Dubai financial crisis

Dubai’s Financial Crisis:

Dubai is usually characterized by sky piercing towers, rotating buildings, spectacular architectural designs, flow of petro-dollars which refers to the income coming from exporting oil and its products to other countries, broad and clean road networks, etc. It represents a face of modernization and advancement and has earned a place amongst one of the most technically advanced countries in the world. This rapid development of the country was a result of the focus of the government on tourism thus promoting the real estate sector with the help of revenues coming from export of oil and natural gas. With the largest real estate company of Dubai Emaar properties becoming bankrupt in the United States and vaDubai proposal to delay the repayment of all its debt’s for a period of 6 months on November 26, 2009 the financial crisis in Dubai was exposed in front of the world which had bad effects on countries around the world. The debts were as large as $59 billion causing a stop to the investment cycle of Dubai for 6 months. The Dubai’s real estate industry was based on huge loans which they expected to pay through the revenues they earn from them but with recession hitting the industry badly their plans failed. Thus the Dubai’s financial crisis to a large extent can be said to be a consequence of real estate bubble burst in Dubai.

Dubai’s Economy:

Before getting to the financial crisis it is important to know the structure of the Dubai’s economy which is one of the most unique and unusual in the world. It is divided into free zones setup by the government of Dubai. The zones are industry specific with Jebel Ali free zone being the fastest growing in the world. The Jebel Ali free zone offers a set of products and services such as: ready to use offices, Business centers, factories, Warehouses, infrastructure ready plots etc. Jebel Ali free zone commonly referred to as Jafza is a part of Dubai based; a state owned Economic Zones World. It is one of the world’s biggest developers of Economic Zones, Logistics and Research and development driven Industrial Parks. The main free zones of Dubai are Jebel Ali free zone, Dubai Internet City, Dubai Media City, and Dubai Maritime City which are based on the industries they are related with.

People have false misconception about Dubai’s economy they believe that it’s mainly driven by oil and gas although the oil sector comprises of less than 6% economy of Dubai that was primarily dependent on oil as a main source of revenue in the past. Dubai being a part of the United Arab Emirates is expected to be great producer of oil, petroleum and natural gas although it is a good producer but compared to other countries of the United Arab Emirates it produces relatively lesser quantities of oil. Dubai produces 240,000 barrels of oil per day and its revenues from natural gas constitute only 2% of the total revenue that United Arab Emirates gets from natural gas. Although it is true that Dubai’s economy was initially build on the revenues generated by its reserves of oil and natural gas but with time it’s oil reserves have reduced significantly as a result of a large increase in the demand for oil and oil products around the world and over the years and Dubai exporting a great amount of oil to other countries it is expected that Dubai’s reserves of oil will get exhausted in the next 20 years and so it has concentrated on the tourism industry to generate good revenues at that time. (Dubai hit hard)

Another large contributing sector of Dubai’s economy is the real estate which forms 22.6% of the economy of Dubai. The great success of this industry is owed to the focus on tourism. Over the years the government of Dubai has concentrated largely on tourism they have invested large capitals in order to promote their tourism in the process they have built sky scrapers, clean and well knit network of roads. The government has focused on providing world class facilities in Dubai in the process creating architectural designs and buildings which attracts tourists from all around the world. As the real estate industry is closely related to the tourism industry it has developed as a major industry in Dubai and contributes greatly to its economy.

According to a survey in 2007 the largest contributing sectors for the Dubai’s economy other than oil were real estate and construction, trade and financial services which contribute 22.6%, 16% and 11% respectively to the Dubai’s economy.

From the facts mentioned above it can be ascertained that there has been a shift in Dubai’s economy from being solely dependent on oil to development of other sectors by using the large amounts of money coming from the oil to development of other sectors like tourism but it has been stuck badly due to fall in prices of buildings and as most of them were based on loans vaDubai formally announced that the biggest of its real estate companies would not be able to repay their debts for a period of at least six months leading to the financial crisis.

The Policy of diversifying to Real Estate:

The funds had always been flowing into Dubai due to its large reserves of oil that it posses and initially the whole economy of Dubai was dependent mainly on income coming from oil and natural gas but there has been a shift as the Dubai government now aims at making the tourism industry the biggest industry of Dubai and has invested a huge capital in developing this industry. In the year 2000 the establishment of Dubai Financial Market (DFM) as a secondary market for trading of trading securities and bonds both locally and globally was major step in diversifying Dubai’s economy. The establishment of Dubai Financial market was a part of the government’s plan to diversify Dubai’s economy from a trade based economy to the one which is tourism and service oriented made real estate more valuable in Dubai.

The inclination of the government towards tourism did turn out to be a promoter for the real estate and construction industry and the real estate industry grew at a rapid pace in Dubai becoming one of the largest industries in Dubai. As a result of the government’s promotion to tourism Dubai witnessed a real estate boom which resulted in appreciation of property prices in Dubai from 2004-2006. These policies transformed Dubai into a center for large scale real estate development projects and made it a home for many large projects and tallest skyscrapers of the world which are now amongst famous buildings of the world. The results of these policies are visible through buildings like the Burj Dubai, the Palm Islands, the Emirates Towers, and the world’s most expensive hotel, the Burj Al Arab which reflect the rapid development and the great advancement of the real estate and construction industry in Dubai making it a world class tourist destination. All the results of these policies led to a great change in Dubai’s landscape which also led to a great amount of foreign investments in Dubai as Dubai became a great destination for investors around the world. For many years Dubai has given great returns to investors around the world with an aggregate of approximately more than 40% per annum which has attracted clients from around the world trying to get the investment ladder ready but during the last few months being hit badly by recession these profits have turned into losses with a depreciation in property prices creating a situation of financial crisis in Dubai.

Although Dubai has given great returns in the past but the ugly face of the Dubai model that it was based on speculation and debt that was somewhere in the breakneck boom in Dubai and with the prices of buildings falling in the recent past this face was exposed as the largest real estate companies were not able to repay their debts that were due till December 2009 and the government asked the investment companies delay the collection of all their funds for at least a period of 6 months which hit badly the finance industry of Dubai which is one of the major industries of Dubai.

The Dubai World:

The Dubai world which is an investment company acts as a regulatory company in Dubai. It manages a portfolio of businesses projects for the Dubai government. It functions across a wide range of industries and projects which promote Dubai as a hub for trading and commerce. Sultan Ahmed bin Sulayem is the chairman of the company.

Sheikh Mohammed bin Rashid Al Maktoum, Prime Minister and Vice President of the United Arab Emirates is the major stake holder of the company. The company was established by Sheikh Mohammed bin Rashid Al Maktoum under a decree ratified on March 2nd 2006 with an aim to regulate and promote trade in Dubai.

The stature of Dubai world is quite large in the global market and it has large investments not only within Dubai but also in countries around the world. Some of its major investments range from MGM Mirage Las Vegas Casino Company to Standard Chartered Plc a London-traded bank and luxury retailer Barneys New York through asset – management firm named Istithmar PJSC.

The Initial success of Dubai in the Period of global financial Crisis

In the early period of global financial system Dubai’s financial structure, dynamic construction and tourism industries and relished tax free incentives seemed to be a great advantage for it and many people even expected it to remain free from any sort of recession. A major factor that created this illusion in the minds of people was the continuance of investment activities and construction at a feverish pace even when there was a lack of capital in all other parts of the world and no other country was even thinking of such investments Dubai announced to construct a new tallest building of the world just after Lehman Brothers collapsed in the United States. All these steps along with the booming infrastructure of Dubai attracted many investors from around the world who thought of Dubai as a good prospect for investment and expected good returns from it. Dubai has built one of the finest infrastructures of the world and it is quite natural for investors to be attracted towards such a place which lead to the initial success of Dubai in a period when the world was facing recession and lacking investments but its overdependence on debts caused the financial crisis.

Seeds of trouble

The global financial crisis during 2008-09 resulted in major downfall of Dubai’s real estate market. It led to slow down of the economy of Dubai. The economic revenue generated was not coming as efficient as before which greatly hindered Dubai’s growth and as most of its plans were based on money borrowed by investment companies and there were no plans to face any downturns in the economy it became difficult for them to repay that loan. As the main aim of Dubai’s economy was the tourism industry a slump in the global markets was always bound to affect the economy of Dubai. At the international press council conducted by Mohammed al – Abbar, senior enough to abide Dubai’s Ruler and UAE’s Vice President or Prime Minister. He was placed at the designation of the Director – General of Dubai’s Department for Economic Development and also as a chairman for Emaar properties the largest real estate company in December 2008 declared the credits that Emaar enterprise had which had an adverse effect on the economy as a whole.

Emaar Enterprise had credits for over 70 billion US Dollars. In addition to it they also had additional 10 billion US Dollars in Dubai with holdings estimated above 350 billion as a real estate asset. Earlier in 2009, situation was worse due to the global economic crisis, heavy tolls on employment, property values, constructions, etc. also added into it and resulted in the decrease in costs of these prices due to slow down in the world markets also hit the real estate sector of Dubai which was expecting a rapid development in order to repay all its debts in stipulated time. This not only hit the real estate industry of Dubai but also the finance industries which financed most of the projects of construction. In Feb 2009, the estimated foreign debt for Dubai was approximated at 100 billion US Dollars. It leads 250,000 United Arab Emirates national to be responsible for more than 400,000 US Dollars of foreign debts which is a very large amount although Dubai had been hit by a financial crisis in the past also. In the year 1999 Dubai was hit by a similar crisis but at that time the debts were much less than the amounts this time and at that time Abu Dhabi supported it but the amounts are very high this time as the main focus of Dubai government in the recent past has been tourism industry and the real estate is closely related to it.

The assessment of Dubai market of property has shown a lot of depreciation or decrement. The property loss was more than 65% of their values since 2001 till November 2008 which has been one of the main causes of the financial crisis as the property market was expecting an increase in prices but the decrease proved to be fatal for it. The construction companies were expecting a rapid increase in the property prices and were expecting to repay their debts using the incomes created from it but that did not happen and lead to the financial crisis

In addition to all these failures in key businesses, consumer satisfaction, wealth etc. is estimated to be in trillions of US Dollars. The financial commitments incurred by governments proved a fatal loss in economic activity.

The Burst of Bubble

Dubai which is governed by Sheikh Mohammed Bin Rashid Al Maktoum borrowed approx 80 billion US Dollars in a period of 4 years of construction for booming the construction market of economy of regional tourism as their main focus was on tourism as they expect that it would lead to a concrete source of income for them even when their oil reserves get exhausted. Emirates suffered a huge loss in the world’s steepest property slump as a result of global recession. The home prices dropped by 50 percent from their value in 2008 leaving Dubai in a situation where they were not able to generate adequate money in order to repay the debts that they had taken in order to promote the real estate industry.

Dubai had 59 billion US Dollars of liabilities in agreement to the standstill of creditors. The debt included more than 3.5 billion dollars of bonds dated December 14. This property unit is from Nakheel PJSC a firm from Dubai.

Analyst said that the prime reason for the financial crisis in Dubai was the mismanagement or the wrong decision of Sheikh Mohammed. He invested all his as well as the Dubai government wealth in the real estate market in United State and had no plans to deal with any kinds of shocks faced in their road to success such as recession. He thought that Dubai would never be stuck with any sort of recession which was a result of lack of adequate planning for bad phases during their journey. The foreign investment of Emaar claimed to be the second largest builders in United States. They ultimately went bankrupt because of the recession and/or filed for chapter 11, which allows reorganization of a company under the laws of bankruptcy for United States.

United States bankruptcy code permits the reorganization of any of the company under the bankruptcy laws of United States of America. Dubai shifted to their crisis mode with their large and dangerous building boom. Their lending bonanza soon vanished due to the crisis. Government and banks took huge steps to provide some backup to the organization and to rescue the falling organization. The bankruptcy of Emaar properties was a big shock for people around the world and even bigger for the people in Dubai as it acted as a hint of the financial crisis that had begun in Dubai which was considered to be one of the flourishing economies of the world.

Announcement and the impact of official moratorium:

Dated: 25 November, 2009, the final announcement came in by the government of Dubai. They announced that the company “intends to ask all its providers for financing to Dubai World, its subsidiary Nakheel to remain ‘standstill’ and extend the maturities until at least the date 30 May 2010”. This announcement meant a great decrease in the inflow of money for all the financial companies who had invested in various projects in Dubai and also sent a bad message to the world which had come to know that Dubai was in a financial crisis. Several months before the announcement Dubai world accounted for $59-billion debt which accounted for nearly three fourth of the emirates total debt of US$80-billion. These debts also included a $3.5-billion debt which the company was unable to pay by its December deadline. This announcement not only led to a degradation of Dubai’s goodwill among investment companies but also had a bad impact on the global markets which were recovering from the impacts of recession, the announcement in a way pushed the recovering markets back when they had started growing.

The impact was very severe as it degraded the investment status of Dubai amongst various investment companies. The government’s announcement led both Standard & Poor’s Investors Services and Moody’s who were the key investors of Dubai heavily downgraded the debt of various Dubai government-related entities with interests in commercial operations, utilities, property, and commodities trading which meant that it became harder for companies to get money for their projects. For Moody, the downgrade meant that the affected agencies would lose their investment grade status which would help Moody to make it very difficult for them to get the money required for their businesses.

The effect was not only internal its impact was felt by all major markets of the world who experienced a drop in their stock indices. The main European markets shattered on November 26 followed by huge drops in Asian stocks on November 27 creating a bad impact on these markets that were recovering from the shocks of recession.

Possibilities of Recovery:

Although Dubai is presently suffering with a financial crisis there are still possibilities that it will recover from this crisis. Abu Dhabi the capital of the United Arab Emirates which is also the richest country of the United Arab Emirates is the brightest ray of hope for Dubai. Dubai has already asked Abu Dhabi to bail it out of the crisis. The hope even increases as Abu Dhabi has helped Dubai in the past when Dubai was in Crisis although the demand is much higher than the past. Abu Dhabi has helped Dubai with an amount of $10 billion in order to bail out the Dubai world. A recent report by HSBC which says that Abu Dhabi has the cash liquidity to support its own companies and banks is even more positive response as Dubai’s point of view. Thus Abu Dhabi may use some of this liquidity to bail out Dubai from this phase of crisis. With the U.A.E central bank showing positive signs by confirming that its board has discussed plans for supporting real estate business by lending Dubai as well as remaining United Arab Emirates has increased the probabilities of recovery for Dubai to a great extent.

Impact on Indian Economy:

Indian banks have communicated to the Reserve Bank of India that their sheets show insignificant investments in Dubai as compared to their revenues generated. The main investments are those of State Bank of India, Bank of Baroda and ICICI combined together denote investments of around Rs 7000 crores with SBI having Rs 1500 crore in the combined charts. However Bank of Baroda’s spreadsheet has Rs 4000 crore invested in UAE with only Rs 600 crores in real estate markets and has no negative impact on the health of the bank.

However the professional front may face losses as Indians constitute 40% of the population of Dubai and are all in the business or service sector and so it may affect the remittances to India could decline provided the company is able to work out a bailout from this scenario.

UAE has not been a significant source of investment in the Indian portfolio however the crises as already stated will affect the remittances or permanent transference of money to the relatives of Indians settled in Dubai was an important component of Indian Economy as in the first quarter of fiscal year 2010 as it formed 45% of the invisibles. But the crises have created intense pressure on employment thereby reducing the invisibles coming to the country.

Dubai World’s subsidiary DP World has investments in the Indian sea ports and planned investments of $ 500 million can hamper India’s water strength.

Dubai crises and Indian exports are closely linked and reached a massive 13% in the fiscal of 2010 as is shown in the graph below. These figures give an estimate of how the exports could falter the critical situation and hamper the export market.

Indian real estate developers who had ventured into Dubai like Nagarjuna Constructions, BSEL Infra, Larsen and Toubro etc

References

1. Dubai Crisis 2009. (n.d.), Retrieved on March 15, 2010 from http://www.gktoday.in/2009/11/what-is-dubai-crisis-2009.html
2. Dubai Economic Crisis. (n.d.), Retrieved on March 15, 2010 from http://www.docstoc.com/docs/23974903/Dubai-Economic-Crisis-And-Its-Impacts-On-India
3. Dubai hit hard. (n.d.), Retrieved on March 15, 2010 from http://www.globalcrisisnews.com/real-estate/dubai-hit-hard-by-financial-crisis/id=625/