I am currently in Dubai. Here, defaulting on debt or even bouncing a cheque is punishable with jail. I am told by friends here that most Indians in financial difficulty take the safest route?the next flight out of Dubai. Yet, when the government-owned investment company, that is, the sovereign wealth fund of Dubai, called Dubai World (DW), defaulted on its payments on November 25, the owners of the fund gave the impression of being antagonistic than apologetic.
Last week, DW warned that it does not have enough money to pay back a $3.5 bn loan that is due in December. It has asked creditors if it can postpone its forthcoming payments until May next year. DW?s announcement shook investor confidence across the Persian Gulf. The announcement appeared to be timed to minimise its impact on markets. It came after the stock market shut and just before the eve of the long Eid-al-Adha holiday that has closed many firms and government offices in the Gulf until December 6. Nevertheless, the news has caused great concern in the global financial markets.
DW was launched in July 2006 as a holding company. The Vice-President & Prime Minister of UAE and the Ruler of Dubai, Sheikh Mohammed, holds the majority stake in the sovereign wealth fund. Through the holding company, the ruler controls some of the biggest businesses in Dubai, including the third-largest port operator in the world, Dubai Ports World and Nakheel, known for residential estate development projects such as the Palm Islands and the Dubai Waterfront. The investment company manages and supervises a portfolio of businesses and projects for the ruler across a wide range of industry segments and projects that promote Dubai as a hub for commerce and trading.
In the region, it is often the case that the ruler, the government, the central bank and the businesses, are effectively the same entity. Dubai is a political territory ruled by a dynastic monarch. It is one of the seven emirates comprising the United Arab Emirates, which includes Abu Dhabi and Sharjah. Dubai borrowed $80 billion to fund a construction boom to transform the economy into a regional tourism and financial hub.
Foreign banks have stopped lending since the beginning of the year. Since then, Dubai has turned to its neighbouring emirate, Abu Dhabi for financial help. Sheikh Mohammed relied on Abu Dhabi?s central bank in February this year to raise $10 billion by selling debt. However, now most creditors are pessimistic and do not foresee help forthcoming from its neighbour should Dubai have difficulty repaying the debt even after six months. The ruler, however, tried to assuage the fears of its 70 creditors by ?clarifying? that those who doubt the unity of Dubai and Abu Dhabi should ?shut up?. I thought you wore an apologetic look when you don?t have money to pay back debt. That apart, I imagine that Dubai can expect financial support from the deep-pocketed Abu Dhabi to keep itself afloat. But Dubai will likely have to abandon a flamboyant economic model that focused on heavy real estate investment and inflows of foreign capital.
The money it borrowed in the last six years wasn?t deployed well. Rather, the frantic investment of the borrowed money in real estate created a bubble. A six-year boom that turned sand dunes into an even more glittering metropolis, creating the world?s tallest building, its biggest shopping mall and, some say, a shrine to unbridled capitalism, is grinding to a halt. Strolling through the streets, the evidence of economic slowdown is obvious. Many construction projects have either been put on hold or cancelled, leaving a trail of half-built towers on the outskirts of the city stretching into the desert. Luxury hotels seem to have a vacant look. Earlier, you expected to see a Ferrari parked beside a Rolls-Royce in Dubai. But now, you are more likely to see a scruffy ?for sale? sign in English and Arabic taped to the windows.
Historically, too much money pouring into the real estate has proved to be a detrimental strategy, especially if it is borrowed money. The regulators, bankers, businesses and speculators were the collective culprits during the Asian crisis and the more recent sub-prime crisis. However, in this case, the buck stops at the state because the regulator, central bank, business and speculator are effectively the state. Dubai?s default is the biggest sovereign default since Argentina in 2001. A series of leveraged investments by the government in real estate have caused this ?bounced cheque?. If a commoner?s cheque for even 100 dirham bounces, he can be jailed here. Probably, it is a little difficult for the rulers to apply the same law to themselves as they apply to commoners. It would be interesting to see, at the very least what corrective action the state undertakes to come out of this financial mess.
The author, formerly with JPMorganChase?s Global Capital Markets, is CEO, Quantum Phinance