DUBAI DEBT

CRISIS: Is it
casino
capitalism

or

free-market
enterprise?
Is it the end of a dream or is
the sun setting on Dubai?
Let us analyse the events, the
background thereto and their
impact on markets in general
with specific reference to
India.

Rama Krishna Vadlamudi November 29th, 2009

If one word epitomizes the last week’s world events, that is, CRASH. The
week started with a crash on Tuesday, November 24th, in the official home
of the world’s most powerful CEO, that is, US president, Barack Obama.
Then we have witnessed another crash following the Dubai desert
sandstorm that was on Thursday. And the third was yesterday, in Russia.
On Tuesday, Barack Obama hosted a state dinner at the White House for
India’s Prime Minister. Escaping the scrutiny of Secret Service of the White
House, a couple gatecrashed into the White House and had a photo op
with Barack Obama and his deputy Joe Biden stunning the world. So, even
the impregnable White House also seems to be vulnerable to a socialite
gatecrashing couple, Tareq and Michaele Salahi from northern Virginia.

Rama Krishna Vadlamudi, BOMBAY www.scribd.com/vrk100 Nov. 29th, 2009 Page 1 of 9

On Thursday, we heard that Dubai Government wanted to postpone
repayment of its debt, through its investment arm-Dubai World, by six
months. This has sent shock waves across the world’s markets – stock as
well commodities. The Asian markets have lost between two and five per
cent. While India’s Sensex crashed by over 950 points on Thursday and
Friday, but recovered 400 points during mid-day to lose around 550 points
in two days and ended at 16,630 on Friday.
Yesterday, media flashed news of another crash. This time it was a train in
Russia that got derailed after suspected terrorists planted explosives on a
track between Moscow and St. Petersburg. In this crash, more than 40
passengers were killed.
Three crashes in as many days and what a week it turns out to be! While
the other two crashes have no impact on financial markets, it’s with the
Dubai crash we are most concerned with at this point of time. It seems no
one, including the all-powerful and ubiquitous US president, is immune
from such crashes. And so are, Indians!
Let us analyse the events, the background thereto and their impact on
markets in general with specific reference to India.
But, before that:

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 What triggered the present debt crisis in Dubai?

Why does such a tiny city-state Dubai attract so much attention of the world
media last week? This is a baffling question for many investors across the world.
Dubai till Thursday was seen as an ‘Oasis of Opportunity’ by many in the world.
Dubai encapsulates free-market economy providing excellent living conditions for
foreign employees and workers, with seven-star luxury for the rich classes, zero
tax rates for businesses, numerous opportunities for the financial markets, offers
superb port facilities, and a safe haven for criminals and the like. That was till
Thursday, when the Dubai World, an investment arm of the Government of
Dubai, had announced that it wanted to postpone its debt obligations by six
months. This has come as a rude awakening for investors, who were in a state of
lull till last week at their own peril.
This has unnerved financial markets across the world and had ripple effects on
Europe, Asia and the US. The delay in payment obligations is seen as equal to
debt default by many in the world. As we know, lenders don’t like such nasty
surprises. Till last month, the Dubai Sheikh was assuring that all was well there.
State-owned Dubai World is a holding company having investments in a host of
businesses. It has a debt of around USD 60 billion (out of the country’s total debt
of USD 80 billion) and it invested heavily in property development across Dubai
through its subsidiary, Nakheel. The latter is building properties, like, The World,
Palm Jumeirah, etc, on the sea. Dubai World, till now, was the mainstay of
Dubai’s economy. Dubai does not get much revenue from oil. It depends on
financial dealings, trade, tourism, property development, etc. It has built its
edifice on debt and now with the credit crunch across the world following global
financial meltdown, it is reeling under debt. The property bubble burst at last with
prices in Dubai crashing by more than 60 per cent putting an end to rampant
speculation. Dubai attracted international attention for its property development
and luxury tourism, embodied in seven-star hotels, like the Burj al-Arab.
Till now, it was assumed by international investors (may be, naively) that Abu
Dhabi would rescue Dubai with funding. Abu Dhabi is the richest emirate among
the seven emirates in the loose federation of the UAE. It funded Dubai to an
extent of USD 20 billion in February this year. But, this time, Abu Dhabi is silent.
There seem to be some differences between the rulers of Dubai and Abu Dhabi
Kingdom.
The crash in property prices in the world following the US sub-prime crisis has its
severe impact on Dubai’s property prices. It is reported in the media that Dubai
used to command double the rates of Mumbai till 2008. But now, it seems, Dubai
property prices are much lesser than Mumbai property prices – with Hiranandani
Group in Mumbai claiming that Dubai is attractive for property investment now!

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What we have seen following the Dubai fiasco is that we all live in an increasingly
globalised world. Any thing that may happen in some remote corner of the world
may come and hit us in the face, that too at a wrong time. As such, investors
need to be cautious about their investments in this truly globalized world.

What is the impact on Foreign Banks?

British banks, Barclays, HSBC, RBS and Standard Chartered Bank have heavy
exposure, to an extent of up to USD 30 billion, to Dubai and these banks may be
impacted severely by the problems associated with the debt crisis in Dubai
World. Citigroup too seemed to have heavy exposure to Dubai World. And it may
face some sort of default risk.

Will there be light at the end of the tunnel?

Kingdoms of Abu Dhabi and Saudi Arabia may come to their rescue, it is hoped.
Because, these countries have their own interests in propping up Dubai’s
economy. Several Abu Dhabi banks have invested heavily in Dubai. Media
reports indicate the Abu Dhabi would come to the aid of Dubai, on a ‘case-by-
case basis.’ If they do that, this is an optimistic trigger for Dubai World. After all,
Abu Dhabi may not be willing to give a ‘blank cheque’ to Dubai.

What is the impact on Indian Economy?

A large number of Indian workers, especially from Kerala, work in Dubai. To that
extent, the inward remittances from them may come down. Some construction
workers are likely to lose their jobs in Dubai. It may have some repercussions on
Kerala’s economy, which is substantially dependent on Gulf money. Since the
global financial meltdown, many low-paid workers in the Middle East have
already lost their jobs. The Dubai debt crisis may further worsen their woes.
India’s property markets have deeper links to Dubai and Indian real estate may
bear the brunt of Dubai’s financial woes, even though many property developers
are denying any such problem. India has got significant exposure to Dubai
through exports and imports. Even gems and jewellery industry may be impacted
negatively with many Indian firms having links to Dubai’s world-famous bullion
markets. A substantial portion of India’s inward NRI remittances come from UAE.

Rama Krishna Vadlamudi, BOMBAY www.scribd.com/vrk100 Nov. 29th, 2009 Page 4 of 9

 What is the impact on Indian Ports?

DP World is a Dubai-based port operator and it is the world’s fourth largest port
operator. It has got a market share of 40 per cent in India’s container traffic. And
it operates container terminals in Nhava Sheva, Kochi, Chennai, Mundra and
Visakhapatnam ports. It is also setting up terminals in Kulpi and Vallarpadam.
The company invested over USD two billion in India and it planned to spend
another USD 12 billion in India in the next five years. DP World is a subsidiary of
Dubai World, which is caught in the debt trap. DP World operates 45 terminals in
29 countries. Some experts opine that the travails of the parent may not have
any significant on DP World’s India operations.

How are Indian Banks affected by the present crisis?

Bank of Baroda : Bank of Baroda has some real estate exposure to Dubai
accounting to around five per cent of its loan book, but its CMD says there won’t
be any impact. The bank’s CMD added that the bank also has exposure in Abu
Dhabi , Ras-Al-Khaimah and Bahrain . Out of the bank’s total loan book of Rs
150,000 crore, Dubai accounts for Rs 4,000 crore. BOB has six branches in the
UAE. Bank’s total exposure to real estate projects in UAE is around Rs 600
crore. The bank claims it does not have any exposure to Nakheel – the real
estate arm of Dubai World.

State Bank of India: The bank has an exposure of Rs 1,443 crore or 0.2 per
cent of total assets in the UAE, which the bank claims as insignificant.

Even as banks are denying that they will be impacted materially by the present
Dubai debt crisis, RBI has directed banks to reveal their exposure to Dubai
World.

What is the extent of Indian companies’ exposure in Dubai?

3i Infotech

The company says it has an office in Dubai, but has no exposure to Dubai World.
Its Dubai office oversees operations in other countries. However, if the Dubai
crisis spreads to other parts of UAE or Middle East countries, then, it may have
some impact on the company.

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Aban Offshore: The oil exploration company has deployed six rigs in West Asia

DLF : According to the company, it had not exposure to Dubai real estate.

Emaar MGF: The company denies any impact of Dubai crisis on its India
operations. However, it may have some repercussions in its plan to come out
with an IPO in India in the next few months. It has already submitted a
preliminary draft prospectus with SEBI for its forthcoming IPO.

HDIL: According the company, it has no exposure to Dubai.

Hiranandani Group: The chairman of the Group said that the unlisted group is
constructing a project in Dubai, 97 per cent of which was already sold and 65 per
cent payment had been received. He added that Indian property prices should go
up because of the Dubai market crash.

Indiabulls Real Estate: According to the company, it does not have any
direct/indirect investment in Dubai and West Asia.

Larsen & Toubro : L&T has around Rs 90-115 crore exposure, in the form of
receivables, from its clients in Dubai, mainly in civil construction. Larsen &
Toubro’s total exposure to the Middle-East over the last two years is to the tune
of USD 200 million. Overall, the Dubai Crisis may not materially impact L & T’s
earnings or profitability.

Nagarjuna Construction Co Ltd: The company has got one venture in Dubai, a
440-apartment project worth Rs 1,500 crore and it seems to be going slow on it.
And the company has got another venture, a water pipeline project in Dubai
worth around Rs 100 crore.

Omaxe: The company wanted to invest Rs 2,850 crore in Dubai and now it may
exit the real estate projects there. The company already paid Rs 50 crore to
Nakheel as first instalment and however it is yet to get possession of the land.

Punj Lloyd: The company claims it has no exposure to Dubai. The company is
doing some oil and gas projects in Abu Dhabi where there are no concerns, it
claims.

Rolta: Anaysts believe the events in Dubai may have some revenue implications
for the company.

SPICEJET: Dubai Government-owned Isthimar owns 13 per cent stake in

Spicejet.

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Unitech : According to the company, it had not exposure to Dubai real estate.

Voltas : The company is executing a Rs 900-crore project in Dubai for Emaar

and the client has fully funded the project, according to the company. Voltas’
order book primarily comes from Abu Dhabi and Qatar.

Note: Please note the above list of Indian companies is only illustrative, but not exhaustive.

What lessons have we learnt from previous crises?

The world has gone through such sovereign debt crises in the past from several
countries. The recent one is Argentina. At the end of 2001, it defaulted on its
foreign debt of around USD 80 billion. The country devalued its currency at that
time. Argentina, which defaulted on its foreign debt at the end of 2001, bounced
back in relatively less number of years. Of course, the fall in the value of
Argentine peso, helped revive the country’s export markets and this in turn gave
the country’s GDP a big boost. The peso was pegged to the dollar at one-to-one
rate for a decade till January 2002, when the peg was removed after the
country’s forex reserves dwindled completely. Later, the peso collapsed to an
exchange rate of three pesos against the US dollar.

Previously, in August 1998, Russia defaulted on its external payments in

dollars. The default was precipated by the collapse of oil to USD 11 a barrel, the
lowest in 25 years in 1998. The collapse of central planning system in the then
Soviet Union also did not help the economic matters either. Earlier in July 1998,
IMF announced a USD 23-billion package for Russia and after receiving first
instalment from IMF, Russia declined to honour the conditionalities of IMF.
Russian central bank withdrew its support to the ruble and the local currency fell
by 38 per cent overnight. Later, IMF also withdrew its Russian package.

The shock waves from Russia reached across the Atlantic and hit Wall Street
strongly and led to the collapse of LTCM, Long Term Capital Management, a
successful hedge fund floated by three Nobel economic laureates and became
well known for its state-of-the-art trading strategies in derivatives based on
complex mathematical models using computer-aided algorithms. LTCM, before
its dramatic collapse, was managing assets worth USD 125 billion. It had a gross
exposure of USD 1.25 trillion in derivatives. As US Fed chairman, Alan
Greenspan, had come to rescue the stakeholders in LTCM through a gradual
winding of derivatives positions over a prolonged period. LTCM’s collapse led to
flight of safety by investors and who lapped up the US treasury securities heavily
forcing the US bond yields to go down dramatically. The Fed worked feverishly
with the top officials of 16 of the world’s most powerful banks and investments
houses and facilitated the gradual liquidation of LTCM’s assets.

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The Fed received brickbats from the US Congress for its unusual and
unprecedented intervention in the LTCM collapse. This is a classic case in Risk
Management or rather the lack of it. Still, bankers do not seem to have learnt any
lessons in Risk Management. These kind of recurring debt crises tempt one to
conclude that bankers, in general, are poor at judging systemic risks.
The story did not end there. The price of oil and natural gas rebounded in the
early 2000s and it was an excellent opportunity for Russia to rise like a Phoenix
from the ashes. Its forex reserves touched USD 300 billion by 2007 from a low of
USD 10 billion in 1999. The Russian government had paid off its foreign debt
substantially.

What is in store for Dubai?

The consensus opinion at this point of time is that the present sandstorm in
Dubai may not be a serious threat to the world’s financial system. After all, when
they could absorb thousands of billions of dollars, why not a mere USD 60 billion,
some argue. But the global financial markets are more worried that other
countries, like, Ireland, Greece, which are heavily indebted may suffer terrible
consequences. Such kind of repercussions is the real worry for the markets.
It is, however, feared by some that Dubai government could go bankrupt if it does
not receive support. Everyone in the markets thought that, in the end, the federal
government in Abu Dhabi would stand by all of Dubai's bad bets. But Abu Dhabi
is watching the events closely and carefully. It's also worth noting that Abu Dhabi
itself owns a large chunk of Dubai World bonds. Latest media reports suggest
that Abu Dhabi Government will come to the rescue of Dubai on a “case-by-case
basis.” This may assuage the raw nerves of financial markets to some extent.
However, Mark Mobius, Franklin Templeton, cautions that stock markets may
lose up to 20 per cent due to the rise in risk aversion following the Dubai crisis.

What is rattling the markets, however, is the lack of information from Dubai
Government about its future course of action except some rhetoric from the
rulers. Rescheduling debt itself may not tantamount to debt default, per se.
Russia defaulted in 1998 which led to the collapse of LTCM and the US Fed led
by Alan Greenspan had to rescue other US banks in a bailout that is structured
innovatively. Even Argentina, which defaulted on its foreign debt at the end of
2001, bounced back in relatively less time aided by a hugely devalued local
currency as described above.
As we have learnt from the Russian and Argentine crises, such extreme debt
crisis situations present an opportunity for the policy makers to fix their
economies and bounce back in style. It remains to be seen whether Dubai will
take this an opportunity to correct its past excesses. In fact, at some point of
time, Abu Dhabi may help Dubai in a substantial way. There lies the optimism for
Dubai in future.

Rama Krishna Vadlamudi, BOMBAY www.scribd.com/vrk100 Nov. 29th, 2009 Page 8 of 9

References:

1. “The Age of Turbulence: Adventures in a New World” by Alan Greenspan

2. “When Genius Failed: The Rise and Fall of Long-Term Capital Management” by Roger
Lowenstein

More on the collapse of LTCM, a classic case of total

failure in Risk Management…

Sourced from Amazon.com:

On September 23, 1998, the boardroom of the New York Fed was a tense place. Around the table
sat the heads of every major Wall Street bank, the chairman of the New York Stock Exchange,
and representatives from numerous European banks, each of whom had been summoned to
discuss a highly unusual prospect: rescuing what had, until then, been the envy of them all, the
extraordinarily successful bond-trading firm of Long-Term Capital Management. Roger
Lowenstein's When Genius Failed is the gripping story of the Fed's unprecedented move, the
incredible heights reached by LTCM, and the firm's eventual dramatic demise.

Lowenstein, a financial journalist and author of Buffett: The Making of an American Capitalist,
examines the personalities, academic experts, and professional relationships at LTCM and
uncovers the layers of numbers behind its roller-coaster ride with the precision of a skilled
surgeon. The fund's enigmatic founder, John Meriwether, spent almost 20 years at Salomon
Brothers, where he formed its renowned Arbitrage Group by hiring academia's top financial
economists. Though Meriwether left Salomon under a cloud of the SEC's wrath, he leapt into his
next venture with ease and enticed most of his former Salomon hires--and eventually even David
Mullins, the former vice chairman of the U.S. Federal Reserve--to join him in starting a hedge
fund that would beat all hedge funds.

LTCM began trading in 1994, after completing a road show that, despite the Ph.D.-touting
partners' lack of social skills and their disdainful condescension of potential investors who
couldn't rise to their intellectual level, netted a whopping $1.25 billion. The fund would seek to
earn a tiny spread on thousands of trades, "as if it were vacuuming nickels that others couldn't
see," in the words of one of its Nobel laureate partners, Myron Scholes. And nickels it found. In
its first two years, LTCM earned $1.6 billion, profits that exceeded 40 percent even after the
partners' hefty cuts. By the spring of 1996, it was holding $140 billion in assets. But the end was
soon in sight, and Lowenstein's detailed account of each successively worse month of 1998,
culminating in a disastrous August and the partners' subsequent panicked moves, is riveting.

The arbitrageur's world is a complicated one, and it might have served Lowenstein well to slow
down and explain in greater detail the complex terms of the more exotic species of investment
flora that cram the book's pages. However, much of the intrigue of the Long-Term story lies in its
dizzying pace (not to mention the dizzying amounts of money won and lost in the fund's short
lifespan). Lowenstein's smooth, conversational but equally urgent tone carries it along well. The
book is a compelling read for those who've always wondered what lay behind the Fed's
controversial involvement with the LTCM hedge-fund debacle.

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