PAKISTAN’s connection with the Middle East goes back to the days of early Islam when an Arab army invaded Sindh and brought the new religion to South Asia. But my interest in the article today is not in religious but in economic links.

These cover a number of areas; including the migration of Pakistani workers to the Middle East, strong links among the banking institutions on both sides of the Gulf, flow of Arab capital into Pakistan, acquisition of assets in Pakistan by the companies of the Middle East and capital flight from Pakistan to the Middle East.

Pakistan, therefore, is affected by the economic health of the Middle East. In the article today I will explore how some of these economic links developed between Pakistan and the Middle East, how the Middle East is affected by the current economic turmoil, and, finally, what will be the impact on Pakistan of these developments.

I will begin with a discussion of the close links between the labour markets of Pakistan and the Middle East. Economic links between Pakistan and the various countries of the Middle East, in particular those that produce and export oil, began to be developed in the late ‘seventies.

Then, the OPEC members of the region began a massive programme of construction that was financed out of the windfall incomes earned by the oil exporting countries as they engineered a four fold increase in the price of oil. This programme needed a large construction force that could not be hired locally.

Many of the construction companies that won contracts in the Middle East had worked in Pakistan implementing the projects under the Indus Water Treaty of 1960. They knew the Pakistani labour market well and turned to it when they needed workers in the Middle East. Millions of young men went to the constructions sites. They were hired for fixed period and lived in large labour camps. They saved almost all of their earnings and remitted them back home to their families. At one point the remittances received by Pakistan were equivalent to about 10 per cent of its gross domestic product. This was even more than the earnings from merchandise exports.

The construction boom ended in the early 1990s. In 1991, the United States launched the first Gulf War to expel the forces of Iraq’s Saddam Hussein from Kuwait. The price of oil fell and with it there was a decline in the appetite of the Middle East to spend on construction projects. Millions of Pakistani workers were sent home, bringing a sharp reduction in the amount of remittances they had been sending. Pakistan’s economy could not absorb this shock. It went into a tail spin. There were severe fiscal and balance of payments problems reminiscent of those the country faces today.

The crisis took a decade to solve. In the meantime, the structure of the labour force Pakistan had in the Middle East changed. As a result, there is now a significant presence of professionals among the migrants from Pakistan. While the construction workers returned, the professionals stayed on.

Following the nationalisation of the banking sector by the government of Prime Minister Zulfikar Ali Bhutto, the community of Pakistani bankers who had aggressively expanded their sector during the go-go years of Ayub Khan, shifted their attention to the Middle East. In addition to the construction boom, the Gulf countries were also investing in developing the service sector, in particular commercial banking and development finance. Many Pakistani bankers left their country and went to the Gulf States.

Agha Hasan Abdi was among the most notable ones in this group of professionals who made the Middle East their home. Many Pakistanis rose rapidly in the ranks of the Middle Eastern banking sector. Some of these bankers brought their institutions to Pakistan once the government policy concerning the ownership of banks changed and the private sector was allowed back into the sector. The current structure of the banking sector has been heavily influenced by the Middle East. Investment by the Middle Eastern banks in Pakistan began to change the structure of financial flows to the country. Foreign direct investment rather than remittances became the dominant flow.

Pakistan also developed strong communication links with the Middle East. Dubai, Abu Dhabi, and now Doha, have become the points of entry for air travel to Pakistan as western airlines pulled out of the country. After the decision by British Air to terminate its operations to Pakistan following the bombing of the Marriott in Islamabad, the only way to travel to the West is either to take PIA or go through the Gulf States.

The Middle East also invested heavily in Pakistan’s telecommunications sector. An Egyptian company bought the largest mobile telephone company while a UAE company purchased the Pakistan Telecommunications when it was privatised. There were also “green field” investments by the Gulf States in the mobile telephony and in the internet.

Other parts of the communication sector were also involved in the deepening of the links between Pakistan and the Middle East. The strict controls Pakistan had on the media, in particular on television, led to the development of Dubai as a centre of telecasts to Pakistan. This link has been maintained even after the controls on TV were eased by the government in the late 1990s and during the period of Pervez Musharraf.

The Middle East also attracted capital from Pakistan especially during the time when the Pakistani economy was under stress. This is the case now and there are reports that Pakistan has seen the flight of capital that has resulted in the outflow of money from Pakistan to the Gulf States, in particular to Dubai. The real estate boom in that city has attracted a significant amount of private investment from Pakistan. During difficult political times, the country’s politicians have taken refuge in the Middle East. The Gulf was the scene of a lot of political activity in the period preceding the collapse of the Musharraf government.

Pakistan was caught up in the enormous transfer of income and wealth to the Middle East that took place in 2007-2008 after the sharp increase in the price of oil. By some measures this was the biggest income transfer in economic history. Several experts estimated in August that oil importing countries were paying oil exporting states about $1.5 trillion per annum, equivalent to about 2.5 per cent of global gross domestic product. At the prices that prevailed in the summer, the value of oil in the ground – much of which was in the Middle East – exceeded the combined value of all the world’s equity and debt markets. McKinsey Global Institute estimated the value of oil in the ground at $162 trillion, more than the total value of all equity markets ($52.3 trillion) plus all debt markets ($67 trillion).

Compared to the first oil boom, the Middle East used a different strategy to absorb this transfer of income. It had then placed the bulk of the transfers it received in the West’s commercial banks which then went on to lend to the middle income countries in the developing world. That led to the debt crisis of the ‘eighties and the loss of growth and economic momentum in the countries that had borrowed heavily from the bank. The transfer of income that occurred in the 1975-1990 period was large and produced structural changes in the global economy that were significant. The same is happening now. This time around, the Middle East created a number of sovereign funds that began to acquire assets not only in the developed parts of the world but also in developing countries such as Pakistan.

A number of interesting conclusions emerge from the above discussion. Pakistan’s contacts with the Middle East, having started with the export of unskilled and semi-skilled labour, now involves a number of other exchanges.

In spite of the strong reservations of most foreign entrepreneurs about investing in Pakistan, those from the Middle East have been considerably less skittish. That notwithstanding, they have concentrated their attention on a few sectors, building on their experience.

The favoured sectors include finance, telecommunications and real estate. For understandable reasons, the flow of capital becomes large when the earnings from oil exports become significant. Now that the price of oil is almost a third of what it was only four months ago, it will have a pronounced effect on the flow of funds from the Middle East to Pakistan. The drop in the oil price may have brought some relief to Pakistan with a stained economy and a balance of payments that has exhausted accumulated reserves and forced the country into the arms of the IMF once again. If it persisted, it could have damaging consequences for the country.

But what we are seeing at this time is a short-term adjustment in what is a long-term trend. The price of oil will go up again once the world economies stabilise and the demand for oil increases once gain. The scale of transfer to the Middle East that was being talked about in the summer of this year will once again enter the calculations of investors and policy makers. The challenge for Pakistan is to devise a policy that makes use of the strong links it has with the Middle East to benefit from the enormous potential wealth of the region but without suffering from the ill effects of this proximity.