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June 12, 2013

Dubai’s Growing Economy Faces High Debt Hurdle in 2014

Dubai has been prospering, which is remarkable, considering that it faced down default in 2009. Real estate has roared back from its earlier crash to boom once again; tourism and business travel have also soared. In addition, foreign businesses have flocked to the emirate, one of the seven that make up the United Arab Emirates, to open offices in the region, attracted by its duty- and tax-free zones.

However, there may be storm clouds on the horizon for this hot business destination. The 2009 near-collapse of Dubai’s economy, built as it was on debt, and known before the financial crisis for its focus on ostentatious wealth, was averted only because of loans. The UAE Central Bank and oil-rich Abu Dhabi each kicked in billions, but the bills will soon be coming due and even the current thriving state of Dubai’s economy may not be equal to the challenge.

Dubai had sought to diversify its economy from oil and, by spending freely built the pre-crash boom that saw it become the “in” spot for many businesses in the UAE. It was so successful at the job that when the crash came, it was disastrous. Credit dried up and only bailouts saved the emirate from going bust. But that’s not the end of the story, since some of what built Dubai’s pre-bust economy has helped to bring the emirate back.

As a free port, or entrepôt, Dubai boasts a number of free trade zones that offer 100% foreign ownership and zero taxes for foreign businesses. Companies from IBM to Sky News and Microsoft to the BBC have taken advantage of its internet and media free zones (called, together, TECOM (Dubai Technology, Electronic Commerce and Media Free Zone Authority).

The Jebel Ali Free Zone is one of the largest transit ports in the world, and recently Qantas inked a deal with Emirates that will allow the Australian airline to shift its European flight hub from Singapore to Dubai (see Australia’s Economy Continues To Grow, With No Recession In Sight). Even the Arab Spring has worked to Dubai’s advantage, as much of the money spent in neighboring areas to forestall public unrest ended up being spent in Dubai.

And if that’s not enough, the emirate has become the go-to place for finance in the Middle East, in the form of the Dubai International Financial Center. Tourism is up, and even the emirate’s bonds are selling well, with a January offering bringing in $1.25 billion in 10-year sukuk and 30-year bonds, the latter the first of their kind that Dubai has offered.

Both lower interest rates and lower costs to insure its debt have made Dubai attractive to investors, despite its looming mountain of debt. How that debt is to be repaid, however, has yet to be addressed in terms that satisfy many of the parties concerned, particularly since despite strong growth the emirate isn’t profiting enough to meet its obligations.

State-owned investment firm Dubai World had reached an agreement with banks in 2011 to restructure its $25 billion in debt, with the understanding that it would, among other things, sell off some assets. However, that has yet to happen, thanks to the effects of the global economic downturn.

Still, the Dubai government wants to avoid more debt restructuring—something that could be somewhat embarrassing for a global financial hub. Instead, it’s looking toward more creative strategies, such as additional bond offerings and perhaps even some partial privatizations; IPOs of assets, rather than selloffs, could present the emirate with at least a partial solution.

Until the details are hammered out, however, investors would be wise to be wary. A March report from Moody’s said, “Little progress has been made on clarifying and strengthening the legal framework for insolvencies/debt restructuring, while details of the Dubai government’s capacity to support its government-related institutions remain uncertain.” -Marlene Satter

 

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