by Vibhas Tattu

When Lehman Brothers collapsed in Sep 2008, the US Government was not a party to it, since Lehman’s woes were entirely of their own making. The US Government‘s tacit decision to let Lehman Brothers collapse under its own inefficiencies, was, at the very least, a legally as well as morally defensible position.

As Dubai World, a large Dubai company with operations around the world, prepares to default on its massive debt burden, the Dubai Government is quite truthfully saying that it is not legally obligated to stave off this debacle. Whether this position is morally defensible however, is probably another question altogether. But then in the delusional world of international finance, moral grounds are not factored into the balance sheet anyway.

What is at play here is the legal fact that the owner of a commercial entity is not personally liable to bailout the commercial entity if it fails. Dubai Government is the owner of Dubai World but has not signed any guarantees on its behalf.  As one of my sources, a senior functionary in a local bank said, those institutions and individuals who gave massive sums of money to Dubai World perhaps thought they were taking a lesser risk since it was a ‘quasi-sovereign risk’. If this was so it was a misapprehension, as recent media reports have clarified. The risk, therefore, has just become riskier if not quite junk. That’s the executive summary of the situation, as it were.

Delving deeper into details we find that what happened was this: On November 25, 2009 Dubai World, a large state owned and diversified company in Dubai, issued a ‘request’ to all its creditors for a standstill on the payment of its sukuks (Islamic Bonds) and other debts for a period of six months upto May 30, 2010 since it was undertaking a major restructuring exercise.  The total debt, which runs to billions of dollars, is believed to consist of bilateral debt s (like bank loans) and sukuks. A sukuk is a Sharia compliant bond, similar to a bond used in Western financial markets, with a fixed maturity date. Sukuks are commonly used in the Middle East to raise money. These sukuks are traded on the Europeans as well as Middle East markets. Some of these payments are due as early as Dec 14, 2009. In layman terms the ‘standstill request’ means that Dubai World is unable to pay its debt obligations on the due date. The details of the restructuring have not been disclosed as yet. What is known is that the total debt of DW is around $ 59 billion. 

This unceremonious announcement has sent shockwaves around the world. When a giant tree is about to be felled, the woodsmen shout ‘timber’ to warn all those in the jungle to get out of harm’s way. The DW announcement has been heard as a cry of ‘timber’ in the financial jungles around the world. The first predictable reaction has been of panic.  The thought that the Dubai bubble has finally burst may have crossed many minds. In the first few days after the announcement there was even talk of a run on banks. In response, the UAE Central Bank announced that it was ready to provide ample liquidity to all local and international banks in UAE , should such a stampede ensue; which in the event did not.  In this same panic, Dubai and Abu Dhabi bourses have hacked off around $ 9 billion (8 %) of market value in the last few days alone. The sukuks which were trading at around $108 before fell to $43 and were then suspended from being traded. The bourses of Europe and India have also dropped significant valuations of various stocks.  Some international banks like HSBC and Standard Chartered Bank which are believed to have large outstanding positions with DW, have taken a massive drubbing in share markets around the world. 

So let’s get to know this company ‘Dubai World’ a little better. Dubai World is the management umbrella to a host of high profile companies like Nakheel, Limitless, Istithmar, DP World, JAFZA etc. Nakheel, the flagship of DW, has built some serious pieces of real estate such as the Palm Jumeirah Islands, Atlantis Hotel, Jebel Ali and Deira Palm Islands, World Islands, Jumeirah Lake Towers etc. Other than the Great Wall of China, the Palm Islands are the only manmade object visible from outer space. Being almost exclusively a real estate developer, Nakheel’s assets have shrunk very seriously in value over the last twelve months and its cash flows have dried up, as the real estate bubble has burst in the UAE, as in the world at large. DP World, another crown jewel in the DW basket, is one of the largest port operators in the world with operations in dozens of countries. DP World’s acquisition of some US ports a few years back caused a furore in the US Congress and it had to ultimately divest its US assets. Istithmar is the overseas investment wing of Dubai World. Some of the prestigious acquisitions of Istithmar or its subsidiaries include a slice of MGM Grand, Las Vegas, Barneys Luxury Stores, New York, and the world’s largest luxury liner Queen Elizabeth 2. JAFZA (Jebel Ali Free Zone Authority) another DW company owns and operates the free zone located in Jebel Ali on the outskirts of Dubai. JAFZA is host to over 6000 local and international businesses in Dubai and is the largest free zone company in the world. These then are the constellations in the DW firmament. The combined asset base of DW companies is estimated at around $100 billion. It can readily be appreciated then, that by any standards, the entity called Dubai World is a giant oak in the business jungle. As of now the markets perceive that this giant is at best unsteady on its feet and at worst about to topple under the weight of its debt of $59 billion. This is reason the cry of ‘timber’ is echoing in the money market jungle.

As with most things in life, it’s all a question of timing. It’s a matter of arranging the dates when the debts will be paid. DW, we are told, is restructuring its debt and its member companies, and not defaulting or filing for bankruptcy. On Dec 01 DW announced that only $26 billion out the total $59 billion debt is up for restructuring. The balance debt is ‘stable’ since it belongs to its more profitable companies like DP World, which are quite able to service their debts, thank you. In fact JAFZA paid the dues on its sukuk on the due date November 30. 

However, those who are heavily invested in the troubled assets of DW like Nakheel are probably in for a rough ride. While the details are not known it is reasonable to assume that investors may have to provide for significant capital losses in addition to factoring considerable delays into their cash flows. Another source who works for an international bank in Dubai told me that if heavy provisions have to be taken against these loans, lots of people in the banking sector could lose their jobs. Out of about 70,000 employees of DW, the restructuring has already taken toll of over 10,000 employees. The collateral and consequential damage in terms of job losses in related sectors could be much wider since this will affect the already weakened banking, construction, real estate and logistics sectors in UAE. As the process of restructuring unfolds in the coming months, the full extent of the debacle and loss in jobs and capital value will become apparent.

On a business outlook level, this event has already made Dubai a riskier investment destination than before. This is reflected in the Credit Default Swap rates which jumped to above 550 basis points in the last few days and are likely to remain high. What this means is that investors will charge a high premium for lending to Dubai companies and institutions operating in Dubai. International ratings agency Standard and Poor’s today cut the ratings of six government related entities in Dubai to junk status. The six GRE’s (govt related entities) are DP World, JAFZA, Emaar, DIFC Investments, Dubai Holding Commercial Operations Group and Dubai Multi Commodities Center Authority.  The PR machinery has swung into damage control mode with analysts making all the right noises saying it’s a relatively minor problem. Rating agency Moody’s has stated that UAE’s overall ratings will not suffer due to this. UAE Leaders have made statements about a strong and vibrant economy that can weather storms. Nonetheless this event may well change the perceptions about Dubai and UAE. Surely some of the hype and gloss will lose its sheen, its being said. 

When Lehman Brothers collapsed and triggered the global meltdown, many giant institutions seemed irreparably damaged. The media had sounded the death knell of investment banking then. Yet barely a year later many of the troubled institutions, including Citibank, Goldman Sachs etc have returned to profit and bonus to boot. So also Dubai may well face considerable turbulence for a while, but who knows, a year from now it will soar into the blue once again.

Vibhas Tattu  hails from India and is a manufacturing engineer by profession. He has worked in India, USA and now in the United Arab Emirates. Vibhas is interested in Shakespeare, Indian music, poetry (English, Hindi and Marathi) and a new found love of writing. He routinely practices Vipassana (“mindfulness”) meditation.

Tattu has a bachelor’s degree in Production Engineering from the University of Bombay and Master’s degree in Industrial Engineering and Operations Research from the University of California at Berkeley, where he was a Fellow.

EMAIL: vibhas1@gmail.com