This was not written by me. It was written by Ayman al-Sanad, username UAE (I believe), who has been working for some time to create workable libraries for so Android devices can properly display Arabic. Oddly there was no thread posted here that I can find so I'm going to go ahead and post it, since I know this is a much-desired feature for many people and at least some people will find it over Google or the like.
As Google has yet to add native support for Right-To-Left languages like Arabic, Persian and Urdu (despite it being the top feature request) Ayman stepped in and created libraries for our usage.
The downloads page is available here: http://ardoid.com/?page_id=5. I'm assuming the libraries will work with any Froyo install. Put the relevant library zip on your SD card, flash it. Reboot will take some time on a black screen.
Big thanks to Ayman for his great work.