The Dubai Case is a Harbinger of New Problems in Financial Markets

Abu Dhabi will once again cover the playful member of the Emirates, but the Dubai case, with its $60 billion of maturing debt, has unsettled the markets and raised further questions about the possibilities of debt servicing and covering the enormous deficits that have arisen from state aid to combat the crisis.

written by Vanja Figenwald
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It’s not over until the fat lady sings, goes the popular saying, which, aside from the fat lady, can be applied to the recently emerged problem called Dubai. Just when the cold sweat began to recede in front of a reserved smile, it turned out that the global economy has not quite emerged from the storm and that there are still some tails to be cut. The world was thus stunned by the news that Dubai requested a deferral of financial obligations, specifically debt payments, for its company Dubai World, which amounts to an impressively high $60 billion. The news barely registered, packaged with the fact that the company Nakheel, the contractor of the megalomaniac islands near Dubai and a subsidiary of Dubai World, has a little problem with $4 billion of its debt. The news resonated strongly because when a company accumulates a debt of $60 billion, it means it has borrowed from every possible source, leading to immediate panic among all investors, resulting in a sudden drop in credit ratings and leading stock indices of banks on European, Asian, and New York exchanges.

Dubai World, a company owned by the United Arab Emirates, a state consisting of seven smaller emirates, has accumulated enormous debt (the total debt of Dubai is $80 billion) through the construction of a series of grand and grossly exaggerated projects in the tourist mecca of Dubai, which has become one of the most famous tourist destinations in the world precisely because of such an image. The world’s astonishment is a result of the belief that the country simply swims in billions earned from oil and that there is nothing it cannot afford, which is quite understandable when one knows what Dubai World has built in Dubai. The facts, however, tell a different story. Except for Abu Dhabi, the first thought of most concerned investors, the other six emirates are not as blessed with oil as most people think. That is why all eyes were on Abu Dhabi, the Germany of the Emirates, which mainly finances the mischief of other members of the United Arab Emirates and serves as the unofficial guarantor of their debts.

How Much Oil is Enough
Because Gulf countries are generally prone to quietly resolving financial problems, a large number of people were unaware of the fact that many companies from that region have indeed felt the waves of the financial crisis, especially in the real estate sector, where large stakes were thrown because it was believed that such a diversification strategy in relation to oil was the best guarantee for a bright future after the wells run dry. Speculation suggests that in 1998, Abu Dhabi lent money to Saudi Arabia to avoid a liquidity crisis, and the governments of Qatar and Kuwait acted intensively to protect their economies from the impact of the financial crisis. Eleven years later, Abu Dhabi would once again step in for its Arab brothers who had indulged in showing off power and producing tasteless kitsch, with a new credit line from the Central Bank, although they were initially hesitant.

After a brief play with the nerves of the creditor army, Abu Dhabi decided to open the bag once again, and the hesitation was meant to serve as a signal to the neighbor to reduce ambitions, but also to the world that Abu Dhabi has no intention of forever patching up the debts of other members of the Emirates. According to the Central Bank, a crisis fund of €9.3 billion was created last year, which will now be made available to the struggling company. The ‘World’ in the name is not just a convenient addition, but reflects the range of the company’s operations, which deals with everything from building artificial islands in the shape of a palm to managing ports around the world and investing in luxury retail like Barneys. Another catalyst for fear that arose after the announcement of the request for a six-month debt payment deferral was the belief that it was merely a harbinger of new storms, as was the case with Bear Stearns, or that a time of serious debt servicing problems would arise for all major global debtors, including Britain, Greece, Ireland, and others.

Endangered Brits
Panic as panic, and without soothing news from Abu Dhabi, was perhaps exaggerated. According to data from the Bank for International Settlements, foreign banks have $130 billion in placements in the United Arab Emirates, with Britain, as expected, deeply entrenched, holding $51 billion in loans. Surprisingly, Americans have lent only $13 billion to the Emirates. Despite the sound amounts, all this constitutes only 0.4 percent of the total exposure of foreign banks. However, the situation is not that simple. The greatest nervousness in the story is caused by that $51 billion exposure of the Brits, perhaps the wealthiest nation hardest hit by the crisis, whose banks still stand on shaky ground, and the economy crawls into recession even after other major world economies have emerged from the dark tunnel. No surprise, the Royal Bank of Scotland, owned by the British Government, is in the worst position, having lent $3.2 billion to Dubai World and barely surviving the waves from America, but a good part of the debt was also created by Barclays, Standard Chartered, and HSBC, with a total of $27 billion. Now, while the situation is such that interest rates are low and central banks directly influence the state of financial markets, the fear of real repayment problems in heavily indebted countries is relatively small, but the real problem could arise when central bank measures begin to fade and interest rates start to rise.

‘Dubai Shock’, as the media have already called it, appeared suddenly and just as suddenly disappeared, leaving behind the fear that every storm leaves, which is that another, worse one will follow. Regardless of the fact that Dubai is not really a serious problem, as the Emirates simply cannot afford a collapse of investor confidence, while on the other hand, they really have money, and not fictitious money, the market did not react violently without reason. The Dubai case, in fact, could truly be a harbinger of new problems in global financial markets, which are increasingly burdened by further borrowings in the hope that the real sector will soon be able to service those debts by emerging from the recession. Whether this is the case or not, it is becoming increasingly clear that there are debtors on all sides, while investors with real money are becoming fewer.