Just deserts for Dubai?

Published on Saturday 28 November 2009 12:22

ITS palm-shaped islands and sky-piercing tower blocks have come to symbolise the explosive growth of the Dubai city-state. The ruling elite eagerly embraced western capitalism and culture, building a modern-day Xanadu that could provide the biggest, best and most ostentatious events and lifestyle to match its ambition to be a true capital of the world.

But this part of the United Arab Emirates is now having to cope with a new reputation: as a region that had been living on borrowed time and other people's money.

The revelation last week that Dubai World, the government-backed investment organisation, wants a six-month delay on paying back its $60 billion of loans sent shockwaves around the world. How could a region seemingly oozing with wealth suddenly find itself with such a problem with debt?

Markets went into freefall on Thursday, fearing a second wave in the financial turmoil that swept the globe last autumn. With the New York Stock Exchange closed for Thanksgiving Day and the Middle East in the middle of an Islamic Feast it was left to Europe to bear the brunt of traders' sell orders.

The FTSE 100 fell 170 points, its biggest one-day fall since March as other markets throughout Europe took a battering and investors awaited the opening of Wall Street on Friday.

But the overnight warnings of financial Armageddon failed to take hold and while the US market fell 200 points at opening, it was not the calamity that some had feared. It looked as if the storm had passed and the damage had been limited. However, this week will prove another nervous one for the markets as they continue to look for assurances from the region that there are no other black holes. They had been assured two months ago by Dubai's ruler Sheikh Mohammed bin Rashid al-Maktoum that there were no problems over the city's liquidity or its rate of growth.

Because last week's events appeared to question his assurances, the markets and other investors worry that they are not being given the full facts. Major credit agencies responded to last week's news by slashing debt ratings on Dubai's state companies, saying they might consider the plan a default.

In recent years, Dubai has expanded with ambitious projects like the Gulf's palm-shaped islands and the world's tallest skyscraper in the hope of becoming a tourist-friendly and cosmopolitan Middle Eastern metropolis. In the process, however, the state-backed networks nicknamed Dubai Inc have racked up $80bn in red ink, and the emirate may now need another bailout from its oil-rich neighbour Abu Dhabi, the capital of the United Arab Emirates. However, an Abu Dhabi official yesterday said it was unwilling to underwrite Dubai's entire debt and will pick and choose which assets it is interested in.

Following a rout in Europe, Asia's stock markets tumbled on Friday while the dollar hit a 14-year low against the yen as investors piled into currencies perceived as safer. Crude oil at one point fell more than 6 per cent.

With Dubai World hard-pressed to pay its bills, banks were likely to take the biggest hit, analysts said. Heavyweight London-based lenders HSBC Holdings and Standard Chartered could face losses of $611 million and $177m respectively, according to early estimates from analysts at Goldman Sachs. Both have substantial Middle East operations.

In Asia, Japan's Sumitomo Mitsui Financial Group, the country's number three bank, could be exposed to Dubai World's indebted property arm to the tune of several hundred million dollars. South Korea estimated the country's financial institutions have $88m exposure. Construction firms from Japan, Australia and South Korea behind Dubai's recent development boom also might be on the hook.

While most have the wherewithal to absorb any losses, Dubai's troubles could lead banks to re-evaluate and scale back their lending.

That could make it more difficult for companies to borrow money and hold down a world economy still emerging from the throes of its deepest recession in decades, analysts said. Equally unsettling for investors was the uncertainty over which companies were exposed and how much money they might actually lose. European banks alone have $87bn at risk in the UAE.

"It touched investors' sensitive nerves," said Cai Junyi, an analyst for Shanghai Securities. "The world is watching whether that will have any substantial impact… Dubai World is just like a small window that might reflect another financial tsunami."

Emerging markets in the Middle East and elsewhere have attracted massive amounts of capital in recent years amid investor enthusiasm for regions with rapid economic growth. This year, financial markets in Asia and Latin America have outperformed ones in the US and Europe. But Dubai's woes could bring a temporary end to the promiscuous buying behind the boom, analysts said.

"I think it will make investors realise they need to be more discriminating about emerging markets," said Arjuna Mahendran, head of Asian investment strategy at HSBC Private Bank in Singapore. "In the longer term we have no doubt that things are going to recover."