Background
Dubai is one of the United Arab Emirates that is not wallowing in oil riches despite having access to credit through the UAE, most of whose members are oil-rich. It has tried to promote itself as something of a tourist destination - something like the Las Vegas of the Middle East - with projects that are brilliant, eccentric or daft, depending on your perspective. The world's tallest skyscraper? An indoor snow skiing slope in the middle of the desert? An artificial island shaped like a palm tree to be covered with mansions?
Dubai World developed or helped to finance such projects, as well as buying real estate all over, including luxury hotels in the U.S. and golf courses around the world. With the international financial crisis precipitated by the U.S. mortgage crisis last year, most of these investments turned sour.
What Happened?
As shoppers were emptying their purses on Black Friday bargains, Dubai’s attempt to reschedule its debt roiled financial markets, plunging risky assets into the red. The government of Dubai requested a six-month payment freeze on the $59 billion debt issued by Dubai World - a state-owned conglomerate that has become known for its extravagant real estate projects.
Worries about Dubai’s debt woes rattled investors’ confidence, precipitating a sell-off in equities, high-yielding corporate bonds, commodities and the Baltic Dry Index, while mature-market government debt, the US dollar and the Japanese yen attracted safe-haven buyers
Further Analysis
A fact not widely known is that Dubai has the worst debt per capita in the world. The amount of the restructured debt for Dubai World is only about $60 billion, so by itself, is insignificant compared to the size of the world economy. The government of Dubai backs the Dubai World debt. If one includes the government of Dubai, total debts are about $80 billion, which is still not a huge amount compared to world assets.
But Dubai doesn't have much oil. It also doesn't have much water, or much arable land either. It is a major financial center, and would like to expand in that role. But without a growing world oil supply (or at least growing Middle-East oil supply), it is difficult to see how continuing growth might happen. Dubai's property values have dropped in the past year and vacancies are a significant issue.
If one knows about peak oil, it is pretty easy to see where Dubai World is headed, over not too long a timeframe. The energy intense plan it has put together is not sustainable for very long. Except for financial services, Dubai does not have much to sell. Financial services generally depend on growth, and in particular growth in debt, but this does not seem really sustainable either, unless extracted resources can provide the needed growth--something that seems increasingly less likely.
Bailout for Dubai?
Based on the above description, a bailout for Dubai is at best a temporary band-aid. Dubai is part of the United Arab Emirates (UAE), and Abu Dhabi is the senior partner in the UAE. Unlike Dubai, Abu Dhabi has significant oil reserves and has a huge sovereign wealth fund. According to the Independent: “As with Iceland, the Ukraine, Hungary and many other states, Dubai can and should be saved. The damage is containable. Aid must come from Dubai’s partners in the United Arab Emirates, especially oil-rich Abu Dhabi; from the Gulf Cooperation Council, dominated by Saudi Arabia; and from the IMF. Abu Dhabi’s sovereign wealth fund alone is worth about $700bn, the biggest in the world. So the funds are there to organize some sort of rescue; the political will must be found.”
So there seem to be funds available. But the question is: will others really want to put more money into what is fairly clearly a sinking ship, especially if one understands the world oil situation?
Conclusion
In the absence of a bail out, the interest rates of the whole region are likely to go up, and this may put more pressure on Abu Dhabi or the Gulf Cooperation Council. But if there is a bankruptcy, the assets may become available very cheaply. This countervailing incentive may ultimately win-we don't know yet. The situation should become much more clear in the following weeks.
