The new Silk Road: Opportunities for Asia and the Gulf

Asia needs capital. The Gulf States are not only flush with money but also have massive
infrastructure needs that Asian companies can help meet. Both sides need regulatory reform to
make the most of this moment.

Dominic Barton, Kito de Boer, and Gregory P. Wilson

Web exclusive, July 2006

The Silk Road between Asia and the Middle East was, until the 13th century, among the world's most important trade
routes. Trade and investment are once again flowing between these regions after 700 years when merchants looked
instead mainly to Europe and the Americas. Now it's up to governments in both Asia and the Middle East to create a
more hospitable investment climate that will allow this new Silk Road to achieve its potential.

While Asia's thirst for Middle Eastern oil is well understood, less often recognized is the increasing flow of direct and
portfolio investment. Thus Sheikh Mohammed bin Rashid Al Maktoum, the ruler of Dubai, used a recent state visit to
Pakistan to announce a multibillion-dollar package of infrastructure, property, and other investments. Prominent
Saudi investors led by Prince Alwaleed bin Talal are paying $2 billion for a stake in China's second-largest state-
owned bank. Bahrain's Gulf Finance House wants to invest up to $1 billion in Singapore's financial, health, tourism,
and leisure industries.

The traffic along the new Silk Road is not one way. A seven-company alliance known as the Singapore Specialist
Construction Consortium is pursuing Middle Eastern construction projects. Dubai is already home to Chinamex Mart,
a minicity of Chinese companies distributing their products throughout the region. In the technology sector, Samsung
Electronics is among the Asian companies intensively cultivating Middle Eastern markets.

From a macroeconomic perspective, these developments make perfect sense. In the five years to 2010, Asia is likely
to require about $1 trillion of foreign direct investment, and China alone will consume more than half of that total.
Meanwhile, with oil prices riding high, investors and companies in the Gulf States have money to invest.

Recent interviews with more than a dozen Gulf investors who collectively control more than $300 billion in assets
revealed that they are set to shift their portfolio asset allocation toward Asia by 10 to 30 percent. We believe that up
to $250 billion from the Gulf States will be available for investment in Asia over the next five years. While the West
would remain Asia's dominant source of investment, this shift represents an important change in the pattern of
global capital flows.

Such a portfolio rebalancing would allow investors in the Gulf to benefit not only from Asia's strong internal growth
but also from the emergence on the world stage of Asian companies such as Haier, Huawei, Lenovo, Petronas,
Ranbaxy, Samsung, and Sterlite Industries. Another straw in the wind: Etisalat, a telecom group located in the
United Arab Emirates, earlier this year acquired a controlling stake in Pakistan Telecommunications for $2.6 billion.

Some of these companies and other low-cost Asian players are in turn well positioned to help meet the Gulf's
massive infrastructure needs. Electricity, highway, telecommunications, water, and other infrastructure projects—
along with agriculture, education, health care, and information technology initiatives—will consume more than $500
billion over the next five years. Dubai alone is spending billions on undertakings such as a Wall Street–style financial
center, a million new homes, the world's largest airport, and 40 new tax- and duty-free "microcities."

The two regions have more in common than a desire for trade and investment. Commercial links between Asia and
the Gulf States should go hand in hand with the growth of Islamic banking in accordance with Sharia, which prohibits
the use of interest or speculation. Today almost 20 percent of private investors in the Gulf say they are prepared to
accept lower-than-conventional market returns or service for full Sharia compliance. Investors with similar attitudes
live in Asian areas such as Indonesia, Malaysia, and even China.

This helps explain why Gulf banks, such as Al Rajhi Bank and Kuwait Finance House, have launched (or are about to
launch) operations in Malaysia, why Malaysian and Singaporean banks are eyeing opportunities to facilitate capital
flows between Asia and the Gulf, and why Kuwait Finance House has secured a mandate to structure the first Islamic
bond in China.
To be sure, these are still early days for the new Silk Road. There remains a lot more opportunity than activity. It is
difficult for companies and investors to shake long-held habits of focusing on Western markets, investing in Western
companies, and purchasing Western equities and bonds.

Asia and the Gulf need to improve their mutual understanding through educational and political exchanges.
Governments also need to move beyond symbolic events such as state visits by promoting a more welcoming
climate for investment. This effort should entail dismantling barriers to competition, such as restrictive licensing rules
and product market regulations. It also means boosting the transparency of financial reporting, creating more
effective markets for corporate control (so investors can readily use stock markets to pressure managers to
perform), and improving corporate governance. Such measures would enhance the economic attractiveness of both
regions and the efficiency of capital allocation.

The good news is that there are signs of progress. Saudi Arabia recently joined Dubai and Bahrain (historically the
financial capital of the Gulf region) in allowing foreigners to invest directly in local companies through the stock
exchange. Similarly, the Gulf Cooperation Council (GCC) is strengthening capital markets through modern laws and
exchanges.

Improving capital markets and corporate governance in Asia and the Gulf States would be valuable under any
circumstances. At a time when companies and investors are just starting to build a new Silk Road, the need for
reform has never been greater.

About the Authors

Dominic Barton is a director in McKinsey's Shanghai office, Kito de Boer is a director in the Dubai office, and Greg
Wilson is an alumnus of the Washington, DC, office.

The authors would like to acknowledge the contributions of Larry Berger, Xavier Jopart, Manish Sharma, Pranav
Shirke, and Steven Strauss to this article.

A version of this article first appeared in the Financial Times on July 4, 2006.