Following this request for a standstill and maturity extension until at least May 30, 2010, which was widely interpreted as a default, although DW did not default outright, Standard & Poor’s and Moodys immediately downgraded all six state-backed Dubai corporations, known as Dubai, Inc., to junk (below investment grade) or close to junk status. Included among them was Emaar Properties, which is involved in luxury housing and commercial real estate investments estimated over $1 billion in Turkey. Its rating was lowered by Standard & Poor’s by two notches to BBB- and cut by Moody’s from Baa1 to Ba2.
Dubai’s five-year credit default swaps spreads, the cost of debt insurance against default, skyrocketed close to 700 basis points, more than doubling since the announcement. The news, although anticipated for several months by those following closely Dubai’s worsening quandary, shocked the global financial system, which had been recovering from the US subprime-mortgage-triggered crisis.
Dubai is a desert city-state and one of the seven largely autonomous members of the federation of United Arab Emirates (UAE), not blessed with oil wealth like Abu Dhabi, another UAE member. DW is the state-owned conglomerate which has led the development of the autocratic and secretive Dubai emirate into a glitzy global financial, trading and tourism center with oversized ambition and flamboyant fanfare. The Daily Mail has called Dubai, especially famous for its lavish man-made, palm-shaped three-mile-wide Palm Jumeirah Island and the world’s tallest building, Nakheel Tower (Burj Dubai), yet to be completed at a cost of $1 billion, “a monument to vanity and greed.” Dubai’s economy has been hard hit by the recession, with property prices beginning to drop precipitously, in the second half of 2008, after enjoying a six-year boom.
The debt moratorium request related specifically to Islamic sukuk bonds worth $3.52 billion, due on Dec. 14 and issued in 2006 by Nakheel Properties, DW’s real estate developer subsidiary with the worst financial problems among all its subsidiaries. (The returns on sukuk bonds, based on Islamic law, which prohibits interest payments, are from a rent-generating real asset.) These bonds, which were trading at a 10 percent premium to face value before the announcement, began trading at close to half face value afterwards. The bondholders were said to be considering lawsuits against Nakheel and exploring the seizure of some of DW’s assets. But the bonds are backed by land in Dubai and it is unclear whether bondholders can have legal recourse to real assets that back sukuk bonds.
DW, Dubai’s largest company involved in multiple megaprojects financed on a debt binge, is the victim of yet another deflated property bubble, fed by euphoric and reckless speculation. DW’s wide-ranging real estate portfolio includes properties all over the world, including the US. But after the debt moratorium request investors have focused on whether the problems of DW, with a total debt of $59 billion, could force the state of Dubai itself, with a total debt estimated by some at as much as $160 billion, double the official figure, into bankruptcy, reigniting the global financial crisis.
Several European banks, especially British banks such as the Royal Bank of Scotland, Barclays, HSBC and Standard Chartered, are believed to be exposed, at around $40 billion, to Dubai debt. But most of Dubai’s debt is owed to several UAE banks, mostly in Dubai and Abu Dhabi. That is why Standard and Poor’s and Moody’s downgraded their ratings, too, following the debt moratorium request. The question now is whether the oil-rich Abu Dhabi, which has already bailed out Dubai with $15 billion earlier this year, will do so again. Abu Dhabi, which has a complicated political relationship with Dubai, holds a significant amount of DW bonds itself. Many observers believe that Abu Dhabi, which could suffer along with the rest of the UAE from the contagion created by the potential bankruptcy of Dubai, will soon step in to save DW and Dubai from a financial meltdown by guaranteeing their debts. Abu Dhabi, thanks to its enormous wealth as the world’s third-largest oil exporter, boasts the world’s richest sovereign wealth fund, the Abu Dhabi Investment Authority, with assets estimated at around $700 billion.
One possible lesson for Turkey from Dubai’s debt debacle is that overly optimistic expectations of massive portfolio or direct investments from the Gulf countries should be scaled down and tempered. Capital inflows from these countries are likely to be relatively unstable given their volatile dependence on oil wealth as well as their potential political instability stemming from autocratic and secretive forms of government.
