Dubai debt 101: A beginner’s guide
While the Muslim world celebrated Eid al-Adha, the tiny emirate of Dubai announced that they were $59 billion in debt. The emirate’s investment arm, Dubai World, further announced that they would extend maturities for six months.
As these things go, the fact that a $59 billion government-owned company intimately tied in with HSBC, Barclays, ING, Royal Bank and Lloyds is unable to make payments is a distinctly bad thing. Because, you see, the extension of debts for six months without payment effectively means Dubai is defaulting on a $59 billion debt. Instantly, a world financial crisis began.
Most of the pieces written on the Dubai crisis so far are written in the jargon of the financial pages and require a background in investing. We’d like to counter that.
Consider this a beginner’s guide to why the Dubai meltdown matters:
1. The news was leaked on a holiday: The initial public announcement of Dubai’s debt came in a press release about restructuring at Dubai World released on the eve of Eid al-Adha. Dubai’s large non-Muslim expatriate community also enjoys time off on Eid. Conveniently, Eid this year coincided with the long American Thanksgiving weekend. Releasing the news this way was basically the Muslim equivalent of a politician admitting to an affair on December 26.
2. Face it, Dubai World is the Dubai government: Dubai World is the holding company company that handled the vast majority of the emirate’s infrastructure and large-scale projects. Billions upon billions of dollars from global banks and investment firms are tied up in Dubai World. Subsidiary DP World is the world’s third largest shipping company and is the corporate entity behind P&O and many of the world’s ports. The majority stakeholder in Dubai World is the ruler of Dubai, Sheikh Mohammed bin Rashid al-Maktoum.
3. Sheikh Mohammed made some staggeringly poor business decisions: In his successful attempt to diversify Dubai’s economy, Sheikh al-Maktoum turned Dubai into the world capital of conspicuous consumption. By combining loose economic regulations with a paternalistic government eager to please foreign investors, Dubai became a major financial center. But the flipside of the emirate’s policies was an abiding yen for godawfullystupid vanity projects. Dubai World was the force behind a giant, palm-tree shaped archipelago of luxury hotels on artifically-constructed islands, the Burj Dubai — a 160-story skyscraper — and Ski Dubai, a year-round indoor ski resort in a country where summer temperatures routinely hit 110 farenheit. These three vanity projects are examples of the massive building boom that took place in the past 20 years within Dubai under al-Maktoum and his predecessors. All construction projects in Dubai are built by poorly paid migrant workers from south Asia and elsewhere. A strong case can be made to call the migrant workers of Dubai ’slaves.’ Apart from the human rights tragedy of these poor bastards working 12 hours a day without pay, the low construction standards in the emirate mean that project costs skyrocket due to routine delays and lack of oversight.
4. The Dubai government is handling the crisis like a petulant 12-year-old: Authorities in Dubai are warning shareholders in Sheikh Mohammed’s Dubai World that Dubai World’s debt is its own and that it is not guaranteed by the emirate’s government. $59 billion is a lot of debt to owe to the world’s largest banks. Defaulting on this cost, as Dubai is threatening to do, would mean a large loss of capital that rightly scares any organization doing large transactions in autocratic countries. One blogger calls the move (rightfully) “staggeringly stupid” and Lex over at the Financial Times sums it up succinctly:
So why the panic? There are sensible explanations. The first is that after a too-quick-to-be-true recovery from the biggest meltdown for generations, Dubai is a reminder the world is not out of the woods. A large default in some faraway land reinforces the sense that another shock can come from anywhere. Second, the news is slapping investors out of their silly belief that emerging markets deserve risk premiums barely above developed ones. Finally, Dubai is a warning not to assume investments are always state-guaranteed, even in this age of government largesse.
5. Forget the butterfly effect and think of the Dubai effect: Thanks to the massive amounts of capital tied up in Dubai World and the holiding company’s foreign investments, well… any possible default or last-minute bailout will have strange effects on the globl economy. For instance, control of Barney’s New York will likely pass to Ron Burkle. There is also speculation that the MGM Mirage in Las Vegas could change hands; it’s also likely that banks and funds that interacted with Dubai World will have to sell/exchange properties to make up for losses. On top of that, plenty of foreign companies were working on construction/infrastructure projects with Dubai World that will now be cancelled or delayed. Add to the $59 billion another likely $10 billion or so worth of money that the investors will never see again. Our bet is that Vinci and BP, who are both working on major projects in the Emirates, will be hit especially hard.
6. An entire friggin’ country defaulted on their debt: For all intents and purposes, Dubai World and the emirate are interchangable. Dubai World’s move sets precedent that could allow other small nation-states to default on their debts.
7. Abu Dhabi is coming to Dubai’s rescue… for a price: Public speculation, fanned by both the governments of Abu Dhabi and Dubai, is that Abu Dhabi will offer a partial bailout to Dubai. Both emirates are member entities of the United Arab Emirates and are ruled by rival branches of the Bani Yas tribe. Think of the tensions between 17th-century Spanish and Austrian Hapsburgs and you’re on the right track; armed warfare between the cousin’s families took place as recently as the 1940s. Add to this all the usual behind-the-scene intrigues one deals with when around fabulously wealthy Middle Eastern royalty and you have a good deal of tension. The Abu Dhabi bailout will inevitably have strings attached and, if it goes through, will likely lead to Abu Dhabi controlling Dubai’s key profit-making entities. Keep in mind that Abu Dhabi has a regular income from oil, while Dubai is oil-poor and is entirely dependent on finance, tourism, construction and service work.
7. Dubai’s crash will reshuffle the politics of the Middle East: Apart from the tensions within the United Arab Emirates, Dubai is a modern-day Casablanca where enemies can quietly do business. Despite the ban on Israeli passport holders entering, Israeli shipping company ZIM has been quietly working in Dubai for decades through dual passport holders and Israeli diamond mogul Lev Leviev has been making some healthy cash there. 120,000 British expatriates work alongside expats and guests from one of the emirate’s largest trading partners — the Islamic Republic of Iran. The tiny city-state conducts billions of dollars in trade with Iran annually. According to John Carney at The Business Insider, Dubai serves as a conduit by which Iranian companies can trade with Western firms and vice-versa:
Of all the United Arab Emirates, Dubai has maintained the closest ties to Iran. Indeed, as international pressure has built on Iran over the past decade, Dubai has prospered from those ties. It provides critical banking and trade links for Iran, often serving as the go-between for European or Asian companies and financial firms that want to do business with Iran without violating international sanctions.
Among others, HSBC and Standard Chartered have been quietly doing business with Iranian firms and the Islamic Republic’s government in the past few years. Abu Dhabi has aggressively placed themselves in the American camp when it comes to foreign policy, and would be all too happy to hit Iran in the wallet while they bail out Dubai. This may be good news for opponents of the Islamic Republic, but is very bad news for any company with business contacts in Tehran. Moreso, emirates like Qatar that have flirted with Iran will likely find this crisis effecting them much more than consistently anti-Iranian neighbors such as Kuwait and Bahrain.
Meanwhile, a quiet exodus is likely to take place from Dubai in the coming years. Even with the Abu Dhabi bailout, Dubai will be correctly perceived as a country that is too financially risky to tie mass amounts of cash into. Abu Dhabi lacks the infrastructure of its flashy neighbor; American-Israeli economist Bernard Avishai speculates that Amman will benefit from Dubai’s pains. Our guess is that more Western companies will be attracted to working in Bahrain and Qatar as a result; Abu Dhabi will still take a serious hit from residual fears of doing business in the United Arab Emirates.