Fabio Scacciavillani

Local Bond Markets as a Cornerstone of Development Strategy

Debt markets represent the leading channel of liquidity for governments, public companies, agencies and financial institutions in many advanced and emerging economies. Developing a local currency fixed income market brings multiple benefits: stable access to capital, diversification of monetary policy instruments, creation of a yield curve for pricing financial assets and tailoring risk management tools.In most countries, the debt market is born out of the need to finance government expenditures. With time, the yield curve on public debt becomes a reference for private entities such as banks, public utilities and corporations, which are then able to tap the market to fund their investments.The development of local bond markets requires a strong commitment from governments to implement a proactive debt management programme as well as ensure a large and diversified issuers base. Therefore, a focused issuance programme of government securities is essential to establish benchmark bonds. Governments should also encourage publicly owned companies (especially utilities) to issue similarly structured securities to provide a slate of issuers that enjoy local name recognition, thereby paving the way for private corporations to issue debt. The GCC countries are investing heavily in infrastructure, which according to estimates requires USD2.2 trillion in financing. It is both opportune and desirable to raise this financing through securities backed by future cash flows from the infrastructure services, as is typical of project financing schemes.Although banks are the obvious buyers of bonds, since government debt is highly attractive for meeting statutory reserve or prudential requirements, authorities should encourage the development of a secondary market among life insurances, asset managers and international institutional investors. To ensure the success of the endeavour, the legal environment needs to be tailored to promote transparency, the seamless and timely flow of information, prevention of insider trading and minimal counterparty risk. As markets develop, issuances further down the credit spectrum will increase and more transparent accounting standards in accordance with International Financial Reporting Standards (IFRS) must be adopted. Another pre-requisite for the development of a healthy bond market is a flexible, interlinked, electronic registry clearing and settlement system.Building and sustaining a vibrant capital market relies on the commitment of long-term stakeholders. In addition to the government and the central bank, market makers, in their capacity as liquidity providers, are essential to ensure an active secondary market, particularly during a hiatus in primary market issuance. Finally, creating a robust framework for creditor rights and investor protection is necessary to instill investor confidence and maintain the momentum of capital market growth.

Infrastructure as an Engine of Growth in MENASA

The MENASA region is experiencing a secular wave of transformation with two epicenters, India and the GCC. In the former, the main drivers are a “Goldilocks” demographics and the long lasting impact of reforms enacted in the 1990s by Dr. Singh (India’s current PM) are expected to solidify and extend this transformation process. In the GCC, the main driver is an energy commodity windfall that for the first time in history is not merely amassed in offshore assets, but is increasingly deployed domestically to transform the Arabian Peninsula into an advanced XXI century knowledge based economy.Two factors will be keys to the future of the region: demographics and urbanization. With fertility rates still well above 2.2, the MENASA region will enjoy the goldilocks of an expanding labor force, while massive internal migration will feed a powerful process of urbanization. These secular waves require a massive commitment to build indispensable infrastructure to sustain the increased population and economic growth. In the two epicenters this need is well understood by policy makers, but a fundamental difference is noticeable. While in the GCC infrastructure projects are anticipating the demand and actually stimulating it (supply side effect), in the rest of MENASA the existing infrastructure are strained due to poor maintenance and intensive usage.Investment in infrastructure sets in motion a virtuous circle: higher productivity and competitiveness translate into higher incomes and higher government revenues and in turn more public investment in a mutually reinforcing pattern, as has been the case of China over the past two decades and the GCC since the turn of the century. In the process, other positive spill-overs are felt in the form of learning-by-doing effects, efficiency gains in companies, human capital improvement, research and development in construction techniques, technology transfers and process innovation. Governments’ role as the largest provider of infrastructure financing in the region needs to be redefined given the crisis and resultant fiscal constraints. The role of private sector needs to be enhanced through privatization and Public-Private Partnerships (PPPs). The availability of capital is a key to spur an investment cycle - given the long-gestation nature of infrastructure projects, there is a need to attract private sector funds and more importantly, a need to develop deep and liquid local currency debt markets to improve access to finance.

The Dubai Mercantile Exchange: Trading, Prices and Market Efficiency - An Econometric Analysis

The Dubai Mercantile Exchange Limited (DME) is the energy commodities exchange located in the DIFC that lists and trades the Oman Crude Oil Futures Contracts (DME Oman). The DME Oman is the sole benchmark for Oman and Dubai crude oil official selling prices, and the only market listing sour crude in the region. To date, over two million contracts or two billion barrels of crude oil have been traded over the DME since its launch in June 2007. Furthermore, the average daily volumes in DME touched 3,000 contracts during Q1 2011 with the highest record reached in January 2011 when the average daily volume was 3,570 contracts (equivalent to 3.5 million barrels of oil per day). Today, it is considered the largest physically-delivered crude oil futures contract in the world with a 35% (at an annual rate) rise in trading volume in 1Q2011. Against this backdrop it is important to test the market efficiency of DME and also test whether the prices are reliable and not subject to manipulation. This paper analyzes the efficiency of DME oil market by using the “weak form of market efficiency�?, which posits that future prices are optimal predictors of spot prices. Furthermore, the analysis is done using the Hansen and Hodrick correction which allows treating the overlapping observation problem. Our empirical results are consistent with the hypothesis that the DME market is efficient with reliable prices that reflect available market information. The DME has added value to oil markets by providing a transparent market price mechanism at a time of higher than average volatility in oil prices and market conditions.

The Case for Gold as a Reserve Asset in the GCC

This paper focuses on some key aspects of the Gulf Monetary Union and specifically on the new central bank policy in the area of reserve management policy. It will address whether holding a substantial part of reserves in gold would enhance the stability of the new currency and in general how a reserve management policy which includes gold fares against the alternative strategy relying exclusively on holding assets denominated in fiat currencies. The original deadline of January 2010 for the Gulf Monetary Union (GMU) has been missed and a new deadline has not been set. Despite this setback the process has not halted and actually, away from the limelight, technical committees are working, with the plans for the inception of the GCC Monetary Council expected to be finalized by Fall 2010. Once the forerunner of the Gulf Central Bank is in place with the appointment of the Governor, one can envisage steady progress both in the institutional framework and in the technical aspects. Credibility will be the key issue for the new currency and therefore an important task for the Gulf Central Bank would be to set in place conditions that brace the trust of international markets. It is likely that the Gulf currency will initially be pegged to the US dollar, but once the initial phase in which the technical aspects of monetary policy conduct will be tested it is logical to expect that the exchange rate rule will be more flexible with a peg to a currency basket, either similar in composition to the SDR, or reflecting trade shares. A linked issue is whether the composition of reserves could help in conferring the new currency credibility and whether it is possible to demonstrate quantitatively that including gold would help to achieve better macroeconomic stability. We conduct a series of simulations based on past data to calculate the return on a portfolio of reserves assets with and without gold. Our results indicate that if a relatively conservative central bank should hold gold as an asset class, its potential returns for any given level of risk (i.e. at any threshold of standard deviation) increase by several points more per year than when excluding gold from its optimal portfolio. Similarly, a dollar invested (in January 1987) by a fictional conservative central bank in an international reserves portfolio with gold would have grown to

Dubai World Central and the Evolution of Dubai Logistic Cluster

6.6 by May 2010 – which is about 1.5 times more than an international reserves portfolio without gold.

Wealth Effects in the GCC from Energy Commodity Prices

The logistics sector has been one of the main forces pushing globalization. At the heart of the logistics revolution lays the integration of transport modes and the standardization of procedures which boosted synergies and economies of scale, to an unprecedent extent. Dubai has been riding high on the wave of this advancements fulfilling a vocation that had suited the Emirate since the late XIX century when its ruler at the time, Sheikh Rashid bin Maktoum, declared its port a free zone. Dubai has thrived in its role as a regional hub reaching a position of prominence in the global logistics network and today it is one of the critical nodes in the global supply chain. This evolution underlines also the growing importance of our region in the world and its gradual transformation from an energy commodity exporter into a diversified economy with a broader economic base and a flourishing, internationally connected, service sector. The opening of the Al Maktoum International Airport in June 2010 has strengthened and expanded this role. With global trade acquiring an even more strategic importance in the world economy, Dubai will reinforce its position at a time when Asia is supplanting the West as the main engine of growth. Research highlights that the relationships between transport costs, production locations, and trade patterns follow different stages. At the beginning of the process, when transport facilities slowly improve and costs drop, competitive advantages are the key driver of trade. Later, as the efficiency in transport grows, intra-industry trade starts to dominate, specialization increases and manufacturers exploit massive economies of scale. To achieve wider supply chain optimization it becomes imperative for companies at different levels of the production chain to coordinate their operations. At the macroeconomic level we observe, as a result, that trade elasticities to global GDP have increased over the last decade all over the world. Likewise, we observe that intra-industry trade among high income economies, but also between low- and high-income countries dominates global trade relationships. As much as 44% of all shipments pertain not to finished goods, but to inputs. Dubai’s logistics sector is poised to catch the tail wind of this new phase in global trade where the services and the organization of logistics will be the dominant success factors and firms will therefore increase scale and specialization while building sophisticated buyer supplier networks. To exploit fully the benefits of seamless integration between the major transport infrastructures in Dubai however a few hurdles must be cleared, such as the upgrade of regulation of intermodal links within the Emirate.

The Exchange Rate Regime of the GCC Monetary Union

Oil-exporting countries, including the GCC economies, have experienced a windfall as a result of high oil prices since 2003. Hydro-carbon revenues in the Middle East which has the world’s largest share of oil and natural gas reserves have filtered into their domestic economies through increased government spending and large scale investment projects. However, given the exhaustible nature of energy resorces, long term planning is necessary in order to ensure that the revenues are not spent unwisely. Friedman’s Permanent Income Hypothesis (PIH) helps to connect economic theory to the practical/empirical approach of estimating the effect of higher energy prices on the stock of wealth represented by fossil fuel underground reserves. The PIH states that individuals base their consumption (and savings) decisions not on their current income which may be subject to transitory, short term fluctuations, but on their permanent income, their longer-term income prospects, and an estimate of their future wealth. The same reasoning, mutatis mutandis, can be applied to countries. In this paper we calculate the permanent income effect on the GCC countries deriving from the fluctuations of energy commodity prices and the implications for the future development of this region. Several scenarios are considered – based on assumptions over oil and gas prices and discount rates of income streams. The central result shows that the present value of the hydrocarbon wealth for the GCC countries can be estimated at USD 11.2 trillion, assuming a 3% rate of return (and discount rate) and a price of

The Role of Gold in the New Financial Architecture

50 per barrel (at 2009 constant prices). The analogous value for natural gas reserves assuming a discount rate of 3% and a price

Sovereign Wealth Funds: between the New Normal and Risky Abnorma

9 per mn Btu stands at USD 7.1 trillion. Hence, the permanent wealth from oil and natural gas reserves under rather conservative assumptions stands at a whopping USD 18.3 trillion, giving GCC the potential to swap their fossil fuel reserves for half of the world’s current (August 2009) stock market capitalization! The energy commodity revenues should not be considered income, but as the transformation of underground wealth into financial wealth. This stream of revenues will be sufficient to finance the transformation of the GCC countries into diversified economies through investments in infrastructure and education. Additionally the revenues will continue to be invested worldwide, with non negligible repercussions on asset valuations and in particular on the continuing restructuring of the world’s financial and corporate sectors. There are a number of important lessons and consequences of the increased wealth of the GCC. • Their higher current and prospective wealth enables the GCC countries and other energy exporters to use their wealth to invest in economic diversification to reduce their vulnerability to oil and gas price fluctuations. • The increased financial wealth of the GCC calls for increased investment and resources to be devoted to wealth and asset management and control. • The fiscal situation and debt capacity of the GCC countries should be analysed taking into consideration the vast current and prospective wealth of the GCC countries. • The recent financial crisis has demonstrated the importance of the financial cushion provided by the international financial assets that the GCC built up over 2003-2008 in helping them weather the global economic and financial crisis.