In recent weeks we have been asked by some international clients for our opinion on the business prospects for Dubai, the UAE and the GCC region in the wake of the recent furore regarding Dubai World’s debt. Despite the hyperbole of some sections of the international press, the reaction of our clients has generally been calm and considered. Of all our current vacancies for companies in Dubai and the region, only one has been directly impacted by recent events. In our opinion this is because a huge amount of de-leveraging has already occurred in the UAE economy this year and the new economic realities have largely been factored in by local and regional companies.
Our judgement is that the more extreme journalistic interpretations have rested on some crucial misunderstandings. The first is an assumption that the Dubai economy consisted purely of a real estate and construction bubble. Given the scale of the development in recent years this is understandable, but it crucially misses the other sectors of the Dubai economy which pre-date the real estate phase and serve as the real basis of the economy. A number of commentators have not adequately assessed the role of Dubai as a trading, distribution and commerce centre within the wider region.
The second misunderstanding is the assessment made on where Dubai is in the recovery process. A number of commentators have interpreted the Dubai World situation as the sudden onset of an economic adjustment; whereas the process has actually been underway for a year and is being worked through. The debt and organizational restructuring of the concerned entities will be a difficult process, but are occurring against the backdrop of a resurgence in the core economic sectors mentioned above. We have seen this manifested in a gradual but steady improvement in the recruitment picture since the lowest point during the summer.
Another common error in reports has been the assumption that Dubai’s situation is in some way unique or unprecedented. Admittedly there was an unsustainable boom in the Dubai real estate sector, but it should be noted that this was only one of many serious asset bubbles that formed leading up to the credit crunch and the scale of Dubai’s debts are minuscule in comparison to the writedowns and credit losses already sustained globally. It should also be pointed out that Dubai’s sovereign debt is actually at very low and manageable levels. The problems are primarily related to non-sovereign debt: the debts of parastatal companies where an important element of caveat emptor must apply, especially as Dubai World’s founding law clearly stated that there was no sovereign guarantee on any issued debt or obligations.
As William Buiter, (recently-appointed Chief Economist at Citigroup), has put it:
I don’t see what the big deal is. Dubai has experienced for most of this decade the craziest construction boom seen in the Middle East since the construction of the Great Pyramids. That boom turned to bust – as booms invariably do. Property developers tend to be highly geared and very procyclical in their revenue flows and access to the capital markets. During construction slumps they drop like flies. Because the property sector is risky (ask Donald Trump), its creditors tend to get better interest rates than the sovereign rate. Dubai is no exception to this rule. If you earn a risk premium during good times, you should not moan when the borrower defaults from time to time when the going gets tough. (…) The debt of the Dubai World Group and of Nakheel was not Dubai sovereign debt or sovereign-guaranteed debt. (…)The government of Dubai is under no legal or moral obligation to provide an ex-post guarantee of the debts of the Dubai World Group and Nakheel.(…) Fortunately, property companies don’t fall into the systemically important category. Their collapse is painful for their shareholders, creditors and, if the local labour markets are weak, their employees. They are not, however, systemically important. Their collapse will not threaten the delicate fabric of financial intermediation.
Even if one does take into account the full extent of all sovereign and parastatal debt, Dubai’s debt-to-GDP ratio is not an international outlier. The nervousness of international markets had a lot to do with an uncomfortable awareness of this fact. To quote William Buiter again:
Public debt to GDP ratios are rising everywhere, and are likely to top 100 percent of annual GDP by 2014 in the US, the UK and in the Euro Area. Structural public sector deficits and primary government financial deficits are at unsustainable levels in many countries, including France, the UK and the US.
In summary, having been operating in the UAE and the region for 30 years, we freely admit that 2009 has been a very challenging year. However, we remain confident that 2010 will see an improved business climate. There are a number of factors which we believe will allow Dubai to emerge from these difficulties with a more streamlined and productive economy. As a business destination it continues to enjoy the advantages of a relatively flexible labour market; low levels of tax and regulation; and excellent infrastructure and transport links. It remains a highly commercial and business-friendly environment in a resource-rich and wealthy region. From a debt management standpoint it does not face the issues of an aging population or high dependency ratios. In addition, as the economic distortions caused by the real estate boom are gradually worked through, the decline in living and business costs has made Dubai far more competitive again from a cost standpoint, after the rapid wage and price inflation of previous years threatened to make the city unaffordable for new business ventures. We are not denying that challenges still remain, but some perspective needs to be maintained.
