The Patterns of Cross-Border Portfolio Investments in the GCC Region: Do Institutional Quality and the Number of Expatriates Play a Role?

Article excerpt

Abstract In this paper, we document the determinants of portfolio investments to Gulf Cooperation Council (GCC) economies by bringing up the role played by market forces, cultural affinities, and institutional quality. We classify the GCC economies as host to 35 countries as per the Coordinated Portfolio Investment Surveys (CPIS) of the IMF for the period 2001-2006. Using the CPIS data and data from various other reliable sources and appropriate panel data analysis techniques, we find a number of interesting results: 1) the relatively higher quality of institutional set up in GCC in comparison to other countries; 2) the relative volume of expatriates across source countries in GCC soil; and 3) bilateral factors such as trade linkages between GCC and source countries, all statistically and significantly explain portfolio investments to the GCC region. Additionally, we uncover the existence of a portfolio "GCC bias". That is, GCC investors exhibit a strong preference towards their own markets when allocating their cross border financial asset holdings.

Keywords International Portfolio Allocation * GCC * Bilateral Linkage * Institutional Quality * Expatriates

JEL Classification E44 * F15 * F36 * F41

I Introduction

The objective of this paper is to shed lights on the determinants of portfolio investments to Gulf Cooperation Council (hereafter GCC) countries by investigating the role played by market forces, labor in-migration, cultural affinities, and institutional quality. The GCC is an interesting case begging for in-depth understanding of capital inflows for many reasons. Following the oil crisis of the 1970s and early 1980s, the GCC had seen the largest increase in oil and gas export revenues. Although part of this money was invested at home to build infrastructure and develop the agricultural sector, a large portion was also allocated to finance investment in the United States and Europe and heavy weaponry. These investments took place to respond to two urgencies at the time: the need for protection against political instability and conflicts in the region and the need to reduce reliance on oil revenues. During the 1970s and the 1980s when war was raging in the Middle-East, it was inconceivable for the rather risk-averse investors to allocate their portfolio in the region since the people who live there and the governments themselves were expatriating capital in the hope of not losing it all at once in a conflict. Moreover, in most of these countries, the law did not permit foreigners to own properties and have their own businesses without a local sponsor.

Although massive investments of GCC oil revenues in US and European markets have solidified political relationships with the West and have provided the much needed protection to keep the political landscape intact, domestic macroeconomic structural reforms did not deliver the good as anticipated. It did not take long for these countries (mostly Saudi Arabia) to realize that supports to the agricultural sector for example out of oil revenues were not the best usage of financial resources when oil prices tumbled in 1983 and thereafter (Hourani et al. 2004). However, a series of unfortunate events that took place in the 1990s and 2000s has brought to the GCC the opportunity to correct the mistakes of the past as oil and gas prices were climbing again to reach record levels in 2000 and thereafter. Also, these events have changed the patterns of portfolio investments to GCC countries. With the SeptemberII attack on US soil, many individuals of Arab descent who had investments in the US and other western countries were looking for a safe haven as fear was mounting that these countries might freeze their capital alleging that they have ties to terrorist organizations. No other countries in the Middle-East and Africa represented a better alternative than the GCC region. The invasion of Iraq in 2003 and the rise of extremism giving rise to a halt in the production of oil in Iraq and a reduction in the world supply of crude oil and natural gas have also benefited the GCC as the price of oil had reached levels never seen before. …