When Dubai World requested a standstill on $60 billion worth of outstanding debt, stock markets were jolted and an entire wave of nervous speculation unfurled overnight. Now, more than a month removed from the Dubai debt crisis, most analysts deem the event an isolated incident, with only evanescent ripple effects on world financial exchanges. While markets certainly did recover, the debt crisis underscores more troubling, systemic problems in Dubai’s investment environment, and merits closer attention.
Upon its inception under governmental decree in 2006, Dubai World rapidly became the largest conglomerate in the Emirates. The investment firm thrived during the nascent property boom, as its subsidiary company, Nakheel, oversaw landmark real estate development projects like the Palm Islands, the Dubai Waterfront, and other ambitious endeavors that soon came to define the region. With the global financial crisis cresting in 2009, however, capital quickly evaporated, and the Dubai property boom, like many before it, became bust.
Financial analysts were quick to point out that Dubai World, unlike Lehman Brothers or Bear Stearns before it, was not a financial intermediary; its debt problems were not intrinsically linked to any sort of complex financial instruments or entangled web of continuously repackaged loans. It's no real surprise, then, that the event ended up being more of a blip on the global radar screen than any slippery inflection point that may have signaled a "double dip" international recession. From a more regional perspective, though, the event and its aftermath could bode ominously for Dubai’s investment future.
Though the Dubai government was not legally or contractually bound to “bail out” Dubai World, its refusal to offer debt assistance speaks to an unhealthily opaque investment environment. For years, government owned developers like Nakheel and Tatweer were able to attract large inflows of foreign capital because of their implicit relationships to the Dubai royal family and governance. This implied sovereign backing gave investors a certain level of assurance and confidence in the extravagant projects they were helping to finance, even if the precise nature of the government’s role remained somewhat nebulous. Although Dubai World’s debt was, technically, never guaranteed by the government, foreign lenders treated it as such, and invested accordingly. In a post 2009 Dubai, however, it will likely be difficult to attract the same volumes of capital from investors now more wary of government owned enterprises.
The crisis also exposed Dubai’s geographic Achilles’ heel: its lack of oil, and resultant dependence on Abu Dhabi. Unlike other Middle East states, Dubai had no oil or gas assets to fall back on when it found itself strapped for cash. Until now, the emirate had always relied on high prices maintaining a steady stream of capital, and kept Abu Dhabi on speed-dial should they ever need extra support. In early 2008, Abu Dhabi provided Dubai with $10 billion worth of low-interest loans, and in early November, two state-run banks contributed $5 billion of aid. This time around, their neighbor didn’t step in until December 14, offering another $10 billion lifeline that helped Nakheel pay off its debt at the last minute. While many saw the assistance as an encouraging sign that the UAE would not let Dubai fend for itself, ultimately, the move only highlights Dubai’s dependence—and the capriciousness of that safety net. If Dubai, as many believe, wants to stand shoulder to shoulder alongside the likes of financial centers like Hong Kong and London, it cannot be so heavily dependent upon an unreliable source of back up. As one senior Abu Dhabi official said to Reuters news agency shortly after news of the crisis broke, the emirate will “pick and choose when and where to assist.”
Perhaps the crisis will, as some predict, engender greater caution among firms when considering investment in emerging economies or other Middle East markets in general. At the very least, though, the standstill will serve as a sorely needed wake up call to the emirate. Throughout the property boom, Dubai was able to grow at meteoric rates through a combination of carefully calibrated expectation management and a meticulously manicured investor-friendly environment. As the late November crisis illustrated, though, much of the Dubai mystique was just that—an ideal of a financial Neverland that mushroomed on the strength of snowballing herd mentality, and that, until this autumn, successfully masked underlying gaps in financial transparency. Going forward, then, it’s paramount that Dubai and the UAE treat the debt crisis not as a mere hiccup, or as a natural byproduct of a global downturn, but as a veritable canary in their economic coal mine. The landscape has changed. Dubai must now do the same.
Amar Toor - Consultant in the Trade and Agriculture Department of the Organization for Economic Cooperation and Development (OECD)
The views expressed in this article are those of the author, and do not reflect the policy or views of the OECD
