Back on track: New measures to guard against future turmoil in the global economy

The global financial crisis hit Dubai hard. Local government-backed investment companies were overextended and had taken on a high level of risk during the years of readily available capital from international banks, many of which had assumed the government would guarantee every deal. Exact figures vary, but estimates suggest that Dubai firms borrowed more than $80bn to finance the construction surge in the years leading up to the crisis. This infusion of funding proved to be disastrous when real estate prices, which were propping up both small- and large-scale construction projects, collapsed. The IMF estimates that real estate prices dropped by almost 60% between 2008 and 2011. The government responded by cancelling hundreds of development contracts and stepped in to help guide the sector by certifying projects for completion.

ROAD TO RECOVERY: While there are already signs of recovery in some segments of the real estate market, one major impact of the crisis has been the increased cost of insuring against the risk of a default, which has in turn pushed up the cost of borrowing. Compounding the issue, ratings agencies reassessed the creditworthiness of Dubai’s government-related entities and lowered their scores, citing a lack of explicit guarantees by the government. The downgrades raised the cost of borrowing even further. Nevertheless, there are positive signs that banks and creditors are returning to Dubai, though they are likely to remain more risk-averse, especially as companies in the emirate are still heavily leveraged.

Many in the emirate see the crisis as unfortunate but also as a valuable opportunity to consolidate the gains made over the past three decades to stabilise the economy for the future. The global financial crisis in many ways shielded Dubai, as the focus remained on markets in the US and Europe. Furthermore, the government has used this opportunity to institute regulations and processes that are expected to ensure a more sustainable growth strategy. Mohamed Lahouel, chief economist for the Department of Economic Development, noted that, “The longer-term outcome of a crisis is how you deal with it. Dubai has shown it is dealing with the key issues and is emerging stronger as a result.”

The high growth rate Dubai has maintained left the emirate exposed to the tightening of global financial markets as a result of the crisis. Not all borrowers were required to publish their fiscal accounts and thus the due diligence over the debt profile was not conducted as thoroughly as possible. Furthermore, the loans being issued were often structured for short-term returns that were not suitable for the infrastructure being financed. The financial crisis illustrated Dubai’s exposure to global markets and laid bare the relationship between Dubai’s business model and its ability to generate cash flows required to service debt.

NECESSARY REFORMS: Despite the surprise and confusion in the wake of the global financial crisis, the government has taken concrete measures to address the need for fiscal reform and the restructuring and reduction of debt levels, particularly among government-related entities.

Authorities have also moved to improve the governance and transparency of these organisations. Among the more significant responses has been the creation of the Higher Fiscal Committee to oversee the debt restructuring negotiations and help government-related entities off-load poor assets. This response has helped them improve their credit ratings and enabled the firms to restructure their debt and return to the markets for support.

Additionally, in a move that exemplified national efforts to stave off a downward spiral, neighbouring Abu Dhabi stepped in to provide a lifeline of support in the immediate aftermath of the crisis in 2009. Dubai’s oil-rich sister emirate extended major financial contributions to help property developer giant and Dubai World subsidiary Nakheel avoid default.

REDUCING & RESTRUCTURING: Many expected 2012 to be an indicative year as several billion dollars worth of bonds were set to mature for Dubai’s largest companies. The emirate went a long way towards restoring investor confidence by meeting all major financial obligations that year. Dubai World’s Jebel Ali Free Zone (JAFZA) and Dubai International Financial Centre (DIFC) were able to meet agreements on maturing bond securities and the refinancing of significant levels of debt. DIFC offloaded assets to raise cash and took on guarantees partially backed by the government to pay back a $1.25bn Islamic bond that matured in mid-2012. The former property arm of Dubai World, Limitless, was not part of the restructuring but, following its transfer to the government in 2011, it concluded a $1.2bn restructuring agreement in October 2012, with all debt to be paid back to bank creditors by 2016.

Similarly, JAFZA was able to repay a $2bn Islamic bond after it refinanced the deal with a $1.2bn loan by issuing a new $650m, seven-year Islamic bond. Demand for the bond was an encouraging sign that the market sees potential in investing in the emirate.

RESTORING CONFIDENCE: However, importantly for the long term, these efforts have helped reduce future uncertainty, since the restructured deals mark a shift in lending away from short-term debt to longer-term maturities better suited to these investments. Credit ratings agencies, including Moody’s and Standard & Poor’s, indicated that increased stability and improved governance will help restore confidence in the emirate and that they are currently reviewing ratings for several state-related entities.

The importance of making these payments on time cannot be understated. Given that debt repayment of Dubai World, DIFC and JAFZA represented some of the largest bond maturities of government-related entities, timely and effective control of debt repayment has gone a long way towards restoring confidence in the emirate’s economy. The Dubai Holding Commercial Operations Group (DHCOG), a unit of Dubai Holding owned by Sheikh Mohammed bin Rashid Al Maktoum, ruler of Dubai, went so far as to pay off a $500m obligation ahead of its February 2012 due date. Although DIFC, JAFZ and DHCOG represented low-quality bonds in Dubai in 2012, emirate entities still have to finance around $10bn in maturing debt, $6bn of which is owed to banks and the remainder considered “inter-company loans”. A move in September 2012 by three banks to resolve the issue of the remaining debt in UK courts was soon reversed, and the banks have returned to the negotiating table with the government to find a solution.

The issuance of two bonds and several large debt restructurings is a strong indicator of the market’s faith in Dubai’s economy. Furthermore, the national deficit is expected to narrow as the government cuts expenditures. The IMF estimates that public spending will fall from 22% of GDP in 2009 to just over 16% in 2012. Higher oil prices have also helped reduce the deficit, but the sector contributes only a small portion of government revenues. Speaking at a press conference, Abdul Rahman Al Saleh, director-general of Dubai’s Department of Finance, confirmed the rising optimism, saying that, “Investors are happy with the government’s efforts over the past three years to counter the impact of the financial crisis and the prudent measures used to control costs and manage the budget deficit.”

TOWARDS STABILISATION: However, while the authority’s response has helped alleviate some concern about Dubai’s debt, the emirate still has other issues to address before it can fully recover and focus on future investments. Banks and investors will likely expect continued attention on paying back financial obligations, with several upcoming government-related maturities. Although earlier restructurings were able to make a high-profile case for the resilience of Dubai’s economy, JAFZA itself will face another push as it must still address several billion dollars worth of debt that is set to mature in 2014.

Dubai’s international standing means that it is also exposed to regional and global fluctuations. Europe poses a particular threat as a continued debt crisis in that region could spread to the UAE. Re-export markets in Middle East and North Africa, South Asia and Africa are also a concern since Dubai serves as a trade hub between these regions. Political instability in Egypt and Syria, for example, shuts off a major source of trade. Furthermore, bilateral trade with Iran has been affected by sanctions against the current regime, and Iranians were important investors in Dubai’s real estate, tourism and financial markets.

Nevertheless, Dubai’s efforts to develop a stronger regulatory environment and improve oversight of its government-related entities will help the emirate withstand future turmoil in the global economy. Furthermore, while many of these organisations were overextended financially, in most cases the investments were in physical capital that may serve as a buffer in a prolonged economic downturn.