Abu Dhabi Announces Support for Banks But Markets Wary of Rift with Dubai

Investors Hold Their Breath

Last week's announcement that Dubai World was looking to delay debt repayments came out of the blue and reignited fears about the emirate's financial position in the wake of its spectacular real-estate bubble. Dubai World drove the emirate's growth with massive investments at home and abroad, but this came at the cost of a US$60-billion debt mountain. The global media has been full of articles over the weekend warning of "castles built on sand", fuelling a vicious cycle of investor fear. Markets reopened today in the United Arab Emirates after the extended religious holiday and promptly shed over 7% of their value. Dubai's main stock index dropped 7.2%, Abu Dhabi's by 8.2%. Banks have also reopened today and are urgently assessing the extent of their troubles.

The U.A.E. central bank sought to offer reassurance ahead of trading, saying that it would make fresh funding available to local banks as well as local subsidiaries of foreign banks if required. Investors had indeed been calling for such a statement, but the pointed absence of references to Dubai has fuelled concerns about the extent of tensions between Abu Dhabi and Dubai. The former is home to the capital of the seven emirates and has the advantage of huge oil wealth. Dubai has negligible oil reserves and has instead driven its growth with credit. The political context of the emirates' relations is examined more closely below.

International markets have been hit by the turmoil in the United Arab Emirates, but not as much as originally feared. Asian stocks were hammered on 27 November, but then European and North American markets stabilised. Today has seen most Asian markets trade higher, but it remains to be seen whether they set the tone for trading elsewhere. Key Asian banks have rushed to downplay their exposure to Dubai World and the wider financial sector in the United Arab Emirates. At the time of writing European markets were down modestly.

Central Bank Support

News that the U.A.E. central bank will support both local and foreign banks has been widely reported on, but the official announcement has yet to be published on the regulator's website. The International Monetary Fund (IMF) was quick to endorse the move yesterday, saying "the United Arab Emirates is a strong resource-based economy and we welcome today’s announcement by the Central Bank of the UAE making available to banks a special additional liquidity facility. We look forward to further clarification by the authorities towards a cooperative mechanism to address the issues between these debtors and their creditors." On the face of it, the statement should offer encouragement that the central bank is ready to step in to maintain liquidity, but as already mentioned there are concerns about how far Abu Dhabi is really prepared to go to bail out Dubai.

The central bank has also stated that the U.A.E. banking system—as a whole—is stronger and sounder than it was a year ago. The Emirates' banking sector suffered protracted liquidity problems in the last quarter of 2008, but systemic problems were averted when the U.A.E. central bank and government pumped in liquidity and announced a deposit guarantee. Balance-sheet changes are required to establish more sustainable liquidity for the sector; stronger deposit growth and slowing lending growth would improve conditions on a more lasting basis. Credit growth has already slowed considerably owing to risk aversion, as well as lower demand, and liquidity pressures have eased. This gives the central bank's assertions some weight, but there is no doubt that asset quality has deteriorated substantially. This requires greater provisioning, which will inevitably hurt the financial performance of local banks.

Banks on Watch

Last week it was reported that four Dubai-based banks had been put on credit watch by Standard and Poor's (S&P, see United Arab Emirates: 27 November 2009: S&P Puts Four Dubai Banks on Credit Watch Due to Dubai World Debt Standstill). Dubai World’s standstill request—to extend the maturity of debt falling due to May 2010—is considered a considerable risk to these banks' financial position, mainly because it comes at a time when the tough economic outlook (driven to a large extent by the Dubai real estate crash) was already burdening them. Moody’s Investors Service also confirmed this morning that U.A.E. banks with the largest exposures would be kept on review. Nonetheless, the ratings agency did state that if the debt standstill remains confined to Dubai World and Nakheel, U.A.E. banks are likely to be able to absorb the stress at their current rating levels. IHS Global Insight, as well as the ratings agencies, will continue to monitor developments, but at present it seems that systemic support—should it be required—will be forthcoming from federal government.

The Political Dynamics

Even though the ongoing crisis is unlikely to affect the United Arab Emirates’ position as one of the most politically stable countries in the greater Middle East and North Africa region, the domestic political implications could be significant. Over the past four years glitzy Dubai has been run by Sheikh Mohammed bin Rashid al-Maktoum effectively as a successful family business. His control has been steadily cemented since 1995, when he took over as crown prince. Much of Dubai’s success has been attributed to Sheikh Mohammed’s business-driven and pro-Western personality, resulting not only in the bold economic strategy, but also growing political weight within the federation. Dubai’s increasing financial strength and its attractiveness to tourists and the world’s business elite alike had not eclipsed Abu Dhabi’s oil wealth or political dominance, but it certainly increased Dubai’s independence and manoeuvrability vis-à-vis its more cautious big brother. Abu Dhabi meanwhile has retained its progressive but cautiously prudent political and economic approach. As a result it has fared significantly better than Dubai during the international financial crisis, and its dominance is now being reasserted. This context has led to speculation over how far Abu Dhabi is prepared to come to Dubai’s rescue, or indeed whether Dubai will accept such a hand. The latter apparently declined to take full advantage of Abu Dhabi’s previous offers. Reliance on Abu Dhabi through this crisis could arguably make it more difficult for Dubai to bounce back and restore its international and domestic standing. For now, however, the political shock is limited and is unlikely to result in any structural shifts. Talk of a major rift between the federation’s two leading emirates appears overstated.

Outlook and Implications

Markets around the world are still unsure how to interpret the situation in Dubai. On one hand the offer of support from oil-rich Abu Dhabi should give a good deal of comfort, but on the other hand there is a danger of an abrupt loss of confidence and a vicious cycle developing. Many foreign banks are heavily exposed to Dubai and the other emirates and can ill afford another shock to their financial position.

Whether or not the current turmoil subsides quickly, Dubai faces a struggle to hold onto its status as the region's financial hub after being helped out by Abu Dhabi. Former chairman of the Dubai Financial Services Authority, Ian Hay Davison, has warned that Dubai may be forced to revert to specialising in trade and abandon its drive to become a regional financial centre. Others have warned that the way in which the debt problems have unfolded and been handled will do serious damage to Dubai’s reputation for years to come. The threat to Dubai's position is further increased by the fact that Abu Dhabi is building a new financial centre of its own on Sowwah Island. This is scheduled for completion by 2014, and will be home to the Abu Dhabi Securities Exchange as well as Al-Hilal Bank and National Bank of Abu Dhabi. These two banks were last week reported to have provided Dubai with US$5 billion in funds (although this is said to be unconnected to the restructuring of Dubai World).