Dubai: crisis and recovery

Last month, Dubai Government announced a long-awaited restructuring proposal for Dubai World’s $23.5bn debt. In a move widely welcomed by local and international markets, the Government will inject $9.5bn into Dubai World, out of which its property development subsidiary Nakheel will receive $8bn. The capital injection will facilitate Dubai World’s restructuring of its activities with a new business plan that will enable it to repay the remaining $14bn in debt over an extended period of five to eight years.

The proposal effectively removes the cloud of uncertainty that has been hanging over local and regional financial markets since November 2008 and significantly restores investor confidence in Dubai. The restructuring proposal will reduce the risk premium that investors have been demanding from regional borrowers. Encouragingly, following the announcement, Dubai’s credit default swap (CDS) dropped to its lowest level in four months.

A main message emerging from the restructuring proposal is that the Government has treated both foreign and local creditors equitably and fairly, without discrimination, a clear refutation of some misinformation. The negotiated proposal took into account the interests of all stakeholders. For creditor banks the proposal offers a highly manageable solution, as the restructuring proposal does not entail any ‘haircuts’ on the value of debt, which would have led to provisioning- dreaded by banks.

Transparency and clarity of ownership had been one of the biggest concerns raised since the proposed debt standstill. The conversion by Dubai Government of $8.9bn of debt and claims - representing 38% of the total amount of standalone debt and guarantees of Dubai World - into equity, effectively answers questions on ownership.

Significantly, it was the government of Dubai that absorbed the burden of the debt-equity conversion, and not the private sector, unlike the case with many recent restructurings around the world. The move clearly demonstrates Dubai’s commitment to supporting the success of its state-owned companies, a mainstay of its economic development strategy.

The debt-equity conversion gives Dubai World and Nakheel a stronger equity base and sound financial footings that allows them to proceed with organisational (initiated with the set-up of a new Nakheel Board) and operational restructuring.

One of the more important lessons from this episode is the need to avoid maturity mismatches arising from long gestation projects (such as the Palm) being financed with short-term money and subsequently facing rollover risk and the need for strengthened corporate governance, better financial controls and risk management.

The news and implementation of the DW financial restructuring will have a positive impact on the outlook for the broader UAE and GCC economy, due to the reduction of investor uncertainty and overall macro-economic risk. Improved economic prospects, along with the fact that creditors were not subject to ‘haircuts’ means that banks will not have to take as many provisions on their balance sheets as previously expected. As a result they will have greater ability to lend. Reduced uncertainty will lead to greater credit growth, which will stimulate economic recovery and expansion.

Viewed from a national perspective, the restructuring proposal, has once again demonstrated the strength of the UAE’s Federal fabric, a refutation of the politically motivated doubting voices. Abu Dhabi’s support for Dubai’s public debt programme has reinforced national unity and shown the Federation’s collective determination to withstand the challenges brought about by the international financial crisis and its efforts to promote more stable and balanced growth.

We are witnessing a confirmation of and moving towards greater federalism. The restructuring proposal will inspire more confidence in Dubai’s and UAE’s ability to deal with the challenges brought by the global economic crisis

Nevertheless, there are lessons from the DW episode to be learned for Dubai and the countries of the region. Dubai World’s debt crisis has highlighted critical gaps in the UAE’s legal and regulatory infrastructure. The GCC, Middle East & North Africa region countries lack modern insolvency framework that can facilitate the restructuring and reorganisation of companies and adequately protect creditors’ rights. Modernisation and reform of the region’s insolvency framework should now be addressed as a policy priority.

The crisis has highlighted the urgent need to invest in the development of local currency money & debt markets which can provide an alternative source of financing for development needs. Active and liquid local currency debt markets can help in ensuring more stable access to capital by local and regional companies and governments. Debt markets can provide infrastructure and development projects, like those of Dubai World’s, more appropriate for longer-dated types of financing than banks.

In the same vein, the positive action by the Dubai Government needs to be followed up with an open communication policy based on strengthened corporate governance practices and increased transparency and disclosure for State Owned and Government Related Enterprises.

Looking back at the last four months, the reaction caused by Dubai World’s debt restructuring announcement is best described as a “storm in a tea cup.” The facts are that the UAE, the GCC and the MENA region countries with access to international capital markets have never defaulted on their debts and obligations and have much stronger economic fundamentals than those of so-called ‘advanced countries’ which were addressing criticism and ‘advice’.

So why the doubts and invidious questioning? One concludes that much of the media hype is politically motivated. Dubai’s Arab economic success story as a multi-cultural, multi-ethnic and multi-religious hub and melting pot is clearly not to the liking of some countries with different geo-strategic ambitions and outlooks and of some of the countries that were actively promoting the interests of their own companies against those of Dubai and DW.

Dr Nasser Al Saidi is chief economist at the DIFC Authority.