1 The Firecracker Report
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November 27, 2009Dubai Default Examined: Serious Implications for the Global Risk Trade, Especiallyin Emerging Markets
This year's Thanksgiving turkey has arrived as a dud. While the U.S. markets were closedover the holiday, Dubai managed to pull the rug from under the global risk trade byannouncing a 6 month moratorium on the debt of Dubai World. The state-sponsored DubaiWorld is an umbrella company that houses a portfolio of businesses, including Nakheel - thefamous real estate developer of the Palm Islands.The debt fueled real estate expansion of Dubai World has resulted, in it accumulating astaggering $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 theappointment of a restructuring officer and has asked debt holders of Dubai World andNakheel to agree to a debt
“standstill”
as well as the extension of all maturities until May2010. 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 marketsinvestors is the problem of non-transparency and Dubai has proved to be noexception.
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 thestate itself) do and say another. AsThe Financial Times Middle East editor RoulaKhalaf 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 theexcesses of the pre-financial crunch days, would meet the obligations of the
companies in which it has stakes, and that Nakheel‟s $4bn de
bt due in Decemberwould be repaid.As always, though, the problem in Dubai is that no one had all the facts, and perhapssome 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 tha
t 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 explicit
ly say that the repayments would be madeon time.Moreover, the recent prospectus to test market appetite for government bonds saidthe government was
“not legally obliged” to meet the obligations of related
2 The Firecracker Report
entities
–
but might at its sole discretion decide to extend such support. [Now wherehave 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 debtladen cousin Dubai. Most investors were under the assumption that in the event of acrisis, Dubai
‟s oil rich neighbor Abu Dhabi was sure to give a helping hand.
And whynot? After all, there was real basis for this assumption - the ruler of Dubai SheikhMohammed 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 furtheron this relationship with Abu Dhabi, he told critics
to “
” .
“
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 havedecided to stick it to the bond holders together. Incidentally the markets were sotaken 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!). Atthe time of this writing they had fallen to ~70.3.
Debt Funded, Real Estate Driven Economic Expansion:
Over the last few yearsDubai rose as a shining city in the desert, with its debt fueled economic expansionbased on three main industries: real estate, shipping and tourism. With the unfoldingof 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 emergingmarkets. Thus far at the time of the writing of this report, the risk trade has begununwinding with Asian markets having taken a huge hit and S&P futures down over 40points. 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 Dubaiannounces a rescue plan for bondholders on Monday - unlikely in our opinion). It will beinteresting to watch how far the U.S. Dollar index rallies in the coming days - whether itbreaks 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 swingas an opportunity to add to our position in physical gold as well as look for entry positionson some high dividend paying stocks like Verizon and AT&T.
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Dubai Default Examined: Sheikh Gave Fake Pep Talk as Recently as Nov 10
Dubai has managed to pull the rug from under the global risk trade by defaulting on its debt and announcing a 6 month moratorium on debt payments of Dubai World its prized congl...
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