On Wednesday, last week, a press release issued by the government of Dubai and the Dubai Financial Support Fund took global markets by total surprise when it announced that the ace construction company owned by the emirate – Dubai World would be restructuring its debt obligations. The document says that “as a first step, Dubai World intends to ask all providers of financing to Dubai World and Nakheel to ‘standstill’ and extend maturities until at least 30 May 2010”.
The impact was immediately felt on global markets, even though the Middle East markets remained closed for Eid holidays. However, since then, there seems to be a semblance of sanity being established and the fears that a Lehman Brothers like situation where one announcement followed the other and took the entire global financial sector down, have been allayed at the moment.
“We doubt the issues in Dubai spread further. The foreign currency liabilities of Dubai World (ex Ports) is $22 billion (according to Dealogic), equivalent to some 0.05% of the combined assets of the US and European banks and 4% of their preprovisioning profits,” say analysts at Credit Suisse.
Abu Dhabi has $50 billion of annual oil revenue and some $400 billion in its sovereign wealth fund. It thus could easily support Dubai, as it did in February.
Moreover, total foreign claims on the UAE (which includes Dubai) are $123 billion, according to the BIS. This clearly exaggerates the exposure to Dubai, as the BIS data includes SWAPs data and, above all, lending to other UAE states than Dubai. Dubai World has about $25 billion of foreign liabilities, according to Dealogic data ($22 billion if Dubai Ports is excluded, as it has been from the “standstill” announcement). This represents less than 0.1% of the assets of the US and Europeans and no more than 4% of their pre-provisioning profits, they add.
“Our banks team believes that as much as a third of the foreign currency debt might be held by UAE banks, thus limiting the exposure to global banks.”
At the moment it is not clear whether UAE sovereign wealth funds would sell assets in order to fund any Dubai bail out (yet, with a standstill agreement, less funds are now needed to bail out Dubai). The key date is meant to be December 14 when the Nakheel $3.5 billion bond matures. Two thirds of these bonds are estimated by our fixed income team to be held by the foreigners.
The potential for economic contagion is very low with the UAE accounting for just 0.3% of global GDP.
However, the impact of the Dubai debacle has more ramifications for India. There are some large exposures undertaken by Indian banks. For example, analysts reckon that ICICI Bank has a middle-east balance sheet size is about $6-7 billion but most of the assets booked here are related to Indian corporates particularly for their foreign currency financing. Exposure to non-India based corporates in UAE is negligible. Similarly, for SBI – the total UAE balance sheet size is 0.3% of loan book ($4 billion approx) and 80% is self-liquidating trade finance. Bank of Baroda does have a sizeable balance sheet of $9 billion in UAE. It also has an exposure to Dubai World but the payment is due from 2011 onwards. No exposure to Nakheel bonds which have been under a cloud.
Moreover, 11% of Gulf capital flows between 2002-06 headed to Asia, says a CLSA report. And, Indian form around 40% of UAE’s population, accounting for around 10-12% of India’s inward remittances. So, an immediate downturn in Dubai’s fortunes could impact India indirectly. But then the slowdown in the real estate sector in Dubai is not a recent phenomenon. The bubble was burst long time ago and several labourers have been heading homewards. So this was not an event based phenomenon.
However, this has the potential to become a catalyst for further deterioration, especially, when seen with the background of other developments in the global economies. Just before the Dubai incident, there has been a growing concern about the need for additional capital in Chinese banks; equity markets around the world had seen erosion as this announcement to raise ‘A’ share market lead to a sell-off. Then there was the Fitch’s downgrade of Mexico, although not to sub-investment grade and with a stable outlook and Vietnam’s devaluation and rate hike. According to analysts at HSBC, “More generally, the fact that emerging markets data has started to surprise on the downside given improved expectations and more challenging base effects.”
Given that this year the markets have experienced a correlated risk trade in emerging markets, this combination of year-end effect and more negative fundamental newsflow could lead to a more sizeable short-term retracement in asset prices and currencies than previously expected, despite the support of plentiful liquidity, analysts at HSBC warn.
The seriousness of the events in Dubai, in particular, could exacerbate this adverse market reaction and potential contagion effects. The HSBC report argues that this is a significant de-risking event that will at a minimum complicate the year-end process as investors re-focus on credit and event risk rather than exclusively concentrating on chasing yield and returns.
It could raise generic concerns around willingness to pay in the emerging markets and about quasi-sovereign exposure. It will also again highlight concentrated rollover risk (not just in emerging markets) and should be expected to impact most ‘crowded trades’, where positioning has increased significantly in recent months, the report tacitly mentions.
With these adverse developments taking place, the downward pressure on Indian equity markets remains stark. At the moment, analysts are unanimous that the valuations in the equity market remain expensive, despite the strong GDP growth that surprised all. Strong liquidity lead inflows keep propping the market from the downslide. The dollar and the pound carry trade have induced some positive mood. But this could change overnight as was seen in the beginning of 2008. As the year comes to a close there is a strange anxiety about what unfolds further. Clearly, all is not behind us.