Dubai City - 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 assumed we may be in for a soft touchdown, Dubai tossed a big and really shiny spanner right into the jobs.

The instant cause for problem was the ask for a grinding halt on rate of interest payments on financial obligation released by Dubai World - a personal, though state-backed, company. This, you may have believed, was a conventional company breast.

Not so. Three points made it specifically vital. Initially, residential or commercial property prices in Dubai had currently fallen by as high as 60% - while the economic situation plainly was still suffering, lots of people assumed the discomfort had currently been taken and the emirate might currently invest its efforts on relocating forwards. Obviously not.

Secondly, there was an implied state guarantee for the financial debts of Dubai World and its subsidiary Nakheel. If Dubai wasn't backing its bonds, that can be construed as a sovereign default (though Moody's mentioned that there was no specific assurance, and actually it had devalued DW bonds because of that).

Finally, the timing of the news - which appeared simply in advance of the Eid al-Adha holiday, when stock markets around the Gulf would certainly be shut. No details, no traders, no liquidity, and a potential default- not the best dish for pleased investors. Some bears have recommended this is the start of the actual economic collapse.

Nonetheless, there have actually been a variety of 'voices of factor' urging that the damage can be restricted to a few bonds, and that Abu Dhabi will certainly step in as fairy godfather.

I think the reality exists somewhere in between the two revers. But to see just what's going on you have to understand exactly how Dubai entered the scenario it's in.

Dubai isn't a petrodollar state. It does not have an awful great deal of oil - sufficient to have actually begun on modernising its economic climate, yet oil and gas revenues contributed less than 6% of GDP in 2006 and possibly a bargain much less than that currently. Its method has actually been to come to be a Gulf 'hub'; which's not exercised severely, with Jebel Ali port one of the top ten container ports worldwide, and trade, entrepot and economic solutions representing over 40% of the economy.

Realty development was originally driven by the services economy. Nevertheless, over recent years, real estate has actually procured into the driving seat; by 2005, construction and property added 25% of overall GDP. After Dubai kicked back a bar on immigrants buying residential or commercial property in 2006, a huge, debt-driven asset boom started; numerous dollars entered into promoting Dubai advancements to UK and Irish customers, and advertising the city as a visitor hot spot.

In some ways, Dubai is very just like Iceland - financial obligation driven property rate inflation, a small population (fewer compared to 200,000 Emiratis, though the overall population is about 2m).

But there's one big distinction. Dubai, though acting in numerous methods as a sovereign state, is part of the United Arab Emirates - a somewhat ambiguously constructed federation where the biggest single economic situation is Abu Dhabi's. That's resulted in hopes that Abu Dhabi will bail out Dubai - but the evidence recommends that if it does, it will own a hard bargain.

Abu Dhabi has actually constantly considered itself the big sibling in this relationship. It's more traditional both socially and financially, and hasn't already been totally happy with Dubai upstaging it financially - nor with Dubai's fairly loosened up way of life selections. Abu Dhabi has said it will back financial institutions - both Emirati and foreign owned - operating in the Gulf. However it has said nothing about Dubai World. And it definitely hasn't already said anything that can be understood as writing a blank cheque.

There are rumours that it will drive a difficult bargain by looking for to regulate assets such as Emirates airlines and the Dubai World ports business. But similarly, it might strike a difficult political deal. Besides, I think Abu Dhabi's not precisely pleased with the means the statement was made - you might translate it as Dubai trying to 'jump' Abu Dhabi into writing them that blank cheque.

According to reports, Dubai has USD 19bn of debt coming due this year and following. That stands versus GDP of USD 90 bn or so (based upon this year's initial quarter GDP); that's over a fifth of GDP used up by payment, before financial debt maintenance, and total debt stands at near 100% of GDP.

The big issue right here is that GDP is mosting likely to reduce. There's been a huge emigration of expats, both professional Brits and blue collar Indian employees, and that's not just from the construction sector; it's likewise from bank head offices, publications and papers, almost every market of the economic climate. So Dubai will be aiming to service that debt on a lower GDP. That's mosting likely to be difficult, and I do not assume the Nakheel/Dubai World bonds are the last we'll hear of it.

Nevertheless, the situation theoretically could be contained within UAE, with a couple of knock-on impacts outside. For example HSBC, which obtained hammered last week, actually has a 2% total exposure to Dubai - way less compared to its direct exposure to US subprime.

The effect on the markets, however, I believe will confirm to be longer long lasting, since Dubai has put an end to an Indian summer of stock trading. Lots of analysts and fund managers were currently worrying that the bull run of 2009 might be getting over-extended; Dubai is most likely to tip the equilibrium for a number of them on the side of greed instead of anxiety. Dubai has actually additionally reminded us really strongly of the absence of transparency of several of the markets financiers have moved right into, looking for to boost returns in a period of reduced base rates.

But Dubai has also eliminated the easy consensus that we were going to ride out this economic crisis without any sovereign defaults. Bear in mind, 1998 saw Russia default, 2002 saw Argentina do it. Up until now, further defaults have actually been prevented - yet numerous economic climates are looking rough. Ireland, Hungary, the Baltic States, are all highly exposed. Federal governments' source to big financial stimulation programs and measurable easing has in truth worsened their economic susceptability, to make sure that the majority of federal governments will enter 2010 much weaker than they began 2007.

The marketplace in credit default swaps reacted quick to the Dubai crisis - in other words, the expense of guaranteeing against sovereign default has risen drastically. The expense of insuring Dubai bonds doubled, Saudi financial debt is up 20%, Qatar up 10%. The effect isn't really limited to the Middle East, either; arising markets have experienced, and Greece has remained in the spotlight too. The rate of financial obligation has likewise been influenced. The sukuk (sharia style bond equivalent) in question dropped from USD 1.10 to 57 cents on the dollar on Wednesday. That's scary for investors that have removaled into bonds as a 'safe house' from equities markets.

It's most likely that even if markets recoup, obtaining expenses for extremely indebted federal governments will climb. That can consist of the United States and UK - which will limit the quantity of stimulation they can feed through to the economic climate, and cause a much slower recovery compared to would otherwise have actually been the case. If the bounce that analysts have actually anticipated does not occur, stock exchange look extended - so even if Dubai doesn't produce the collapse of the world economic situation, my sensation is it will possibly cause softer equity markets.

Also if Abu Dhabi pays all Dubai's financial obligations, the issue is that you cannot place the shade of default back in the box - capitalists' attitude and their danger aversion will certainly have been affected by the events of last week. Particularly, the 'deal attitude' that saw numerous financiers buying up 'scrap' supplies and re-entering the UK real estate market earlier this year might recede.

Nevertheless, if you thought that a 50% fall in real estate costs indicated that Dubai was a deal, you've had your fingers really severely melted.

I presume this might be the end of the 'back to business as typical' stage of the economic crisis. The truth is, economies like Dubai and, attempt I say it, the UK require some significant restructuring before they can return to growth.

You can't be an ostrich and stick your head in the sand. Though, that stated, Dubai does have a dreadful great deal of sand to stick it in!

If you want to discover more concerning Dubai and the global investing overview, have a look at the most recent [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 normal column at Stockopedia concerning UK Value Investing with views on the most effective alternatives and challenges for worth financiers in the UK market.