Is There Another Dubai on the Horizon?

Dubai has forged a reputation as the “wild child” of the seven emirates that make up the United Arab Emirates (UAE). For the past decade, Dubai World – Dubai’s state-owned investment company – has helped launched countless mega-projects, including the infamous, man-made “palm tree” islands. For many outsiders, Dubai exemplified the excesses available only for those with access to limitless oil money, so with oil prices again on the rise, how could Dubai suddenly find itself in the middle of credit crisis?

Assuming that oil was funding Dubai’s development, would be your first mistake – Dubai, in fact, has very little oil of its own. It has relied on its membership with the UAE and ruling emirate Abu Dhabi (which does have huge supplies of oil) – as the means to obtain billions in international loans to back its lavish lifestyle. Sadly for Dubai’s jet set, the credit taps were turned off some time ago, and the inability to find new lenders and investors to make up the shortfall means the parties could be on hold for awhile.

Dubai’s Credit Crunch

Last week we learned that the glamorous hotels and sparkling attractions were essentially mortgaged to the hilt and Dubai World was in danger of falling into insolvency. A hastily arranged press release announced that Dubai World was seeking a six-month moratorium on some of its debt repayment obligations even as it frantically tried to refinance $26 billion of the estimated $60 billion the agency owed. Naturally, this sent shockwaves through the markets as analysts tried to determine the potential exposure for international banks – particularly UK-based banks which are known to have lent billions.

Further shockwaves resulted when Dubai’s government initially refused to guarantee Dubai World’s debts, and as a result, Standard & Poors quickly cut the credit rating of several Dubai-based investment companies to “junk” status; four banks were also downgraded. The swiftness of the response by the international community seems to have registered with UAE authorities, who have since created a lending facility to ensure that banks in the region have sufficient operating capital. The UAE government – led by Abu Dhabi – has also signaled a willingness to cover the debts saying that it is not willing to allow Dubai’s credit problems to drag down the economy of the entire UAE. Not exactly a ringing endorsement or pledge of support perhaps, but it seems to have been sufficient to soothe investor anxiety and has helped the region’s stock markets reverse earlier losses.

Where is the next Dubai?

The suddenness of Dubai’s credit issue hit the news in spectacular fashion, but in the past two years, we have seen several other countries requiring a quick infusion of capital to remain solvent. The numbers were not as dramatic perhaps as we saw with Dubai, but Hungary and the Ukraine both received US$16.5 billion in emergency funding from the International Monetary Fund (IMF) just over a year ago. This was followed by a $US30.1 billion bailout for Romania and US$2.6 billion to keep Latvia from going under. Eyes are now turning to what many feel could be the next candidate for emergency funding – Greece, and once again, it is a reliance on borrowed money to cover rising expenses that could prove to be Greece’s Achilles Heel.

In 2009, Greece’s credit rating was downgraded because of the country’s mounting debts, and this drove up the cost of insuring its government bonds, adding further to the nation’s rising debt. This even became a central issue in the election earlier this year, resulting in the ruling government’s removal from office in favor of a new government that pledged to cut the operating deficit.

However, even with a new deficit reduction program in place, Greece still suffered a budget shortfall equal to more than 9 percent of the value of its Gross Domestic Product (GDP)*. This is in direct violation of the European Union rule limiting yearly deficits to no more than 3 percent of GDP; in addition, Greece’s total debt is more than 90 percent of its GDP.

But it’s really not fair to single-out Greece as the US actually has a higher deficit-to-GDP ratio in excess of 12 percent, and its debt ratio is almost as bad as Greece at 87 percent. Italy, actually has a debt-to-GDP ratio of 115.3 percent while Japan has a ratio that is positively in the stratosphere at 217 percent! On the other side of the scale, we have Australia and China with current debt-to-GDP ratios of 11.3 and 19.8 percent respectively.

Now, I am not suggesting that Japan or the US could fail. Yes, debt loads for both countries are extraordinarily high, but economies of this size have the capacity to deal with a debt crisis if forced to act. The US for instance, could slash its spending or raise taxes, but either of these options would be political suicide, so they will not be considered unless absolutely necessary. I have no doubt that we will reach that point someday, but for now, these remedies are not being considered.

I do believe that one or more countries will require emergency funding within the next year to meet its obligations. It could be one of the countries already discussed, or maybe one of several others struggling to deal with compounding debt, but I have no doubt that as long as it remains difficult for some of the smaller countries to maintain affordable credit lines, there will be more victims.

* Debt ratio information taken from the International Monetary Fund’s 2009 World Economic Outlook

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