With an objective of establishing the Middle East logistics, leisure and financial hub, the government of Dubai has promoted 300 billion US dollar-scale construction projects over the past four years with an ambitious scheme of turning the city into a world class tourist and financial center. In this process, the Dubai city government and enterprises raised funds via global bond markets, and the amount of debts of the government and state-owned firms has expanded like snowballing. To date, the size of open debts has come to 59 billion US dollars, far beyond its ability to repay. Dubai’s debt represents about 100% of its GDP. While this figure is not unreasonable by international standards, Dubai has very little reserves of its own to offset its debt burden. Moreover, despite its $60 billion economy, Dubai accounts for only $5 billion (or 5%) of the UAE’s revenues as Dubai has virtually no taxes. Indeed, Dubai relies on transfers from UAE Government to finance its budget. This support is critical as Dubai faces about $20 billion in both 2011 and 2012.
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Most of the debt is attached to the fund’s real estate arm known as Nakheel, whose projects include the palm-shaped island in the Gulf. The crisis was prompted by Dubai World, the development company behind three palm shaped islands as well as an off-shore replica of the globe, defaulting on its debt. An $80billion debt default in the emirate has already reawakened the specter of a global ‘double dip’. It is seeking to suspend repayments on all or part of its $59 billion in debt from Dubai. Everyone has gone into panic mode. Otherwise, British banks also teetering on the brink of a fresh meltdown after it emerged they had invested heavily in crisis-hit Dubai. Fears of a dangerous new phase in the economic crisis swept around the globe as traders responded to the shock announcement that a debt-laden Dubai state corporation was unable to meet its interest bill.
The Dubai Debt Crisis has had 3 major effects, and if it is not addressed correctly, could spread dangerously throughout the global economy.
Firstly, in regards to the GCC and Mid East region, the Dubai Debt crisis has carried very negative effects. The idea that these GREs are not actually owned by the government and thus not directly tied to sovereign financial backing is a dangerous decoupling being toyed with by Dubai World that will erode foreign confidence in these markets if it is carried through to execution. Furthermore, it is impossible to build a global financial center if you’re not playing by international financial rules – from a respect and trust point of view, a Nakheel bond default would put Dubai and the GCC back significantly in their strategic aims. In that case, any GCC business relying on international demand/finance and not focused on regional growth and demand will likely suffer, as the regional players may be the only ones willing to play at the table after a Dubai World default.
Secondly, the crisis has served as a reminder that emerging markets carry risk, and with far less transparency than what is typically seen in the West, this risk can be magnified. Further, Dubai is the first key emerging market to have its books opened, so to speak, on the effects of the financial crisis that rocked Western markets nearly 12 months ago. There may be financial toxicity lurking in other emerging markets, which may begin coming to light over the next year – posing a significant challenge to the global economy still reeling from the collapses in the Western markets. If the focus for recovery has so far been in the West, moving forward the same focus must be given to developing nations in order to avoid a global double-dip recession.
Lastly, the impact of sovereign wealth from the Middle East and specifically the GCC region on world markets has not been studied in the detail that perhaps it should, given the enormous amount of wealth and outflow of capital from this region into a variant of industries worldwide. These funds may play a significant role in revitalizing tired financial markets and so the dynamics of how these funds work the transparency level that they operate with and their capital allocation strategies should be more closely examined. They are the Middle East’s “hedge funds” and they may have potentially just as great an impact on the global financial industry moving forward as USA-based Wall Street giants had in this last run-up.
Dubai’s government investment firm Dubai World shocked markets on Thursday (26th November 2009) when it asked for a six-month delay in repaying a US$59 billion tranche of its total debt of $80 billion. Dubai, touted as an economic miracle of the Middle East, poured billions of dollars in borrowed money into building huge luxury developments and lavish tourist attractions. Now, investors are worried about the health of banks that lent money to the debt-ridden emirate. News that Dubai’s flagship government-owned holding company was looking to delay debt payments has shaken financial markets, sending global equity indices sharply lower said by Vassili Serebriakov, Wells Fargo.
Win Thin, Brown Brothers Harriman said its operations are worldwide but they are concentrated in property and real estate development. Besides, every country is undergoing a painful recession and/or deep correction in the property market, so Dubai World is simply getting squeezed in all of its investments.
Several real estate properties have already dropped in price by up to 50% and we have not even seen the full extent of the global financial crisis. Dubai’s economy diversified away from oil towards real estate and tourism making it extremely vulnerable to today’s market conditions.
Unlike the US mortgage crisis, which was triggered by the bursting of the property bubble and whose negative impact led to the collapse of the US financial system and extended to the world’s real economy, the Dubai crisis is more about credit dealing between borrowers and lenders. Defaults or credit violations will mainly cause losses to creditors alone and risks are not expected to extend to the whole financial market. As investors picked up risky assets in the recent rally since March 2009, concerns of another wave of financial turmoil rose. Overall the fallout shows how vulnerable the world economy remains despite signs of recovery. The rise in risk concerns is well documented in the costs of insuring debt. Dubai’s attempts to delay debt repayments spurred a surge in the cost of insuring government and company bonds from default around the world and may curb lending throughout the Arabian Gulf. Credit-default swaps on the sovereign debt of the Gulf emirate surged, Malaysia and Korea increased. Stock markets around the world slumped and commodities dropped the most in a single day since July 2009.
Another question is will the Dubai debt crisis cause RBA to pause? The Reserve Bank of Australia (RBA) hold a policy meeting, general consensus is that the RBA will hike rates 25bps to 3.75%. The Dubai debt crisis may make the RBA rate decision a closer call. Because of concern about the potential fallout from the Dubai debt crisis an argument could be made for a pause in the RBA rate hike cycle. If Dubai World were allowed to default on its debt there could be serious consequences for the global financial markets. If the RBA views the Dubai debt crisis as a potential threat to the global financial markets like the Lehman Brothers collapse in 2008, the RBA policy board may elect to delay future rate hikes. A pause by the RBA could send additional shockwaves through the global markets and dampen risk sentiment.
The UAE (United Arab Emirates) provided liquidity to Dubai World and this helped to stabilize the global financial markets. Concern about fallout from the Dubai debt crisis receded a bit. There are also reports that a number of international banks are working on a possible bailout plan for Dubai World. Moody’s says that UAE banks can absorb potential fallout from Dubai debt crisis.
According to the RBA, the risk of serious contraction in Australian economy has passed, inflation has been declining but not as fast as earlier thought and it is time to begin gradually reduce monetary stimulus. The RBA noted that business borrowing remains weak and that the strength of the AUD limits output and helps to constrain price pressures. RBA interest rates remain well below the level at the start of the global financial crisis and this affords the RBA room to normalize interest rates. GULF stock markets steadied after heavy losses in the previous two days, in the absence of fresh developments in the Dubai debt crisis and as the UAE markets were closed. The Kuwait Stock Exchange down 1.4% to a nine-month low after fluctuating sharply at the start of trading. The Dubai market shed 12,5% of its value and Abu Dhabi lost 11,5% in two days of trading following the Dubai World announcement that it was seeking to suspend payment of some of its US$59 billion of debt. Fears of a dangerous new phase in the economic crisis had swept around the globe as traders responded to the shock announcement that a debt-laden Dubai state corporation was unable to meet its interest bill. Shares plunged, weak currencies were battered and more than US$23.3 billion was wiped from the value of British banks on fears that they would be left nursing new losses.
On the other hand, according to the United Arab Emirates Banks Association, HSBC has US$18.3 billion of loans outstanding to the UAE, of which Dubai is one of seven emirates. HSBC declined to comment. More than US$4.3 billion was slashed from the value of Barclays, while Lloyds and Royal Bank of Scotland, both partly owned by the taxpayer, saw their values fall by $2.8 billion and $2.5 billion respectively. One analyst said that the fears were overdone because Abu Dhabi would eventually come to the rescue to save the UAE from embarrassment. Dubai World has liabilities of US$60 billion, about three quarters of Dubai’s total state debt. Its subsidiary Nakheel built The Palm Islands development, but the property bubble in the emirate burst a year ago, leaving buildings unfinished, debts unpaid and paper fortunes erased.
Singapore shares fell 1.09 per cent in reaction to news that a Dubai government investment company had asked for more time to repay its debt of nearly US$60 billion. In the meantime, the Monetary Authority of Singapore (MAS) said it does not expect developments in Dubai to affect Singapore’s financial stability. On a comparative basis, it certainly puts Singapore in a very positive light at this point, in the sense that the government has a huge amount of reserves and also a very aggressive strategy to Islamic banking.
In London, the FTSE fell around 1.5 percent, wiped almost £44 billion from bleu-chip stocks. In Frankfurt, the Dax index fell 1.32 percent to 5,540.34 while in France; the CAC lost 1 percent to 3,639.66. Asian markets were also under pressure overnight as Hong Kong’s Hang Seng fell more than 5 percent and Japan’s Nikkei was 3 percent lower. While Dubai’s rulers have done their best to calm fears, claiming the situation was under control. British banks face fresh crisis after it emerged they had invested $80 billions in crisis-hit Dubai.
The Dubai crisis testifies that swollen real estate bubbles are sure to explode someday no matter what efforts are made to stop them. When it comes to China, if the property sector is still regarded as a prerequisite of gross domestic product growth and land sales still remain the main source of local revenues, a Dubai-like crisis is unavoidable. The Dubai case should serve as a wake-up call for the real estate-preoccupied Chinese local governments to formulate effective measures desperately needed to avoid a similar crisis in the country. China should learn lessons from the Dubai crisis and take concrete measures to prevent a similar crisis from happening in its speculation-ridden real estate sector, which could undermine the national economy.
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According to The Straits Times, publication date on 28th November 2009 report that Dubai government’s debt crisis would trigger a fresh financial meltdown. Stock markets around the world reeled, investors panicked, shares of banks in Asia and Europe were savaged, with HSBC Holdings and Standard Chartered Bank faring the worst in Hong Kong, and ING Group and Royal Bank of Scotland among the biggest losers in Europe. All four have been involved in Dubai World deals. Moreover, The Hang Seng Index in Hong Kong plunged 4.8 per cent, while Japan’s Nikkei 225 Stock Average slumped 3.2 per cent to a four-month low. South Korean shares also closed at a four-month low after falling 4.7 per cent. In Europe, major markets lost just over 3 per cent in Thursday’s trading. The FTSE 100 index in London closed down 3.2 per cent – its worst one-day fall since March – while Germany’s DAX fell 3.2 per cent and France’s CAC-40 dropped 3.4 per cent. The European markets were down fractionally yesterday after the mid-morning session. The Dubai news caused panic throughout trading in London. Markets in the United States were also closed on Thursday (26th Nov 2009) for the Thanksgiving holiday, but the Dow was down about 200 points as soon as markets opened for trading last night.
Besides that, HSBC’s Middle East arm was by far the biggest single foreign lender in the United Arab Emirates (UAE), with outstanding loans of $17 billion as at the end of last year, according to an Agence France-Presse report. It is not clear how much of this was lent to Dubai. Stanchart was next with $7.8 billion owed as at end-2008, and Barclays Bank was third with $3.6 billion, said AFP. Citigroup analysts said Japan’s largest banks, Mitsubishi UFJ Financial and Sumitomo Mitsui, had also lent hundreds of millions of dollars to Dubai World.
Around the Street November 27, 2009, Credit-default swap (CDS) spreads knee jerked wider, not surprisingly, on Nov. 27 in the wake of the Dubai World news, as the rising threat of default on their bonds increased protection costs around the world. The Markit CDX North American investment grade index jumped 7 basis points to 109, the highest in two months. But, emerging market spreads were over two times wider as collateral damage to that region is more worrisome. CDS contracts on Qatar debt widened 15 basis points to 129 basis points, while the cost to protect Abu Dhabi debt jumped 24 basis points to 184 basis points. Malaysian CDS widened 13 basis points to 117. The Emirates Bank credit default swap rate is out nearly 300 basis points wider at 289 basis points. Dubai Holding Co.’s CDS climbed 290 basis points to 1,155 basis points. DP World, the largest port operator in the Mideast, surged 201 basis points to 810 basis points (a 12% upfront fee is also required).
Now British banks face fresh crisis after investing billions in Dubai, which the first shoots of recovery could be wiped out by a second wave of recession. Stock markets around the world have endured another turbulent 24 hours. In London, the FTSE fell around 1.5 per cent first thing after a 3 per cent fall yesterday wiped almost £44 billion from blue-chip stocks. The index recovered its poise to stand 0.5 per cent lower after the first hour of trading. It was at 5188.73 at 12.45pm, down from 5194.13 at start of trading this morning. In Frankfurt, the Dax index fell 1.32 per cent to 5,540.34 while in France, the CAC lost 1 per cent to 3,639.66. Asian markets were also under pressure overnight as Hong Kong’s Hang Seng fell more than 5 per cent and Japan’s Nikkei was 3 per cent lower. Banks worldwide saw £14billion wiped off their market value yesterday. Dubai’s rulers have done their best to calm fears, claiming the situation was under control.
Sheikh Ahmed bin Saeed al Maktoum, the uncle of Dubai’s ruler Sheikh Mohammed bin Rashid al Maktoum, said: ”Our intervention in Dubai World was carefully planned and reflects its specific financial position. ‘The government is spearheading the restructuring of this commercial operation in the full knowledge of how the markets would react. There were reports today that the emirate may consider selling the QE2, bought for $100million in 2007, to tackle some of its debt.
In additional, Shares plunged, weak currencies were battered and more than £14 billion was wiped from the value of British banks on fears that they would be left nursing new losses. Nervous traders transferred the focus of their anxieties from the risk of companies failing to the risk of nation states defaulting. Investors’ owed money by Mexico, Russia and Greece saw the price of insuring themselves against default rocket. Although the scale of Dubai’s debts is comparatively modest at $80 billion (£48 billion), the uncertainty spooked the markets, with no one sure who its creditors are. Several banks rushed out statements to reassure investors that their exposure was small.
In the previous year, Dubai was developing into the global hub of Islamic finance. Dubai already hosted the world’s oldest fully-fledged Islamic bank, the Dubai Islamic Bank, established in1975. Moreover, Dubai was attempting to surpass Malaysia as the first global issuer of Islamic bonds (sukuk). The sukuk market has been deeply affected by the economic downturn, since the issuance of the Islamic bonds in 2008 shrank to $14.9 billion, with a 56% decrease compared to 2007. Dubai World, the investment company that manages the portfolio of the Dubai government, was establishing itself as a leading global issuer o f sukuk. Several other companies based in Gulf were investing in the Islamic financial industry the petrodollars gained during the oil bonanza. The Dubai debt crisis may therefore have a negative impact not just on Dubai, but on the Islamic financial industry as a whole. Moreover, Islamic finance suffers from the lack of effective international regulation, which has been highlighted during the Dubai crisis. One reason why sukuk attracted the attention of the market in the fiasco was that their payment due on December 14 was the centre of the time-resetting negotiations: Islamic bonds so to say triggered the crisis. The government announcement of its intention to enforce payment rescheduling immediately led both Moody’s and Standard services to heavily downgrade the Islamic sukuk along with bonds of various government related entities in Dubai.
A more realistic approach could not have missed the point that the amount due on sukuk was no more than 6 -7% of the total money involved and failure had not yet taken place. Rating agencies could have shown a little more restraint in their decisions. They wield enormous power in the global bond markets: they can literally make or unmake a government not by actual downgrading but by merely announcing the intention to do so. There are increasing murmurs in financial circles as to why these agencies are allowed to continue rating debt issues? As the bond issuers themselves have to pay for the evaluation exercise, there candidly is scope for the ratings moving in tandem with the payments. It is not very clear what rules of conduct these agencies follow, who design these rules and who oversees their observance: There is presumably a case for setting up regulatory frameworks for the rating agencies even for establishing separate ones for Islamic bonds, Hasan, Zubair (2009).
Judging from the current situation, the Dubai debt crisis has a limited extent and impact and, with regard to global economic recovery, it is only an “aftershock” at best in the ongoing economic recovery process, and its influence on global financial crisis will also be short-lived. Dubai is not the Wall Street after all, but both lessons and viewpoints on revelation from the debt crisis have provided for people are really profound and penetrating.
First of all, economic construction should be carried out in compliance with a nation’s capacity instead of outreaching itself to rely on large-scale money borrowing.
Second, economic development cannot be driven or pulled by the over-reliance on the real estate industry. Although the United Arab Emirates (UAE) is the world’s leading oil producer, Dubai’s oil resources, however, would be depleted by 2010. In this contest, it has to shift to the real estate and tourism-related economic development.
Third, monetary policy should be geared to inflation, asset price, debt build-up and global capital flows. The depreciation of U.S. dollar in Dubai over the past two years has had the biggest impact on the purchasing parity of the UAE dirham against other currencies owing to its direct peg against the U.S. dollar. This has given rise to the price increase and brings double-digit inflation to virtually all the Gulf States.
As a conclusion, Dubai debt crisis will be resolved soon. The UAE federal government is prepared to provide further financial support to Dubai, which is struggling to pay off $26 billion debt owed by troubled conglomerate Dubai World. The government would support Dubai by Finance minister Sheikh Hamdan bin Rashid al-Maktoum, because Dubai is part of the federation, Dubai World is currently in talks over the restructuring of a $26 billion debt. The UAE capital has already stepped in to offer financial support to its neighbor. If global liquidity had been growing, and liquidity in Dubai had been ample, Dubai World would probably have avoided this crisis. More generally, the lack of liquidity on a global and local basis means that the pressure on vulnerable borrowers will remain severe because final demand will continue to be weak until overall liquidity conditions ease.
All in all, the Dubai World incident strikes us as a short-lived blip, and may have been used as an excuse for profit-taking across global markets as year-end looms. Notably, most equity markets across the Asian region have rebounded.