Fears over Dubai’s ability to service its debts led Abu Dhabi finally to stage a marked response at the weekend. In a ‘lender of last resort’-type move the emirate bought $10bn of Dubai bonds to help its neighbour raise funds.
As Bloomberg reports, the market responded very positively to the action:
Feb. 23 (Bloomberg) — Dubai shares jumped as the United Arab Emirates’ central bank bought $10 billion worth of bonds issued by Dubai after the emirate struggled to raise funds amid a global credit squeeze that ended its real-estate boom. Emaar Properties PJSC, the U.A.E’s biggest real-estate developer, climbed the most in more than a month. Dubai Islamic Bank PJSC rose for the first time this week and Dubai Financial Market PJSC also advanced. The U.A.E. central bank bought half of an unsecured, $20 billion, 5-year notes issue at an annual interest rate of 4 percent.
“This is the kind of support the market was looking for,” said Rami Sidani, who manages $250 million as head of Middle East and North Africa investments at Schroders Investment Management Ltd. in Dubai. “The market was pricing in the probability of the whole economy going bankrupt, which is a misunderstanding of the relationship between Dubai and Abu Dhabi.”
However, that’s only part of the story. Corporate to bank deposits are still too high, while interbank interest rates are too high compared with the rest of the region. As highlighted by the UAE central bank governor’s speech on Thursday, loans and advances on a gross basis also still exceed customer deposits by AED116b.
The $10b bought by Abu Dhabi is only half of the $20b full Dubai corporate bond issue, and there’s no news yet on the uptake of the remaining sum.
However, the positive signal is that the emirates are working together, according to Standard Chartered, especially as some had feared Dubai’s desire to appear fully autonomous could get in the way of any such package. Nevertheless the bank says:
The launch of the Dubai bonds is another move by the government to assure the markets that the emirates are working together. There has been concern surrounding Dubai’s ability to pay its debts. The bond issuance, with USD 10bn already purchased by the central bank, gives Dubai the ability to refund all its needs for this year, which we estimate at USD 14bn. We expect markets to respond positively.
That said, relying on Abu Dhabi to bailout Dubai is perhaps false logic. Abu Dhabi, is certainly in a significantly better position. That’s not to say it isn’t facing its own pressures. For one, the emirate already injected cash into its own banking system earlier this month. Fitch interpreted this as a plan to enable Abu Dhabi projects to continue as planned, as well as to provide a cushion for potential future problems in loan books, in particular real-estate related exposures.
This makes sense in so much as the emirate, just like Dubai, is heavily dependent on incomes sourced from a foreign labour pool, something which would risk severe contraction if projects were scrapped. As Standard Chartered warned in January:
The biggest risk facing the UAE economy is related to its labour market. With the majority of the labour force made up of foreign nationals, rising job losses could lead to a reversal in population flows. Foreign nationals who lose their jobs have to leave the country within a short period of time. According to the Ministry of Economy, the expatriate population grew by close to 7% in 2007, with expatriates totaling 3.62 mn, against only 864,000 nationals. How these demographic factors play out will have serious consequences for the economy. While there is no official data on the current status of the labour market, there are signs that the UAE is shedding jobs. While construction and real estate are the worst-affected sectors, job losses now seem to be spreading to other sectors. Ministry of Labour officials were quoted in the local press saying that visa cancelations in Dubai have accelerated since October 2008, and are now averaging 1,500 a day and exceeding 2,000 on some days. The labour market usually lags the business cycle, so the hope is that the job losses currently evident on the ground are mostly a reflection of what has already happened to the economy rather than an indication of where it is heading. Nevertheless, policy needs to focus on avoiding a sharp deterioration of the labour market (as well as improving liquidity conditions) to prevent a deep recession and to ensure that fiscal stimulus measures announced by the federal and Dubai governments are effective.
Then there’s the performance of the Abu Dhabi’s sovereign wealth fund, Abu Dhabi Investment Authority. Its well publicised $7.5bn investment in Citigroup has, for one taken, a severe knock.
Economists Brad Setser of CFR and RGE Monitor’s Rachel Ziemba, however, have estimated the fund’s total losses could be as much as $125b. As Ziemba points out more recently (our emphasis):
Abu Dhabi’s stock of liquid assets might not be quite as high as it might like. In a recent paper, Brad Setser and I argue that the funds of the Abu Dhabi Investment Authority (ADIA) may never have been as large as some observers thought (we peg its peak at close to $480b early in 2008 and suggest it may have suffered valuation losses that took its AUM down as low as $300b (see this post for more recent calculations that suggest the GCC’s foreign assets fell to $1.16 trillion by the end of January from $1.19 trillion in December – and if February ends anywhere near Friday’s close, a similar $30 billion loss is likely).
The calculations are based on an index based portfolio so we might be a bit off. However, given that liquidity is at a shortage and Abu Dhabi may also run a fiscal deficit, it may prefer to preserve its capital for investments prioritized for domestic development.
In that scenario, helping out fellow emirate Dubai may come at a lesser priority to assuring Abu Dhabi’s own health. One for all and all for one may therefore not be the model the UAE ends up with.
Related links:
How worried should we be about Dubai? – RGE Monitor
Two tales of a city – FT Alphaville