The fact that Dubai has been struggling under huge debts is not a surprise to anyone who has followed the Emirate’s economy over the last 10 years.
A huge property-led boom saw money pile into infrastructure and construction projects like the Palm Jumeirah or the soon-to-be-completed 810 meter Burj Dubai tower that will dwarf any building on earth.
Building the world’s tallest building has always been viewed by investors as a sign that a local economy is about to head south. Dubai World, the most indebted of Dubai’s state-sponsored companies, owes $60 billion of which $22 billion must be refinanced by 2011.
Dubai World and Dubai’s authorities have been able to raise this kind of money in the first place due to implicit support of its oil rich neighbor Abu Dhabi.
Dubai has very few energy resources and raises little money via income tax due to its competitive tax policies. The state has consistently run deficits and the Emirate's growth has therefore been funded via the money markets.
Dubai is one of 7 Emirates that make up the United Arab Emirates. Abu Dhabi, with huge energy reserves and a sovereign wealth fund thought to be worth $630 billion, is the richest of them.
Its banks are major creditors of Dubai and its companies, but news that they are no longer willing to keep buying or refinancing Dubai’s major company’s debt shocked global markets.
This week two of Dubai’s biggest companies, Dubai World and Nakheel asked creditors for a debt standstill that has spooked investors across the world.
Bad News for Creditors
After an Abu Dhabi-led bailout of Dubai in February of $10 billion, some investors where convinced that more money would keep flowing.
It is not a matter of whether Abu Dhabi can bailout Dubai but a question of the terms under which they will be willing to do so and what impact this will have on other creditors.
Global banking giants like HSBC , Citi , Standard Chartered and Barclays all have significant exposure to the UAE, of which some will be exposed directly to Dubai.
Analysts at Commerzbank in London believe these companies and others are now facing losses of up to 50 percent on their investments. Luis Costa from the EMEA debt team believes Abu Dhabi will come to the rescue, but only on terms that suit it and its lenders.
“Help will probably be selective. It does not necessarily mean principals will be fully paid here. As a matter of fact, given the levels of haircut in other recent emerging markets restructuring deals, a 40-50 percent destruction of principal (haircut) would not be absurd at all,” Costa said.
So bad news for creditors; and expect those from outside the UAE to get the worst of any restructuring of debt.
Luis Costa has warned in the past that 2010 and 2011 will be classic years of 'global debt restructuring' at various levels like corporate, quasi-sovereign and sovereign credits.
How Dubai and its rich neighbor Abu Dhabi handle this restructuring could give the bond markets a clear signal of how other highly indebted countries, firms and state-backed firms, go about doing the same thing over the next 2 years.