Dubai and Debt

Stephen DeAngelis

December 1, 2009

Two years ago I wrote a couple of glowing articles about Dubai and how it had transformed itself into an economic powerhouse and showpiece of capitalism (see On Becoming a Tiger and Attracting FDI and Creating a Brighter Future in Dubai). If you have been following the news lately, you know that Dubai is in economic trouble and its uncertain future threatens global markets. Dubai’s troubles began with what is now known as the Great Recession. Two years ago approximately 20 percent of the world’s large construction cranes were at work in Dubai. They have stopped lifting. Laid off workers have abandoned expensive cars in the airport parking lot and fled the country. The city’s leader, Sheikh Mohammed bin Rashid al-Maktoum who was hailed as a visionary, has come under increasing criticism [see “The perils of autocracy,” The Economist, 11 July 2009 print issue]. The magazine describes Dubai’s situation this way:

“It was once hailed as a miracle. New cities, even new islands, were springing out of the desert or the shimmering turquoise sea. Nowadays, ten months after the financial crisis came crashing in on the United Arab Emirates (UAE), nearly destroying its shiniest component, Dubai, hundreds of cranes and dredgers have yet to resume work. … For the first time since the seven Gulf statelets joined together as a union in 1971, people are beginning to mutter—rather quietly, for sure— whether there may be something amiss with the autocratic, opaque system that hitherto seemed to work so well behind closed doors. … In the past few weeks it has become clear, nonetheless, that the bottom has yet to be reached. … In the short run, the much richer and more conservative state of Abu Dhabi, with 90% of the UAE’s oil reserves, will bail out its miscreant, extravagant neighbour, along with the other five, poorer statelets if they need help too. “In the long run, Dubai has enough assets to tide it over,” says a banker in Abu Dhabi, pointing to Dubai’s huge container trans-shipment business, its airline, aluminium smelter, tourism, and role as a regional services hub. Above all, Dubai and Abu Dhabi are too enmeshed to allow one part to fail. … Abu Dhabi is ahead of Dubai in terms of government openness and efficiency. But in both the emirates all the big decisions are still taken behind closed doors. In the mild words of a diplomat, ‘neither Abu Dhabi nor Dubai are very good at clarity in decision-making.’ Vital decisions are often not put in writing. The aim of the two ruling families has been to modernise and open up the economy without modernising or opening up the politics to the extent that the people might one day dispense with their royal rulers. In the short run, there seems little chance of that happening. … The indigenous emiratis, who count for less than a fifth of the 5m people living in the UAE, have hitherto been mollycoddled by benevolent rulers. In a couple of years, a recovery may ensue. A resurgence of oil prices is helping. But if the economy gets stuck, the glory days, at least of the Maktoums, may be numbered.”

Six months on from when that report was published things have only gotten worse. Last week state-owned Dubai World and its main property subsidiary Nakheel asked banks to delay the requirement for it repay billions of dollars in debt for six months. UAE stocks tumbled 6-7 percent on the news and spooked global markets. As of this morning, fortunately, the situation seems to have stabilized. “The Dubai crisis began … when the emirate said Dubai World would not be able to make on-time payments for some of its $59 billion in debt. The company invested in lavish real estate projects, including artificial islands in the shape of a palm tree and a globe, and spent heavily to acquire stakes in glittering properties like Barneys in New York and the MGM Mirage in Las Vegas” [“Arab Emirates Aim to Limit Dubai Crisis in Pledge to Banks,” by Vikas Bajaj and Graham Bowley, New York Times, 30 November 2009]. As expected, Abu Dhabi has stepped in with promises to lend money to Dubai to get it through the crisis. Bajaj and Bowley report:

“Trying to prevent a run on its banks, and financial turmoil that some fear could spread globally, the United Arab Emirates helped calm financial markets … with its pledge to lend money to banks operating in Dubai, an action that came amid concerns about excessive borrowing around the world. The move by the group’s central bank was an attempt to head off the kind of crisis of confidence that froze credit markets last year and brought the global economy to the brink of failure, threatening everyone from hedge fund billionaires to retirees who had their savings in supposedly safe investments. … While Dubai is not big enough to set off financial repercussions outside the Middle East, the main fear is that investors could flee risky markets all at once in search of safer havens for their money. As in September 2008, when the failure of Lehman Brothers heightened worries about all financial institutions, they might pull back, regardless of the markets’ strength. Those fears were allayed only after the United States announced a huge bank bailout and began guaranteeing a variety of borrowing that slowly helped credit markets begin functioning again. That many of these measures remain in place could help contain any problems from Dubai now. But while the federation is following a similar strategy, albeit on a smaller scale, analysts expressed concern that the promise of added funds to support Dubai banks might not be enough to keep anxiety from jumping to other countries and institutions. Indeed, an analysis from Goldman Sachs … said that the failure of federation authorities to provide a blanket guarantee for all of Dubai’s debt showed that governments worldwide were less willing to bail out overextended companies and their investors.”

As both The Economist and Bajaj and Bowley note, Abu Dhabi is the key player in the Dubai crisis. It has vast oil reserves and remains solvent. The relationship between the emirates is complex, especially between Abu Dhabi and Dubai [“Crisis Puts Focus on Dubai’s Complex Relationship With Abu Dhabi,” by Robert F. Worth, Heather Timmons, and Landon Thomas, Jr., New York Times, 30 November 2009]. The authors report:

“It was the most subtle of gestures, but looking back, many in Dubai now see it as a sign of their salvation. At the grand opening of the Dubai Air Show, … the crown prince of Abu Dhabi, Sheik Muhammad bin Zayed al-Nahyan, placed his hand over the hand of Dubai’s ruler, Sheik Mohammed bin Rashid al-Maktoum. That was widely viewed among people here as a sign that Abu Dhabi, by far the largest and richest member-state of the United Arab Emirates federation, would take care of Dubai. … Dubai is famous as the brash, secular upstart of the emirates, and Abu Dhabi is known as the religious and conservative big brother. Tensions between the two are legion, but when reporters questioned Sheik Mohammed about tensions, … he told them to ‘shut up.’ … Still, as fear from Dubai’s debt crisis circled the globe, an unaccustomed quiet settled here at the center of the storm — and it was more than just the hush of the Id al-Adha holiday.”

According to the authors, many people in Dubai remain in denial about the extent of the emirate’s debt problems. They claim that western media is exaggerating the problems because they are jealous of Dubai’s success. Locals also play down the tension between emirates. Worth et al. continue:

“Abu Dhabi, which has more oil than Dubai and no cash problems, could wipe out Dubai World’s $59 billion in debt easily, analysts say. But that seems unlikely. Despite the announcement by the emirates’ central bank … that it would make more money available to local and foreign banks in Dubai, analysts say such imprecise promises — the bank did not say how much, or that it would back all the debt of Dubai or Dubai World — may not be enough to placate investors. Many have been left wondering, again, if the Emirate’s debts are worse than most of the world suspects. Analysts estimate Dubai’s total debt at around $80 billion, but some here say it could well be closer to $120 billion, or more. … Dubai’s rags to riches, and possibly back to rags, tale ‘has all the elements of a Greek tragedy,’ said Jan Randolph, head of sovereign risk at Global Insight, a London research company, with ‘hubris and pathos’ in equal measure. The operative question is whether Abu Dhabi and the United Arab Emirates federation will rescue Dubai from the consequences of its profligacy.”

The world is hoping that Abu Dhabi steps up because its failure to do so could send financial ripples around the globe.

“The secondary effects could spread to Greece, Britain and some Baltic states, all heavily indebted nations, or to India and the Philippines, where foreign workers in Dubai send back millions to support family each year, or to any corner of the market for credit that individuals, companies and countries all rely on. Inside Dubai, the crisis has brought to the fore fears and resentments that the legion of foreign workers who make up 90 percent of Dubai’s population have long held toward the small minority of Emiratis who own the place. Expatriates here have complained for years that Dubai is too secretive about its debt and finances and that its rapid growth came at the expense of accountability.”

The story of Dubai is the story of excess. Dubai is likely to emerge out of this crisis a bit humbled, indebted to Abu Dhabi, and, hopefully, a lot smarter about taking on too much debt. Dubai World still has a large and diversified portfolio that should become profitable as the global economy emerges from recession. A lot of countries, like a lot of people, are learning about the downside of debt during this current crisis. Credit is an essential lubricant for the global economy; but, it can turn to sludge if used improperly.