Dubai Default Examined

We invite you to read additional posts on our blog The Firecracker Report. November 27, 2009 Dubai Default Examined: Serious Implications for the Global Risk Trade, Especially in Emerging Markets This year's Thanksgiving turkey has arrived as a dud. While the U.S. markets were closed over the holiday, Dubai managed to pull the rug from under the global risk trade by announcing a 6 month moratorium on the debt of Dubai World. The state-sponsored Dubai World is an umbrella company that houses a portfolio of businesses, including Nakheel - the famous real estate developer of the Palm Islands. The debt fueled real estate expansion of Dubai World has resulted, in it accumulating a staggering $59 billion of debt, almost 6x the $10bn of sovereign debt of the Dubai state. Thus far, as part of the restructuring process the Government of Dubai has announced the appointment of a restructuring officer and has asked debt holders of Dubai World and Nakheel to agree to a debt “standstill” as well as the extension of all maturities until May 2010. Reader should note that being an Islamic republic Dubai‟s debt does not carry interest payments; only the principal is due at maturity. There are three important conclusions to be drawn from this crisis: 1. Non-Transparency: One of the biggest challenges facing emerging markets investors is the problem of non-transparency and Dubai has proved to be no exception. As is the case in most emerging markets the underlings (CEO and CFO) point to one thing, while the owners and the real decision makers (in this case the state itself) do and say another. As The Financial Times Middle East editor Roula Khalaf points out: “For months, all indications in Dubai were that the heavily indebted city-state, symbol of the rise of the region as an economic powerhouse as much as of the excesses of the pre-financial crunch days, would meet the obligations of the companies in which it has stakes, and that Nakheel‟s $4bn debt due in December would be repaid. As always, though, the problem in Dubai is that no one had all the facts, and perhaps some in the financial community had made all the wrong assumptions. The whole affair, one analyst told me on Thursday, was “typical of the way things work in Dubai – top down and in a vacuum – and that makes it very difficult for investors”. True, top officials had indicated repeatedly that Dubai would not default on its debt – and Nakheel, the Palm real estate developer, was assumed to be too important for Dubai‟s image. But officials did not explicitly say that the repayments would be made on time. Moreover, the recent prospectus to test market appetite for government bonds said the government was “not legally obliged” to meet the obligations of related 1

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entities –but might at its sole discretion decide to extend such support. [Now where have we heard that before? Fannie and Freddie of course]. 2. Investors Assumed the Presence of a Shining Knight: The United Arab Emirates (UAE) is a federation of seven emirates, including the oil rich Abu Dhabi and its debt laden cousin Dubai. Most investors were under the assumption that in the event of a crisis, Dubai‟s oil rich neighbor Abu Dhabi was sure to give a helping hand. And why not? After all, there was real basis for this assumption - the ruler of Dubai Sheikh Mohammed bin Rashid al Maktoum said so himself. For it was recently at a Bank of America conference on November 10, 2009, the Sheikh assured investors that ““The worst is over and Dubai is now well placed to repay its debt”. When question further on this relationship with Abu Dhabi, he told critics to “shut up”. “I assure you that we will be there for each other when we need it,” Sheikh Mohammed said. Well so much for that friendship, unless of course both Abu Dhabi and Dubai have decided to stick it to the bond holders together. Incidentally the markets were so taken by the Sheikh‟s fake pep talk that credit spreads for Dubai actually narrowed, and as recently as last week Nakheel‟s bonds was trading at ~111 (Above par!). At the time of this writing they had fallen to ~70. 3. Debt Funded, Real Estate Driven Economic Expansion: Over the last few years Dubai rose as a shining city in the desert, with its debt fueled economic expansion based on three main industries: real estate, shipping and tourism. With the unfolding of the global financial crisis, all three of these industries have taken a massive hit. Dubai‟s default will have serious implications for the global risk trade, especially in emerging markets. Thus far at the time of the writing of this report, the risk trade has begun unwinding with Asian markets having taken a huge hit and S&P futures down over 40 points. Given that stock and commodity markets were already feeling heavily overbought, coupled with this crisis, markets could be in for a severe correction (unless of course Dubai announces a rescue plan for bondholders on Monday - unlikely in our opinion). It will be interesting to watch how far the U.S. Dollar index rallies in the coming days - whether it breaks above its 50 day moving average of 76. That will be a key indicator of the extent of the dollar carry trade. A lot of short dollar players could be in for a nasty squeeze. Over the next couple of days, we plan to watch the action carefully and use the down swing as an opportunity to add to our position in physical gold as well as look for entry positions on some high dividend paying stocks like Verizon and AT&T.

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About the Firecracker Report The Firecracker Report is a financial and geopolitical analysis blog started by a team of exWall Streeter‟s with extensive banking and investing experience. We strongly feel that in the current era of corporatized propaganda driven news the „real‟ news often goes unreported. We have therefore chosen to lend our voices and join the growing ranks of independent bloggers that aim to bring insightful commentary and analysis to their readers. We invite you to visit our blog and would love to hear your thoughts and comments. We can be reached at [email protected]

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