Sunday, February 7, 2010
What better way to compliment the Burj Khalifa than naming this the Parthe-Nahyan?
Dubai has had its mantle of most interesting sovereign debtor taken from it this week by countries in Southern Europe. There are some interesting similarities and differences between these two regions and I think it makes sense to discuss them comparatively. It also gives me a chance to branch out from talking about Dubai so exclusively.
Greece and Dubai have come to their problems differently. Dubai borrowed a massive amount of money to finance the construction of major infrastructure projects inside the Emirate as well as to buy international trophy assets. The implementation of the construction projects probably involved a lot of siphoning off of funds by Emirate merchant families thus the actual value that went into them was less than was borrowed. With the onset of the international financial crisis the earning power of those assets is now substantially less, and in the case of real estate spectacularly less, than when the money was lent leading to the threat of default. Additionally the prices of the international trophy assets have all declined.
The Greeks have run into problems because even before the crisis began they were running a fairly substantial budget deficit and as a result piling up substantial debts. The structural issues with the Greek deficit can be found in many EU countries but they are a worse in Greece. There is a substantial welfare state as elsewhere in the EU but the rule of law is also weaker and there is widespread tax evasion or avoidance. There are also strong unions in the public sector which make it difficult for the government to rein in spending. These issues were exacerbated by the financial crisis. Government outlays for unemployment and stimulus increased but also tax revenues declined. International maritime shipping isa major industry in Greece and has been particularly hard hit by the declines in international trade.
I think there are two interesting similarities between the Greek and Dubai situations both of which actually favour Dubai on a relative basis.
The first is that neither Dubai nor Greece are in charge of their monetary policy. Greece is a member of the Euro-zone and Dubai uses the Emirati Dirham which is controlled by the Central Bank and thus effectively by Abu Dhabi. This is a serious problem for Greece, the European Central Bank has a single mandate and that is price stability, as opposed to the Federal Reserve which has twin (and some would say opposing) goals of price stability and maximum employment. As a result the ECB tends to be more conservative with regard to its rate setting policy keeping rates relatively high and the Euro relatively strong. This is a tough position for a debtor because it both constricts growth and it maintains the value of the debt relative to real assets.
Dubai on the other hand uses the Dirham which is pegged to the dollar. Thus while it cannot control its monetary policy it effectively imports the monetary policy of the United States. This is helpful because the US is also a massive debtor trying to climb its way out of recession. This is not so good for Abu Dhabi which may suffer from asset bubbles as a result but it is great for Dubai. Dubai’s problems are just so large that it is hard to see this positive effect at work. If Dubai had the same monetary policy as Greece it would be in far worse shape.
The other similarity between Dubai and Greece is the role of outside agents. As both countries have struggled with their debts investors have been looking for possible saviours, in the case of Dubai they have looked to Abu Dhabi and in the case of Greece they have looked to the EU, the IMF and to Germany.
The financial world had been very focused on an EU investigation of the steps that Greece was taking to tighten its fiscal deficit. There was a lot of scepticism in the markets about whether Greece would be able to enact a tough enough reform package. In the end the EU gave its blessing to the package which instead of calming the markets had the effect of causing speculative attack on Portugal and Spain the two next countries in line behind Greece with troubled debt issues. Despite this weeks news Greece is nowhere near out of the woods as it has to roll over billions in debt over the next few months, a similar position to Dubai. Personally I think the Greeks will make it but if not then what?
If Greece requires external support it is not clear from where it would come. The European Central Bank has neither the mandate nor the resources to execute a US or UK style “quantitative easing” whereby it would just print Euros to buy Greek debt. The EU itself has no taxing power and its budget is far too small to help. It might be possible to create some special EU legislation to enable a financial rescue but this would be a highly complex process and would still have to be funded somehow. It is possible that EU member states may step in to preserve the stability of the Euro and the concept of European integration.
The trouble is that it is very hard to predict the actions of European voters. What would the fiscally conservative Germans say about paying higher taxes to finance profligate public spending in Greece? Who would think that Greek workers would go on strike to protest the very reforms that are meant to keep the government which pays them afloat yet that is what they are doing. It is possible that the IMF could be called in but if the Greek voters are unwilling to enact the relatively mild reforms being proposed what are the chances that they would impose the sort of draconian reforms the IMF is likely to require short of a default?
From this perspective the opaque relationship between Abu Dhabi and Dubai regarding the Dubai Financial Support Fund seems very simple and predictable. It may only be a matter of time before the bondholders are asking the Greeks "Who's your Abu Dhaddy?"
Never a dull moment in international finance.