Dubai is in a 'nasty mess of its own making' – but so are we
Dec 04, 2009
Dubai has already given the world some of its biggest buildings (see below) and biggest indoor ski slope, says Alistair Osborne in The Daily Telegraph. Now it has produced "the biggest debt-market cock-up".
Last Wednesday, the Emirate's government suddenly asked creditors of Dubai World, a large state-sponsored conglomerate with $60bn of obligations, to agree to a standstill on debt repayments until next June at the earliest. This included the $3.5bn Islamic bond issued by the group's Nakheel property subsidiary – the company behind the palm island land reclamation project – and due to be repaid in mid-December. Then it shut up shop for a four-day Islamic holiday.
Dubai shocks the markets
The announcement left investors feeling "wronged and wrong-footed", says The Economist. Only three weeks before the government had insisted it would meet all current and future obligations on its $80bn or so of debt (although some analysts reckon about the same sum is hidden off balance sheet).
And shortly before the announcement it revealed that it had just raised a further $5bn from Abu Dhabi, the capital of the United Arab Emirates (UAE), which had stumped up $10bn for Dubai in February. With no further details likely to arrive until this Monday due to the holiday, uncertainty over Dubai's finances, Abu Dhabi's support for Dubai and banks' exposure to the region spread rapidly.
The cost of insuring sovereign Dubai debt against default, as measured by the market for credit default swaps, rocketed to Icelandic levels, reaching an annual $650,000 for every $10m of debt issued for five years (see chart).
Risk aversion returned to world markets, with Europe suffering its worst rout since April late last week and oil sliding by $3 a barrel on Thursday. Dubai's "failure to communicate decisively and promptly with the capital markets on which it relies has left its ambition of becoming a credible financial services hub in tatters", says Lex in the FT.
On Monday when UAE markets opened, Dubai and Abu Dhabi fell by 7% and 8% respectively, but globally calm began to return. Dubai confirmed that it would not guarantee Dubai World's debts, but the latter said it was working on restructuring $26bn of debt – much lower than the $60bn rumoured during the news blackout.
Oil-rich Abu Dhabi, which has the world's largest sovereign wealth fund, with $630bn of assets, looks set to offer Dubai support – albeit on a case-by-case basis and at the price of establishing more influence over the emirate. The UAE central bank in Abu Dhabi established an emergency liquidity facility for local and foreign banks, allaying fears that frightened investors would pull their money out and leave banks high and dry. The UAE's move will help avert a "Lehman-style" liquidity squeeze, says Greg Gibbs of Royal Bank of Scotland.
A new financial crisis?
Fears of a new global financial meltdown amid a Dubai default are overblown, says Walter Molano of BCP Securities. Dubai isn't of systemic importance, as Lehman Brothers was. And foreign banks' exposure looks manageable, adds Lex.
Credit Suisse estimates that European banks account for half of Dubai's debt of approximately $80bn. If they lose 50% on this, bad loan provisions will jump by 5% next year, implying a €5bn hit, a "drop" compared to the near $2trn global banks have already written off. British banks are the most exposed to the UAE, with $50bn of the $123bn foreign claims on it. But "they will not be derailed" by Dubai. Dubai is the "long overdue consequence of the bursting of the global property bubble", says Capital Economics, not "a new financial crisis".
The spectre of sovereign defaults
The important point about Dubai is that "it's a reminder of two unpleasant realities" that investors have neglected, says Stephanie Flanders on Bbc.co.uk. One is that "there is still plenty of bad news" to come. The IMF recently said that global banks are less than halfway through their credit-crunch losses, with up to $1.5trn still to come, says Jeremy Warner in The Daily Telegraph. The latest worry is a "tsunami of red ink" forming in the US commercial property sector, says Michael Panzner on Dailymarkets.com. The losses to come in turn highlight the contrast between the rapid market recovery and the still shaky global fundamentals.
The second major issue is the worry that governments may have "bankrupted themselves" by bailing out the world financial system, says David Smith in The Sunday Times. The potential default in Dubai has revived fears of sovereign debt crises all over the world.
You can see why, says Warner. These are "uncharted waters, quite without precedent in peacetime". Moody's reckons the total stock of government paper, mostly issued by advanced economies, will have jumped by 50% between the start of the crisis two years ago and the end of 2010 – and will then climb by another 50%. The worry is that the markets could lose patience with all this debt and demand higher long-term interest rates before the recovery has taken hold. Moody's has just warned that Britain may face a debt crisis next year. So Dubai may be "in a nasty mess of its own making", says Tracy Corrigan in The Daily Telegraph, "but so are the rest of us".
The 'Skyscraper Curse' strikes again
There is often a correlation between financial bubbles bursting and attempts to construct the world's tallest building, says William Pesek on Bloomberg.com. In 1931, for instance, the Empire State building, designed in the exuberant 1920s, finally opened, "presaging years of gloom".
The Sears Tower was the world's tallest building when it opened in 1973, coinciding with the advent of stagflation. In the late 1990s, Malaysia's Petronas Towers, conceived during the 'go-go' days of the mid-1990s, opened in 1998 as the Asian crisis struck. And the "Skyscraper Curse" has struck again in Dubai. The Burj Dubai (pictured, right) is the latest tallest building in the world at almost 820 metres, constructed by property group Emaar. The $1bn tower is due to open in January.
The link between all these buildings is easy credit, fuelling confidence, ambition, exuberance and hubris, says Pesek. "Architectural overreach" thus tends to mark the height of the boom. Commenting on the construction boom in Dubai in 2006, Claudia Zeisberger of the Asia Pacific Institute of Finance at Insead in Singapore said: "all the building going on made me feel like I was experiencing the last days of ancient Rome". Skyscrapers, says Mark Thornton of the Ludwig von Mises Institute, have become a "marker of the 20th-century business cycle."
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