Index compiler MSCI's latest snub to the United Arab Emirates and Qatar underlines the need for the Gulf neighbours to push through reforms, but problems plaguing UAE stocks run a lot deeper and investor apathy is a big worry.

On Wednesday, MSCI kept the two energy exporters as frontier markets, the third time it has opted not to give them emerging market status.

It urged the UAE to introduce new regulations to allow securities borrowing and short-selling and repeated a plea to Qatar to raise foreign ownership limits from 25 per cent.

Dubai shares fell sharply in early trade in response to the decision, taking their losses to near 17 per cent this year.

Yet the stocks have languished near 7-year lows for the past few weeks, showing investors were already fretting about other issues such as a lack of diversification and a degree of opacity that is especially worrisome when returns are meagre.

"Probably the biggest factor for MSCI clients is the shortage of liquidity on UAE markets," said Jeff Singer, chief executive of NASDAQ Dubai, one of three bourses in the UAE.

Turnover on the Dubai Financial Market, Nasdaq Dubai's sister bourse, is about a tenth of that of 2008, while the Dubai index is down 78 per cent from a 2008 peak.

These declines stem from a real estate crash that sent stocks on the property-dominated bourse tumbling and the sector remains mired in a savage correction.

This has obscured the fact the wider UAE economy is recovering and is forecast to grow 3.8 per cent in 2011 and 2012.

"The UAE stock markets are not deep enough to reflect the economy -- if there had been a wider variety of listings, the market declines of the past few years would have been smaller," said Jassim Alseddiqi, chief executive of Abu Dhabi Capital Management. "Apart from Dana Gas, energy is not represented, and nor is tourism.

"Banks have done very well since 2002, even with the financial crisis, but bank stocks are not very liquid."

Foreign institutions are also worried about the treatment of minority investors, with trading in mortgage provider Amlak suspended since 2008 and the abrupt delisting of Aabar Investments another worrying precedent.

"It's a myth that investors have short memories -- unless there's a compelling investment story, they find it difficult to forgive past transgressions," said a Dubai-based fund manager who asked not be identified.

Qatar, the world's richest country per capita, should be of interest to foreign investors. Its stock market is in the black for the year, a rarity in itself.

But daily trades on the index rarely cross 10 million shares, making it difficult to exit positions in bluechip stocks, a worry for foreign investors keen to maintain nimble portfolios in uncertain times.

"Qatar didn't make enough progress in opening up some of the higher-profile stocks to foreign investors to the extent that these investors would like," said Ibrahim Masood, senior investment officer at Mashreq Bank in Dubai.

"The UAE would be failing (to be upgraded) because of a lack of interest, whereas Qatar's fundamental story is more straight-forward and believable."

Nasdaq Dubai's Singer preferred to see the glass half full.

"The decision gives the UAE the opportunity to improve some of its operations and work aggressively over the next few months to makes changes that would enable institutional investors to come into the market," he said.

"Short-selling would create more liquidity by allowing investors with competing convictions to play the market - at the moment, investors can only come in if they believe the market will go up."