Dubai's Global Headache

by John M. Curtis
(310) 204-8700

Copyright Nov. 27, 2009
All Rights Reserved.                    

        Shocking world financial markets, the extravagant independent Middle Eastern city-state of Dubai announced it would ask creditors for a six-month reprieve on roughly $60 billion in debt.  Dubai’s Finance Minister Sheikh Mohammed bin Rashid al-Makoum asked for a “standstill” on about $59 billion in state-owned Dubai World debt, uable to meet obligations, especially $3.52 billion in Islamic bonds from its property unit Nakheel PJSC due Dec. 14.  Dubai already tapped out its more conservative oil-rich capital of the United Arab Emirate Abu Dhabi, borrowing $10 billion last February.  Signaling problems ahead, al-Makhoum told skeptics to “shut up” over a perceived rift with Abu Dhabi, owner of the world’s biggest sovereign wealth fund.   Al-Makhoum’s request for patience fell on deaf ears, prompting Standard & Poors and Moody’s Investors Service to down grade Dubai’s bonds to junk.

              Caught in the global financial meltdown, Abu Dhabi expanded development at breakneck speed, primarily soliciting investment from Europe and Asia.  Dubai World hoped to turn Dubai into a Las Vegas-like financial Mecca, building the world’s largest skyscraper, largely sitting un-leased together with other grossly overdeveloped commercial real estate ventures.  While U.S. banks have some exposure, especially Citibank, U.S. stock markets dropped only modestly Friday, processing damage to European and Asian markets.  Debt “restructuring may be considered a default under our default criteria,” said S&P in a statement, downgrading Dubai’s bond rating to junk status.  “There is no clarity about what exactly is happening,” said Emad Mostaque,  London-based Middle East, $100-billion equity-fund manager for Pictet Asset Management Ltd.

            Dubai’s Thanksgiving Day default rattled markets globally, hoping for a global economic recovery.  Running out of cash mirrored a disastrous real estate market in Dubai, where equity values for both residential and commercial real fell by over 50%.  Despite assurances from Sheikh al-Makhoum about repaying debt, Abu Dhabi’s leading government-controlled banks, National Bank of Abu Dhabi, PJSC and Islamic lender Al Hillal Bank, already bought $5 billion in government bonds.  Now that the bonds are downgraded to junk, Abu Dhabi stands to lose billions.  Dubai World’s credit default swaps, those abstract securities that broke American International Group, jumped 163%, anticipating added risk of insuring Dubai debt.  Dubai World’s bond prices took a hit, dropping 86 cents.  Rapidly escalating credit default swap prices indicate greater risk to Dubai’s investments.

            Wall Street took Dubai’s default in stride, losing only 1.5% or 155 point on the Dow Jones Industrial Average.  Kingmakers on Wall Street aren’t ready for another wholesale sell-off, realizing most U.S. banks weren’t as exposed to Dubai’s financial woes.  Switzerland’s UBS and Germany’s Deutsche Bank expect Dubai to lose another 30% in real estate value before the crisis bottoms out.  “I don’t think the collateral damage is going to be that great,” said Jeffrey Sauat, chief investment strategist at Raymond James.  “People will dig into this over the weekend, but I think balance sheets have healed enough to withstand a shock like this,” referring to the renewed liquidity of U.S. banks.  Dubai’s extravagant real estate expansion, including the Gulf’s palm tree-shaped islands and world’s tallest skyscraper, anticipated an eventual contraction in real estate prices and development.

            Dubai’s problems prompted a rally in the U.S. dollar and corresponding sell-off in gold futures.  With Dubai teetering, you’d expect a flight into government-backed bonds and precious metals.  While no one expects a widespread sell off in gold, markets anticipate possible liquidation of gold inventories, pushing down prices.  British banks, including London-based HSBC Holdings and Standard Chartered, face loses in the hundreds of millions, not billions, appeared most exposed to Dubai’s default, causing a decline in the Pound Sterling.  In the U.S. Citibank and JPMorgan Chase showed the most exposure in the U.A.E., perhaps as high a $3 billion.  European exposure was far greater, in excess of $86 billion.  “It touched investors’ sensitive nerves,” said Cai Junyi, an analyst a Singapore Securities, fearing that Dubai World’s problems represent the tip of the iceberg.

            Dubai’s problems mirror the popped global real estate bubble, fueled by cheap petro-dollars from Abu Dhabi.  Now that the world’s in recession, it’s more difficult for Dubai to maintain the same level of extravagance.  “The world is watching whether that will have any substantial impact . . . Dubai World is just like a small window that might reflect another financial tsunami,” said Junyi, fearing that Dubai’s default could trigger a worldwide slide in global equities and sovereign wealth funds.  Unlike Abu Dhabi’s oil wealth, Dubai has no other source of income other than entertainment and real estate.  Without a booming world economy, it was just a matter of time before Sheikh Mohammed’s fantasy blew up.  Whether things recover in the long-term says little about Dubai’s crash, whose dried up cash flow makes it impossible to repay investors and bond holders waiting for their cash.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

©1999-2012 Discobolos Consulting Services, Inc.
(310) 204-8300
All Rights Reserved.