Dubai's financial crisis: a Q&A

Dubai, the gulf emirate that has grown explosively over the last decade, is now at the centre of markets' attention on fears that it could struggle to repay its debt.

Q. Where did Dubai go wrong? I thought it was in the "oil-rich Gulf"?

A. Dubai is part of the United Arab Emirates, seven city-states which have separate ruling families, separate budgets, but security, immigration and foreign policies in common. Abu Dhabi has nearly all the UAE's oil. To keep up, Dubai from the 1950s on diversified its economy into ports, trade, services and finance, largely successfully. But its liquidity-fuelled real estate and tourism binge in the last decade may have been one step too far.

Q. What is the extent of its problems?

A. The emirate has said it has $80bn of debts, though some analysts say the true figure could be double that. Dubai World, the state-owned holding company whose bail-out plans triggered the current crisis, has liabilities of about $60bn, though only part of that is debt. The main problem is its real estate subsidiary Nakheel, which has huge bonds coming due, including an Islamic bond for $3.5bn in December. It appears to have little cash flow to meet payments - as well as relying on debt, it also sold most developments off-plan, with new developments now on hold.

Q. The big market crash after Lehman Brothers folded was more than a year ago. Why has Dubai only just been hit?

A. The property crash hit Dubai at the time - house prices fell 50 pc in six months. Nakheel was known to be in trouble. But investors assumed that as a state-owned company it would not default on its debt. The government refused to issue detailed statements of how it was to handle Dubai World's debt problems, and rounded on those who said that the crash had undermined Dubai's development model.

This encouraged a belief that a rescue package was already in place, probably funded by Abu Dhabi. The statement on Wednesday that the government was asking for a six-month standstill on repayments implied the rescue was in doubt.

Q. Why hasn't Abu Dhabi come to Dubai's aid? It has the world's largest sovereign wealth fund.

A. Abu Dhabi has, via the federal central bank, bought one $10bn bond issued by the Dubai government earlier this year, and, via its own banks, bought another $5bn bond this week. But the latter came with a rider that it was not to be used for the Dubai World bail-out. This raises two questions: what are the other debts for which it is to be used? And how is the Dubai World debt to be met, even after the six-month delay, if Abu Dhabi will not fund the rescue package?

Q. What about other Dubai companies? How are they doing?

A. Dubai World owns DP World, the successful ports operator which bought P&O. Other arms of the Dubai government, and the ruling family's directly owned holding companies, also own successful companies such as Emirates Airlines and Jumeirah Hotels, as well as stakes in buildings and businesses around the world, including the London Stock Exchange. But the emirate's lack of transparency and relatively untested financial legal system means that no-one knows if these can be demanded as collateral against Dubai World and other government debts.

Q. Nevertheless, exposure of western banks to the debt seems quite small compared to the trillions of dollars to which we have become accustomed. Why the panic?

A. At the most basic level, fears that exposed banks will have to write down losses, and that both Dubai and Abu Dhabi may have to sell worldwide assets, has hit prices everywhere. At an "animal spirits" level, the disclosure of significant unforeseen problems in Dubai has refocused attention on where else might have hidden "black holes". The health of sovereign debt worldwide, already seen as the major financial issue for the next decade, is also being reexamined.

Q. Can Dubai survive?

A. Dubai is still seen as the premier place to do business in the Middle East and beyond. It is a preferred base for not just Arab but Pakistani, Iranian and even Indian businesses, due to the wider region's political uncertainty. Its reputation for liberal attitudes helps. But events this week have damaged its reputation for economic competence, which the emirate's rulers will now have to work hard to restore.

Markets crash on Dubai default fears

Dubai is shaking investor confidence across the Persian Gulf after it sought a six-month reprieve on debt payments that risked triggering the biggest sovereign default since Argentina in 2001. The move caused a drop on world markets on Thursday and raised questions about Dubai's reputation as a magnet for international investment.

In Europe, the FTSE 100, Germany's DAX and the CAC-40 in France opened sharply lower. Earlier in Asia, the Shanghai index sank 119 points, or 3.6%, in the biggest one-day fall since August 31. Hong Kong's Hang Seng shed 1.8%. Wall Street was closed for the Thanksgiving holiday and most markets in the Middle East were silent because of a major Islamic feast.

Stocks, bonds and currencies fell across developing countries. The MSCI Emerging Markets Index of stocks dropped 1.1%, led by declines in China and Russia.

The fallout came swiftly after Wednesday's statement that Dubai's main development engine, Dubai World, would ask creditors for a standstill on paying back its $60 billion debt until at least May. The company's real estate arm, Nakheel -- whose projects include the palm-shaped island in the Gulf -- shoulders the bulk of money due to banks, investment houses and outside development contractors.

In total, the state-backed networks nicknamed Dubai Inc are $80 billion in the red and the emirate needed a bailout earlier this year from its oil-rich neighbour Abu Dhabi, the capital of the United Arab Emirates.

``Nakheel is now standing on the brink of failure given the astonishing amount of cash Dubai would have to inject into it in order to see the enterprise survive,'' said Luis Costa, emerging-market debt strategist at Commerzbank AG in London. ``Events like this are a perfect storm.''

``Dubai's standstill announcement ... was vague and it remains difficult to discern whether the call for a standstill will be voluntary,'' said a statement from the Eurasia Group, a Washington-based research group that assesses political and financial risk

for foreign investors interested in Dubai. ``If it is not, Dubai World will be going into default and that will have more serious negative repercussions for Dubai's sovereign debt, Dubai World and market confidence in the UAE in general,'' the statement added.

``There is nothing investors dislike more than this kind of event,'' said Norval Loftus, the head of convertible bonds and Islamic debt at Matrix Group Ltd. in London, which manages $2.5 billion of assets including Dubai credits. ``The worst-case scenario will of course be involuntary restructuring on the Nakheel security that brings into question the entire nature of the sovereign support for various borrowers in the region.''

Moodys Investors Service and Standard & Poor's cut the ratings on state companies yesterday, saying they may consider state-controlled Dubai World's plan to delay debt payments a default. The sheikhdom, ruled by Sheikh Mohammed Bin Rashid Al Maktoum, borrowed $80 billion in a four-year construction boom that reduced its reliance on falling oil supplies and created the region's tourism and financial hub.

``Dubai is the most indicative of the huge global liquidity boom and now in the aftermath there will be further defaults to come in emerging markets and globally,'' said Nick Chamie, head of emerging-market research at Toronto-based RBC Capital Markets.