hat would be the impact of the Dubai meltdown on Pakistan? For several years now Pakistan has drawn closer to the Gulf States as sources of fi- nance. That happened as other financial and capi- tal markets became increasingly shy of putting money into Pakistan. In 2008, the UAE provided 20 per cent of the total foreign direct investment that came to Pakistan. Dubai had agreed to participate actively in the financing of several mega projects launched by the Musharraf government. Their total cost was estimated at $36 billion.
FOR a number of years Dubai’s model of economic development seemed to be a spectacular success.
Among its main elements was competition among the several companies owned by the state; the decision by the managers of these companies to invest in the service sector, thus leap-frogging into the most dynamic part of the global economy; to leverage these investments by borrowing abroad, often using the sukuk, an Islamic bond, for this purpose; and the belief that, in case of financial difficulties, Abu Dhabi, the emirate’s oil rich neighbour, would come to its rescue.
The economy was centrally managed with the full involvement of Sheikh Muhammad bin Rashid alMaktoun, the head of Dubai state. The sheikh had been personally involved in encouraging the development of many projects in Dubai and was convinced that by turning the emirate into an airline hub, a tourist attraction and an educational and health centre for the region, he would give a non-oil base to the economy.
Initially, there was concentration on developing housing and office space in Dubai. However, the economy came under considerable strain when real estate prices fell by 40 per cent, repeating the pattern seen in other highly leveraged world economies. This put a tremendous strain on the highly leveraged Dubai firms.
The announcement on November 26 that Dubai World, the emirate’s flagship company, will default on its $3.5 billion bond due for maturity on December 14, 2009 shook the world of finance. The state owned company was struggling under the burden of $59 billion in liabilities. Dubai’s total debt was estimated at $80 billion, equal to its gross domestic product. The unexpected action by the government sent shivers down the spines of the international financial and capital markets. It will also have profound consequences for Pakistan, a country that had become increas ingly integrated with the economies of the Gulf states. I will get to the likely impact on Pakistan later in this article.
In announcing the decision, Dubai government did not use the word “default”; it called it “debt standstill” and asked that the creditors they will need to accept a six months moratorium on the payments on the bond. In the world of finance a failure to make payments on time is called default. It is no wonder that the action by Dubai had such an impact on the global markets.
According to one analyst, “the restructuring of Dubai World’s debt has been in the works for some time, but investors had grown confident that the Islamic bond, or sukuk, guaranteed by the stateowned company would be treated separately and would be paid off to maintain confidence in the trade and finance-oriented economy.” It appeared that the government was working to ward off the possibility of default. The department of finance had issued $5 billion bonds from two Abu Dhabi-controlled banks. But the government made clear that the resources raised would not be used to pay the Nakheel bond. That may have been a requirement of the Abu Dhabi government, the oil rich and more conservatively managed sister state of Dubai.
These bond issues were one-half of the second tranche of $10 billion that the Dubai government is raising after borrowing $10 billion from the United Arab Emirates central bank in February. Apparently officials in Abu Dhabi – the country that is acting as the lender of last resort for its financially troubled neighbour – were not aware of the default decision. There was considerable consternation in Abu Dhabi’s official finan cial circles.
According to one London based fund manager, “it’s good that Abu Dhabi isn’t going to support every white elephant in Dubai. It’s a hard but a correct decision. It would have been irrational to write the cheque for Nakheel.” Abu Dhabi sits on nine per cent of the world’s oil reserves and manages the world’s largest sovereign wealth fund but was not prepared to finance its sister state’s extravagant ways.
Sheikh Ahmed bin Saeed Al Maktoum, chairman of the Supreme Fiscal Committee, said: “While the government understands the concerns of the market and the creditors, it had to intervene because of the need to take decisive action to address its particular debt burden.” He said that the payment moratorium was needed to restructure Dubai World and place its business on a sound footing. The main problem with the company was the aggressive play by Nakheel, a property company, a subsidiary of Dubai World. The cost of insuring Dubai’s debt jumped to five per cent a year.
Restructuring of Dubai world would involve considerable pain, including the scaling down of some of the expensive properties owned by the subsidiary companies of Dubai World as well as the sale of some of the properties acquired in some of the world’s more prestigious addresses.
Istithmar, the investment arm of Dubai World, owned a number of prime properties around the world including some in London and New York. These will probably be offered for sale as a part of the restructuring of the parent company. More problematic will be the properties Nakheel has developed in Dubai including Palm Jumeirah, the first of three artificial islands off the Dubai coast and the acquisition of Q2 luxury liner which will be anchored outside Dubai and become a hotel. The liner has as yet to make it to Dubai; it has been diverted to Cape Town and will serve as a hotel for the World Cup football contest in that city in 2010.
What would be the impact of the Dubai meltdown on Pakistan? For several years now Pakistan has drawn closer to the Gulf States as sources of finance. That happened as other financial and capital markets became increasingly shy of putting money into Pakistan. The UAE investment community was less shy and was prepared to bring finance into Pakistan. This was particularly the case in the sectors in which the Gulf States had gained some experience. These included banking and real estate.
Heavy investments were made in these two sectors of the Pakistani economy by the public and private companies in the Dubai and Abu Dhabi. The UAE investment in Pakistan is estimated at $13.1 billion. In 2008, the UAE provided 20 per cent of the total foreign direct investment that came to Pakistan. Dubai had agreed to participate actively in the financing of several mega projects launched by the Musharraf government. Their total cost was estimated at $36 billion.
Shunned by western airlines, a number of Gulf carriers had aggressively penetrated the Pakistani market. The Dubai problem, however, will make the investors from the Gulf more weary of taking risks in a country faced with numerous crises including a security situation that is keeping away the Westerners from the country. In fact, I had come to believe that Pakistan could play the role of a bridge between the oilrich countries of the Middle East and China to its east and India to its south. Such ambitions may to be put on hold while Dubai comes to terms with its new economic situation.
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