Markets Reel

Just as equity markets were casting off the huge losses sustained during the global economic crisis, this week’s news about escalating credit problems in Dubai has shredded optimism. Asia’s markets plunged today, Japan’s Nikkei 225 Average losing 3.2% to close at 9081.52. This is its lowest close since July. Australia’s main index was down 2.9%, South Korea’s 4.7%, and Taiwan’s 3.2%. Hong Kong’s Hang Seng fell even further, to the tune of 4.8%, with major banks bearing the brunt. Standard Chartered’s shares closed down 8.6%, while HSBC lost 7.6%. India’s Sensex index was off 3.7%, while China’s Shanghai Composite fell a more modest 2.4%. The Asian markets picked up where Europe’s markets left off yesterday, and the latter are poised for further losses today. The U.S. markets were closed yesterday for Thanksgiving, but a heavy sell-off is now in prospect when they reopen. Investors have instead been pouring funds into the safer havens of government bonds.

The main reason for investor nerves is concern over international banks’ exposure to debt held by Dubai World and other struggling businesses in the Gulf region. During the region’s boom, banks around the world rushed in to take advantage of the opportunities, and some are now finding it hard to extricate themselves. These include most of the big-name U.K. banks who have already suffered acutely during the global crisis. Many international banks have been quick to state today that their direct exposure to Dubai World is minimal, but the markets have hammered them nonetheless. There are concerns that if major Western banks suffer renewed heavy losses this will then slow the flow of their credit to other economies that have relied on it to stimulate growth. The situation is feeding wider misgivings that equity rallies have been unjustified in recent months and that the global financial crisis is far from over.

Key banks within the Gulf region face particular challenges, with reports today suggesting that Abu Dhabi Commercial Bank and Emirate NBD have the biggest direct exposures to Dubai World. Abu Dhabi Commercial Bank is said by Bloomberg to be owed US$1.9 billion by the conglomerate, and is currently in talks to ascertain how the exposure will be handed. The bank is the country’s third largest, and the government's 65% ownership stake is held through its sovereign wealth fund. Members of the royal family hold an additional 13% stake. The remaining shares are publicly held and traded on the Abu Dhabi Securities Market. Dubai World’s next largest creditor bank is said to be Dubai-based Emirates NBD. It is worth noting, however, that until the banks themselves disclose the extent of their exposure and the likelihood of restructuring/recovery of the loans, all news is rather speculative in nature.

Dubai Seeks to Reassure

The panic started two days ago when it emerged that Dubai World, a government-owned conglomerate that drove the emirate’s spectacular growth during the boom years, had requested a six-month debt standstill and announced restructuring plans. This undermined confidence that the government would plug credit holes. Ratings agencies moving quickly to downgrade the debt of various Dubai government-related entities, meaning a sharp increase in the price of insuring against default. The authorities have tried to reassure creditors that they have a grip on the situation; Dubai World’s chairman, Sultan Ahmed bin Sulayem (who is also top lieutenant to Dubai’s hereditary ruler, Sheikh Muhammad bin Rashid al-Maktoum), and the rest of the management are to remain in place and will work together with Deloitte LLP to engineer a corporate restructuring effort. The government claims that the Dubai World intervention was "carefully planned and reflects its specific financial position". The Financial Support Fund (FSF) that was established earlier this year to manage Dubai’s debt will also be involved. As part of the initial phase of restructuring, a debt standstill has been requested, extending Dubai World’s debt maturities until 30 May 2010. More news is promised on the interventions next week. The standstill request will have an immediate impact on the US$3.5-billion bond that Nakheel, the real estate subsidiary of Dubai World, was scheduled to repay in December. The repayment had taken on a symbolic importance, seen as a crucial test of Dubai’s ability to repay its debts in light of the real estate crash that has taken its toll on the emirate’s economy. Although it is thought that company officials are discussing various options with lenders, there are, as yet, no definitive details regarding the deal.

The news of the restructuring and debt standstill was preceded by an announcement that Dubai had raised US$5 billion from two local banks: the National Bank of Dubai and the Al Hilal Bank, both of which are based in Abu Dhabi. Each of the banks is reported to have subscribed to US$2.5 billion in bonds issued by the emirate, which is said to be unconnected to the restructuring of Dubai World. The funds raised are reported to be part of a US$20-billion borrowing programme and are said to be tantamount to a federal bailout, led by the oil-rich and better positioned capital of the country. The funds will be used to pay down international debt and unpaid bills to contractors (including some £200 million, or US$327.5 million, owed to British contractors alone). It is worth noting that Dubai World’s cash-generating ports division DP World is not part of the restructuring effort.

Outlook and Implications

How successfully Dubai World is restructured is a crucial test of the emirate’s leadership, and highlights the pitfalls when an economy is so enmeshed with the political elite. The general lack of transparency is undermining confidence in the statements emerging over the past two days. There is uncertainty over how deep DP World’s problems are and how far the authorities are willing to intervene and reassure international creditors. It remains to be seen whether the U.A.E. authorities, particularly the central bank, will handle the matter any differently to—or with greater transparency than—the Saudi authorities during the height of the Algosaibi and Saad trouble a few months ago. Together, these events have raised concerns about the lending practices and choices of banks across the Middle East. The concentration of lending, as well as the tendency to lend on the basis of reputation (thus perceived creditworthiness of the borrower) rather than sound business considerations of risk and reward has proven highly problematic. The fact that Abu Dhabi and its banks are generally in a better position and will be able to support the emirate of Dubai—averting systemic threats—should not detract from the lessons to be learnt from over-lending to certain segments.

In the meantime it is the broader loss of investor confidence that is having a greater global economic and market impact. The news from Dubai feeds into wider concerns about ongoing global credit problems, and raises doubts about how long governments around the world are going to be prepared to prop up key assets. Dubai has previously been highly active in propping up its struggling companies; if it starts to pull the plug investors start looking at other sovereigns more anxiously.

This week’s news will further undermine confidence in Dubai’s shattered real-estate market. Across the Persian Gulf region, there have been huge falls in property values, but the crash in real estate and construction has been particularly spectacular in Dubai. A dizzying boom in property prices over the four years preceding the global crisis created asset bubbles that exploded in the second half of 2008. Even before this week’s drama property prices and rents stood as much as 60% below their pre-crisis peaks. Furthermore, there is still a huge oversupply problem, with 25% of Dubai's homes lying empty, according to a recent report by Colliers. Dubai's commercial property market is also facing savage headwinds with huge additional supply of office and retail space in the pipeline. As we are seeing this week, the negative aftershocks from Dubai's property crash continue to affect economies far beyond its own borders, since capital inflows from many countries had contributed to the emirate's real-estate and construction boom.

Global Insight (Reino Unido)