been a great need for such a market. Should more currencies (or a unified currency) de-peg from the dollar, then top quality products would have to be developed very quickly in order to deal with exchange rate and interest rate volatility.

Conclusion

What conclusions can we draw after this brief look at the issues facing corporate treasurers in the Middle East? It is clear that the systems and products available in the Middle East are not quite at a level to match those available elsewhere in established financial markets. The banking infrastructure in the Middle East is still playing catch up against the infrastructure found in other financial centres. Great strides have been made over the past two years in terms of reforming payment and clearing systems, but there is still work to be done to keep up with the high pace of change at other financial centres. Significantly, while those established markets are currently contemplating recession, the Middle East is buoyant.

Recent history shows the ability of Middle Eastern economies to grow and adapt rapidly. It is therefore easy to imagine the financial markets of the Middle East catching up with the rest in the not too distant future. With establishment of a unified GCC currency, short-term uncertainty looks likely to give way to longer-term stability and prosperity.

Treasury departments and boards must follow the lead of GCC countries and recognise the importance of knowledge investment and management if they are to flourish in a similar way.

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