DISSERTATION FINANCIAL INTEGRATION OF STOCK MARKETS IN THE GULF COOPERATION COUNCIL COUNTRIES Submitted by Saleh I. Alsuhaibani Department of Economics In partial fulfillment of the requirements For the Degree of Doctor of Philosophy Colorado State University Fort Collins, Colorado Summer 2004 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. UMI Number: 3143808 INFORMATION TO USERS The quality of this reproduction is dependent upon the quality of the copy submitted. Broken or indistinct print, colored or poor quality illustrations and photographs, print bleed-through, substandard margins, and improper alignment can adversely affect reproduction. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if unauthorized copyright material had to be removed, a note will indicate the deletion. ® UMI UMI Microform 3143808 Copyright 2004 by ProQuest Information and Learning Company. All rights reserved. This microform edition is protected against unauthorized copying under Title 17, United States Code. ProQuest Information and Learning Company 300 North Zeeb Road P.O. Box 1346 Ann Arbor, Ml 48106-1346 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. COLORADO STATE UNIVERSITY JULY 10, 2004 WE HEREBY RECOMMEND THAT THE DISSERTATION PREPARED UNDER OUR SUPERVISION BY SALEH ALSUHAIBANI ENTITLED FINANCIAL INTEGRATION OF STOCK MARKETS IN THE GULF COOPERATION COUNCIL COUNTRIES BE ACCEPTED AS FULFILLING IN PART REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY. Committee on Graduate Work Alexandra Bemasek Robert W. Kling Adviser: Liang-Shing Fai spartment Head: Ronnie J. Phillips i Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. ABSTRACT OF DISSERTATION FINANCIAL INTEGRATION OF STOCK MARKETS IN THE GULF COOPERATION COUNCIL COUNTRIES The purpose of this study was to establish the level of integration that exists among the GCC stock markets and between GCC stock markets and major international markets. The research defines market integration in terms of co-movement of stock prices. Markets are considered to be integrated if national stock prices share a common long-run relationship. Correlation, cointegration analysis, and Granger causality tests were applied in the investigation of the stock markets’ integration. The five GCC stock markets included in the analyses represent five GCC states—Bahrain, Kuwait, Oman, Qatar, and Saudi Arabia. The measures of major international stock markets were applied to stock markets in the United States (S&P 500), the United Kingdom (FTSE 100), and Japan (Nikkei 225). Additionally, the Morgan Stanley Capital International Index (MSCI) reflected all major stock markets on a global basis. Weekly country equity market indices were collected for the period from August 1998 to August 2003. Evidence of cointegration was found for some pairs of the GCC stock markets during the five-year period. Multilateral cointegration of the five markets was established minimally among these markets as a group. Contemporaneous correlations among the GCC markets are less than perfect. However, the estimates suggest considerable effects of variations in one market on another. The study suggests that the GCC stock markets, except the BSE, are not cointegrated with the developed markets, ii Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. which indicates that there is considerable evidence of the diversification benefits of investing in the emerging markets of the Gulf region. That is consistent with results of the correlation analysis, which found negative correlations among GCC and developed stock markets. The UK market is found to be the most influential market, while the US market is the least influential market affecting stock markets in the GCC countries. Saleh I. Alsuhaibani Economics Department Colorado State University Fort Collins, CO 80523 Summer 2004 iii Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. ACKNOWLEDGMENTS For the success of this dissertation, many contributors have participated profoundly in its creation. Before I pay my gratitude to those who support me, I would like to thank God for his indispensable guidance. First of all, I would like to express my gratefulness to my parents, Ibrahim and Lolwah, for their prayers, care, and their endless moral support in my entire life. Also, I would like to thank my uncle, Ibrahim, for his significant role in my academic life. My brother Khaled’s consistent support is always in my appreciation. Lama, my patient wife, has always stood next to me supporting, encouraging, and inspiring me. She has been with me through ups and downs. I will be always thankful to her. I also would like to express my gratitude to my adviser, Dr. L.S. Fan, for his crucial academic efforts, which brought this dissertation to reality. Dr. Fan’s great personality traits have always supported and pushed me forward. I am also thankful to Dr. R. Kling for his insightful comments, which have enriched my dissertation. Dr. C. M. Fan’s contribution at the early stages of this dissertation had an insightful impact in developing my study. I would like to thank Dr. J. Olienyk for his perceptive contribution in the financial aspects. I am thankful to Dr. A. Bemasek for her time and efforts. Regardless of her tight schedule, Dr. Bemasek recently has accepted an invitation to join my committee, for which I am very appreciative. Finally, I am thankful to the government of Saudi Arabia, through the Saudi Arabian Monetary Agency (SAMA), for their generous financial support. iv Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. TABLE OF CONTENTS CHAPTER PAGE I. INTRODUCTION 1 1.1 Stock Market Integration: An Overview 3 1.2 Statement of the Problem 6 1.3 Motivation for the Study 8 1.4 Data 12 1.5 Organization of the Study 13 II LITERATURE REVIEW 15 III ECONOMIC AND FINANCIAL INTEGRATION IN THE GCC COUNTRIES 28 3.1 Economic Overview 31 3.1.1 Economic Structure 31 3.1.2 Economic Performance 34 3.2 Efforts Toward Economic Integration 38 3.2.1 The Unified Economic Agreement 39 3.2.2 The Gulf Customs Union 41 3.2.3 Monetary Union 43 3.3 Financial Integration and Liberalization 46 3.3.1 Banking Sector 47 3.3.2 Stock Markets 50 3.3.3 Intra-region Investment 54 3.3.4 Foreign Direct Investment 56 IV. GCC STOCK MARKETS DEVELOPMENT 62 4.1 Bahrain Stock Exchange 66 4.2 Kuwait Stock Exchange 67 4.3 Muscat Securities Market 69 4.4 Doha Securities Market 70 4.5 Saudi Stock Market 71 4.6 Stock Markets of UAE 74 V. METHODOLOGY 79 5.1 The Model 79 5.2 Correlation 81 5.3 Unit Root Test 82 5.4 Cointegration 85 v Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 5.5 Granger Causality Test 89 VI. INVESTIGATING THE INTEGRATION OF THE GCC STOCK MARKETS 91 6.1 Correlation Test 92 6.2 Cointegration Analysis 96 6.2.1 Augmented Dickey-Fuller Test 96 6.2.2 Bilateral Cointegration 99 6.2.3 Multilateral Cointegration 103 6.2.4 Vector Error Correction Model 105 6.3 Test for Causality 107 VII. INTEGRATION OF THE GCC STOCK MARKETS AND MAJOR INTERNATIONAL STOCK MARKETS 110 7.1 Correlation Test 111 7.2 Cointegration Analysis 113 7.2.1 Augmented Dickey-Fuller Test 113 7.2.2 Test for Cointegration 116 7.3 Test for Causality 118 Vffl. SUMMARY, CONCLUSIONS, AND POLICY RECOMMENDATIONS 123 8.1 Summary of the Study 123 8.2 Conclusions 128 8.3 Policy Recommendations 130 REFERENCES 133 APPENDICES 140 vi Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. LIST OF TABLES Table 4.1: Descriptive Statistics of Weekly Returns by Market 65 Table 4.2: Market Capitalization 76 Table 4.3: Number of Companies Listed 76 Table 4.4: Volume of Shares Traded 77 Table 4.5: Value of Shares Traded 77 Table 4.6: Turnover Ratio 77 Table 6.1: Correlation Matrix for Market Index among the GCC Markets 92 Table 6.2: ADF Findings for Level for GCC Stock Markets 97 Table 6.3: ADF Findings for First Difference for GCC Stock Markets 98 Table 6.4: Findings of Bilateral Cointegration among GCC Stock Markets 100 Table 6.5: Findings of Multilateral Cointegration among GCC Stock Markets 104 Table 6.6: Results of VECM for GCC Stock Markets 106 Table 6.7: Results of Granger Causality Test for GCC Stock Markets 108 Table 7.1: Correlation Matrix for Market Index among GCC and Developed Stock Markets 111 Table 7.2: ADF Findings for Level for Developed Stock Markets 114 Table 7.3: ADF Findings for First Difference for Developed Stock Markets 115 Table 7.4: Bilateral Cointegration Findings for GCC and Developed Stock Markets 117 Table 7.5: Results of Granger Causality for BSE and Developed Markets 119 Table 7.6: Results of Granger Causality for DSM and Developed Markets 120 vii Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Table 7.7: Results of Granger Causality for KSE and Developed Markets 120 Table 7.8: Results of Granger Causality for MSM and Developed Markets 121 Table 7.9: Results of Granger Causality for SSM and Developed Markets 122 viii Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. LIST OF FIGURES Figure 3.1: Average of Oil Sector GDP-Total GDP Ratio 32 Figure 3.2: Average of Oil Revenue-Total Revenue Ratio 32 Figure 3.3: Average of Oil Export—Total Exports Ratio 33 Figure 3.4: Average of Trade/GDP Ratio 33 Figure 3.5: Real GDP Growth Rate 34 Figure 3.6: Nominal Per Capita GDP 35 Figure 3.7: Convergence of Inflation Rates 36 Figure 3.8: Budget Surplus/Deficit-GDP Ratio 37 Figure 3.9: Ratio of Intra-trade to Total Trade in GCC countries 41 Figure 4.1: Market Capitalization as a Percentage of GDP 78 Figure 4.2: Weekly Performance of GCC Stock Markets 78 Figure 6.1: GCC Market Clusters 95 ix Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. CHAPTER I INTRODUCTION The growing integration of financial markets has been the subject of extensive research over the last two decades. The degree of integration of stock markets around the world increased significantly during the 1980s and 1990s. Major factors underlying this process are attributed to the increase in capital flows across national boundaries, potential benefits from diversification of investment on an international level, and the existence of stock market leaders and followers. International stock markets have become more integrated as capital account restrictions have been lifted in developed counties. Developing countries have made such efforts toward liberalization and deregulation of their capital markets. As a result, capital flows to developing counties, including Foreign Direct Investments (FDI), have sharply increased in recent years. The increase of capital flows to developing countries has been accompanied by a significant rise in the degree of integration of world capital markets. A key factor causing growing integration of world stock markets is the increased globalization of investment seeking higher rates of return and the opportunity to diversify risk internationally. The potential benefits of diversification from investing in markets of developing counties, which are known as Emerging Stock Markets (ESMs), have been observed in the last few years. Equity portfolio flows to emerging markets have led to an expansion in these markets. According to Emerging Stock Markets 1 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Factbook, total market capitalization of ESMs has increased from $981.61 billion in 1992 to $2,572 billion in 2001. The growth of ESMs has been attributed to financial liberalization and an increase in foreign portfolio flow from industrial countries. With the presence of dominant economies, the existence of stock market leaders and followers has been observed in the real world. Stock market integration has been evidenced as a result of the 1987 crash; as the US market collapsed, developed and emerging markets followed. Many studies found a substantial amount of integration among markets, with the US market as the most influential, followed by the markets of Tokyo, London, and Paris, respectively. With the emergence of globalization, the majority of the countries of the world have formed regional blocks to protect their trade. However, in recent years it can be seen that regional blocks are realizing that competitive advantage can be gained if there is a horizontal integration in financial sectors as well as other economic activities. The Gulf countries,1 in spite of their differential financial openness, are finally realizing the value of horizontal integration. The opportunities for integrating the stock markets among the Gulf states no doubt would change the financial structure in the region. Currently the Gulf countries are making efforts to follow the parallel trading system of the stock exchanges of other regional blocks, including the European Union and that of the United States. Such integration would not only boost investment level but it would also increase the viability of the Gulf states as an investment arena for investors around the world (PricewaterhouseCoopers for the European Commission, 2003). 1 The Gulf here is the Persian Gulf, which is located in the southwest of Asia. The Gulf countries discussed in this study are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE. 2 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 1.1 Stock Market Integration: An Overview The term “stock market integration” means different things in different contexts. One meaning ascribed to the term implies an amalgamation of stock markets regionally or globally, where the same securities are available in multiple stock exchanges, investors can live in one country and trade with an exchange in another, and stock exchange members on a regional or global basis provide investment services by foreign firms. A second meaning of the term “stock market integration” refers to a regional or global investment environment wherein the pricing of financial assets with similar risk and return profiles are comparable in trading on stock exchanges on a transnational basis (Alford, 1993). However, this study will focus on the integration of stock markets in the Gulf region of the Middle East within the context of the latter conception of stock market integration, where the pricing of financial assets with similar risk and return profiles are comparable in trading on stock exchanges on a transnational basis. The definition of financial market integration usually involves equality of asset prices. Shepherd (1994) stated that this equality requires asset substitutability and capital mobility. Kenen (1976) defines equity market integration operationally, which is a part of financial market integration, in term of market prices’ interdependence, although it is usually defined theoretically in terms of equality of expected stock returns. The concept of financial market integration is based on the law of one price in more than one market—if assets of the same risk in different markets have the same yield, then the financial markets are defined as integrated (Stulz, 1981). When yields are 3 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. different, arbitrage is expected to bring them back into equality. A corollary of this hypothesis is that assets are perfectly substitutable, and/or capital is perfectly mobile. Shepherd (1994) maintains that perfect assets substitution means there is uncovered interest rate parity, while perfect capital mobility implies the presence of covered interest rate parity. However, when there are regulatory and informational barriers in the way of the exchange of financial assets, then the forward premium may be different from the expected exchange rate change, and perfect asset substitution does not always mean there is perfect capital mobility. In addition, there may not be uncovered interest rate parity because of risk premium in foreign exchange markets caused by such things as default risk. There are, therefore, significant differences between the theoretical definition of financial market integration and the way market integration operates in the real world. Practically, capital market integration means that participants in one market have to pay attention to what happens in other related markets (Roca, 2000). There are several factors that affect the extent of integration between different equity markets such as: Economic integration. When economies are highly integrated, there is a corresponding high integration of their equity markets (Eun and Shim, 1989). The dividend discount model shows that economic activity affects the discount rate and movement in dividends, which in turn affect stock prices. Disturbances in one economy that is integrated with another affect the stock markets of both economies, with a corresponding increase in price co-movement. 4 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Janakiramanan and Lamba (1997) hypothesized that the stock market prices in a country that is world dominant will create ripple effects in stock markets worldwide, as a result of economic factors affecting the dominant country’s economy. Prices in the US stock market therefore drive prices in other small equity markets. Price co-movements also occur because the markets of two countries can react to another market that is dominant. Espitia and Santamaria (1994) found that interaction among European stock markets was high due to each market’s interaction with the US market. Price co­ movement can also occur when two markets react indirectly to a third market. For example, the Singapore market could react to the US market one day, and then on the next day might react to the UK’s reaction to the US market. Multiple-listing of stocks. Co-movement is also affected by multiple listing of stocks. For example, if a share is listed in the stock markets of two countries, disturbances in one market can be transmitted to the other. For example, many Swiss stocks are multiple listed in other European markets, so they are substantially affected by other European markets. Barriers of regulation and information. The degree and speed of capital mobility and portfolio readjustment are affected by regulatory and information barriers. When barriers are high, there is less equity market integration. One way to locate barriers is to find evidence that there are limitations on cross-border transactions. Institutionalization and securitization. When institutions transfer funds overseas, there is increased equity market integration (Fabozzi and Modigliani, 1992). Examples of such institutions are country and global funds such as the Korea Fund and Templeton Funds. Securitization, or the use of securities in raising funds, enables companies to cross-list 5 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. shares in different stocks, thereby facilitating international diversification because investors can access shares listed in different exchanges. Market contagion. Prices in different national stock markets can move together because of a contagion effect. An error in one market can be transmitted to another market because investors take action in their own market based on action in another market. Market contagion has been used to explain the stock market crash of 1987, when equity prices worldwide fell almost simultaneously (King and Wadhwani, 1990). Theories on contagion explain that it operates more along regional than along global lines such as the Asian financial crisis in 1997, which spread particularly within Asian countries. In general, contagion more typically spreads from large countries to smaller ones. 1.2 Statement of the Problem While stock markets exist in several Middle Eastern countries, the developmental levels of these stock markets vary greatly from one another. Some of the markets are much more efficient than others in generating the capital required by the economy and more effective in facilitating the creation of wealth. A part of the variance among stock markets in the Middle East lies in the differences in governmental policies applying trading on the exchanges. In Saudi Arabia, only Saudi Arabian-owned and chartered banks, as an example, are permitted to act as stockbrokers. Further, until recently Saudi Arabia allowed only residents of the Gulf Cooperation Council (GCC) countries to purchase shares in Saudi Arabian public companies or joint stock companies. In contrast, some other countries in the region have much freer stock markets. 6 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. The integration of stock markets in the Gulf region of the Middle East can lead to an enhanced environment for both investors and companies whose shares are traded on the stock exchanges in these countries. The few studies reported in the literature indicate that the level of integration of these stock markets was minimal. It is important, however, to establish the level of integration that does exist so that policymakers in the affected Gulf region countries will have the necessary and valid information upon which to develop policies to enhance stock market integration in the region. The purpose of this study is to investigate the interrelationship among the GCC stock markets in the long run. Five markets are included: the stock markets in Bahrain, Kuwait, Oman, Qatar and Saudi Arabia. Accordingly, the study investigates research questions related to integration among these five stock markets. Moreover, the study investigates the integration of these markets with leading international stock markets. In this context, four world stock markets were selected: the stock markets in the USA, the UK, Japan, and other developed markets represented by the Morgan Stanley Capital International (MSCI) Index. Specifically, the study addresses the following research questions for the presence of integration: 1. What are the characteristics of the bilateral integration of the stock markets in Bahrain, Kuwait, Oman, Qatar, and Saudi Arabia (i.e., Bahrain and Kuwait, Bahrain and Oman, Bahrain and Qatar, Bahrain and Saudi Arabia, Kuwait and Oman, Kuwait and Qatar, Kuwait and Saudi Arabia, Oman and Qatar, Oman and Saudi Arabia, and Qatar and Saudi Arabia)? How is the price movement in one market transmitted to other markets? 7 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 2. What are the characteristics of the integration of the stock markets in Bahrain, Kuwait, Oman, Qatar and Saudi Arabia as a group? 3. What are the characteristics of the bilateral integration of each stock exchange in the GCC countries with the S&P 500, FTSE 100, Nikkei 225 and MSCI index? Do international markets influence the GCC markets? 1.3 Motivation for the Study There are several reasons why policymakers and economists focus on financial integration. In the first place, it is axiomatic that the macroeconomic policy mix depends crucially on the openness of the financial system (Fleming, 1962; Mundell, 1963). The more mobile is capital, the more substitutable financial assets and the less flexible the exchange rate, the more difficult it is for a country to set its interest rates independently of interest rates in the rest of the world. Financial integration induces change in basic economic structure and in the operating environment for policy, business and households. This change can also make it confusing and difficult to determine what is happening in an economy in transition, and so some prospective view on what happens to an economy when it liberalizes its capital market is necessary. For the Gulf states, integration of stock exchanges in these countries means that the business environment in these countries would have to change and improve its trade infrastructure. The construction of trade zones, tax-free policies, and special subsidies for foreign investors, as well as ownership shares in companies invested locally, would attract foreign investors. The emergence of the foreign investors in the region means that the local banking and private sector would have to meet 8 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. international standards of quality and operations in order to compete effectively (Korajczyk, 1995; Bill and Springborg, 1994). Economic growth is fundamentally linked to financial integration. A number of recent models show how improved risk sharing leads to higher economic growth. For example, Pagano (1993) presents a study relating financial markets integration to economic growth. Capital market integration provides the opportunity for better diversification. In a segmented economy, a consumer or a firm may only select low-risk low-expected-retum investments. With integrated markets, individuals shift to high-risk high-expected-retum projects because they are able to diversify their overall risk (Obstfeld, 1994). There is an expanding body of empirical work on the relation between capital market restrictions and economic growth. King and Levine (1993) detail a significant cross-sectional correlation between variables that proxy for both the depth of the financial sector and its development and economic growth. Atje and Jovanovic (1993) found a significant correlation between the ratio of stock market trading volume to GDP and economic growth. Bekaert and Harvey (1995) explored an empirical relation between financial integration and economic development. The potential promotion for monetary union is another motivation of stock market integration in the Gulf region. In 2001, the GCC states decided to establish a single currency pegged to the US dollar by January 2010. The establishment of a monetary union will create an important regional entity. The monetary union is likely to promote policy coordination, reduce transaction cost and provide a more stable environment for business and for facilitating investment decisions. The high correlation of the stock markets will automatically cause the promotion of a single currency 9 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. because the returns on the investment have to be the same for all countries. Stock market integration would make the effect of exogenous shocks similar on integrated countries, making it is easier to stimulate these economies by sharing a common monetary policy. Stock market integration provides benefits to the investors and companies that are involved in the integration process. One of the more important advantages is the lowering of the risk premium associated with investing in stocks of those countries in comparison with investing in a non-integrated stock market. Hamara (2002) found that stock market integration leads to lower levels of price variability of equity stocks traded in the integrated markets. A lower level of price variability manifests itself as reduced volatility in the markets that are integrated. Moreover, stock market integration also leads to increases in both quality and quantity of information. These are substantial advantages to both investors and the companies whose equity shares are traded in the markets. The integration of stock markets will benefit the investors by enabling them to invest in a variety of new firms from other countries and minimize transaction and monitoring costs. Investors from different countries of the GCC states will be able to invest in ventures outside their country, yielding them the same profit or even more. If the GCC countries strengthen their structures, investors will invest in these states rather than in less-developed states due to the risk involved. Investors will invest in firms where they get the assurance of a return on their investment. Investors will also benefit from the fact that a large number of companies will be enlisted on the integrated stock 10 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. market, they can buy and sell shares more easily, and they can benefit from the convenience of an integrated stock market. Companies whose shares are traded on an integrated stock market gain many advantages. Companies are able to raise capital by reaching investors in other countries. They are able to raise capital in a less costly manner. Cost of capital is likely to be lower if a firm has unrestricted access to regional and international capital markets. Moreover, stock market integration enables companies to expand and benefit from economies of scale, as they are able to attain economies of large-scale production. Stock markets’ integration may involve some costs as well. The extensive dependence on other countries’ markets will cause subtle and less visible problems. Conflicts with the other countries may affect the economy on the whole. Substantial political changes in one country can adversely influence the neighboring states, causing the stock market to fluctuate. If markets are found to be integrated, there is a danger that a disturbance in one market may spill over to other markets, as happened in the crash of 1987. Another disadvantage of stock markets’ integration arises from losing the benefits of diversification. If markets move in parallel, the gain from diversification will disappear as these markets provide similar returns over time. If stock markets are not found to be integrated, the finding will allow policy makers to identify and correct problems. A typical barrier to stock market integration involves restricted capital flows across national borders. Thus, a finding of non­ integration among the stock markets of the GCC countries could highlight the policy changes required to improve stock market functioning in the region for the benefit of 11 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. both investors and companies whose equity stocks are traded on the regional stock exchanges. 1.4 Data Stock markets in five countries in the Gulf area have sufficient history to permit an investigation of the degree of integration among these stock markets. These five markets are: Bahrain Stock Exchange (BSE) in Bahrain, Doha Securities Market (DSM) in Qatar, Kuwait Stock Exchange (KSE) in Kuwait, Muscat Securities Market (MSM) in Oman, and Saudi Stock Market (SSM) in Saudi Arabia. Four stock markets functioning in the Gulf region have been in continuous operation since 1995. These four stock markets are those in Bahrain, Kuwait, Oman, and Saudi Arabia. The fifth GCC stock exchange included in the study, DSM, has been in continuous operation since 1998. Stock markets in the United Arab Emirates (UAE) are relatively new. Abu Dhabi Securities Market and Dubai Financial Market were founded officially in 2000. Data for the study pertaining to the five stock markets listed above cover a sufficient time span to provide reliable outcomes for the data analyses. The data that obtained relative to the stock exchanges in the five Gulf region countries are the closing weekly value index for each exchange. The data was obtained directly from the five stock exchanges and the Arab Monetary Fund (AMF) located in Abu Dhabi, UAE, for the inclusive period from August 14, 1998, to August 15, 2003 (a data set of 262 weeks for each of the five stock exchanges included in the investigation). In order to measure integration with international stock markets, four world stock market indices are selected. Standard and Poor’s 500 (S&P 500) Index is selected 12 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. as a measure of performance of the top 500 companies in the US market. Financial Times Stock Exchange 100 (FTSE 100) Index and Nihon Keizai Shimbun 225, or Nikkei 225 Index as it is more widely known, are selected to measure the performance of the UK and Japanese stock exchanges, respectively. Morgan Stanley Capital International (MSCI) Index in US dollars is considered as a measure of world stock markets’ performance. It is a complex index that is designed to measure the performance of global developed equity markets.2 Weekly data of developed markets was obtained from DataStream Data Base for the study period. The primary criterion for admissibility of the data is that it is reliable. The second criterion for admissibility is that the data reflect trading for all equity shares traded on an exchange. An important requirement of the analysis is that data for comparable equity assets be available across the stock exchanges included in the investigation. 1.5 Organization of the Study Following this introductory chapter, the dissertation has seven additional chapters. The following chapter provides a review of relevant theoretical literature, as well as a review of studies of transnational stock market integration, both global and regional. The third chapter of the study presents an overview of economic structure and economic and financial integration in GCC countries, focusing on efforts toward economic integration from the Unified Economic Agreement in 1981 to the 2 As of April 2002 the MSCI World Index consisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the UK and the US. 13 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. commitment made in 2001 to adopt a common currency by 2010. The fourth chapter introduces stock market development in GCC countries in terms of market capitalization, volume of shares traded and value of shares traded. Market regulations and trading systems are considered in this chapter as well. The fifth chapter presents the methodology used in the study. The sixth chapter presents the results of the research investigating bilateral and multilateral integration of the five stock markets included in the study. The seventh chapter introduces the results of the research investigating bilateral integration of each stock exchange in the five countries included in the investigation with world stock markets. The final chapter provides the conclusions drawn from the study findings, and presents necessary policy recommendations for financial regulators in the GCC countries. 14 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. CHAPTER II LITERATURE REVIEW The literature review develops a theoretical background for the study through a review of relevant theories. The literature review places the study in context by reviewing prior stock market integration studies in both global and regional contexts. Although there has been extensive research on equity market integration, there is no set agreement on this phenomenon. Research results differ according to the methodology used, the model, the data, the sample, and the time period. Some studies have concluded that world equity markets are integrated, that the US market is the most influential stock market in the world, and that the Japanese market is the second most influential. On the other hand, some studies have reported no lead or lag relationships among international markets at all. Grubel (1968) was the first to explore the risk-retum relationships of internationally diversified portfolios by employing the models of portfolio balance developed by Tobin (1958) and Markowitz (1959). He studied the effect of international diversification of asset holdings on international economic relations by using data on the share price indices of 11 industrialized countries from 1959 to 1966. Results indicated that diversification among the 11 countries has allowed investors a superior retum-risk trade-off compared to a portfolio consisting of Moody’s Industrial Average of Common Stock. Final conclusions were that international capital movements are directly affected not only by interest rate differentials but also by rates of growth in total 15 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. asset holdings in any two countries. Capital flows between countries when interest rate differentials are zero or negative, but usually does not flow when there is a positive interest differential. Granger (1969) studied the feedback and functions arising in spectral analysis between certain economic models, in particular the cross-spectrum and the partial cross­ spectrum. Direction of causality was studied. Conclusions were that in the two-variable case, feedback mechanisms have two causal relations, and the cross spectrum is the sum of two cross-spectra, each of which is closely connected with one of the causations. Agmon (1972) compiled and compared monthly data on the following four stock market indices: the US (Fisher Arithmetic Index and Dow Jones), Germany (Frankfurter Allgemeine Zietung), the UK (Financial Times Ordinary Share and Economist/Extel Indicator), and Japan (Tokyo Stock Exchange Price and Dow Jones Tokyo) from January 1955 to October 1966. Agmon concluded that there was a high degree of relationship among the four markets, with very fast responses in the non-US markets to changes in the US market. He considered that the US, UK, and Germany comprise a single multinational equity market. Later, Dwyer and Hafer (1988) studied the same markets and came up with different results. Correlation analyses and unit root tests were used to evaluate daily stock market prices from July 1987 to January 1988. Between 1957 and 1987, stock market prices were evaluated on a monthly basis and broken down into two periods: 1957 to 1973, and 1973 to 1987. The conclusion reached is that there was a linkage among changes in stock market prices, but no linkage among levels. In addition, there was a low correlation among markets that were higher in the later period. And more recently, Jeon and Von Furstenberg (1990) investigated 16 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. relationships among the same four markets from January 1986 to November 1988. They used vector autoregression analysis and found that after the crash of 1987 the influence of the US decreased, with the Tokyo market becoming increasingly independent of other markets. There were more co-movements after the crash of 1987. Stehle (1977) studied the segmentation of the US stock market and other markets, using a version of the Capital Asset Pricing Model to analyze monthly equity market data from stock price indices for Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Switzerland, the UK and the US Conclusions were that there was neither segmentation nor integration of the US equity market with other stock markets. Finnerty and Schneeweis (1979) studied how international equity and bond returns move together during a period of floating exchange rates. They used data from weekly stock market index levels, exchange rates, and corporate bond yields for the US, UK, France, Belgium, Netherlands, Italy, West Germany, Switzerland, and Japan from April 1973 to July 1977. Results revealed a low correlation between foreign and US stock and long-term bond returns. Hillard (1979) examined daily equity market data from Frankfurt, New York, Tokyo, Zurich, Amsterdam, Paris, London, Milan, and Toronto for linkages during the period of the oil crisis from July 1973 to April 1974. Hillard used cross-spectral analysis and found high correlations among markets on the same continent, but low correlations among markets on different continents. Errunza and Losq (1985) examined whether equity markets were integrated or segmented, using monthly return data for securities from Chile, India, Korea, Thailand, Argentina, Mexico, Greece, Zimbabwe, Brazil, and the US between 1976 and 1980. 17 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Mild segmentation was discovered, using a restricted version of international capital asset pricing. Aggarwal and Soenen (1989) compiled weekly data for seven Asia-Pacific fixed-income and equity markets, with the goal of determining the diversification gains to US investors. Data was compiled from seven markets from 1981 to 1985: US (S&P 500), Philippines (Manila Mining), Thailand (Bangkok Book Club), Hong Kong (Hang Seng), Singapore-Malaysia (Straits Times), and Japan (Nikkei Stock Average). Commercial bank deposit rates for 1981 to 1985, and foreign exchange rates for the same time period, were also examined. The methods used were mean-variance and correlation analysis. Results of the examination of data from these seven markets revealed low correlations among US market and Asia-Pacific market returns in both fixed-income and equity markets. Conclusions were that US investors could profit by investing in the Asia-Pacific markets. A similar result was concluded by Bailey and Stulz (1990), who found that there is a low correlation between the US and Pacific Basin markets, resulting in significant return on investment for US investors working in these markets. They reached that conclusion by using mean-variance and correlation analysis of returns to analyze daily, weekly, and monthly stock market data for the US (S&P 500) and the same Pacific Basin markets. Estimates were made of the return of investment to be expected from investing in these markets from January 1977 to December 1985. Eun and Shim (1989) used vector autoregression analyses to study the movement of international stock markets. The study used the daily Morgan Stanley Capital International stock market indices for Canada, France, Australia, Germany, 18 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Japan, the UK, Hong Kong, Switzerland, and the US from December 1979 to December 1985. Conclusions were that there is significant interdependence among these nine markets, with the US market being the most influential, followed by Switzerland and the UK. Australia, Canada, Hong Kong and the UK were discovered to have significant interdependence, which was attributed to the fact that all were British Commonwealth members. There was no lag in responses between Canada and the UK, while responses among France, Germany, and Switzerland occurred within one day. There was a two- day lag between Australia and Japan. Becker, et al. (1990) used correlations and regression analyses with ordinary least squares (OLS) to determine the relationships between the opening price of Japan’s stock market on one day and the closing price for the US equity market on the previous day. It investigated also the opening price of the US equity market on one day and the closing price of Japan’s market on the previous day. Daily opening and closing data for the Nikkei Index, S&P 500, and the yen/dollar exchange rate were used from October 5, 1985, to December 1988. Conclusions reached were that the opening price of Japan’s market is highly correlated with the US previous day closing price, but the opening price of the US market is not influenced by the previous day’s closing price in Japan. Campbell and Hamao (1992) measured integration between the US and Japanese stock markets. They examined the value-weighted index of the New York Stock Exchange and the Tokyo Stock Exchange to determine the integration between US and Japanese equity markets. Single latent variable capital asset pricing models were used to study the one-month Treasury bill yield and the 20-year government bond yield for both countries. Data were studied from January 1971 to March 1993. Conclusions were that 19 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. there was considerable integration of the US and Japanese markets in the 1980s. US and Japanese excess returns (return on stock less risk-free interest rate) moved together, with similar variables explaining excess returns in the US and Japan. Fischer and Palasvirta (1990) investigated changes among 23 national stock market indices, including the US and the two emerging markets of Malaysia and Mexico, using cross-spectral analysis in their study. They found that levels of interdependence were increasing among these markets, with the US having the most influence. King and Wadhwani (1990) used high-frequency data from the stock markets of New York, London, and Tokyo from July 1987 to February 1988 to study linkages among these markets during the 1987 crash. The contagion model of stock markets was used for the analysis, which showed evidence of contagion among the markets studied. The larger the volatility, the larger the contagion effect observed, in particular immediately after the crash. Ng et al. (1991) examined the volatility spill-over among the following five stock markets: US (S&P 500), Tokyo (Tokyo Stock Price Index), Korea (Composite Stock Price Index), Taiwan (Stock Exchange Weighted Stock Price Index), and Thailand (SET Index) from January 1985 to December 1987. The autoregressive conditional heteroskedasticity (ARCH) model was used, and conclusions were that there is no volatility spill-over to Taiwan and Korea from the US. In addition, spill-over from the US to Japan and Thailand occurs only when cross-country investments occur in Japan and Thailand. The final conclusion was that cross-country investment transmits volatility among different national markets. 20 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Solnik (1991) examined the benefits of diversification within the following markets of the Asian Pacific: Australia, Hong Kong, Korea, Thailand, Japan, Singapore, Malaysia, Taiwan, and Japan, and other developed markets in France, Germany, the US, and the UK from December 1977 to December 1988. Mean-variance and correlation analyses of local and US dollar returns were used, and it was found that there is higher correlation between US and European returns than there is with Pacific Basin returns. The correlation of the US with the rest of the world is relatively low (0.43). There is low correlation between the three markets of Korea, Taiwan and Thailand and other markets. Arshanapalli and Doukas (1993) used unit root and cointegration analyses to examine relationships and interactions among the stock markets of New York (Dow Jones Industrial Average), Japan (Nikkei 225), Paris (CAC General Price), Frankfurt (FAZ General Price), and London (FTSE 100) from January 1980 to May 1990. The authors concluded that there has been an increasing interdependence among these stock markets after the crash of 1987, except for the Nikkei index. The French, UK and German markets were significantly affected by the US market. The Japanese market performance had no links at all with any market in the US, France, Germany and the UK. Koch and Koch (1993) examined the changes in relationships among national market indices since 1972, using Morgan Stanley Capital International stock market indices for Hong Kong, West Germany, the UK, the US, Japan, Australia, Singapore, and Switzerland for 1972, 1980, and 1987. A structural, block-recursive, dynamic simultaneous equations model was used to study contemporaneous and lead-lag 21 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. relationships. Conclusions were that there are increasing interrelationships in these markets, with Japan’s influence increasing while that of the US declines. Lag time was usually 48 hours. Additional conclusions were that intermarket relationships were informationally efficient. Espitia and Santamaria (1994) studied the interdependence among markets in New York, London, Paris, Milan, Madrid, and Tokyo, using daily data from October 1987 to September 1992. The authors used vector autoregression analysis to determine interrelationships among markets in these six countries and how one market affects others. A high level of interdependence was discovered among these six markets, with New York being the most influential among the six. The second most influential was Tokyo, followed by London and Paris. There was no influence noted by other European markets, and European markets were not noticeably interdependent with each other. King, et al. (1994) analyzed the time variation in the covariances and the integration between the stock markets of the US, Australia, Canada, Germany, Netherlands, Spain, Sweden, Austria, Belgium, France, Italy, Norway, Spain, Switzerland, the UK, and Denmark. Monthly Morgan Stanley Capital International stock market indices for these countries were used in a multivariate factor model- dynamic version of the Arbitrage Pricing Theory, together with vector autoregression and autoregressive conditional heteroskedasticity. Conclusions were that these stock markets are not integrated. To et al. (1994) investigated interdependence among the emerging and major equity markets of Argentina, Brazil, Chile, Colombia, Greece, India, Jordan, Korea, Malaysia, Mexico, Nigeria, Pakistan, the Philippines, Taiwan, Venezuela, Zimbabwe, 22 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Japan, the UK and the US from 1976 to 1992. Unit root, cointegration and vector autoregression analyses revealed increasing interaction among these markets from 1985 to 1992, with the US being the most influential market. The US influences Brazil, Greece, India, Mexico, Malaysia, the Philippines and Thailand; the UK influences African emerging markets; the US, UK and Japan influence Colombia, Greece, Mexico, the Philippines, Taiwan and Thailand; and Japan affects Asian emerging markets. Akdogan (1995) studied equity market integration in Europe and market relationships between the US and Europe. For the first study, Akdogan used data published by the IMF to determine relationships among the UK, Germany, France, the Netherlands, Belgium, Denmark, Italy and Spain between 1978 and 1992. The second study examined relationships among Belgium, Denmark, France, Germany, Italy, Netherlands, Spain, the UK, Australia, Norway, Sweden, and Switzerland from January 1972 to February 1992. The third study used the same data as the second study to examine markets in the European Union, the European Free Trade Association, and the Americas. The methods used included single index, bifactor, market size-adjusted, regional and international formulations of the Capital Asset Pricing Model. Akdogan concluded that these markets became integrated in the 1980s, but were segmented in the 1970s. Bekaert and Harvey (1995) studied capital market integration caused by a conditional regime-switching model, with the goal of predicting returns in countries that are separated from world capital markets in one part of the sample, and later become integrated in the sample. Results indicate time-varying integration for a number of countries. Conclusions were that several emerging markets show time-varying 23 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. integration. More integration was observed in some markets than knowledge of investment restrictions in those markets might lead one to expect. Other markets appear segmented even though foreigners have relatively free access to their capital markets. Conclusions were that world capital markets are not becoming more integrated in those countries characterized by a regime-switching model. Smith et al. (1995) used monthly Morgan Stanley International Capital Perspective stock market indices to study equity integration among the following eight stock markets: the US, Canada, the UK, Japan, Germany, France, Switzerland, and Australia. In addition, the three-month Treasury bill rate for the US was compared with the Canadian finance paper rate. The Gensake rate for Japan, the French interbank loan rate, the interbank loan rate for Switzerland and the interbank sterling rate for Australia were also studied. These investigations were conducted from August 1980 to September 1991 using the Capital Asset Pricing Model. Conclusions were that there is no full integration or equality of risk/return ratios between any of these equity markets. Kwan et al. (1995) used monthly stock market series for Japan, Taiwan, West Germany, Singapore, Australia, South Korea, Hong Kong, the UK and the US to study the long-run and short-run linkages among equity markets in these countries. Conclusions drawn from the Granger-causality and cointegration analyses were that there is no cointegration among these markets, although there is bidirectional causality between Japan and South Korea, Singapore and Australia, Singapore and the UK, Taiwan and Singapore, Singapore and Hong Kong, Taiwan and Japan, and Taiwan and South Korea. The US market leads Australia, Japan, Hong Kong and the UK, with no market leading the US. 24 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Some research has pointed to close regional, economic and geographical relationships as causing linkages between some equity market groups. For example, research indicates that Japanese and Asian emerging markets are linked, and the UK and African markets are linked. Jorion and Schwartz (1986) used monthly return data from January 1963 to December 1982 to study integration between Canadian and US stock markets. The Capital Asset Pricing Model, plus the maximum-likelihood estimation technique, were used, and conclusions were that legal barriers prevent integration of the Canadian and US markets. With respect to the regional integration of stock markets in Europe, Pagano and Roell (1993) found a high level of correlation in the pricing of stocks with similar risk and return profiles on the London and Paris stock exchanges. The study involved the pricing of 16 different common equity securities across 380 different trading opportunities. Moon (2001) applied cointegration analysis and variance decomposition analyses to investigate the integration of stock markets in East Asia. He also compared the integration of East Asian stock markets with the integration of European stock markets. Moon found that the integration of the East Asian stock markets strengthened in the early- to mid-1990s. The study found that the linkages among the East Asian markets were stronger than the linkages among European stock markets. Neaime (2002) applied unit root tests for stationarity to assess the integration of seven stock markets in North Africa and the Middle East. The stock markets included in the analysis were Bahrain, Egypt, Jordan, Kuwait, Morocco, Saudi Arabia, and Turkey. 25 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. For the unit root analysis, he applied both the Phillips-Perron (PP) and Augmented Dickey-Fuller (ADF) tests. Following the determination of stationarity characteristics of the stock markets, Neaime applied the Johansen (1988) cointegration test. He segregated the stock markets of the Gulf Cooperation Council countries in the study (Bahrain, Kuwait, and Saudi Arabia) from the remaining four North African and Middle East countries in the study to test for stock market integration among the countries of the two groups separately. He found that the stock markets of the four non-Gulf Cooperation Council countries (Egypt, Jordan, Morocco, and Turkey) were integrated with one another, while the stocks markets of the three Gulf Cooperation Council countries included in the study (Bahrain, Kuwait, and Saudi Arabia) were characterised by only minimum integration. Research on equity market linkages has shown mixed results. Most conclusions have been based on asset pricing models, while others have used correlations and econometric techniques that are not reliable. In addition, the daily or monthly equity market data used in some studies has been shown to be unreliable because it is excessively short-term. In fact, stock markets act in predictable ways depending on the day and month, and reliable information is obtained only by analyzing information on a yearly basis (Bailey and Stulz, 1990). Research results on equity market integration are mixed because of problems with methodology and data. Since the crash of the stock market in the United States in 1987, the conclusion of several studies is that the correlation of co-movements in prices and volume among international stock exchanges is higher than was the case before the 1987 crash (Hamao, Masulis, and Ng, 1990; Lee and Kim, 1993; and Masih and Masih, 1997). Many of the studies also identified other 26 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. factors involved in the higher correlations in movements in prices and trading volume across international markets. Hamao et al. (1990), as an example, cited increased financial and economic integration among Western European countries as a major contributing factor to increased levels of co-movement in that region. Chelley-Steeley, et al. (1998) cited exchange controls in the European Community as a major factor explaining the increased levels of co-movement among Western European stock exchanges. 27 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. CHAPTER III ECONOMIC AND FINANCIAL INTEGRATION IN THE GCC COUNTRIES Since the mid-1950s, the terms “economic integration” and “regionalism” have become main economic concepts. The processes the terms refer to eliminate restrictions on international trade and mobility of labor and capital. The objective has been to enhance trade among specific nations without restrictions or limitations for the benefit of each nation based primarily on the theory of comparative advantage. Since that time, a number of unions have been created, such as economic unions, common markets, customs unions, and political unions. The organizations involve countries within a particular region for the purpose of benefiting each other about the same way as they would if they were all states in one country. At the same time, each member nation retains its identity, government, and culture with only the economic system being affected. The integration of a number of European countries, known as the European Economic Union (EEU), serves as an excellent example. Since its creation in 1950, the integration has delivered half a century of stability, peace, and economic prosperity for member nations. It has helped raise standards of living, built an internal market, launched the Euro as a unified currency and strengthened the EEU’s voice in the world. Such integration is not limited to developed countries. Developing countries also seek integration with each other. A major block among developing countries is the 28 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Cooperation Council for the Arab States of the Gulf, more commonly known as the Gulf Cooperation Council (GCC), which was founded on May 25, 1981. The member states of the Cooperation Council are the Kingdom of Bahrain (formerly known as the State of Bahrain), the State of Kuwait, the Sultanate of Oman, the State of Qatar, the Kingdom of Saudi Arabia, and the State of United Arab Emirates (UAE). The Council aims to deepen areas of cooperation among member countries in various fields. The GCC Charter emphasized the deepening and strengthening of relations, links and areas of cooperation among citizens. The charter sets forth the special relations, common qualities, and similar systems founded in the creed of Islam, faith in a common destiny and sharing one goal, and the cooperation among states to serve the objectives of Arab nations in the Middle East. The Charter states that the basic objectives are to effect coordination, integration and inter-connection among member states in all fields. It strengthens ties among their peoples, formulating similar regulations in various fields such as economy, finance, trade, customs, tourism, legislation, and administration as well as fostering scientific and technical progress in industry, mining, agriculture, water and animal resources, establishing scientific research centers, setting up join ventures, and encouraging cooperation from and with the private sector (GCC, Concept and Foundations, 2003). The council plays its role through three main entities. The GCC Supreme Council is the highest authority of the GCC. It consists of the Majesties and Highnesses, the leaders of member countries. Its presidency rotates according to the Arabic alphabetical order of the names of the member states. It convenes one regular session every year. However, extraordinary sessions may be convened at the request of any 29 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. member state seconded by another. In 1998, the GCC Supreme Council decided to hold consultative meeting in between two summits every year. Meetings of the Supreme Council are considered valid if attended by two thirds of the member states, at which time each has one vote. Resolutions on substantive matters are issued by unanimous approval of the members present, while a majority is enough to approve matters of a procedural nature (GCC, The Organizational Structure, 2003). The second entity is the Ministerial Council. It is made up of the Ministers of Foreign Affairs of the various states, or other ministers acting on their behalf. The Presidency of the Ministerial Council presides over the session of the Supreme Court, or, when necessary, with the member state that is next to preside over the Supreme Council. The Ministerial Council convenes every three months, and may hold extraordinary meetings upon the request of one member state seconded by another. The meeting is considered valid if attended by two thirds of the member states. The Ministerial Council is authorized to propose policies, lay out recommendations, and encourage and coordinate the already existing activities in oil fields. Resolutions adopted by other ministerial committees are referred to the Ministerial Council, which in turn would refer the relevant matters, along with appropriate recommendations, to the Supreme Council for approval. The Ministerial Council is also charged with arranging the Supreme Council meetings and preparing agenda (GCC, The Organizational Structure, 2003). The third entity is the Secretariat-General, which is responsible, among other functions, for preparing studies relating to cooperation, coordination, and integrated plans and programs for joint work. It also prepares for the meetings, and prepares the 30 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. agendas and draft resolutions for the Supreme Council and the Ministerial Council. The headquarters of the Secretariat General is located in Riyadh, Saudi Arabia. It is divided into six directorates or sectors of activity in the areas of political affairs, economic affairs, environment and human resources, legal affairs, financial and administrative affairs, and information. 3.1 Economic Overview 3.1.1 Economic Structure The economies of the GCC nations are largely dominated by the oil sector. The GCC countries produce on average 13.6 million barrels a day, which represents about 20 percent of the world oil supply, and have about 44 percent of the world’s proven crude oil reserves. With the exception of Bahrain, the oil sector accounts on the average for about 40 percent of GDP, and its revenue represents approximately 70 percent of total government revenues in the last decade. Such exports comprise on the average 65 percent of total exports. Four of the GCC countries (Kuwait, Qatar, Saudi Arabia and UAE) are members of the Organization of the Petroleum Exporting Countries (OPEC), and they play an important role in stabilizing oil prices. Oil dependency is illustrated in Figures 3.1, 3.2, and 3.3. The economies of the GCC countries are considered to be among the most open economies in the Middle East due to heavy reliance on exported oil and imported consumer and capital goods. Traditionally, the degree of openness is measured by the value of traded goods and services (exports plus imports) as a percentage of GDP. As shown in Figure 3.4, the average ratio for the GCC countries is relatively high and is 31 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. higher than the world average and for other countries in the region. High ratios reflect high dependency on oil exports and capital goods imports. 50% 45% -I 40% 35% o 30% 25%os - 20% 15% 10% 5% 0% Oman QatarBahrain Kuwait i Oman Qatar Saudi Arabia UAE country Source: IMF, World Economic Outlook 2003 Figure 3.1: Average of Oil Sector GDP-Total GDP Ratio (1991-2002) 90% j 80% - 70% 60% J o 50% -j S? 40% -j 30% \ 20% -j 10% -j 0% 4- Bahrain Kuwait Oman Qatar Saudi Arabia UAE country Source: IMF, World Economic Outlook 2003 Figure 3.2: Average of Oil Revenue-Total Revenue Ratio (1990-2002) 32 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 0.9 - 0.8 -j' 0.7 I 0.6 - O 0.5 \ £ 0.4 4 0.3 -} 0.2 - 0.1 j 0 + - ■ I Bahrain Kuwait Oman Qatar Saudi U.A.E Arabia country Source: IMF, World Economic Outlook 2003 Figure 3.3: Average of Oil Export/Total Exports Ratio (1990-2002) 160% 140% Bes at Ip TV 11 4mm 111 r ; B 'J . . . ! Bahrain Kuwait Oman Qatar Saudi United World Other Arabia Arab Average Middle Emirates Eastern Countries Countiy/Region Source: World Bank, World Development Indicators Figure 3.4: Average of Trade / GDP Ratio (1980-2000) 33 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 3.1.2 Economic Performance The economic outlook of the GCC countries is shaped by factors influencing demand for oil. The economies of the GCC nations continue to be largely dominated by the oil sector and thus remain at the mercy of fluctuations in the price of as well as the demand for petroleum in the international markets. Fueled by a dramatic increase in the price of oil during the 1970s, per capita GDP in the region grew from a simple average of $2,366 in 1970 to $12,495 in 1995. The GCC countries have experienced frequent large swings in overall GDP growth as a result of wide fluctuations in their oil production and volatile international oil prices. Annual real GDP growth averaged about 4 percent in the period from 1991 to 2002 and GDP per capita has grown gradually in all countries since 1991, as shown in Figures 3.5 and 3.6. Bahrain Kuwait Oman - . .Qatar —— S.Arabia U.A.E Source: IMF, World Economic Outlook 2003 Figure 3.5: Real GDP Growth Rate (1991-2002) 34 o> -0.2 - j - 0.6 1991 1993 1995 1997 1999 2001 country Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 35000 - 30000 m- 3 25000 - a. 8 20000 - £L 15000 - ***»• O. Q (3 10000 - 5000 0 «>' or cf » SS* SF s p OV oV £ r tf ' V <£ r * country Bahrain Kuwait - ———Oman — - -Qatar — — S.Arabia UAE Source: IMF, World Economic Outlook 2003 Figure 3.6: Nominal Per Capita GDP from 1991 to 2002 In Bahrain, economic growth has become quite independent from oil shocks as reflected in 1998, when oil prices collapsed. That independence has contributed to a gradual improvement in the country’s per capita GDP. Kuwait’s growth rate has declined from 10 percent on average in the first half of 1990s to about 1 percent from 1996 to 2002, reflecting a drop in oil output. GDP per capita has decreased in the second half as well. Qatar turned to its huge untapped reserves of natural gas to improve its economic activity. As a result, real GDP growth climbed to about 7 percent on average between 1997 and 2002 compared to less than 3 percent during the period from 1990 to 1996, leading to a sharp increase in per capita GDP, which reached $30,850 in 2000, becoming among the highest income countries in the world. Saudi Arabia recorded the lowest economic growth in the GCC area during the last decade, with an average of 2 percent, leading to stagnant per capita GDP. The economies of Oman and 35 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. the UAE grew similarly, with approximate average of 5 percent; per capita income increased slightly in last decade. Inflation rates have been low in the GCC area by both regional and international standards, an average of 1.6 percent in the last decade. Saudi Arabia and Bahrain had the lowest inflation rates in the GCC area, with less than 1 percent on average during the past decade. Oman’s inflation rate is relatively low, less than 2 percent on average from 1991 to 2002. Kuwait and Qatar recorded a moderate inflation rate for the same period, with the average rates of 2.33 percent and 2.06 percent, respectively. The UAE recorded the highest inflation rate in the region, averaging 3.5 percent over the same period. Figure 3.7 shows the convergence of inflation rates in the member countries in the last few years. 6.00 -j — Bahrain --K uw ait — Oman — ■ Qatar — S.Araibia - U.A.E 4.00 - 2.00 - o.oo 4 - 2.00 - - 4.00 - 1992 1994 1996 1998 2000 2002 Y ear Source: IMF, International Financial Statistics, 2003 Figure 3.7: Convergence of Inflation Rates 36 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. The regional crisis of 1990-91 increased a need for expenditures that placed pressure on the budgets of the GCC countries. The countries directly involved suffered the worst. The budget deficit in Kuwait, for example, exceeded 100 percent of GDP in 1991. Later, total expenditure was reduced significantly, resulting in a shift from deficit to surplus in late 1990s. Saudi Arabia’s budget deficit increased to 17 percent of GDP in 1991. As a result, the country implemented a fiscal policy involving primarily cuts in expenditure (Sassanpour, 1996). The result was a decline in the budget deficit ratio from 11 percent in 1992 to an average of 3 percent in later years. Other GCC countries generally recorded small consolidated fiscal deficits during the period from 1991 to 1999. These deficits averaged about 2 percent of GDP. Rising global oil prices in 2000 contributed to a sharp improvement in the fiscal accounts that reached a surplus of 6 percent of GDP on average from 2000 to 2002. Figure 3.8 illustrates the improvement of fiscal accounts in the last decade. 40% 20% csu -20% -40% -60% 1992 1994 1996 1998 2000 Year Bahrain Kuwait Oman Qatar — S. Arabia — U.A.E Source: IMF, International Financial Statistics, 2003 Figure 3.8: Budget Surpius/Deficit-GDP Ratio (1992-2002) 37 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. The GCC countries’ current accounts remained sensitive to oil price movements because oil still accounts on average for about 65 percent of export receipts. Excluding Kuwait and the UAE, the average external current account balance of the GCC countries moved from an average deficit of close to 5 percent of GDP a year in the first half of the 1990s to a surge in the deficit of around 9 percent in 1998 due to the decline in oil prices. The balance turned into a surplus, reaching 4 percent of GDP in 2000- 2002, reflecting the recovery in oil prices. Kuwait and the UAE experienced a current account surplus in the last decade, even in 1998 when global oil prices collapsed. That can be attributed to large government investment income receipts in Kuwait and to a more diversified economy in the UAE compared to other GCC countries. Traditional measures of financial deepening indicate the region is well monetized. In most GCC countries, the ratio of money supply (M3) to GDP ranges between 50 percent and 90 percent, and has been relatively stable over the years, reflecting the ability of the banking sector to attract more deposits. 3.2 Efforts Toward Economic Integration Economic cooperation is considered to be the cornerstone of the GCC. This goal is broad, moving from cooperation and coordination to advanced stages of economic integration. Economic integration has been a focus of the council since its establishment, and has been promoted through different stages in the last two decades. This section presents major stages of economic integration from the Unified Economic Agreement in 1981 to the commitment made in 2001 to adopt a common currency by 2010. 38 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 3.2.1 The Unified Economic Agreement The first effort toward economic integration in the GCC countries was through the Unified Economic Agreement (UEA) in 1981. The agreement determined the complete framework for economic and financial cooperation among the GCC states. The UEA stresses the establishment of GCC joint projects in industry, agriculture, and services using public, private, or mixed capital in order to achieve economic integration. The UEA is divided into seven chapters with a total of 28 articles. The first chapter concerns trade. It states that all national products, including agricultural, animal, industrial, and natural resources products are tariff-exempt. It calls for more coordination regarding trade policies. The second chapter underlines free movement of capital and labor between member states, and freedom of ownership and participation in economic activities for GCC citizens. Coordination of economic development plans among member countries was the focus of chapter three. Since all member countries depend mainly on oil, harmonization of their oil policies is needed to achieve an advanced stage of economic integration. Chapter four states that member countries should cooperate with each other for common technical cooperation through supporting scientific research and importing technology. Chapter five calls for free transportation of passengers and cargo of member countries with a need to establish transportation infrastructure. Chapter six focuses on financial and monetary cooperation. It calls for coordination regarding investment laws, convergence in fiscal and monetary policies, and more harmonization between monetary authorities and banking sectors in member countries. The last chapter presents closing provisions (GCC, The Unified Economic Agreement, 2003). 39 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. The major achievement of the UEA is trade liberalization among member countries. According to the agreement, all products that are of national origin will be traded as national products. In order for a product to qualify as a “product of national origin,” it must be produced locally with value added of 40 percent or more and at least 51 percent of the enterprise owned by GCC citizens. In practice, the definition of products of national origin varies from country to country due to deviations in standards and measurements among GCC countries. Although free trade was introduced in 1981, trade barriers were not eliminated completely. There has not been much growth in intra-regional trade among GCC members because of several factors. The main reason is that there is a similarity in the economic structures of GCC countries. With the exception of Bahrain, GCC countries have oil-based economies. Because of this similarity, there is little opportunity for member countries to complement one another. Besides that, non-tariff barriers such as differential product specifications, overburdening bureaucracy, and obstacles over borders caused by defense and security issues exist (Dar and Presley, 2001). Even though the Unified Economic Agreement is the GCC's major success on the economic side, most of its clauses remain simply ink on paper. While some articles have not been applied yet, other have been delayed. For instance, restrictions on capital and labor still exist in most member states. The implementation of a custom union is in fact 15 years late. Moreover, the UEA existed for some 20 years without change or update in spite of dramatic changes in economic conditions for member countries and the world economy as a whole in the last two decades. In 2001, the UEA was supplanted by a new agreement called the Economic Agreement. 40 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 3.2.2 The Gulf Customs Union According to the Economic Agreement signed in December 2001, the Gulf Customs Union (GCU) came into effect in January 2003, moving member states to a single customs area in which trade barriers, taxes, and related procedures are eliminated among them. The objective of this union was to create competition, efficiency, income, productivity, growth, and more jobs, and to achieve an advanced state of economic integration. The benefits of a customs union would be achieved upon the untangling and removal of economic distortions caused by different tariff levels. With large variations in external tariffs and trade policies among GCC counties, the economic integration process has progressed slowly over the last two decades. Source: Arab Monetary Fund Figure 3.9: Ratio of Intra-trade to Total Trade in GCC Countries 3 Tariff on some imports was low (within 5 percent) in UAE, while in Saudi Arabia it reached 21 percent. 41 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. However, the GCC countries’ trade with each other far less than do countries in any other regional bloc. The share of trade among GCC countries has increased from 5 percent in 1981 to only 7 percent in 2000 as shown in Figure 3.9. It is low compared to other regional trading groups, such as the EU, which exceeded 55 percent in 2002. With the exception of Saudi Arabia and Bahrain, other GCC countries have failed to show any significant sign of intra-trade integration. The Gulf Customs Union (GCU) was designed to increase trade among GCC member countries, create links to the international marketplace, and push local producers to match the rest of the world in pricing. The GCU is based on the following principles: • A Common External Tariff (CET) of 5 percent that is applicable to all imports into the six member states that come from the rest of the world • Common customs laws, regulations and rules in all member states • Unification of customs procedures and financial and administrative instructions • With the exception of the prohibited and restricted goods, and taking into consideration the implementation of the veterinary and agricultural quarantine regulations, all goods move freely among the GCC countries without customs or non-customs restrictions (GCC, The GCC Customs Union, 2003). The GCU is expected to play an important role in liberalizing trade in the region. Economists state that increasing Arab trade (only 2 percent of the world’s trade) would enable Arab countries to deal on a more equal footing with the world’s giant economic blocs, such as the European Union, the GCC’s biggest trading partner, and would benefit from joining the WTO. Membership in the WTO and adherence to its 42 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. rules and regulations can be advantageous, particularly for the Gulf countries as they will be entitled to most-favored-nation treatment and national status treatment, effectively securing market access.4 Membership and compliance with WTO obligations encourage greater private sector participation, increasing competition, efficiency, and product diversification. Admittedly, membership encourages diversification in the global community (Al-Khatib and Hashmi, 2003). 3.2.3 Monetary Union A factor indicative of an advanced stage of economic integration is monetary union. The theory of an optimum currency area (OCA), introduced mainly by Mundell in 1961, is a major framework available to economists for assessing the feasibility of monetary union. An OCA can be defined as a region that exhibits key elements necessary for, and which would profit by, having its own currency and its own monetary policy. The theory predicts that it is beneficial for countries to join monetary union if they are highly economically integrated (Mundell, 1961). The OCA theory predicts that a high degree of economic integration between a country and a fixed exchange rate area magnify the monetary efficiency gain the country reaps when it fixes its exchange rate against the area’s currencies. Monetary efficiency is promoted by avoiding uncertainty and reducing transaction costs. On the other hand, the theory indicates that there are costs incurred by a country that joins a currency area. These costs can be considered as a country loses its ability to use monetary policy to stabilize its economy. A high degree of economic integration 4 Currently, Bahrain, Kuwait, Qatar, Oman and UAE are members of the WTO, while Saudi Arabia applied for WTO membership in 1993 and negotiations continue. 43 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. between a country and the fixed exchange rate area that it joins reduces the resulting economic stability loss due to output market disturbances (Krugman and Obstfeld, 2000). The GCC states realize that a common currency is beneficial to their economies and will promote an advanced stage of economic integration. As stated above, joining a currency area can be beneficial for a country in terms of reducing transaction costs and avoiding uncertainty associated with exchange rate fluctuations. Therefore, a joint currency has been a high priority for member countries since the founding of the GCC. The UEA outlines guiding principles toward monetary union. According to Article 22 of the agreement: Member States shall seek to coordinate their financial, monetary and banking policies and enhance cooperation between monetary agencies and central banks, including the attempt to establish a joint currency in order to further their desired economic integration (GCC, The Unified Economic Agreement, 2003). A large step toward an advanced stage of economic integration was taken in December 2001. The member states agreed to adopt a common currency by 2010. The member countries set a preliminary agenda for monetary union. According to the agenda, a temporal program of monetary union will consist of three stages. The first stage began with the announcement of a single currency in the end of 2001 and spanned until the end of 2002. In this stage, all GCC states were required to peg their currency officially to the US dollar no later than January 2003. This stage did not require much effort because all the countries already correlate their currencies to the US dollar except Kuwait, which pegged the Kuwaiti diner to the US dollar in the end of 2002. The second stage will last from 2003 until 2008. There is the implication that a set of criteria 44 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. will be created in 2003 and will be met by the end of 2008. The final stage will take place from 2008 through 2010, and will include issuing the common currency and establishing related institutions such as a gulf central bank. In order to benefit from the European experience, GCC monetary authorities asked the European Central Bank (ECB) to conduct a study on the modalities to be followed while integrating the economies of member countries and implementing a common currency. Much can be learned from the experience European Union. Specific criteria were set up in Maastricht in 1991 for all EU countries willing to join the single currency. The following is a brief summary of the five criteria laid out for a single currency in the Maastricht Treaty: • Government budget deficit has to be below 3 percent of GDP. • The public debt has to be less than 60 percent of GDP. • Inflation rates must not exceed 1.5 percent above average of the three EU countries with the lowest inflation rate. • Interest rates must not exceed 2 percent above average of the three EU countries with the lowest interest rate. • Exchange rates must be kept within “normal” fluctuation margins of Europe’s exchange rate mechanism. In order to be involved in a single currency area, GCC countries need to achieve a high level of economic convergence to ensure smooth movement down the often- difficult road to monetary union. They need to be aware of the vast disparities in their financial and economic positions that are required for monetary union, in particular the public debt, interest rates and fiscal deficits. The GCC countries are advised to follow 45 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. criteria similar to those that the European countries adopted in Maastricht in 1991 while working toward a single currency. The ability of GCC countries to meet these criteria would provide preliminary indicators for GCC countries’ readiness for a common currency based on the European experience. Regarding the fiscal criteria, all member countries have lately fulfilled the condition of the budget deficit-to-GDP ratio. A major problem arises in the debt-to- GDP ratio criterion that might be a barrier toward a monetary union in the region. A huge divergence in this ratio exists among member countries. The inflation-rate criterion can be met by all member states. The range of highest inflation rate in the region to the average of the three countries with the lowest inflation rates has declined from 4.58 in 1992 to 2.9 in 2002. The same thing can be said about the interest rate criterion. Monthly average interest rates on deposits for three months have moved closely since 1997. Finally, the exchange rate criterion has already been met because the six GCC currencies are already pegged to the US dollar. 3.3 Financial Integration and Liberalization During the 1980s and 1990s, the financial sector played an important role in the GCC countries. This was made possible by commercial oil production, which accumulated large amounts of oil income. This gave impetus to the development of financial institutions in these countries. Cooperative efforts have so far been made to liberalize capital and develop interaction and integration among financial institutions in these countries. Since its creation, the GCC countries have taken steps to achieve financial integration. They have lifted formal impediments to the free movement of 46 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. labor and capital across boundaries, and they have similar policy preferences regarding liberal capital flows. The Unified Economic Agreement considered such issues of financial integration. Article 8 of the agreement states that: The Member States shall agree on executive principles to ensure that each Member State shall grant the citizens of all other Member States the same treatment as is granted to its own citizens without any discrimination of differentiation in the following fields: 1. Freedom of movement, work and residence. 2. Right of ownership, inheritance and bequest. 3. Freedom of exercising economic activity. 4. Free movement of capital (GCC, The Unified Economic Agreement, 2003). The Economic Agreement signed in 2001 added other areas of economic participation. It allowed GCC citizens and business to own and trade shares of joint companies in other GCC countries, and to establish companies as well. Moreover, it called for unified tax treatment among citizens and business of GCC counties across borders. The GCC countries have similar financial systems, which mainly consist of the central bank, commercial banks, insurance companies, stock brokerage firms, stock exchanges, etc. Integration of the GCC financial systems has increased in the last few years as a result of the deregulation of domestic interest rates and the removal of remaining capital controls, which have facilitated free private capital movements. 3.3.1 Banking Sector The beginning of the banking industry in the GCC countries goes back to 1926, when the first bank was opened in Saudi Arabia to meet needs of pilgrims for Saudi 47 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Rials. With the discovery of oil, banks have grown rapidly in terms of number of branches and total assets to play a major role in economic development. In terms of shareholders’ equity, the GCC banks are relatively large compared to other countries in the region. According to Al-Majalla magazine, nine out of the 10 largest Arab banks in 2002 were from the GCC countries (Al-Majalla, 2003). Although the majority are privately owned, the role of the public sector remains substantial through equity participation in several banks or through a number of government-owned specialized credit institutions that provide financing to public and private sector enterprises at subsidized rates. Degree of openness of banking system varies from one country to another across the GCC countries. Bahrain has the most liberalized banking sector in the region, allowing foreign commercial banks, offshore banking units, foreign exchange brokers and representative offices to operate freely in the country. Qatar, Oman, and the UAE technically allow foreign banks to operate in a limited way through offshore banking units. In Saudi Arabia, the foreign share of operating banks (with the exception of the GCC banks) must not exceed 40 percent, while in Kuwait, banking is closed to foreigners. Due to the limited size of the markets they service, GCC commercial banks are faced with a strong need for consolidation. In order to evolve into major players in international financial markets, it is imperative that these banks succeed in expanding their asset base. Such a strategy will allow them to improve the quality of their assets through diversification, and to invest in expensive new technology that has increasingly become critical to success in the global banking industry (Jaber, 2000). 48 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. The nature of the banking system in the GCC countries is conservative. Banking roles and regulations were designed to guarantee the liquidity of banks and the soundness of their operations with a view to preventing bank failure. In spite of that, regulations must be balanced. The regulations must allow for the development of new services. For instance, some of the GCC countries still lack a deposit insurance system to protect depositors in the case of bank failure. One of the major factors in promoting integration of the banking sector in the GCC states is the need for uniform rules and regulations regarding banking. All GCC countries have laws that lay down a comprehensive framework for the banking industry’s regulatory and supervisory structures. These laws also go a long way in delimiting (sometimes excessively) the activities of financial institutions operating within their boundaries. Nevertheless, banking laws in the GCC countries do suffer from a number of shortcomings. For one, these laws are relatively dated, with the newest banking law in the region—those of the UAE—originating in 1980. They do not necessarily incorporate the regulatory developments that have occurred during the late 1980s and 1990s. Nor do they take into consideration the global changes that have taken place in the banking industry since that time (Jaber, 2000). In order to integrate their financial systems, the GCC countries permitted the governmental specialized credit institutions to offer free or low interest loans for domestic investment. Since 1986, Gulf Cooperation Council citizens have been treated equally in applying for loans from any of the special funds. These financial institutions include funds for agricultural, industrial, and real estate loans. 49 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. On the banking side, progress has been made by GCC regulators to integrate their banking systems. A major accomplishment in this regard is the resolution taken by Kuwait Summit 1997, which permits national banks to open branches in GCC member states. The resolution is intended to develop the banking sector and increase its competitiveness, both regionally and internationally. The GCC also established the Gulf Network of the National ATM Networks, and approved the Centrality of Risks Law, the Efficiency of Capital and Risks of Assets Law, and the Credit Concentration in GCC Banks Law (GCC, Areas of Cooperation, 2003). Although progress has been made by the GCC countries, there exists substantial room for improvement. To integrate the banking system within the GCC countries will require extensive evaluation of rules and regulations that will enable member state banks to work more closely together both from the perspective of country to country, but also when functioning within the international system. 3.3.2 Stock Markets Most of the GCC stock markets are relatively small and virtually closed to foreign investors, a situation that blocks foreign portfolio investment inflows. Moreover, these markets (with the exception of the BSE) still impose some restrictions on nationals of GCC countries, even though the Supreme Council in 1988 called for free participation in the GCC stock markets among member states. Variation in governmental policies applying trading on these exchanges has led to different degrees of openness in these markets. 50 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. The Bahrain Stock Exchange is the most liberalized market in the region. In 1999, the market was opened up to foreign investors, with GCC nationals being allowed to own up to 100 percent (up from 49 percent) of joint companies, and non-GCC investment up from 24 percent to 49 percent. This move reflected positively on the trading figures, with the increase of shares traded by GCC investors up from 16.4 percent in 1998 to 25 percent in 2000, and non-GCC investors up from 1.5 percent in 1998 to 9 percent in 2000 of total traded shares. By the end of 2002, GCC and non- GCC nationals owned approximately 49 percent and 7.5 percent of Bahraini companies, respectively. The Doha Securities Market (DSM) in Qatar came into existence in May 1997 listing only the public shareholding companies. In February 2000, the government issued a law allowing GCC nationals to hold up to 25 percent of Qatari shares in all firms listed on the DSM, with the exception of banks and finance companies. It is expected that non-GCC nationals will also soon be allowed to invest in shares through mutual funds. The Qatar Telecommunications (Q-Tel) in late 1998 issued an initial public offering (IPO) that was open to both local and Gulf investors. Although the Kuwait Stock Exchange (KSE) is the oldest market in the region, it is still not fully liberalized. Non-GCC nationals are forbidden to trade in Kuwaiti stocks on the KSE, except through the medium of mutual funds. GCC country nationals have been allowed to own shares of the Kuwaiti companies listed on the exchange, with the restriction that they cannot hold more than 49 percent of the total shares outstanding of banks and insurance companies. 51 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. When trading began in 1989 on the Muscat Securities Market (MSM), the market was closed to non-Omani citizens. Later, GCC nationals and foreigners were allowed to invest in the market. In 1998, there were 123 companies listed in the market. Of these, 98 were open to GCC nationals and 56 were open to all foreign investors, normally up to a limit of 49 percent foreign ownership. In March 2003, GCC nationals and foreigners owned 8.5 percent and 8 percent of capital of companies listed on the market, respectively. Currently, all