A week ago, Dubai announced to the world that one of its largest entities, Dubai World, will be seeking a moratorium on its debt, believed to be somewhere in the range of $60 Billion.
Soon after, various holidays around the world sent people home and the global markets headed south. Watching the news you would have to believe that the rug has been pulled out from under us, yet again, and we’re about to enter a double-dip recession.
Since then news has been emerging slowly. First came the announcement that DP World, the ports company, will not require any debt restructuring. Then came the news that Dubai World was not a Sovereign-backed entity, despite the widely held belief that it was, and finally the news that the only companies seeking a moratorium are Nakheel and Limitless.
Rumors and questions abound: was Abu Dhabi letting Dubai sink so it can exercise some control over it? Has the city gone bankrupt? What would happen if Saudi Arabia steps in to rescue Dubai?
Sure, it has been a pretty tiring week for the residents of Dubai: comparisons with the Argentinean crisis were floating freely and, as a student of economics in the 90’s, I remember reading about the Argentinean crisis. There was a run on the banks, astronomical inflation, violent protests broke-out and people got shot on the streets!
It was mayhem.
Monday morning arrived, sun shining and blue sky above, a typical Dubai morning in this city. The banks opened their doors for business after the Eid holidays and lo-and-behold, I detected no cues or masses rushing to withdraw their money. Everyone seems to trust the Central Bank’s backing of the country’s financial institutions.
As the days went by, the problem now seemed to shrink from a $60 billion problem to somewhere under $10 billion. In a city that generated the amount of wealth that Dubai has over the past few years, this doesn’t seem so bad really.
It will, however, impact the long-term growth prospects of Dubai. Its ability to borrow has been impacted negatively and, when the crisis is over and done with, the companies here will be challenged when raising capital
Furthermore, this will serve as one of the toughest tests that the Islamic Sukuk, a Shariah-complaint form of bonds, will ever face. Sukuk are still the pimply-faced teenager in the world of finance, this is the right of passage they will need to go through before they can be regarded as a viable financial tool
Essentially, Sukuk differ from regular bonds in that a Special Purpose Vehicle, or SPV, is set up by the offering company which will own assets that it then leases back to the recipient, with the idea being that Islamic Finance stipulates that risk needs to be shared and money cannot be lent, though rent is allowed.
Naturally, the banks that use this vehicle are well aware of its risks and have also built into the terms & conditions the necessary legal safeguards. However, this will serve as a true testament to the legal, financial and regulatory systems in Dubai and its outcome could have a tremendous impact on the regional sukuk market.
The world will be watching, and we’ll be waiting to see how this story unravels.
