Despite Dubai the Gulf economies are not built on sand

Published on Saturday 12 December 2009 13:31

SINCE the vast towers and palm-shaped islands began their thrust from out of the barren desert on the once humble shores of the creek where pearl divers had plied their trade, there has always been something of the mirage in Dubai.

Its illusory solidity, though, confounded investors – and the global markets – when Dubai World, the government vehicle behind much of the region's grandiose development projects, announced it would ask for a six-month standstill on $26 billion (16bn) of debt. Its subsidiary property fund, Nakheel, a $3.5bn bond due for maturity this month, said it met with lenders on Monday to discuss how and when payments would be made.

The government's negotiations with the lenders, including Lloyds Banking Group, Royal Bank of Scotland, HSBC and Standard Chartered, as well as Abu Dhabi banks, have been kept under tight wraps. It is the way that business is done in Dubai – secretive and opaque like a sandstorm.

Saftar Sarwar, a Glasgow-based board member of the Islamic Finance Council UK and a wealth manager with Barclays predicts the assets will be split between the troubled commercial and residential property assets and those that have retained value, including Dubai Ports World, owner of P&O.

"The Dubai government is looking to create a good Dubai World and a bad Dubai World," he says. "There is a lot of good stuff there in terms of infrastructure, the port and the free trade zone areas."

Already Dubai has ring-fenced prized assets such as Emirates airline and its investment portfolio, Istithmar World, which owns stakes in high-end US retailer Barneys.

According to the bond's prospectus, Nakheel creditors may win the right to seize a strip of barren waterfront land the size of Manhattan, part of the Dubai Waterfront project where Nakheel had plans to build a city twice the size of Hong Kong Island.

But it came as a surprise to many that Dubai World, owned by Dubai's ruler Sheikh Mohammed bin Rashid al-Maktoum, was not backed by the Dubai government – or the Emirate's oil rich neighbour, Abu Dhabi.

Most investors were reassured by the close ties between state and business. Dubai World and Nakheel chairman Sultan Ahmed bin Sulayem, for example, had longstanding ties as one of three main advisers to al-Maktoum – although the joke doing the rounds in Dubai recently is that Bin Sulayem "raised the Palm but sunk the Sheikh".

But Sarwar shrugs off investor indignation. As with any deal, the hard and fast rule is investments go up and they go down, no matter where they are. And investors should have read the small print.

"Investors are getting confused," says Sarwar. "Dubai World is government owned, but the Dubai government is not a sovereign wealth fund. As the Dubai government said, even though it was government-owned it was never government-guaranteed

"Like a lot of investments over the past two years, investors should have done more due diligence on what they were investing in.

"Some of Dubai World investments are no different from a western corporate or property bond investment. If things are difficult you will invariably have risks and potential losses."

Not everyone has as forgiving an attitude towards Dubai reneging on its payments. As a result of Dubai World's default, other partners and banks in the area have been hit by downgrades in their credit ratings. Last week, Moody's downgraded three Dubai-based banks on the basis of "the weakening in Dubai's economy" and warned that "negative investment sentiment that has been sparked by the restructuring could have longer-lasting effects" on the region's economy.

For Western investors, who jumped into Nakheel in 2006 when it launched as the biggest Islamic bond, or sukuk, in history, the ride has been rough.

"It was always difficult to (figure out] where the government was involved and where it was giving its explicit involvement," said Jaime Sanz, a senior director at ratings agency Fitch. "From now on, they're going to have to be very clear about guarantees."

Sarwar admits the government has taken a risk freaking out the markets, and highlights the importance of clarity.

"The Dubai government recognises in terms of capital markets that they need to move with complete professionalism and transparency.

"Clearly you don't want to be creating an issue where people get let down for whatever reason.

"Capital markets have got long memories and may not want to reinvest," says Sarwar.

But fans of the sukuk model say these may yet prove more resilient – despite Dubai's default.

Sukuk are securities that comply with Islamic law, which forbids interest-bearing bonds. Plus with rules regarding speculation and interest, they are asset-based and eschew trickier western investments frothed up by derivative based trading.

But what investors seem to have forgotten is there is no "free lunch".

"An Islamic structure goes on the scenario where investors share the profits but also share losses," he explains.

"It should not be a free lunch for anybody."

Although Kuwait's Investment Dar – an Islamic investment firm – defaulted on a $100m sukuk in May, rated sukuk are finding strong demand, including recent issues by the World Bank's International Finance Corporation and GE Capital, a unit of General Electric. The idea is that although Dubai has been subject to a massive property bubble, the Gulf is still home to wealth funds of more than $2.2 trillion searching for asset-backed and Islamic compliant investments.

Professor Mahmood Faruqui, senior adviser at the Bank of London and the Middle East, has defended the basis of Sharia banking.

"The problem in Dubai is not one of Islamic finance. The Sharia system allows stability through transparency and co-operation between regulators."

Sarwar says that Scotland and the UK as a whole should look seriously at the Middle East as a source of potential investment, particularly in infrastructure.

"The Abu Dhabi investment authority has something like $600m plus. They want to diversify and that will continue," says Sarwar.

"Gulf sovereign wealth funds are worth $2 trillion, which is the size of the UK economy and that will double or treble over the next few years. There is no reason why Scotland, with its infrastructure requirements, cannot partake of that opportunity."