Dubai

With the exception of Bahrain, where anti-government protests were violently suppressed by the ruling royal family with military support from Saudi Arabia, the kingdoms and sheikhdoms of the Arabian Gulf – in America we refer to it as the Persian Gulf, but that terminology does not sit well with the Arabs – have appeared largely immune from the struggles of the Arab Spring. There have been no street demonstrations, no tear gas, no bullets, rubber or live.

I have just returned from a three-week stay in the Middle East. A few days in Doha, the Qatari capital, to attend the World Petroleum Congress and then the rest of the time in Kuwait, where I am part of a team doing a feasibility study for a technology park. It was my first-ever visit to Qatar and my first to Kuwait since 1986. Doha, flush with money from natural gas, a small low-slung, dun-colored city 20 years ago, now resembles a sci-fi movie set, all futuristic towers glowing with neon, surrounded by the most barren of landscapes. Kuwait City has expanded enormously, and sprawls almost from the Saudi border in the South to the Iraqi frontier in the north. Areas that were empty desert 25 years ago are now studded with new suburbs filled with enormous mansions and shopping malls. Young Kuwaitis zoom around town in Hummers, Range Rovers, and Maseratis or on Japanese super-bikes, stopping to eat at any of a mind-boggling array of Western restaurant chains. Applebee’s, Chili’s, Taco Bell, Burger King, McDonald’s, Pizza Hut, TGI Friday’s, they are all there. The 1991 Iraqi invasion seems impossibly distant. [click to continue…]

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Last year I wrote a blog post about the financial collapse of Dubai World and its effects on Dubai’s own Roman-candle economy and on other emerging economies worldwide. I had previously written about the effects of the global financial crisis on Dubai’s prospects. I concluded that the Dubai World implosion, together with the economy-wide devastation resulting from the global recession, did not bode well, but that it was too early to write off Dubai’s future role in the world economy, given its ability to sell ever-more audacious and astonishing projects to eager investors.

Almost a year on, the prospect is, if anything, even murkier. On the one hand, the $25 billion restructuring of Dubai World has been agreed by 99 per cent of the company’s creditors. A new $1 billion bond issue, announced yesterday by Dubai’s government, seems timed to take advantage of the rising confidence that may result from the Dubai World restructuring, which was finalized earlier this month. At the same time, the bond prospectus notes that government regulators have withdrawn authorization for 495 property development projects, representing about half of all planned developments in the emirate. This in addition to the numerous projects that developers themselves have canceled for lack of financing.

This would be devastating for any economy, but it is doubly so for Dubai, which depends on property and finance for over 40% of its GDP (against less than 2.5% for oil). According to an article in today’s Financial Times, government revenue fell by 13% in 2009, but the drop would have been much greater were it not for a sharp rise on other revenues such as police fines and revenues from airport and toll road user fees. Nevertheless, Dubai expects a 2010 fiscal deficit of $1.6 billion. The bond issue prospectus also shows a rise in the overall debt of the government and state-owned companies at about $28.5 billion, up from $19 billion a year ago. These numbers exclude many state-affiliated entities such as companies owned by the ruling Al-Makhtoum family rather than by the government itself. The emirate’s total debt is estimated at around $110 billion.

Its huge debt has not blocked on Dubai’s access to capital markets, though it has raised the cost of borrowing. The current bond issue is expected to yield 6.875% for the five-year tranche and 8% for the 10-year tranche. These yields are substantially more than German or U.S. equivalents (3.7% and 2.5%, respectively, for the 10-year bond), but in the same ballpark as Ireland (6.5%), which enjoys explicit and implicit bailout guarantees from the European Union and the IMF. Private or partially private companies in Dubai will see their financing costs rise as a consequence.

The tide has shifted against Dubai. There is a widespread perception that Abu Dhabi, the leading Emirate (Abu Dhabi’s ruler is also President of the UAE, while Dubai’s ruler is Vice President), having helped bail out Dubai to the tune of $10 billion, will now call more of the shots and may restrain some of Dubai’s grander ambitions. With no small symbolic importance, Burj Dubai in downtown Dubai, the world’s tallest building, was renamed Burj Khalifa shortly before it opened in January 2010, in honor of Khalifa bin Zayed al Nayhan, the UAE President and Abu Dhabi ruler.

MSCI, renowned for its global stock market indices, in July declined to reclassify the UAE from frontier to emerging market status, a decision almost certainly related to Dubai’s ongoing problems and heightened perceptions of risk. MSCI’s UAE Index lost nearly 90% of its value during the second half of 2008, but had clawed back about half of that by November 2009, when the Dubai World collapse wiped out almost all of those recent gains. Since then, the index has traded at around a third of its early 2008 value, although there has been some rebound in the past few weeks. The Dubai Financial Market (DFM) Index has performed even worse: it closed today at 1690.19 UAE Dirhams, 70% below its May 29, 2008 close, though it has gained 14% since the end of August, presumably on news of the DW resolution. This looks like more of a blip than the beginning of a sustained climb.

I’ve said it before and I’ll repeat it here: You can’t write off Dubai, which has pulled more rabbits out of more hats than almost any other place in the world. It is likely to be a long time, however, before Dubai’s property and financial markets regain their pre-recession luster and its gravity-defying rise resumes.

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It must be fun to spark a world financial panic and then go on a five-day vacation. By now everyone knows that on Wednesday of last week, right before the Muslim world shut down for the Eid-al-Adha festival, Dubai World, the flagship investment company owned by the Government of Dubai and/or Dubai’s ruler Sheikh Mohammed bin Rashid al-Makhtoum, announced a standstill on its debt repayments, with specific reference to a $4 billion bond payment that Nakheel, a Dubai World property development subsidiary, is due to pay in December. The world has now, finally, woken up to realize that the Dubai miracle is built on sand, both literally and figuratively.

I hate to say I told you so (why do people always say that? I’m usually delighted to say I told you so), but in a blog post that appeared on this site last July “Can Dubai Come Back?” I advised investors to steer clear of Dubai, pointing out that “rampant intermingling of public and private funds and little transparency over who owns and owes what,” it was hard to know exactly what is going on inside any company.  By all indications Nakheel and also Emaar, another state-owned property developer, were perilously close to insolvency if they hadn’t already crossed the line. Nakheel had shelved development of the second and third Palm Island projects and Emaar, developer of the world’s tallest building Burj Dubai, was trying to get itself acquired by Dubai Holdings. Arguments about whether or not all these companies were then or are now insolvent are pretty much beside the point. I likened the Dubai property and investment markets to a game of three-card monte, where losses and liabilities could be moved about and hidden from view.  Given the interlocking nature of UAE companies, when you buy a share of one  it’s hard to know who else’s hidden risks and liabilities you’re buying too.

Today, the first day of trading in the UAE since last Wednesday’s market close, the Dubai Stock Exchange closed down 7 per cent and Abu Dhabi’s 8 per cent. DP World, a profitable Dubai World ports operating subsidiary, saw its price drop 15 per cent. Some analysts now predict that the Dubai property market, already down around 50% from its peak, could drop a further 40% for a total 70% peak-to-trough decline.

For those of us not resident or invested in Dubai, the question is whether Dubai’s woes will spread to other markets.  This possibility of contagion, especially to other emerging markets, is foremost in many people’s minds, especially since statements by the government of Abu Dhabi and by the UAE federal government have put paid to the assumption that Dubai World as a state-owned enterprise enjoyed some implicit government guarantee against insolvency.  The famed Mark Mobius of Templeton Asset Management has warned that a default by Dubai World could trigger defaults – especially of state-owned companies – in other markets and could lead to a 20 per cent drop in emerging markets overall. This could easily happen, since many investors seem unable to distinguish one emerging market from another, but is the risk based on anything more substantial than the madness of crowds?

I think not. Dubai’s slump may be deeper and more protracted than anyone expected, but Dubai’s rulers have never ceased to astound with their imagination and audacity. I wouldn’t write them off just yet, though investors and Dubai’s richer cousins in Abu Dhabi may use the occasion to force Dubai’s companies and government to operate with greater transparency. This would be a good thing.

As for other markets, their exposure to Dubai is minimal. It’s important to remember that total foreign claims on UAE debtors amount to only $123 billion: a lot of money to be sure, but not really that much in the global scheme of things. Over 40% of that debt, or $50 billion, is held by British banks, but that is almost pocket change compared to the size of the losses and rescue packages earlier this year.  The British government has already put over $120 billion into the rescue of three big banks since the start of the financial crisis last year, and has just pledged another $43 billion for the Royal Bank of Scotland (RBS) alone.

As for other emerging markets, most of them are built on a real – as opposed to a financial – economy.  It is hard to imagine the Dubai crisis registering as more than a blip on markets in Brazil, India, Indonesia, South Africa, Egypt, or China, since these markets consist largely of companies that grow, extract or manufacture physical products or that supply essential services like telecoms. Even most of the banks in these countries are likely to be less exposed to Dubai than their counterparts in Britain. Any short-term sell-offs in otherwise sound emerging markets represent good buying opportunities rather than a call for a retreat to safety. Besides, in today’s world can anyone tell me what is safe?

Some emerging markets funds have been hit by the crisis. The Market Vectors Africa ETF (AFK) closed down just over 3 per cent today and is down more than 6 per cent over the past five days, but it is up more than 60% since its February 2009 low. Even T. Rowe Price’s Africa and Middle East Fund (TRAMX), which has over 12% of its holdings in UAE property and financial investments, lost 3.4 per cent today but is still up more than 60 per cent over its March 2008 trough. The ING Russia Fund (LETRX) fell more than 4.2%today, though whether that has anything to do with Dubai is unclear. Maybe Russia, whose economy is increasingly dominated by state-owned companies known for a lack of transparency but which some investors may think are implicitly backed by the Russian government, is suffering some contagion. Even so, it is up more than 175% since its low in February 2009.

Most of my other emerging markets holdings, including  the MSCI Brazil Index ETF (EZW), the Market Vectors Indonesia ETF (IDX), the MSCI Thailand Index ETF (THD), Cemex (CX), and Brasil Foods (PDA), closed up today.  It’s impossible to know whether Dubai has any more nasty surprises to reveal, but on the evidence so far the fallout from Dubai’s crisis is going to be limited to the Emirates and their fellow GCC (Gulf Cooperation Council) members.

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It’s official: the recession has hit the United Arab Emirates, especially Dubai, hard. Well, maybe not official official, but I’m convinced. It’s not always easy to tell what’s happening in that part of the world. With rampant intermingling of public and private funds and  little transparency over who owns and owes what, appearances can be deceiving.

Most of the economic and business numbers have been pretty grim, but losses can easily be moved around, as in a game of three-card monte. For every big real estate project mothballed or scrubbed during the past six months, other highly visible  projects like the Dubai Metro have continued apace, and new ones are still being announced. Even as property values started to spiral downwards and huge property companies began to look distinctly wobbly towards the end of last year, there was still so much cash sloshing around and so many big projects still being announced and built the picture was pretty unclear. [click to continue…]

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