The End of Dubai Inc?

Press accounts in recent weeks are raising concern that Dubai might be in serious financial straits. Zawya Dow Jones reported on Tuesday that the government has hired financial advisers to help restructure its economy as it struggles to meet payments on its large debt. Wednesday, the Financial Times reported that Dubai was in talks with Abu Dhabi to arrange for a loan facility that would make state funds available to Dubai firms as international credit markets continue to dry up. Dubai officials later denied the allegations in a report on Al-Arabiya. Still, speculation about Dubai's financial health is rampant. According to local rumors, Dubai might offer Abu Dhabi strategic stakes in some of its largest firms, including Emirates Airlines, Nakheel, and Dubai Proprieties. Rumors have become so persistent that Dubai World CEO Sultan Ahmad bin Sulayem on Tuesday angrily denied that the company was in any kind of financial trouble. He said that the company was studying options for offering stakes in Dubai World for public subscriptions but that the company had not entered into negotiations for selling stakes or received any offers.

It's hard to appreciate how serious the issue of Dubai's indebtedness may become for the emirate. Estimates vary on how much debt they actually hold. Fitch estimates that Dubai's debt level is close to $70 billion, which as the FT notes, puts their debt to GDP level at more than 100 percent. But, in a separate report quoted by Zawya Dow Jones, Standard and Poors estimates that its debt to GDP level is closer to 42 percent. What is not at issue, however, is the seriousness of Dubai's failing economic health. Dubai's once thriving real estate market, which accounts for 30 percent of local GDP, is slowing rapidly. HSBC Global Research found that real estate prices in the secondary market fell in October by four percent in Dubai, with much more substantial price erosions in certain developments. For example, prices at the Pal on Palm Jumeriah fell by 32 percent; and at DIFC (last week rebranded as NASDAQ Dubai in order to attract more business to the fledgling exchange), prices fell by 30 percent. These are the first price declines the emirate has seen in six years. The decline in the real estate sector, along with Dubai's ability to finance its ever growing debt on equitable terms, has caused Citibank to name Dubai as the most vulnerable to an economic downturn in the Persian Gulf in a report released early last week.

Many of the problems confronting Dubai have been long standing. Analysts for years have been concerned about over-building in the emirate itself and a far too aggressive mergers and acquisitions strategy overseas. Rulers of Dubai have always shrugged off these concerns building a modern metropolis out of the dessert to great success. Analysts questioned the viability of Jebel Ali and Port Rashid when MBR's father, Rashid bin Saeed, began building the twin ports in the late 1970s. They continued to question the construction boom from the mid 1990s on. And while many of these doubts appear to have been unjustified as Dubai proved time and time again that it could best the capacity argument, what it could not outrun was the issue of growing too large too fast. What many of the state-owned firms are wrestling with now (even more than the downturn in their home market) is the souring of their investments overseas because of the global downturn and the tight credit market internationally. Like any corporation that undertakes a massive expansion over a short period of time, Dubai entities had to borrow to make it work. And when the market goes down and demand dries up, so goes the rationale behind making those investments. Over expansion has cost many an industry.

What makes Dubai different is that (to borrow a phrase from the US crisis), it is too big to fail. Duabi is not just the crown jewel of the UAE but also for the rest of the Persian Gulf. The belief that business transactions could happen smoothly and profitably was realized in Dubai first. Foreign ownership of property was brought to Dubai first. World class transportation hubs and a hint of western ethos making businessmen comfortable all began in Dubai. If Dubai fails, so does the rest of the region. That is not to say that other Gulf countries will move to bail the emirate out (Abu Dhabi has enough surplus capital for that) but they all have a stake in continuing the dream, even if it is more tarnished than it once was.