How Worried Should We Be About Dubai? Update: Is the Bailout Underway?
note: this piece was primarily written Feb 18 but I have appended an update which describes the Dubai’s February 22 capital raising – $10 billion in 5 year bonds purchased by the UAE central bank (the first tranche of a total of $20 billion to be raised) – and suggesting implications of the purchases. This is the most significant step that Federal authorities have taken to support Dubai and avoid the default of its institutions, which could have negative effects on Abu Dhabi, the rest of the UAE and the GCC as a whole.
In recent weeks CDS spreads on the debt of Dubai’s largest State-linked vehicles like Dubai Holding etc shot up dramatically after Abu Dhabi announced a unilateral recapitalization of its banks. The cost to buy protection on the 1 year bond has doubled since late January and now stands at 1073bps. The jump in the 5 yr has been less sharp but stands at over 1400bps. Since Dubai has limited sovereign debt (about $10 billion and may be climbing given the likely fiscal deficit) these large state-linked companies provide a proxy for the perceived credit worthiness of Dubai’s government. Ie people are worried about Dubai’s ability to support its banks, its property sector in the fact of the most severe global recession and the first real test of the Dubai model (economic diversification from hydrocarbons towards services)
Given Dubai’s debt stock ($80b or 148% of GDP, see Moodys recent research for a breakdown), its vulnerability to global liquidity and the worsening outlook for its domestic property market (despite the ability to control supply), it is perhaps not a surprise that the outlook for the emirate seems much more precarious, particularly in contrast to its cash rich neighbour, Abu Dhabi. Given the links of Dubai’s debtors to the government, and the effect that their vulnerabilities could have on the UAE federation, it has widely been assumed that the UAE govt (or rather Abu Dhabi) would come to the aid of Dubai when the crunch came. However, there has been more uncertainty than some expected. Key tests are ahead in coming months as Dubai adjusts to a world where leverage remains scarce. Around $20 billion of the outstanding debt ($80 billion) comes due in 2009, including several large syndications like that of Borse Dubai which was having trouble rolling over its $4b loan that expired at the end of February. Breaking views notes that the $4b capital needed is a test case as allowing the institution to implode would have broader reverberations. It now seems that the UAE federal government might be coming to the rescue. Meed suggests that it will loan Borse dubai $1b to make up the shortfall from private investments. So far (feb 17) Borse Dubai only managed to secure $1.25 billion of commitments from commercial banks, although some further commitments from banks could bring the final bank tranche to $1.5 billion. Even the capital that Dubai attracts will come at a higher cost. Borse Dubai might have to pay 430bps above Libor rather than the 130bps the maturing loan carried.
Unlike some of its neighbours (especially Abu Dhabi) Dubai’s growth was primarily debt financed, making it more vulnerable to the global liquidity crunch and more local liquidity tightening triggered first by the withdrawal of speculative capital and – later by the fall in the oil price. Although Dubai has little oil, it was clearly a petrodollar recycling hub. It accounted for much of the UAE’s external debt stock (some of Abu Dhabi’s state investors accounted for the rest ). Dubai based banks likely also absorbed most of the bank lending to the UAE. Moodys vulnerability indicators show that the UAE is among the most vulnerable in the MENA region (if much less vulnerable that Eastern European countries that are being forced to rapidly and painfully adjust).
Data from the BIS (see chart below) show that loans extended to the UAE first tapered off and then fell in Q2 and Q3 of 2008 (the most recent data) This is consistent with the outflows of short-term capital once dirham revaluation was taken off the table that contributed to a local credit crunch as well as the the escalation of credit crunch on a global scale and a reluctance to lend to the Gulf as the oil price began to fall. Of remaining loans, UK banks are most exposed. Looking at shifts in the UAE’s central bank reserves details the scale of this flows. The UAE’s reserves doubled to almost $100 billion but have subsequently fallen to $44 billion at the end of Q3 (most recent data). No wonder the project finance costs and domestic interbank rates shot up.
Liabilities of BIS banks to UAEThe following gives an outlook of how net flows of funds (deposits abroad – loans) of the UAE compare to the rest of the GCC. the UAE has consistently borrowed more from foreign banks than it has borrowed abroad for the last 18 months. Despite the drop in loans extended to the UAE, it continued to be a net borrower from the international banking system – unlike for example Saudi Arabia or Kuwait.
Dubai is experiencing a property bust. Prices and volumes have been falling for some time and even efforts to control the supply (by merging and providing capital to the main mortgage lenders or pulling back on projects have had limited effect.) The secondary market in particular has dried up. Meanwhile with a number of foreigners losing their jobs will be another blow to consumption and property markets. It has been widely assumed that oil-rich Abu Dhabi would come to Dubai’s aid in one way or another, providing the needed capital and solidifying Abu Dhabi’s role within the power structure of the UAE. It seemed likely that federal institutions were taking the upper hand – including the central bank. In fact the first UAE government responses to the financial strains on UAE banks seemed to be evidence enough. But the next stage has been less unclear.
Moreover the structure of some of the liquidity provided including the temporary ‘repo window’ still created disincentives for banks to take advantage of the funds – likely because authorities wanted to force regulatory changes to stem the significant credit growth. While most UAE banks received long-term deposits back in the fall from the central bank, they remain undercapitalized given the loss of whole sale financing and the fact that the property bust is undermining the quality of underlying assets – property, credit card debt etc. Standard chartered suggests that UAE banks need an additional $27 billion to be adequately capitalized. Other institutions like a permanent repo window and other tools to control the money supply are also needed. These capital needs persist despite Abu Dhabi’s injections to its banks, however, the support of the emirate’s government does add to the stability of financial institutions there and reduce the risk of systemic risk. Abu Dhabi provided capital injections to five banks operating in the emirate in the form of 5 year deposits. Yet allowing a default of a major state-linked banks could have broader reverberations in the region.
Why hasn’t Abu Dhabi made more funds available to Dubai given that the uncertainty undermines UAE asset quality and the “UAE brand”? One explanation might be politics
between the emirates. Reportedly Dubai has not actually asked for funds, perhaps fearing a loss of autonomy. However, doing so within the federal structure would be less politically tricky even if the ultimate source of the funds would be Abu Dhabi. However, even Abu Dhabi’s stock of liquid assets might not be quite as high as it might like. In a recent paper, Brad Setser and I argue that the funds of the Abu Dhabi Investment Authority (ADIA) may never have been as large as some observers thought (we peg its peak at close to $480b early in 2008 and suggest it may have suffered valuation losses that took its AUM down as low as $300b (see this post for more recent calculations that suggest the GCC’s foreign assets fell to $1.16 trillion by the end of January from $1.19 trillion in December – and if February ends anywhere near Friday’s close, a similar $30 billion loss is likely). The calculations are based on an index based portfolio so we might be a bit off. However, given that liquidity is at a shortage and Abu Dhabi may also run a fiscal deficit, it may prefer to preserve its capital for investments prioritized for domestic development.
Yet it is not in Abu Dhabi’s interest to let too large a gap in credit worthiness emerge with Dubai particularly as its banks and institutions are exposed to Dubai’s property markets. Furthermore there are risks to the property markets and financial institutions throughout the region even if most countries are more insulated. Abu Dhabi may prefer to avoid such a bust. But as Moody’s notes, the corporate sectors of the GCC have not been tested in this way in the past and do face significant financing needs.
Broader cost cutting is going on in Dubai including several mergers in the property sector and job reductions. Dubai International Capital and Dubai Group, investment focused entities belonging to Sheikh Mohammed plan a quasi merger. This seems to make sense and may reduce overcapacities. In fact these two entities always seemed to be encroaching on each others turf (investment in financials, private equity holdings etc) in a UAE that was serving as a laboratory for investment abroad, though recently Dubai group was reportedly branching into Islamic finance. Furthermore like others relying on leverage their business model has come under challenge. The sharing of back office support may be the first step to a re-merger. Needless to say, any funds and projects overly reliant on leverage should continue to be very quiet (the QIA might be one exception)
The combination of much more subdued credit growth, reduction in oil production and reduction in non-oil trade and services will keep the UAE’s growth weak in 2009. The country’s non-oil diversification has exposed it to sectors that are faltering globally (shipping, tourism, property, finance). Government support and the fact that many sectors are centralized can cushion the blow somewhat – fiscal policy is expected to be expansionary, the budgets of the UAE federal government (which spends mostly in the smaller five emirates) and Dubai show expenditure growth in 2009. Abu Dhabi will likely do so also though its budget has not been disclosed. Yet there is a broader question where will the funds come from or what price will be charged to get there. Yet given the direct linkages between the UAE’s borrowers and the national and sub-national governments, funds should be forthcoming even if they are pricey and become more so with oil at $35 a barrel.
UPDATE: As suggested above, Federal funds have been made available for Dubai at relatively affordable terms fixed 4% rate for five years with the central bank of the UAE subscribing in full to the first $10 billion tranche of the capital raising. While structured as a bond issue, this does seem to be in practice a loan and one backstopped by Abu Dhabi, through the federal structure. It might thus strengthen the federal structure which has been relatively loose. It remains to be seen what changes may come within the structure of the country and its economic institutions. These funds will not only allow Dubai’s government-backed investors to meet their debt payments, but also to carry out spending plans. Given that private funds will be less available it will be government backed investment which has a more significant role in supporting growth for the rest of this year and even into 2010. As noted above Dubai plans to increase spending about 20% even as revenues are expected to fall, leading to a significant deficit.
Similarly Borse Dubai also turned inward in its search for capital in the face of unfriendly international capital markets. It received about $1 billion from Dubai authorities, and its parent, ICD which itself raised $6 billion last year, funneled money through dubai banks to make up half of the bond issue that international banks were reluctant to fund. In total, ICD provided as much as $2.3 billion of the funds Borse needed. Unlike Eastern Europe, Dubai can tap some of the latent or not so latent resources at home. This should ease some of the cost of protection on Dubai’s debt, but may raise other questions about the availability of capital in the UAE especially now that the needs of liquid assets are so great.The UAE central bank had under $45 billion in foreign exchange reserves at the end of September (the most recent data), a fall of about half from the peak in March 2008, the height of speculative inflows. Central bank reserves may well be lower than $45 billion now given the continued outflows. The Central bank has subsequently provided both dinar and dollar liquidity to conventional and islamic banks. While a range of federal and Abu Dhabi institutions likely have some liquidity, the needs are mounting within the UAE.
Perhaps its wishful thinking to hope that we might see more transparency regarding some of the Gulf’s pools of capital to emerge out of this heightened crisis. But releasing some more frequent information from the UAE’s central bank (which releases figures on reserves et al) with about a six month lag) or new information on other pools of capital might assuage capital concerns.
22 Responses to “How Worried Should We Be About Dubai? Update: Is the Bailout Underway?”
mark mcfarland • February 17th, 2009 at 12:03 pm
The national currency of the UAE is the dirham, not the dinar.
Rachel • February 17th, 2009 at 3:50 pm
Thanks Mark, my apologies… I typed much too fast. thanks for the catch
Jeomoan Kurian • February 18th, 2009 at 10:29 am
A good analysis. One of my cousins who live there in Dubai describes me some ground realities which are results of the slowdown. Less funds flowing into Dubai , fewer ships arriving Dubai shores. This article is really infromative about the debt leverage.
Peter Cooper • February 19th, 2009 at 2:14 am
Bourse Dubai has secured its funding, albeit at high costs as you suggest, see:http://gulfnews.com/business/Markets/10287366.htmlDubai real estate remains a problem but there is good work being done, see:http://arabianmoney.net/2009/02/19/can-visas-and-regulation-revive-dubai-real-estate/The UAE is still in an enviable condition in comparison to the rest of the world.
Shahid K • February 19th, 2009 at 5:09 am
A very good article to identify the cause!!!but if the solution would have given then it would be the best.because it is very easy to identify or disgnose the diesease but it is much more skillful to set the treatement.Please if you can describe in brief about the solution of these crises and how much time it would take to regain.
Anonymous • February 20th, 2009 at 9:26 am
This is exactly the kind of solid business analysis we lack in Dubai. Probably the best commentary I have seen to date.
Ali Hassan • February 20th, 2009 at 3:43 pm
You are right and wrong.First, Borse Dubai secured only $1B to $1.5B in financing, compared to their asking for $4B.Second, the property sector in Dubai is rapidly going down the tube, and there’s not much hope in sight.I should know this…….I am a senior banker in Dubai.
Rachel • February 20th, 2009 at 5:54 pm
Thanks for your insights – both of you. and yes BD received its financing but even what it did receive is with high costs… the same thing goes for any country and company that is highly levered. With jobs being lost and expats leaving Dubai, the demand for property is likely to continue to go down. some estimates suggest that Dubai’s population will shrink by 12-15%+
Guest • February 22nd, 2009 at 7:42 pm
The article says, “the UAE has consistently borrowed more from foreign banks than it has borrowed abroad for the last 18 months.” Doesn’t it mean the same thing to borrow from abroad as to borrow from a foreign bank? What share of the banks in the BIS data consist of other GCC banks or their offshore subsidiaries?Now that the UAE has bailed out Dubai, will UAE CDS spreads go up too? The reserve and debt numbers may be six months stale, but perhaps the spreads give a hint of where they might stand now.
Peter Cooper • February 23rd, 2009 at 3:20 am
There are still a great many problems to sort out from the Dubai real estate bust but this is a good start, and is a reminder of the wealth of the UAE of which Dubai is the commercial capital, see:http://arabianmoney.net/2009/02/23/uae-central-bank-bails-out-dubai/
sage • February 23rd, 2009 at 1:13 pm
i agree w/ ali, the dubai prop. market is going down the tubes. the place has been totally overbuilt fueled by debt (internal & external). although it’s leadership has made valient attempts at ‘branding’ the place, fundamentally, dubai has no value propostion & aside from petroleum, so also the rest of the uae.while on the subject, another place w/ a similar dynamic is panama. watch it start to implode soon. aside from the canal & it’s location as a distribution hub, the place also has no value proposition.in both the uae & panama, the ‘banks’ are in a tenious situation.
Rupert Neil Bumfrey • February 23rd, 2009 at 10:16 pm
Less than two weeks ago Abu Dhabi banks were boosted with tier 1 capital at 5%, whereas Dubai, with Icelandic level CDS, have received an unsecured loan at 4%.Now to my simplistic mind this represents a discount of 20% for Dubai, with no strings!Has the UAE Central Bank decided to ignore economic equations, or was the situation in Dubai so dire that they were literally gifted the cash?Why the euphoria, as you highlight Dubai’s debt has just increased?
Anonymous • February 24th, 2009 at 12:18 am
Given that all of the concern in the past 3 months has been about a growing threat of potential default by Dubai should Abu Dhabi not come to the rescue, it is hardly surprising to see markets rally and CDS spreads decrease on this welcome news that the Federation will step in to assist individual Emirates. While the international press bashing on Dubai has been quite exagerated and fuelled on hearsay and rumours, the factual reporting in this article is to be applauded. Regardless of the naysayers who will be only happy to make statement such as “the property markets are going down the tubes” I believe that it is policy decisions such as the bailout of what is essentially the poster child of the middle east and other initiatives which are underway that will have a strong bearing on investors’ desire to commit to the market and banks willingness to release liquidity into the market. Let this be the type of responsible journalism that gets facts to decision makers.
Guest • February 24th, 2009 at 2:33 am
wow…and I thought that US was doomed by peoples over-optimistic mortgages…Laid-Off Foreigners Flee as Dubai Spirals Down
DUBAI, United Arab Emirates — Sofia, a 34-year-old Frenchwoman, moved here a year ago to take a job in advertising, so confident about Dubai’s fast-growing economy that she bought an apartment for almost $300,000 with a 15-year mortgage.Now, like many of the foreign workers who make up 90 percent of the population here, she has been laid off and faces the prospect of being forced to leave this Persian Gulf city — or worse.“I’m really scared of what could happen, because I bought property here,” said Sofia, who asked that her last name be withheld because she is still hunting for a new job. “If I can’t pay it off, I was told I could end up in debtors’ prison.”With Dubai’s economy in free fall, newspapers have reported that more than 3,000 cars sit abandoned in the parking lot at the Dubai Airport, left by fleeing, debt-ridden foreigners (who could in fact be imprisoned if they failed to pay their bills). Some are said to have maxed-out credit cards inside and notes of apology taped to the windshield.The government says the real number is much lower. But the stories contain at least a grain of truth: jobless people here lose their work visas and then must leave the country within a month. That in turn reduces spending, creates housing vacancies and lowers real estate prices, in a downward spiral that has left parts of Dubai — once hailed as the economic superpower of the Middle East — looking like a ghost town.No one knows how bad things have become, though it is clear that tens of thousands have left, real estate prices have crashed and scores of Dubai’s major construction projects have been suspended or canceled. But with the government unwilling to provide data, rumors are bound to flourish, damaging confidence and further undermining the economy.Instead of moving toward greater transparency, the emirates seem to be moving in the other direction. A new draft media law would make it a crime to damage the country’s reputation or economy, punishable by fines of up to 1 million dirhams (about $272,000). Some say it is already having a chilling effect on reporting about the crisis….But Dubai, unlike Abu Dhabi or nearby Qatar and Saudi Arabia, does not have its own oil, and had built its reputation on real estate, finance and tourism. Now, many expatriates here talk about Dubai as though it were a con game all along. Lurid rumors spread quickly: the Palm Jumeira, an artificial island that is one of this city’s trademark developments, is said to be sinking, and when you turn the faucets in the hotels built atop it, only cockroaches come out.
(full story at: http://www.nytimes.com/2009/02/12/world/middleeast/12dubai.html?_r=2&ref=world)
Anonymous • February 24th, 2009 at 5:08 am
Dubai is making a good move by diversifying away from hydrocarbons. The old-world system of everybody importing oil from the Middle East desert cartel is on its way to a dusty death. The Saudi cost of production for a barrel of oil is something close to $5 whereas crude sells for $38.Close to $70 is what the shiekhs demand for oil, to make sure they can fund the whole government with the oil money and have more left over.Plenty of new oil is being discovered all the time in Central Asia, Siberia, even in the Arabian Sea, Indian Ocean and Bay of Bengal. Also oil supplies from Angola, Sudan, Congo, Nigeria etc are increasingly a viable alternative to replace the Middle East.
Rachel • February 24th, 2009 at 4:28 pm
guest – thanks for pointing out my typo. the perils of typing too fast. Given that the UAE’s foreign asset position still remains quite robust with respect to its liabilities, I would not expect the cost of protecting its debt to skyrocket – despite the point I make above questioning its liquid assets.
John Swetye • February 27th, 2009 at 2:33 am
Hi Rachel,Really enjoyed the article.I’ve seen arial shots of that palm tree development in Dubai many times.When I found out the prices they were asking it seemed like it was a real estate crash waiting to happen.js
Anonymous • February 27th, 2009 at 2:16 pm
people unfamiliar with dubai/uae assume its a normal country,it isn’t.it’s a mirage, its not a democracy, its really a one man company made to look like 20-25 corporates that run everything from utilities to all services/hotels, 1 man owns everything, the worst is THERE IS NO RULE OF LAW/NO JUDICIAL SYSTEM AT ALL, this is only revealed when u get deeper inside, freehold property laws do not exsist(govt will have u believe they do, practically don’t) every contract whether B2C or B2B in property is 2day in dispute & can’t be resolved becos there is a conflict of interest where 1 disputing party not only owns the country but also the judicial system, it worked in boom times when everyone saw only up & there were no disputes, the banks/govt all have no money, dubai will be set back 10 years…
meha • June 22nd, 2009 at 5:01 am
I agree with u what u mention is true really there is no law for public especially expatriates Indian, Pakistan etc… they are treating like we r slave very badly affect the people they are protecting only their peoples like they r only human beings we are nothing we are a doll we don’t any soul we are animals
Anonymous • July 24th, 2009 at 7:39 am
It is amazing that the ruler of Dubai embarked on such an expansion of the Emirate with such a low capital base.Foreign companies were only too eager to offer there wares to the Sheikh, running from their own over saturated markets and rubbing their hands at the prospect of great profits. They sold Dubai things which they don’t even have in their own nations. For instance, Emirates is running a fleet of the latest Airbus A380 when Air France, Lufthansa or British Airways do not have an order for a single example.The same goes for the many expats, including the thousands of Indians who outnumber even the local community in their presence, that came their for the better prospects being offered compared to their home nations.The reality in Dubai is as much the result of great ambition or over ambition, as the eagerness of the many players to capitalise on this opportunity.The UAE Federal Government or Abu Dhabi has not only bailed out the Emirate of Dubai but also the many organisations and Individuals that have benefited from the boom years. It would be refreshing to see some of them bringing the same spirit to the whole situation instead of the remarks by Mr Ali Hassan, the self proclaimed senior banker in Dubai.
Anonymous • August 18th, 2009 at 2:40 pm
The post by meha is not sufficient. I FELT LIKE WRITING MORE…THERE IS NO RUE. NO JUSTICE. IF SOMEONE CHEATES YOU, ATTACK YOU, DO ANYTHING HARMFUL TO YOU, YOU CANT GET JUSTICE IN UAE. THE OFFICIALS ARE IGNORANT, ARROGANT, AGREESIVE, UNCIVILISED UAE NATIONALS. THERE IS NO JUDICIARY SYSTEM. EVERYTHING IS BASED ON INFLUENCE. IF YOU KNOW ARAB SHEIKH, YOU CAN GET THINGS DONE. DONT EXPECT POLITE WORD OR DECENCY OR MANNERS OR ETTIQUATES FROM ARAB SHEIKS. IF ONE NEEDS MONEY ONLY, NOT PRINCILPLE, THEN GO TO UAE AND LIVE LIKE A DOG OR DONGY OR A SLAVE IN THE DESERT. THEY HAVE HIGHRISE BUILDING ONLY. IF YOU HAVE ONE EXPERINCE, YOU WILL NEVER EVER GO TO UAE. BE IT IN THE FORM OF RENT, PROPERTY, CAR OR JOB.NO RULE, NO LAW, NOTHING.NO POLICE WILL HELP YOU. THEY ARE JOKERS. THEY WILL MAKE FUN OF YOU. THE WHOLE COUNTRY IS FULL OF CRIMINALS FROM PAKISTAN AND INDIA. YOU WILL HAVE TO FACE ALL KIND OF EXPLOITATION, THREATENING, INTIMIDATION FROM LANDLORD, CARDEALER, POLICE AND EMPLOYER. IF YOU WANT TO LIVE IN TOTALLY UNCIVILISED PLACE, THEN GO THERE. YOU CAN SEE ALL KIND OF FILTH IN THIS WORLD IN UAE ESPECILLY IN DUBAI. DUBAI COURT IS THERE. BUT NO USE FOR EXPATS. THE RULING WILL BE ALWAYS IN FAVOR OF NATIONALS OR CRIMINALS. SHARJAH GOLD SOUK AND NEAR BY AREAS ARE CROWDED WITH PAKISTANI SECOND HAND CAR DEALERS. ONCE THEY ENTER IN TO YOUR CAR, THEY WILL KILL YOU AND TAKE YOUR CAR. DONT NEVER EVER EVER DEAL WITH ANY PAKISTANI.IN UAE.. I CAN WRITE A NOVEL HERE ABOUT THIS. I HAVE SEEN AND HEARD AND EXPERINCED SO MANY INCIDENTS OF LOOTING ROBING AND CHEATING BY PAKISTANI AND UAE NATIONALS. BECAUSE THERE IS NO RULE NO LAW NO JUSTICE NO CIVILISED GOVT. OFFICIALS OR POLICE IN UAE ESPECIALLY IN DUBAI.
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