Cicero Policy Briefer

Issue 42, January 2010
 

Has Dubai taught us how capitalism works?

By Georgie Rawkins

On 26 November, Dubai World, the wholly state-owned Emirati holding company, asked for a six-month moratorium on debt service on debt estimated to be around the $60 billion mark. Nakheel, a property developer and one of the companies in Dubai World’s portfolio, also announced a debt service delay on the same day. This prompted many hysterical reactions from the worldwide media, gleefully suggesting that this was the first sign of the fateful “double dip” leading to the inevitable financial Armageddon that we have been promised by some analysts.

I am more of the view that the markets’ reactions were slightly overblown; Dubai World’s debts pale in comparison to the many billions of dollars lost by banks across the world last year and the defaults are unlikely to undermine the global banking system in any significant way. Indeed, the markets have since illustrated this by rebounding from their lows, with investors concluding that the damage might be contained. Richard Meddings, FD of Standard Chartered, which is believed to have one of the highest exposures to the Middle East amongst global banks, has said of the potential losses in Dubai: "The situation is fluid and in its early stages, but…we don't expect any impairment to be material…We retain a high level of confidence in the prospects of the Middle East."

Just 20 years ago, Dubai was a sleepy smugglers’ port surrounded by desert; but it has long had aspirations for global dominance. Its growth rate, once the Al Maktoum family decided that the emirate could not rely long-term on its comparatively tiny oil supplies, has abounded at a rate of knots, with investments spread across such far-reaching interests as prestigious international hotels, global airlines, American department stores, custom-built island communities spelling out poetry in the sea and ski slopes in the desert. Dubai borrowed many ideas for its development from Singapore and other South-East Asian tigers, inspired by their similarities in possessing an effective and efficient infrastructure planned by the state with the express intention of attracting international business investment, and many commercially run companies that were owned by the government and had the implicit guarantee of the sovereign.

Besides the effective infrastructure, the government also adopted a paternalistic attitude and relaxed fiscal regulations in order to further encourage foreign investment. As a result, the emirate became a major financial and tourism centre—but the extraordinarily ambitious plans created a property bubble, with considerable amounts of money invested several years ago in construction projects that are yet to see the light of day. It was destined to burst, and burst it has—in typically spectacular style, with markets crashing and investors attempting to pull out of the beleaguered emirate despite the government’s denial of the seriousness of the situation.

The United Arab Emirates’ central bank has announced that it is backing all deposits in locally owned and foreign banks, but they have stated that they will not stretch to a full bail-out of Dubai World—a decision that investors are likely to be reassured by, as it goes against the oft-criticised situation in the West of banks and corporate entities deemed “too important to fail”. This is contradictory to one of the classical tenets of capitalism: laissez faire, laissez aller, laissez passer, in the sense that the free market is best left to its own devices and that it will dispense with inefficiencies in a quicker and more deliberate manner than any external body could.

The $10 billion bail-out that was announced last week echoes a previous bail-out for the same amount for Dubai from the UAE Central Bank in February. There are, of course, strings attached to this injection of capital. Abu Dhabi recognises that a default on the $3.5 billion sukuk owed by Nakheel would mean a large loss of capital that would frighten many organisations from conducting large transactions in autocratic countries—and indeed many Abu Dhabi businessmen have themselves invested in Dubai, meaning a default could affect the credit rating of the entire country. But they are not prepared for a return to the profligacy of the emirate that has long been seen as Abu Dhabi’s extravagant and narcissistic younger brother. It is highly likely that Abu Dhabi will demand a strong influence over Dubai’s key profit-making entities—and this will in turn have a significant impact upon Dubai’s economy, which is entirely reliant on these corporations, given the absence of any significant income from oil.

Whatever these conditions are, the facts remain that this is simply the first step in settling Dubai’s vast debts, and the fundamental origins of the situation have not changed. Dubai remains leveraged to the hilt and it is still unclear how they will repay future debt obligations. At a time of severe lack of transparency on the government's part, one thing is clear: Dubai certainly isn’t out of the woods just yet.

Georgie Rawkins can be contacted on +44 (0)20 7665 9530 or click here to email.