The debt situation in Dubai is a serious problem that has the potential to make a select set of investors very rich. The biggest stumbling block is the fact that this, like other debt-fuelled crises, is mired in a tangled web of complicated business relationships. That’s why today I’m breaking down what Dubai’s debt situation could mean for the world’s financial institutions – and your portfolio…
From time to time a substantial story rolls along that, while outside of my normal purview of our direct options, may still have an indirect impact on currency plays — and the Master FX Options Trader portfolio.
Such is the case with the United Arab Emirates, Abu Dhabi, Dubai, and its state-owned conglomerate, Dubai World.
If you heard all the Dubai news over the Thanksgiving weekend and saw the palpable fear on some commentators’ faces, but wondered what it all meant, I’m here today to set things straight.
Let’s begin with just a summary of the region and how it works.
The UAE, United Arab Emirates, is a confederation of seven states (called emirates). The two most well known are Abu Dhabi and Dubai.
The capital of the seven emirates is Abu Dhabi; it is the wealthiest and second-largest city in the group. It also lays claim to the sixth-largest oil reserve in the world. Just to prohibit some confusion, Abu Dhabi is the name of both the capital city and the state it is in, something like New York, New York.
In some respects, Abu Dhabi is like an older, wiser, more fiscally conservative brother to Dubai, which has been rather profligate in its assumption of debt and flamboyant in its projection the state’s image. Being a sort of Las Vegas and Disneyland of the region, it has built a gorgeous skyline, and as its oil revenues have dwindled, they have turned their attention to the money to be made in tourism. But attracting tourists to the desert is a difficult proposition. It takes glitz. It takes glamour. And apparently it takes around $60 billion in borrowed money.
The borrowing, however, was not done by the state of Dubai directly, and is not owed directly by them to any creditors. Instead, Dubai has a state-owned but “independent” company called Dubai World. My guess is that the more problems that stem out of the company, the more “independent” it will become. At any rate, this company has been the driving engine and catalyst for much of the growth seen in the region.
I do not know how much they have spent already. I don’t know how much they have borrowed and repaid up to this point. But that, as they say, is, water under the bridge. What matters is that they have requested a payment hiatus on $60 billion in loans.
The emirate of Dubai has said it is washing its hands of the whole thing. They are not offering a bailout, and they are not guaranteeing the company. This, of course, troubled investors and depositors in Dubai’s banks. Fearing a run on the “company store,” the central bank of the UAE stepped up to the plate and guaranteed all deposits in regional banks. In other words, no reason for the public to be afraid (and frankly, the markets liked that, too).
But what they didn’t say may be just as important — because the speech from the Dubai “Fed” did not offer help to the troubled Dubai World conglomerate. Essentially, since it guaranteed the public’s deposits but didn’t fork over public money to bail the troubled company out, they took the taxpayer right off the hook. If this is truly how it unfolds, then hooray for Abu Dhabi. The U.S. Fed could take some lessons. But the play is not quite over yet. If the UAE is not going to be on the hook for Dubai World’s excesses, who is? Who actually lent all this money out in the first place?
Actually, it looks as though the United Kingdom could be the hardest hit. Half of that debt is owed to banks based there. Some $13 billion of that money is on loan from the Royal Bank of Scotland and Standard Chartered; another $17 billion is from HSBC, whose stock fell from $62 down to $58 on the news.
Since the United Kingdom is still struggling to get any kind of recovery started, the news weighed heavily on its currency — at least initially. More bad debt on the books is not exactly what it needed at this point. Since the United Kingdom has already been issued a warning by Fitch about its sovereign debt rating, it certainly does not want an increase in borrowing costs for their gilts. This only adds to that burden.
But the world of finance has some pretty big bullies in it. I would think it highly likely that Abu Dhabi would be the subject of great external pressure if the situation remains wobbly. And this pressure could lead them to the conclusion that Dubai World is “to big to fail.”
That would relieve the pressure from the Eurozone (which has exposure by way of Germany) and U.K. banks. Beyond all doubt the West has financed itself up to its eyeballs, and one on this side of the world is willing to tack on a little more. RGE’s Nouriel Roubini is already predicting that the cost of U.S. bailout debt will rise from 40% to 80% of GDP. Not much room to borrow there.
And certainly Europe won’t be volunteering much help, because it’s having troubles of its own. It was recently announced that the cost of financing Greece’s debt has grown equal to that of Turkey’s debt… at one time considered a far more risky proposition. Should those individual countries continue to add to the red side of Europe’s ledger, some of the other larger states will need to jump in and bail them out. In the past, I’ve talked about the PIGS of the Eurozone: Portugal, Ireland, Greece and Spain. Add them to the increasing troubles in Lavia, Lithuania, Estonia, Belgium and Hungary, where foreign debt now exceeds 100% of GDP, and the “camel’s back” grows increasingly weaker.
But I digress. Back to Dubai… and Dubai World. CMA Datavision, a credit market tracking company, puts the chance at a full default of Dubai World at just under 36%. And while that would be bad for banks, it could have real effects in the commercial real estate market. Dubai World has some of the world’s premier properties under its control, including the world’s largest skyscraper and a series of man-made islands that resemble a palm tree and a world globe. Such things do not come cheaply. And they only have a limited application in terms of profitability. But if they go belly up, and are allowed to fail, that could make the sound of the “other shoe dropping” in the real estate venue. And considering that Abu Dhabi just gave Dubai a $10 billion bailout back in February, they may not be so anxious until some other pressure is applied.
Of course, the $60 billion of debt that Dubai has racked up is just a drop in the bucket compared to the TRILLIONS (that’s with a “T”) that have already flooded the market from other stimulating economies. David Buik, an analyst at London-based BGP Partners, figures the trouble in the UAE won’t amount to more than just an “unfortunate public relations exercise by Dubai.” We shall see how this unfolds and whether or not the ripples dissipate or turn into bigger waves.
And we’ll keep that in the back of our minds as we explore the news elsewhere around the globe.
Until next time,
Bill Jenkins
December 3, 2009
Understanding Dubai’s Debt Problem was originally featured in the Tomorrow In Review.