The future of the Gulf monarchies

Christopher M Davidson predicts the end of the monarchical regime form in the Arab Gulf. Whether or not the prediction is born out the changes he observes and analyses in his provocatively titled book After the Sheikhs: the Coming Collapse of the Gulf Monarchies (Hurst and Co London 2014, originally published in 2012) has some bearing on Islamic finance and sukuk in particular — not only in the Gulf states themselves but globally, including in western financial centres for Islamic finance. And to London which is principally of interest to the UK Islamic Finance Blog.

UK Islamic Finance Blog has previously considered the possible although still uncertain implications of low fossil fuel prices — chiefly oil and natural gas. The political risks and the transformation of regional political economies elaborated in After the Sheikhs superimpose on that a socio-political level of analysis. In the short term the increasingly embattled character of these regimes (along a continuum from more stable Qatar to less stable Bahrain and Saudi Arabia) would reduce the ability of the state to deploy its sovereign wealth funds in international markets thereby reducing the origination of new sukuk issues. It is also possible that as improbable as it may seem should these regimes be replaced the successor states could have much less global engagement — including less interest (an unfortunately chosen word in this context) in Islamic financial contracts governed by foreign laws or adjudicated in (for example) England. The issue of what would take the place of the status quo is not analysed by the book beyond re-stating the threats that the existing regimes perceive (and in some cases capitalise upon for their own ends), with Islamism being foremost among these. Should Ikhwan style Islamism gain ground that could translate into greater latitude for Islamic banking and finance domestically or even the conversion of entire banking systems to an Islamic variant (as has previously occurred in Pakistan, Iran and Sudan) however these new banking systems and financial markets could also take on a disengaged form one that shies away from international capital markets. Should the successor regimes incur the enmity of the broader international community in an Iranian style sanctions would of course severely restrict the ability to engage in international finance of any sort and as has been seen until very recently in Iran the possession of oil wealth is at best an imperfect protection from external pressure and isolation.

Should lesser changes in the political forms of Gulf regimes occur with for example steps towards Kuwait style constitutional and (quasi) Parliamentary rule (which retains a monarch but permits greater liberalisation and freedoms as well as participation) sukuk and domestic Islamic banking could become a tool to accommodate and appease domestic political actors. The last country to license Islamic banking in the GCC states (Oman) and to have recently issued a debut sovereign sukuk as reported in this blog is an example where after decades of resisting and granting conventional finance and banking a monopoly the Islamic variant was a response in part to the Arab revolutions across North Africa and a way of buttressing regime legitimacy if only symbolically.

A further factor in Davidson’s analysis that suggests fragility in the Gulf is the inability of the regimes to diversify their economies, to create labour forces comprised of citizens rather than expatriates, and the predicted decline in the oil and gas reserves that remain in the region. Almost independent of the political factors considered above Islamic finance is a likely beneficiary of this decline and the need both economic and social to finance the countries and their (in some cases rapidly) growing populations. It could also extend to sakk issues with lower thresholds of investment, in order to tap into domestic private wealth combined with marketing the appeal of instruments and investments compatible with Islamic law and religious beliefs.

It should be remembered that Davidson is not the first observer to predict the collapse of the Gulf monarchies — as Davidson acknowledges the history of such predictions goes back at least to Fred Halliday’s Arabia Without Sultans (first published in 1974). It should also be remembered that Davidson is not the first to subscribe to what energy analysts describe as the ‘peak oil’ thesis — that the end of oil reserves is rapidly approaching and that the peak for exploitation is past or soon to be past. The reason why this thesis has been falsified in the past has been a tendency to insufficiently appreciate the ability of as yet untried (or even unknown) technologies to access new reserves and to do so in a manner that allows commercial exploitation to continue. There seems little reason to doubt that this could be the case with respect to current predictions of the decline of the largest source of Gulf wealth. Of course pointing that out is not to say that there are not other reasons to develop other methods that will reduce environmental damage and provide more sustainable sources for ever increasing global energy demand.

Returning to Islamic finance and the concerns of the legal practitioner, the weight of inertia and the persistence of international law firms advising on sukuk structuring suggests that in case there is an increase in sakk origination in the Gulf (the second most significant in global sakk issuances after the Southeast Asian centre the capital of which is Malaysia) the role of English courts and contract law would continue.

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