Is Dubai about to crash and burn?

Dubai's business model has always worried me - build lots of big buildings and hotels, create expensive artificial islands and cram them with shoddily built houses... but its been hard for me to see where the underlying real value generation is. Sure, there is some logistics (port, airlines), some outsourcing based on imported Indians and more reliable infrastructure than in India itself, and financial services and regional offices for multinationals. But is that enough to generate the earnings needed to fund the massive investments long term?

Most of the people coming to Dubai seem to be people selling services to each other, and to the people building the buildings. Sure, they all need places to live, something to eat, booze, but then what? The construction workers are mostly there to export whatever meager earnings they can save back to India and Pakistan. Dubai comes across as the world's biggest pyramid scheme - everything's OK as long as the influx of new arrivals continues to grow and the cheap loans are available.

But the current financial crisis and world recession has exposed these fundamental risks to that model. The credit Dubai has relied on to fund all that construction is gone. The people in Europe buying second houses on the Palm are retrenching their spending, fast. Tourists are spending less, and looking to stay closer to home.

And the buyers who were intending to sell their off-plan deposit purchased properties to make a quick buck are now facing a huge drop in market prices and no-one to sell the properties to.

It is now reported that Dubai is asking for emergency loans from the UAE Government, in other words - Abu Dhabi. This was perhaps expected, but it has happened a lot quicker than analysts thought.

Abu Dhabi's financial power is based on robust oil production of over 2 million bbls a day of oil. With a small local population, Abu Dhabi are rolling in cash with the recent high oil prices. Meanwhile, Dubai has been a net oil importer for years. That's one reason why their debt is running over 120% of GDP.

In many ways, Dubai has a similar model to Singapore. But Singapore has many many more advantages: surrounded by Asian tigers, big foreign reserves, solid high tech manufacturing, and a population of highly educated locals who all work their asses off and save a huge proportion of their earnings. And even Singapore is struggling somewhat right now. If Singapore - with a history of fantastic development - is in a bit of trouble, how can Dubai be sound? I don't buy it.

I predict in a few years Dubai will be exposed as the mega-tulip bulb bubble / Ponzi scheme it really is. No matter how many fireworks they let off. The big party last night at the Atlantis Hotel on the Palm strikes me as a desperate frenzy of champagne drinking denial on the deck of the Titanic.

Financial Times Article

Dubai in UAE talks over state funds
Financial Times
November 18 2008

Dubai is in talks with the United Arab Emirates government over a loan facility that would make state funds available to companies as international sources of capital dry up.

The plan, one of several options under discussion by the authorities, would draw on support from the cash-rich federal government, bankrolled by Abu Dhabi, the capital that also owns 90 per cent of UAE oil wealth.

Dubai, which derives its wealth from its role as a port and trading centre, is at the tail end of almost a decade of strong growth but now faces declining real estate and stock markets, clogged credit markets and a collapse of oil prices, the main barometer of the region’s economic health.

The emirate’s ability to engineer a soft landing is vital for companies betting on the Gulf as a heaven of stability and a source of growth amid the global downturn.

The plan, which could be unveiled next week, would establish a facility for state-owned companies similar to a Dh120bn ($33bn, €26bn, £22bn) liquidity package for UAE banks announced in October.

According to officials in Dubai, the terms of the facility have yet to be defined but it would be likely to lend to companies that need help refinancing existing debt.

The economic crisis has highlighted the inter-dependence of the seven emirates that make up the UAE, and the crucial role of the federal government, which has at times been overshadowed by the rivalry between the trade and commerce hub of Dubai and Abu Dhabi, the oil town that now has its own ambitions to diversify its economy away from oil.

Concern over Dubai’s high level of debt has fuelled talk that stakes in companies will be sold to Abu Dhabi. Fitch Rating Agency says Dubai’s debt is at $70bn, more than 100 per cent of gross domestic product.

Citi said Dubai’s exposure to real estate and debt made it the Gulf economy most vulnerable to the global economic downturn. The bank expects consolidation among Dubai’s state-owned companies, rather than significant financial aid from Abu Dhabi, but says it will “pull through with some help”.

Dubai officials insist that the emirate has enough internal cash resources to refinance the more than $20bn worth of debt due over the next couple of years. But merging Dubai companies or launching initial public offerings to raise cash, are also options being explored.

Dubai has also set up a high-level committee to steer the emirate through the crisis, and is expected to introduce measures to reassure investors in the property market, which is beginning to decline after years of steep price increases.

The first test for the restructuring of Dubai’s debt will come with maturing loans for Dubai International Financial Centre, the emirate’s financial district and Borse Dubai, the holding company for the emirate’s two stock exchanges, which has a larger loan maturing in February.

The DIFC says it is comfortable about meeting its commitments for a $500m loan maturing in the next few weeks. An official close to the DIFC say it could pay off the loan if a refinancing is not completed in time.

Borse Dubai officials said the company was selecting a lead manager for the refinancing of its $3.5bn loan, raised to fund its acquisition with Nasdaq of Nordic exchanges group OMX. The loan matures in February.

Borse Dubai said the rising cost of borrowing should be cancelled out by falling interest rates. “Even if Borse Dubai pays plus 300 basis points on the loan, the cost will be about the same,” said an official involved in the refinancing discussions.