What Does Dubai’s Financial Crisis Mean for Emerging Markets?

It must be fun to spark a world financial panic and then go on a five-day vacation. By now everyone knows that on Wednesday of last week, right before the Muslim world shut down for the Eid-al-Adha festival, Dubai World, the flagship investment company owned by the Government of Dubai and/or Dubai’s ruler Sheikh Mohammed bin Rashid al-Makhtoum, announced a standstill on its debt repayments, with specific reference to a $4 billion bond payment that Nakheel, a Dubai World property development subsidiary, is due to pay in December. The world has now, finally, woken up to realize that the Dubai miracle is built on sand, both literally and figuratively.

I hate to say I told you so (why do people always say that? I’m usually delighted to say I told you so), but in a blog post that appeared on this site last July “Can Dubai Come Back?” I advised investors to steer clear of Dubai, pointing out that “rampant intermingling of public and private funds and little transparency over who owns and owes what,” it was hard to know exactly what is going on inside any company.  By all indications Nakheel and also Emaar, another state-owned property developer, were perilously close to insolvency if they hadn’t already crossed the line. Nakheel had shelved development of the second and third Palm Island projects and Emaar, developer of the world’s tallest building Burj Dubai, was trying to get itself acquired by Dubai Holdings. Arguments about whether or not all these companies were then or are now insolvent are pretty much beside the point. I likened the Dubai property and investment markets to a game of three-card monte, where losses and liabilities could be moved about and hidden from view.  Given the interlocking nature of UAE companies, when you buy a share of one  it’s hard to know who else’s hidden risks and liabilities you’re buying too.

Today, the first day of trading in the UAE since last Wednesday’s market close, the Dubai Stock Exchange closed down 7 per cent and Abu Dhabi’s 8 per cent. DP World, a profitable Dubai World ports operating subsidiary, saw its price drop 15 per cent. Some analysts now predict that the Dubai property market, already down around 50% from its peak, could drop a further 40% for a total 70% peak-to-trough decline.

For those of us not resident or invested in Dubai, the question is whether Dubai’s woes will spread to other markets.  This possibility of contagion, especially to other emerging markets, is foremost in many people’s minds, especially since statements by the government of Abu Dhabi and by the UAE federal government have put paid to the assumption that Dubai World as a state-owned enterprise enjoyed some implicit government guarantee against insolvency.  The famed Mark Mobius of Templeton Asset Management has warned that a default by Dubai World could trigger defaults – especially of state-owned companies – in other markets and could lead to a 20 per cent drop in emerging markets overall. This could easily happen, since many investors seem unable to distinguish one emerging market from another, but is the risk based on anything more substantial than the madness of crowds?

I think not. Dubai’s slump may be deeper and more protracted than anyone expected, but Dubai’s rulers have never ceased to astound with their imagination and audacity. I wouldn’t write them off just yet, though investors and Dubai’s richer cousins in Abu Dhabi may use the occasion to force Dubai’s companies and government to operate with greater transparency. This would be a good thing.

As for other markets, their exposure to Dubai is minimal. It’s important to remember that total foreign claims on UAE debtors amount to only $123 billion: a lot of money to be sure, but not really that much in the global scheme of things. Over 40% of that debt, or $50 billion, is held by British banks, but that is almost pocket change compared to the size of the losses and rescue packages earlier this year.  The British government has already put over $120 billion into the rescue of three big banks since the start of the financial crisis last year, and has just pledged another $43 billion for the Royal Bank of Scotland (RBS) alone.

As for other emerging markets, most of them are built on a real – as opposed to a financial – economy.  It is hard to imagine the Dubai crisis registering as more than a blip on markets in Brazil, India, Indonesia, South Africa, Egypt, or China, since these markets consist largely of companies that grow, extract or manufacture physical products or that supply essential services like telecoms. Even most of the banks in these countries are likely to be less exposed to Dubai than their counterparts in Britain. Any short-term sell-offs in otherwise sound emerging markets represent good buying opportunities rather than a call for a retreat to safety. Besides, in today’s world can anyone tell me what is safe?

Some emerging markets funds have been hit by the crisis. The Market Vectors Africa ETF (AFK) closed down just over 3 per cent today and is down more than 6 per cent over the past five days, but it is up more than 60% since its February 2009 low. Even T. Rowe Price’s Africa and Middle East Fund (TRAMX), which has over 12% of its holdings in UAE property and financial investments, lost 3.4 per cent today but is still up more than 60 per cent over its March 2008 trough. The ING Russia Fund (LETRX) fell more than 4.2%today, though whether that has anything to do with Dubai is unclear. Maybe Russia, whose economy is increasingly dominated by state-owned companies known for a lack of transparency but which some investors may think are implicitly backed by the Russian government, is suffering some contagion. Even so, it is up more than 175% since its low in February 2009.

Most of my other emerging markets holdings, including  the MSCI Brazil Index ETF (EZW), the Market Vectors Indonesia ETF (IDX), the MSCI Thailand Index ETF (THD), Cemex (CX), and Brasil Foods (PDA), closed up today.  It’s impossible to know whether Dubai has any more nasty surprises to reveal, but on the evidence so far the fallout from Dubai’s crisis is going to be limited to the Emirates and their fellow GCC (Gulf Cooperation Council) members.