Dubai – Is This a Game Changer For the Global Economy?
By Victor Igden
Just when the stock exchange was trading at brand-new highs and people believed we may be in for a soft landing, Dubai threw a massive and very glossy spanner into the works.
The immediate cause for issue was the ask for a standstill on passion repayments on debt issued by Dubai World – a personal, though state-backed, corporation. This, you may have thought, was a typical business bust.
Not so. 3 things made it especially crucial. Initially, residential property rates in Dubai had already fallen by as much as 60% – while the economy plainly was still experiencing, lots of people thought the discomfort had currently been taken and the emirate could currently spend its efforts on moving forwards. Evidently not.
Secondly, there was a suggested state warranty for the debts of Dubai World and its subsidiary Nakheel. If Dubai wasn’t backing its bonds, that might be construed as a sovereign default (though Moody’s pointed out that there was no specific assurance, and in fact it had actually downgraded DW bonds due to that).
Finally, the timing of the news – which appeared just ahead of the Eid al-Adha vacation, when stock exchange around the Gulf would be shut. No details, no traders, no liquidity, and a potential default- not the best dish for delighted financiers. Some bears have actually recommended this is the start of the actual monetary collapse.
However, there have actually been a variety of ‘voices of reason’ insisting that the damages can be limited to a few bonds, which Abu Dhabi will step in as fairy godfather.
I believe the truth lies somewhere in between both revers. Yet to see exactly what’s going on you need to know just how Dubai entered into the situation it’s in.
Dubai isn’t a petrodollar state. It does not have a dreadful lot of oil – sufficient to have actually started on modernising its economic situation, however oil and gas profits added much less than 6% of GDP in 2006 and most likely a good deal less than that now. Its method has been to become a Gulf ‘hub’; and that’s not exercised terribly, with Jebel Ali port one of the leading ten container ports worldwide, and trade, entrepot and economic services representing over 40% of the economic situation.
Property growth was initially owned by the solutions economy. Nevertheless, over recent years, property has managed to get into the motoring seat; by 2005, construction and residential or commercial property added 25% of total GDP. After Dubai unwinded a bar on foreigners acquiring home in 2006, a significant, debt-driven asset boom started; millions of dollars entered into promoting Dubai developments to UK and Irish customers, and advertising the city as a tourist location.
Somehow, Dubai is really just like Iceland – financial obligation driven property rate inflation, a tiny populace (less than 200,000 Emiratis, though the total population is about 2m).
However there’s one big distinction. Dubai, though acting in many means as a sovereign state, belongs to the United Arab Emirates – a somewhat ambiguously created federation in which the biggest solitary economic situation is Abu Dhabi’s. That’s brought about hopes that Abu Dhabi will certainly bail out Dubai – yet the evidence suggests that if it does, it will certainly own a difficult bargain.
Abu Dhabi has actually always considered itself the big sibling in this partnership. It’s even more traditional both socially and monetarily, and hasn’t been completely happy with Dubai upstaging it economically – neither with Dubai’s fairly unwinded lifestyle options. Abu Dhabi has said it will certainly back banks – both Emirati and foreign had – operating in the Gulf. However it has actually stated absolutely nothing concerning Dubai World. And it certainly hasn’t already said anything that might be construed as composing an empty cheque.
There are rumours that it will certainly drive a tough deal by seeking to control assets such as Emirates airline companies and the Dubai World ports business. Yet similarly, it might strike a hard political bargain. Besides, I presume Abu Dhabi’s not specifically delighted with the method the announcement was made – you can interpret it as Dubai aiming to ‘bounce’ Abu Dhabi into composing them that empty cheque.
Inning accordance with records, Dubai has USD 19bn of debt coming due this year and next. That stands against GDP of USD 90 bn or so (based upon this year’s initial quarter GDP); that mores than a fifth of GDP taken up by settlement, prior to financial debt maintenance, and total debt stands at close to 100% of GDP.
The big problem below is that GDP is mosting likely to reduce. There’s been an enormous emigration of deportees, both specialist Brits and blue collar Indian employees, which’s not just from the construction field; it’s likewise from bank head workplaces, publications and newspapers, almost every field of the economic climate. So Dubai will certainly be aiming to service that financial obligation on a reduced GDP. That’s going to be difficult, and I do not think the Nakheel/Dubai World bonds are the last we’ll become aware of it.
Nonetheless, the dilemma in theory could be included within UAE, with a few knock-on influences outside. As an example HSBC, which got hammered recently, in fact has a 2% total direct exposure to Dubai – means much less than its exposure to United States subprime.
The influence on the markets, though, I assume will verify to be longer enduring, due to the fact that Dubai has actually put an end to an Indian summer of stock trading. Several experts and fund supervisors were already worrying that the bull run of 2009 might be obtaining over-extended; Dubai is likely to tip the equilibrium for much of them on the side of greed rather than concern. Dubai has additionally reminded us extremely powerfully of the lack of openness of a few of the markets investors have moved right into, seeking to boost returns in an age of low base rates.
However Dubai has additionally eliminated the simple consensus that we were mosting likely to ride out this economic downturn without any sovereign defaults. Remember, 1998 saw Russia default, 2002 saw Argentina do it. Up until now, more defaults have been prevented – but many economic climates are looking rocky. Ireland, Hungary, the Baltic States, are all very revealed. Federal governments’ resource to big financial stimulation programmes and measurable easing has in reality aggravated their economic susceptability, so that the majority of federal governments will certainly get in 2010 much weak than they started 2007.
The marketplace in credit default swaps reacted quickly to the Dubai situation – in other words, the cost of guaranteeing against sovereign default has climbed considerably. The cost of guaranteeing Dubai bonds increased, Saudi financial obligation is up 20%, Qatar up 10%. The effect isn’t limited to the Middle East, either; arising markets have endured, and Greece has actually remained in the spotlight as well. The rate of financial debt has also been impacted. The sukuk (sharia design bond equivalent) concerned dropped from USD 1.10 to 57 cents on the buck on Wednesday. That’s terrifying for capitalists that have actually removaled right into bonds as a ‘safe haven’ from equities markets.
It’s most likely that even if markets recover, borrowing costs for extremely indebted governments will certainly climb. That can consist of the US and UK – which will restrict the amount of stimulus they can feed with to the economic climate, and lead to a much slower healing than would certainly otherwise have actually held true. If the bounce that analysts have actually expected does not take place, securities market look extended – so even if Dubai doesn’t cause the collapse of the world economic situation, my feeling is it will possibly cause softer equity markets.
Even if Abu Dhabi pays all Dubai’s financial obligations, the problem is that you can’t put the spectre of default back in the box – capitalists’ attitude and their threat hostility will have been influenced by the occasions of recently. Specifically, the ‘deal way of thinking’ that saw numerous capitalists purchasing up ‘junk’ supplies and coming back the UK real estate market earlier this year can recede.
After all, if you believed that a 50% loss in realty rates suggested that Dubai was a deal, you’ve had your fingers very badly melted.
I believe this can be completion of the ‘back to business as normal’ stage of the economic downturn. The reality is, economic climates like Dubai and, dare I state it, the UK require some dramatic restructuring prior to they can resume development.
You can not be an ostrich and stick your head in the sand. Though, that said, Dubai does have a dreadful lot of sand to stick it in!
If you want to learn more about Dubai and the global investing expectation, check out the most up to date [http://www.stockopedia.co.uk/article] Macro-Investing column at Stockopedia.
Victor Igden is a writer who spent fifteen years working in the City as an analyst. He creates a regular column at Stockopedia about UK Worth Investing with sights on the most effective alternatives and challenges for value financiers in the UK market.