AsianInvestor Qatar report: Middle East-Asia trade

Asian Investor Qatar report, July 2013

The Middle East and Asia have trade at the core of their shared history. Two thousand years ago, the Silk Road linked the two regions for the Chinese silk trade, followed by Indian, Bactrian, Arab and Persian merchants in the centuries that followed. Today, links between the two are once again in the foreground of global trade.

The most obvious trade link is outbound from the Middle East and dominated by oil. “Exports out of this region are hydrocarbon-related, and clearly the demand for them is driven by the huge demographic and economic growth in China and India primarily, as well as Vietnam, Korea and Thailand,” says Tim Evans, regional head of trade and receivables finance at HSBC Middle East. “That is the key flow we are seeing.”

What’s interesting about this link is the way that it has grown to make up an ever-greater proportion of Gulf hydrocarbon exports globally. According to HSBC research, Asia ex-Japan is expected to account for the highest levels of growth in regional export flows from the UAE in both the periods 2013-15 and 2016-20; HSBC reaches the same conclusion about Saudi Arabia. Saudi exports to India are expected to grow by 12% annually to 2015, 11% to 2020 and 10% in the 10 years beyond. With figures of 7%, 11% and 10% respectively for China.

Standard Chartered’s senior economist for MENA, Shady Shaher, says that Asia’s composition of Qatar’s LNG exports jumped from 40% in 2011 to 80% in 2012, and that half of Iraq’s oil now goes to China. As QatarGas says in written comments to AsianInvestor: “The People’s Republic of China is a key focal market for Qatargas.” It already delivers 5MTPA of LNG to China, has commissioned 50% of Chinese regas terminals, signed a long-term LNG sales and purchase agreement with Thailand’s PTT in December 2012, and delivered its first cargo of LNG to Singapore in March – all of this on top of the more than 1700 cargoes it has so far delivered to its founding market, Japan.

“Asia needs energy security, and the Middle East has the hydrocarbons to supply that,” says Saher. “At the same time, demand out of the US is dropping because of the resurgence of alternatives there” such as the development of shale gas, “demand isn’t growing in Western Europe at the same rates as in the past because of economic conditions, and demand out of Asia has grown.” Almost 50% of the GCC’s exports are now going to Asia, he says.

This flow has a range of knock-on effects in the other direction, to Asia’s benefit, Evans says. “The Middle East sells hydrocarbon products to Asia; Asia pays for them in dollars; those dollars are then reinvested, in many cases, in infrastructure projects in the Middle East; and much of the work on developing that infrastructure is going to contractors in Asia,” he says. “Quid pro quo.”

Indeed, the steady arrival of Asian contractors in the region – particularly Korean, but increasingly Chinese too – has been one of the most important trade flows from Asia, bringing with it significant imports of building materials too. There is a temptation to see this as a trade-off: that Asian countries, in return for buying hydrocarbons, have expected to see important contracts go to their companies. But, while there is no doubt an element of that, a more important point is that Asian contractors have got considerably better over time.

“One aspect is the growing ability of Asian contractors to deliver on large scale projects,” says Shaher. Koreans in particular have made a name for their technical expertise – they were closely involved in the building of Burj Khalifa, the world’s tallest building, for example. “They are delivering on price and quality.”

Perhaps the clearest example of this growing trust came when the Abu Dhabi government awarded mandates to a group of South Korean firms to build the UAE’s first nuclear power stations.  “If you had told me 10 years ago an Asian player would have won a contract to build a nuclear power plant in a Middle Eastern oil exporter, I would have told you that would be very hard,” Shaher says. “But the dynamics have changed.”

Asian countries also provide vehicles, shoes, textiles, clothing and house furniture. One of the biggest malls in Dubai, for example, is Dragon Mart, a kilometre long, filled with companies that source purely from China and selling everything from children’s toys to pots and pans. Increasingly, the Gulf imports consumer electronics and cars from Asia.

Elsewhere, it’s about food security. Countries in the region with major food import needs – Egypt with wheat, for example, or Saudi Arabia with barley – may also source their product from Asia.

And a theme like food can be more nuanced than one might at first imagine.  For example, migrant labour – with the vast majority of the day-to-day populations of Qatar and the UAE made up of non-citizens, chiefly construction workers from South Asia or domestic helpers from the Philippines, for example – does not have a huge impact on trade flows, as workers tend to arrive on set contracts, with their housing and food provided, and with their earnings remitted home rather than being paid into the local economy. But they do need to be fed, which drives imports of foods. On top of that, there is agriculture. “In Saudi they don’t just import crops to eat for human consumption,” says Daniel Broby, CIO of Silk Invest, and investor specialising in frontier markets in Asia, the Middle East and Africa. “They import husks to feed the cows, because dairy herds in the desert don’t have much food.”

Investment themes like this, outside of energy but based on consumer patterns, are of particular interest to investors like Broby. “If you focus on the consumer, you can benefit from trade and investment flows without having to compete head-on with what I would call silly money,” he says, referring to situations in energy or infrastructure where a foreign government might fund a project cheaply for political reasons.

Financing trade flows is not generally a challenge because of the wealth of most Middle East states. “The population of the Middle East is roughly 350-400 million; if it was a country on its own it would be the third or fourth most populous in the world,” says Evans. “And aside from those countries that don’t have oil, such as Lebanon, Egypt and Jordan, the ones that do have an ability to spend on infrastructure that leads to import flow.” Some trade finance liquidity has dried up from European banks, but Asian banks are increasingly expected to take up the slack and there is a role for export credit-led financing in bigger projects.

One influence on trade patterns has been the Arab Spring, as it has prompted some governments, notably Saudi Arabia’s, to dilute any sense of dissent by heavy social spending – not on international property or other global assets, as has often been the case, but on local development. “Following the Arab Spring, Middle East countries are moving more towards domestic expenditure, which is driving import flows,” says Evans. “They are acquiring cement, steel, copper, aluminium, and bringing in labourers, which drives imports of foodstuffs.”

Then there are investment flows. The GCC countries host some of the largest and most powerful sovereign wealth funds in the world. The Abu Dhabi Investment Authority, Qatar Investment Authority, Kuwait Investment Authority and the sovereign wealth elements of the Saudi Arabia Monetary Agency represent an undisclosed amount but certainly more than US$1 trillion between them, while there are other smaller or peripheral sovereign entities in many of those countries alongside the bigger funds.

The only one that discloses its allocation bands is ADIA, and its most recent annual report, for 2012, tells us that emerging market equities must account for a minimum of 10% and a maximum of 20% of the portfolio – a far higher weighting than would be reflected by global stock market indices. That’s without considering emerging market investments in debt or alternatives. In aggregate, emerging markets can account for up to 25% of the portfolio, and developed Asia a further 20%.

While other funds are less open about what they do, managers who serve them note that Kuwait’s fund has also shifted towards emerging markets in recent years. Managers report that Middle East sovereign funds find a greater demographic similarity in Asia than in the developed world, and that – recent wobbles in stock and bond markets notwithstanding – the longer term growth potential is higher in Asia too.

Alongside this, one sees the steady fortification of new trade corridors: not just the Silk Road but the so-called South-South pattern.  “In the 50s and 60s, the notion was that trade was emerged market to emerged market,” says Evans. “In the 80s, it was emerging to emerged. Now we are seeing more emerging to emerging, and the GCC has done a very good job of positioning itself at the centre of that, between China and India, Africa and South America.”

It is also worth remembering that in addition to trade to and from the Gulf, there is plenty of trade through it, such as through Dubai’s Freeport and the region’s bigger airports in Dubai, Doha and Abu Dhabi. “There is far more activity, whether into the region or passing through the Freeport, than anyone really gives credit to,” says Broby. And the same argument could be made about air traffic, as Evans says: “If you look at Emirates Airlines’ new destinations, they appear to be following the trade flows. When you get on a plane from Dubai to Shanghai, it’s full of Brazilians who say the easiest way to get from Brazil to China is via Dubai.” This is increasingly true of Doha and Abu Dhabi too as their airlines, Qatar Airways and Etihad, grow. “This part of the world will benefit from that South-South trade.”

Shaher adds: “We will continue to have trade corridors built up, especially among emerging market countries: Asia and the Middle East, Asia and Africa, Asia and Africa via the Middle East.” Increasingly, global trade will be about the places with the people and the growth.

Box: Islamic links

Some Asian countries have focused on their shared religion to forge links with the Middle East. This has been most obvious in Malaysia. When Malaysia began opening its banking system to new entrants, the first three takers where all Middle East related and all had at least some focus on Islamic finance: Al Rajhi, which made an extremely visible push into retail as well as an institutional business; Kuwait Finance House, which has focused more on traditional strengths in areas like aircraft finance; and Asian Finance, owned by a consortium led by Qatar Islamic Bank.

Malaysia aspires to be a global hub for Islamic finance and its Malaysia International Islamic Financial Centre seeks to be a magnet for this business, particularly on the asset management side, and most especially for Middle Eastern money.

In January 2011 a Malaysia-GCC framework agreement was signed – “a pact underpinned by common cultural and historical ties and designed to spur the development of trade and investment,” as Evelyn Devadason, Associate Professor at the University of Malaya, describes it. That said, agreements like these haven’t necessarily spurred any growth in bilateral economic cooperation. Malaysia-GCC trade has certainly grown – from US$627 million in 1990 to US$10.4 billion by 2010, according to the university – but the Gulf still only constituted less than 3% of Malaysia’s world trade at the end of that period.

Still, the direction is clear. Most recently, investment has been concentrated in the Iskandar Johor Economic Development Area in southern peninsula Malaysia, near Singapore. “IJEDA, given its proximity to Singapore, is becoming a focal point for investments from the GCC,” says Devadason, who believes Qatar is also planning petrochemical facilities in the area.

Sovereign wealth is also showing interest. The Qatar Investment Authority signed an agreement with a Malaysian partner in 2012 to build a Harrods-branded luxury hotel in Kuala Lumpur.

“Another interesting shift is that Arab countries are now looking to Malaysia to enhance halal standards and promote related products,” she says. This is a striking development: traditionally the Gulf has imported meat and halal products from Australia, New Zealand, Ireland, Brazil, Canada and the US. “With the Gulf changing its focus to Asia, the food and chemicals industries in Malaysia that are largely bound by halal laws command an edge over other regional manufacturers.” Penang has built an International Halal Industry Park partly to cater for this need, and Saudi Arabia’s Al Rajhi Bank is a major investor within it.

But perhaps it’s financial services and the Islamic connection that presents the greatest opportunity for common ground. “Malaysia seems to project enormous potential in attracting Muslim capital from the Middle East, particularly from the GCC countries,” says Devadason. “The present low investment and trade levels between the GCC emerging market and Malaysia represent unexplored bilateral opportunities.”