Sunday, May 2, 2010

It may be a storm in a teacup, but it can still kill you if you live in the teacup.

So the Dubai World Drama continues. The powers that be at Dubai World are grudgingly considering raising to 2% from 1% the interest rate they’ll pay on the extended loans. Analysts say this would result in a 20-25% loss to the creditors. This is because while they would nominally get their principal back the amount of money they would earn in interest would be far less than they are expecting or could get elsewhere if they were paid back in full on time. Nakheel suppliers on the other hand are getting cash this month plus an Islamic security that will yield 10%. Reuters is reporting that the Bankers are not happy. Perhaps not unhappy enough to try their luck with a declaration of default but unhappy enough to push for more. The drama is not over.

Support for the deal is coming from an unsurprising source: Dubai itself. In a letter to the editor Nasser Al Saidi, the Chief Economist of the DIFC, has published a rousing defence of the Dubai World restructuring and has attempted to draw some lessons from it. While it is not surprising that Dubai is praising itself for its handling of the crisis two things are disturbing about the letter. The first is that the crisis is far from over: the Dubai World creditors have not accepted the plan, the losses elsewhere in Dubai continue to be staggering and Dubai has no room left to manoeuvre without another appeal to Abu Dhabi because they have completely drained the DFSF. The Second is the very disturbing sense I get from reading the letter that the powers that be in Dubai have neither a sure grasp of reality nor an awareness that, here in the future, their bold assertions of the impossible inspire laughter rather than awe.

Dr. Al Saidi says that the restructuring proposal “removes the cloud of uncertainty” which has hovered over regional markets of late and points to the recent declines of the Dubai CDS spreads from their crisis highs. Unmentioned goes the fact that Dubai CDS are still 150 bps higher than they were before the crisis began, are higher than either Portugal or even Lebanon both of which are in serious fiscal trouble. At 414 are right about where Greece was before its’ spike to 1000 and then forcible bailout by the IMF. It would seem that some uncertainty remains.

He goes on to say that the “main message emerging from the restructuring proposal is that the Government has treated both foreign and local creditors equitably and fairly, without discrimination, a clear refutation of some misinformation.” I find this hilarious. So, there are three main groups of creditors here: the banks at the Dubai World level (mostly international,) real estate investors at the Nakheel level (mostly Emiratis as they were given first pick of the land,) and trade creditors at the Nakheel level (also mostly Emiratis.)

So where does the money go? $8 billion goes to Nakheel, $1.5 billion to the parent, clearly favouring the Nakheel Creditors who are largely Emirati at the expense of the creditors of the parent company who are largely foreign. The banks (largely foreign) who extend their loans get 1%, the trade creditors (largely Emirati) who have to take some of their payment in newly issued bonds paying 10%. This is to say that the foreigners and the few Emirati banks involved lose 20-25% of the value and the trade creditors get paid a little something extra for their time. The good Dr. seems to think that just because they are not taking a principal haircut that the banks are not losing anything. On the contrary they are losing a great deal.

This is not to say that the Emirati trade creditors will not lose out as well. Even after another $8 billion is poured into Nakheel it is still a real estate development company in the worst performing and most overbuilt real estate market in the world. I would bet that despite the fact that their tradable securities will carry a 10% coupon that the Nakheel certificates will trade at a substantial discount in order to reflect this.

Dubai through the voice of Dr. Saidi goes on to congratulate itself for resolving the issues of ownership and taking on itself the burden of the equitization rather than compelling the creditors to do so. This is also a bit disingenuous because Dubai had no choice but to do so or else face a general insolvency and an involuntary equitization of both itself and the creditors. This plan as it stands drains the DFSF to zero and still clips the Dubai World creditors for 20% of the value of their investment. Had Dubai insisted on taking maintaining its position in the capital structure there would still be an equiziation but they would have also lost control. The restructuring allows them to pass losses to the creditors at the parent company level, drain the DFSF to try to revive Nakheel and pay off Emirati real estate investors and trade creditors and maintain control. Personally I think this is unwise because I do not believe Nakheel can be revived but this was not a selfless act by Dubai by any means.

He goes on to describe the restructuring as a triumph of federalism. This is also difficult for me to understand because the restructuring is entirely a Dubai only affair. Dubai drains the DFSF, which admittedly was originally from Abu Dhabi and converts its debt to equity. No new Abu Dhabi or UAE funds are involved. Indeed, the rescue of the trade creditors has enabled Dubai to maintain the independence of Arabtec. Now that the trade creditors are getting paid off in front of the creditors at the parent company level Arabtec does not need the Abu Dhabi lifeline and so has broken off its merger talks. It looks to me like this is the opposite of federalism, it is the reassertion of Dubai’s autonomy from Abu Dhabi though I think it is likely to be temporary.

After this Dr. Saidi draws a few conclusions:

1.) The middle east needs a better insolvency regime.
2.) Countries in the middle east should work to enhance the quality of their local currency debt markets
3.) Dubai should not borrow short term for long term projects.
4.) There should be more open communication by Dubai about the health of its state owned enterprises.

I think these are all reasonable suggestions though personally I think that the best way to achieve the first would be to actually put Nakheel into insolvency. Given that the local currency is pegged to the dollar by the vastly stronger power of Abu Dhabi I’m not sure I understand why there is a need to enable Dubai to borrow in AED. While its true that one should not borrow short term for a long term project that’s not really what happened here, they borrowed mid-term and then lit the money on fire with profligacy and corruption so that after several years of marketing and office redecorating there isn’t much left for the creditors.

The real problem with the essay I think is the last two paragraphs which I reproduce here:

Looking back at the last four months, the reaction caused by Dubai World’s debt restructuring announcement is best described as a “storm in a tea cup.” The facts are that the UAE, the GCC and the MENA region countries with access to international capital markets have never defaulted on their debts and obligations and have much stronger economic fundamentals than those of so‐called ‘advanced countries’ which were addressing criticism and ‘advice’.

So why the doubts and invidious questioning? One concludes that much of the media hype is politically motivated. Dubai’s Arab economic success story as a multi‐cultural, multi‐ethnic and multi‐religious hub and melting pot is clearly not to the liking of some countries with different geostrategic ambitions and outlooks and of some of the countries that were actively promoting the interests of their own companies against those of Dubai and DW.

The Dubai financial crisis has been many things over the past six months. One thing it has not been is a storm in a teacup. It was in fact a near death experience for Dubai’s sovereignty and it’s not even over because the success or failure of the restructuring, if it is even approved, turns on the successful resurrection of Nakheel. Furthermore Dubai is not stronger financially than either its advanced or its emerging critics. Dubai should not group itself fiscally with the rest of the GCC. Dubai CDS are trading today at 414 bps. Abu Dhabi is trading at 102 and Saudi Arabia is trading at 70. The markets see that Dubai is not in the same boat as the others, Dubai would be vastly better prepared to cope with what’s coming if it could come to terms with those facts as well.

Then there is the bizarre idea that this is all politically motivated by some unnamed countries which want Dubai’s multi-cultural multi-ethnic model to fail. This is preposterous. Dubai has engaged in massively self destructive economic policies. Those policies have destroyed tens of billions of dollars of value for both Emirati and international investors. If the foreign press was motivated by anything it was schadenfreude. The fact of the matter is that Dubai is simply no longer important enough for someone to go to the effort of manufacturing a crisis in order to bring it low. Indeed, Dubai’s most active enemy is itself. By perpetuating the fiction that its travails are the result of fear-mongering by invisible enemies it only lengthens the time it will take for it to take the bitter medicine and move itself forward.


Rupert Neil Bumfrey said...

I thought in the best interests of ping pong your article should be linked through to Arabian Business, as you had incorporated their link.

Alas they have rejected the link through their comments:
Thank you for your recent comment posted on

We regret to inform you that your post did not meet the terms and conditions for comments and therefore will not be published.

"All posts are sent to the administrator for review and are published only after approval. reserves the right to remove any comment at any time for any reason. Please keep your responses appropriate and on topic.

Arabian Business would like to point out that only comments relevant to the story will be published. Any containing personal insults or inappropriate language will not be approved".

So much for the hoped for boost to transparency etc.

Anonymous said...

Thank you for a little straight talk. These guys are always trying to pat themselves or their higher ups on the back while the fact of the matter is nothing is resolved yet, they did not act decisively in face of the crisis but only when forced too, the same as most governments around the world. The sad thing is the leaders here don't need to get re-elected so you would expect a bit more honesty and real action. The Dubai PR machine is still in full swing it seems. Unfortunately, when the next shoe drops their credibility with the world financial system, will be even more tattered.
In regards to Nakheel, just drive around town a bit and its obvious that the oversupply continues. Certainly, the "crowds" are no longer moving here - so, how will the buildings be filled?

Anonymous said...

"it's a missunderstanding..."

seriously the tea cup's size is from Deira to Waterfront.

Anonymous said...

Hey Anon,

What do you mean how the building will get filled

that has been sorted out