Dubai builds, but they don’t come

September 16, 2009

DUBAI/There is something surreal about the financial crisis that has engulfed Dubai.

A small desert emirate, without significant hydrocarbon reserves, Dubai finds itself geared to the eyebrows in the midst of a global downturn. Deutsche Bank estimates its external debts at about $74.3 billion. That, for the record, is 107 percent of the emirate’s expected 2009 GDP, or more than 14 times its government revenues for 2006 (the latest year for which data is available).

But it isn’t just the extreme leverage that is surreal. Dubai has long borrowed heavily to invest. The real twist comes from the wacky way that Dubai has chosen to invest its borrowed cash.

True, not all of Dubai’s money-making schemes were foolish. The development of DP World, a ports services business, made eminent sense, given the emirate’s status as a trade hub. And this has proved reasonably successful.

But some of its “get rich quick” ideas were about as sound as something out of Gulliver’s Travels — the attempts of the state of Lagado to extract sunbeams from cucumbers, for instance. Into this category one might put the attempt to conjure a financial centre out of the desert, or to build luxury housing on sandbanks in the Arabian Gulf. Or, indeed, the attempt to create a sovereign wealth fund, Istithmar, without having any surpluses to inject into it in the first place.

Outsiders have long marvelled at this “build it and they will come” approach. Now its shortcomings are becoming clear. Much of Dubai is half-built and they probably won’t come.

Istithmar, for instance, used leverage to pursue an investment strategy built around luxury goods, retail and financial services. It is not hard to see why this has hit the rocks. Istithmar’s parent, Dubai World, is in the process of restructuring some $12 billion of the debt it has taken on.

Predictably, it has been forced into the expedient of trying to sell good assets to fund losses on the toxic ones. However its attempts to hawk part of its $6.6 billion stake in listed DP World to a local private equity firm have thus far proved fruitless as the two sides failed to agree on price.

How the crisis pans out depends on Dubai’s willingness to stand behind the various state-controlled enterprises it has spawned. Thus far it has been willing to do so. But the calls on the emirate’s meagre finances (its government revenues were little more $5 billion in 2006) seem relentless. In December it must repay or refinance a $3.5 billion bond taken out by Nakheel, Dubai World’s property unit. And the losses from other failed ventures, such as Istithmar’s investment in high end U.S. retailer Barneys, are also mounting up. Deutsche Bank reckons it will have to refinance an average of $12.5 billion in external debt between 2010 and 2013.

To continue to backstop ventures that have lost significant value or may take longer than expected to generate free cashflow, Dubai may be forced to turn for assistance to its cash rich neighbour Abu Dhabi, which has already lent it $10 billion and has provisionally undertaken to provide a further $10 billion of assistance.

Were this to be sought it might stabilise Dubai’s finances, but at a cost. Dubai’s ambition to be a financial hub, tourist destination and haven for the world’s super rich depended to some extent on its relatively liberal social attitudes. The more dependent the emirate becomes on its conservative neighbour for money, the harder it may be to retain that liberal tinge.

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