>The Dubai Debt crisis: What really happened?

Dubai’s debt woes are a lot older and deeper than Friday’s announcement by Dubai World (a
conglomerate of the government of Dubai) might indicate. The announcement-asking for a
standstill on the repayment of USD 60 bn worth of debt till May, 2010-appears to be a culmination of the stress that Dubai has been witnessing over the last year. It is just a visible symptom of the woes of an economy long reeling under the weight of a real estate crash that hit the economy over a year ago. Since their peak in 2008, real-estate prices have plummeted to 60% of their precrisis levels thus exposing highly leveraged real-estate developers to the risk of default. In fact, major credit rating agencies such as Standard and Poor’s and Moody’s had placed several government related entities (GREs) and local banks on negative rating watch as far back as May, 2009 indicating that the prospect of rising credit risk and debt default had become real much earlier than Friday’s announcement.

In an effort to ride over repayments falling due over the year (including USD 327.5 mn to British
contractors and USD 9 bn of international debt falling due over the next four months), Dubai
sought to draw down support from Abu Dhabi- UAE’s wealthiest member and unlike Dubai, an oil producer. On the face of it, this was not such a difficult task with Abu Dhabi having a history of providing big ticket financing to Dubai. Abu Dhabi and Dubai appeared to tie up financing
arrangements. However the negotiations soon turned fractious and acquired a political hue with
Dubai asking for “unconditional” support and Abu Dhabi intent on following through any support
only under the condition of an asset transfer (market rumours suggest that Abu Dhabi was keen on taking over Emirates Airlines, Emistalat, DP World and others) in return for funding. Talks
between the two countries subsequently broke down prompting Dubai to issue a 5-yr USD 20 bn
loan programme in February, 2009. USD 10 bn of this amount was subscribed by the UAE central bank. However, with foreign exchange reserves totaling only USD 25 bn at its disposal and the rest of the reserves parked in sovereign wealth funds of member nations, the central bank could not subscribe to the residual USD 10 bn. The residual amount was originally supposed to be subscribed by Abu Dhabi Investment Authority (ADIA), which handles UAE’s largest forex reserves totaling USD 627 bn. However, it failed to come through and a last minute deal was worked out with two Abu Dhabi banks (Al Hilal Bank and NBAD) subscribing to USD 5 bn of the residual USD 10 bn amount.

Despite securing sizeable financing to meet its debt needs, events snowballed to a crisis last Friday when Dubai announced its willingness to a standstill on the liabilities of Dubai World and declared that the USD 5 bn raised from Abu Dhabi banks would be used for purposes other than the immediate needs of Dubai World. This statement came in the backdrop of a USD 3.5 bn Nakheel (subsidiary of Dubai World) bond falling due on December 14, 2009 thus prompting fears of an imminent default on the note. It also underscored the fact that while investors had expected an ‘implicit’ guarantee on debt raised by GREs like Dubai world (there was no explicit guarantee) the Dubai government was unwilling to play ball.

The status of the repayment falling due remains uncertain as of now. While Dubai World is looking to restructure USD 26 bn of its obligations (including the USD 3.5 bn Nakheel bond falling due in December,2009 and USD 5.7 bn of debt falling due before May,2010) whether banks and creditors will agree to Dubai World’s terms remains to be seen. The fate of the remaining USD 13-14 bn is less uncertain with bulk of the amount held by units such as DP World that have enough cash flow to service impending obligations.

Dubai World’s financial mess is as much a reflection of the real-estate market as it is of the
complexities of UAE politics. With the lion’s share of foreign assets (over 95% on last count) being held by Abu Dhabi, the ability of both the central bank of UAE and the Dubai government to help out in times of crisis is limited. Total foreign exchange reserves of the UAE sum up to USD 700 bn (including Abu Dhabi’s foreign assets) and the USD 60 bn of debt owed by Dubai World or the USD 100 bn of debt held by Dubai is easily manageable if Abu Dhabi co-operates. Would Abu Dhabi not have engaged in a power struggle over Dubai’s assets, chances are that Dubai’s debt problems would not have been as exposed as they were last week. However, with both Abu Dhabi and the government of Dubai now explicitly backing away from Dubai World’s obligations one thing appears clear. Dubai’s GREs (government related entities) and private debtors will have to bear the brunt of bad investment decisions alone.

To read the full report: DUBAI DEBT CRISIS