On reading the recent spate of death of Dubai articles (FT, Guardian, NY Times, WSJ etc) you’d think the place was finished. I spent a few weeks there recently and although there seemed to be visible signs of a slowdown (less traffic, quieter restaurants, etc) it’s far from game over.

Dubai is facing its first major crisis since the formation of the United Arab Emirates.

A Brief History.
Expansionary policies due to the dollar peg have meant that the UAE had negative real interest rates for much of the 2000s. The price of oil was also on a seemingly unstoppable upwards trajectory leading to huge surpluses in the region. With all that liquidity sloshing about Dubai merrily got drunk on cheap credit. Inevitable bubbles formed. Inevitably the bubbles burst with Abu Dhabi recently stepping in to bail Dubai out with a US$10bn 4% bond. There is a coming home to roost irony in Abu Dhabi’s partial responsibility for the original global savings glut (alongside Kuwait / Saudi / Qatar / China / Japan et al) that created the liquidity and the mad and blind hunt for yield that manifested itself down the road in the Dubai property bubble (and farther away and on a much larger scale those in the US and the UK).

No sensible person had any doubt Dubai was experiencing a whopping real estate bubble. It took off with Nakheel’s Palm Jumeira project in 2001 but accelerated worryingly in the last few years. The only question as with all bubbles was when and how it would pop.

Well, we’re in the middle of finding out. There’s no doubt that Dubai overreached and got caught up in its own hubris. That is not to take away from the very real progress and development that the city achieved in its second major growth spurt 2001 onwards.
It has cemented its position as the Middle East’s leading tourism, commercial and trading hub. It has a significant head start on its goals shared by regional rivals of becoming the Middle East Media (where it’s strong in advertising and publishing in particular), Finance and Healthcare centers.
It’s easy to overlook the fact that alongside all the rotating, floating, Swarovski-encrusted penthouse towers and the Versace designed temperature controlled fake beaches there was massive investment in more productive infrastructure: roads, bridges, metros, airport, sports facilities, warehouses, offices and even the speculative housing stock was often built to global quality standards (Emaar and DIFC’s developments stand out).
At some point the price of doing business in Dubai will fall enough to entice new investments. Businesses that were priced out of Dubai will become financially viable as the rents and operating costs deflate. When that happens, Dubai will probably boast one of the world’s greatest value for money locations to set up shop (brand new infrastructure at burst bubble prices).

Getting from here to there will be painful though. So how do get out of this mess we’re in:

Finance. Banking.
Dubai set out to become the Middle East’s financial center, taking Singapore and Hong Kong as its models, it easily out maneuvered the entrenched leader Bahrain and has built an arguably insurmountable lead on its most serious competitor – Doha.
Unfortunately the Dubai International Financial Center was just finding its groove when the once in many generations global reshaping of the finance world started taking place. As global finance shrinks, the DIFC’s business ambitions will necessarily to be toned down. The business opportunity still exists though and Dubai’s hard infrastructure bodes well for the city to emerge ahead (even the soft infrastructure was improving after a shaky start and will continue to do so). Finance is still an attractive industry for Dubai; bankers will remain amongst the world’s best paid employees. Goldman may have recalled their MD back to London but in time the region will re-emerge as an important growth zone for the industry.
So the indebted DIFC just needs to stay afloat – the recent refinancing of Borse Dubai bodes well – and it should emerge well-positioned to succeed (DIFC Investments’ destiny is less clear).

The local banking industry is of far greater concern. There are concerns over UAE banks’ exposures to Dubai real estate (via mortgages, development loans and personal / commercial loans), Dubai government’s over-leveraged investment and development companies (DP World, Nakheel, Dubai Holding, Zabeel Investments etc) and to a lesser extent Dubai’s major trading families (whose projections for project-financed projects were done in far rosier times). The Dubai economy is a credit-driven economy and the uncertainty surrounding banks’ books (and even solvency) will have a severe impact on economic growth. Most commentators are not quite sure what to make of Abu Dhabi’s recent capital injections restricted to Abu Dhabi banks (although the go-it-alone fears have receded post Dubailout). It is not in the country’s (i.e. Abu Dhabi’s) interests to have weak banks. There is plenty of cross-emirate exposure in the banking sector and so Abu Dhabi and the central bank will do what it takes to avert systemic risk.
Ultimately, the consolidation that has been a long time coming will probably need to happen, perhaps with strengthened Abu Dhabi institutions swooping on the more vulnerable banks. Banks across the board will book significant losses as the quality of their loan books deteriorates rapidly. A look at the devastating combination of a real estate crash, an expatriate loan book quality possibly on the brink of a precipitous fall, exposure to a cash-starved Dubai government (and related entities) and a collapsed stock market makes it clear why.
Abu Dhabi will have no choice but recapitalize and perhaps orchestrate mergers (both within and across emirates).
For things to turn around we need to establish the bottom of the cycle (stock market, real estate, economy). Only once banks are confident of the size of the write-downs required and have been been sufficiently recapitalized will they be ready to lend again. The way to get to the bottom is via transparency. Balance sheets exposures to the areas mentioned need to be clarified and marked to market in a transparent and realistic manner. Additionally, asset prices need to stabilize which will happen once the property market finds a new equilibrium.
This is one of the most immediate threats to Dubai’s economy recovery. Solution (painful as it will be) = Transparency.

Dubai Debt.
The central bank’s recent Dubailout (coined by Lex) that quickly followed the too close for comfort (and possibly federally helped) refinancing of Borse Dubai’s $2.5 billion loan bodes well for Dubai getting through 2009 without defaulting on its significant loan commitments. This is good but will still be acutely painful as Dubai entities focus on conserving cash and paying down debt. There will be very little new spending (relative to what Dubai has recently become accustomed to). The government’s planned deficit budget spending is small fry compared to the spending or lack of Dubai Inc:
Sultan Bin Sulayem I imagine will be one of the main losers when we get through this episode. DP World, Nakheel, Istithmar, Limitless are so loaded up on debt and so exposed to an imploding local property market (a bubble and oversupply both very much a consequence of Nakheel’s actions) that they alone probably threatened Dubai’s solvency. Unfortunately this all coincides with a global collapse in trade which will make life difficult for DP World – which is the Dubai World bedrock.
Emaar, bruised as it is, has emerged most unscathed. It is one of Dubai’s few truly globally competitive companies. This is partly due to its status as a public company that has required adherence to the Dubai Financial Market’s disclosure rules. AlAbbar came out with the much quoted debt figure of US$80bn (10 sovereign and 70 Dubai Inc entities) and $90bn in government assets and an additional $260bn in state-affiliated companies’ assets whatever the actually meant. When and how were these assets valued? Do these debt figures include amounts owed to local banks? Nobody really knows the answers to these questions, at times it seems that perhaps nobody within the government is quite sure either.
Dubai Holding is the next problem child. Perhaps even more than the DP World family of companies, Dubai Holding relied on leverage to grow (DP World at least had solid foundations in Jafza). Again the sprawling conglomerate is overly exposed the Dubai property market and has also seen its international assets plummet in value (Dubai International Capital is perhaps one of the worst performing funds). Mohamed Al Gergawi is chairman of the group, which is almost wholly-owned by Sheikh Mohamed Bin Rashid.

There have been major failures of management, financial discipline and risk management at these wholly-owned Dubai Inc organizations.

• Lack of centralized financial control;
• Lack of accountability;
• Massive conflicts of interests;
• An overly-acquiescent culture (Lack of hard questions asked – there is a yes-man culture at many of these organizations.

Most commentators saw a bubble forming in Dubai but all of the government’s actions only served to encourage the irrational exuberance. At root is a combination of a lack of experience (and basic economic understanding at the highest levels) and a void of constructively dissenting opinion (which stems from the local political structure). Solution = Transparency / Openness / Freedom of Speech (a space for genuine debate on local policies and strategies).

Tourism.
Dubai’s vision of becoming a hybrid Las Vegas / Florida for the region was running wildly behind schedule primarily due to Dubailand’s poor execution. That may prove to be in part a good thing – with developments of questionable value (Falcon City / Lyons in Dubai?!) possibly not happening. But again plenty of world-class infrastructure was or is close to being completed. The Jumeira properties, Emaar’s Downtown project, Dubai Festival City and the Atlantis are just a few of the tourism projects that successfully put Dubai on the map and will keep it there for years to come.
There was in parallel to the property over building but the medium term fundamentals for tourism in Dubai are still strong. Again an equilibrium will be reached where flight and hotel rates are cut enough to entice tourists back to Dubai. There may be a few casualties but I am sanguine about the sector’s systemic risk to the economy. Cutting hotel room rates is far less painful than reducing property prices.
The long term outlook for Dubai Airports and Emirates Airlines is more troubling. These are two of Dubai’s most successful and best-run companies. Unfortunately their success has attracted the attention of two deep-pocketed regional rivals. There’s not much to be done about Doha’s plans to become Dubai – or its good parts at least – but Abu Dhabi and Dubai have to rise above their petty tribal rivalry and coordinate their airline and airport plans. Dubai World Central was to be the world’s biggest airport and it was planned very close to the Abu Dhabi border.
Dubai should negotiate a takeover of Etihad and the World Central airport project should be moved across the border so that it serves both emirates (The mono rail project should then be connected to Abu Dhabi’s MRT plans and both should feed into an improved federal public transportation network).
If Dubai, Abu Dhabi and Doha deliver on their current plans, all three are probably doomed to material losses brought on by the inevitable resulting (massive) oversupply. Solution = Coordination / Consolidation.

Trade.
DP World is in uncharted waters. Loaded up with debt at a time when world trade is collapsing. From a recent FT article:

(For the first time in the 53-year history of container shipping, four months have now gone by without a single new order for new vessels, according to broker Howe Robinson.) But existing commitments still weigh heavily – operators are due to take delivery of ships with 1.1m new container slots this year, even though utilisation rates suggest 200,000 fewer slots are actually needed.

DP World is (alongside Emirates and Dubai) one of the true long-term assets but it operates in a cyclical industry that is about to enter an extended period of painful decline. The financial strength to see it out is paramount. Abu Dhabi could wait a bit and take DP World over at a bargain. At some point trade will resume – although that point seems nowhere in sight- and DP World will be well positioned to be one of the world’s dominant players. Whether or not it can wait it out alone financially until the recovery is a moot point.

Real Estate.
Dubai’s skyline is both its most impressive and most worrisome achievement.
The overbuilding is staggering and the government is responsible. Its policies and investments skewed the market resulting not just in oversupply but wrong supply too with a misguided and un-thought-out focus on the luxury and ultra luxury segments of the market. All the signs of overheating were summarily ignored. Instead the authorities kept adding fuel to the fire with each more audacious than the last project announcement. Crucially the subtly controlled local press was unhelpfully uncritical. Banks easily worked around the mandated limits of meant to ensure their exposure to real estate didn’t rise above 20% of their assets. The Quality of mortgage vetting was laughable (ask me, I have one). Speculators piled in (it seemed everyone in Dubai was playing the property market on the side). A riposte I hear is that the government was only reacting to market signals. After all inflation was rampant and the price of a property was the primary contributor. True, but had the government let the market react freely the building binge would not have been so focused on the high-end of the market where speculative behavior was focused.
Consolidation again will most likely be a feature of the solution to the property mire. The solvency of many small and medium sized developers must be in doubt. Even some of the larger developers (Damac, Dynasty Zarooni etc) are possibly beyond financial rescues. The official response has moved past the denial phase and steps are being taken to deal with the fallout.
So much of the recent growth in Dubai was directly or indirectly dependent on the real estate sector, that the turning point will only come once the sector stabilizes. Only once weak developers have failed and prices have bottomed, will the banks be able to fully address their re-capitalization needs in order to slowly resume lending again. When that point is reached, Dubai can set out once again attracting new business with what should be an attractive value proposition (low cost high quality infrastructure). Solution = Transparency.

Dubai.
As a friend who works at one of the government agencies said to me recently- “Dubai isn’t just the business capital of the UAE. It’s the business capital of the entire Middle East. To kids in Cairo and Damascus, Dubai is their capital – we cannot fail them“.
Dubai will not fail. It will adapt as it always has. Sure, it may not be the amalgam of all those tripped out CityScape models, but that’s to be welcomed.
Worryingly a rebuttal I increasingly hear in Dubai is the defensive Why are they picking on us? line. The world is experiencing a once in many decades contraction that has left no one unharmed. True, but Dubai has also made many mistakes (understandable for such a young city) along its magnificent growth trajectory. It would be a shameful waste if it didn’t take stock of them in order to emerge truly stronger (a crisis, after all, is a terrible thing to waste!). Dubai has always pioneered. It has single-handedly taught the Middle east how to dream and hope again after 2001.
The glitzy buildings have now been built (or half-built). It’s now time for the deep reflection of what went wrong and what we must learn to emerge stronger. A partial list:

• Embrace Transparency – Dubai needs to shake its secretive instinct;
• Update Soft Infrastructure (legal frameworks, bankruptcy laws, respect of rule of law, this sort of thing to be avoided);
• Institutionalize – Dubai is far too person-driven (scary thought experiment – imagine current ruler falls ill suddenly);
• Introduce Check and balances – Accountability;
• Free press. Worryingly the country seems to be moving in the opposite direction here;
• Define roles of government and government entities

Recommended: DubaiCan’s Dubai RIP : Don’t Bet On It.

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