Since Dubai government-owned companies flirted with default in 2009, the big questions asked by bond investors in the region involved the level of support given by the state to indebted firms that it owns.
The government of Abu Dhabi has been forced to face this question itself, with the emir taking steps over the summer to formalise the process of deciding which firms receive explicit state support.
In a document sent to government-owned entities by the Abu Dhabi Executive Council, the emirate said that it would only be responsible for debt formally guaranteed by the council or Abu Dhabi law. It also put a cap on borrowing, limiting new debt issuance to 5 per cent of the emirate’s gross domestic product (GDP) a year. Crucially, it gave the Debt Management Office (DMO), an arm of the Abu Dhabi Department of Finance, more power to block state-owned entities from issuing new debt.
Bankers and analysts say the move is an important step towards institutionalising the process for future debt issues, but largely builds on already widely held assumptions.
“There is no new policy,” says Bashar al-Natoor, corporate analyst at rating agency Fitch Ratings. “The statements simply clarify how and when Abu Dhabi will guarantee debts of state-linked companies.”
The last time Abu Dhabi made any public statements about its support for state firms was in August 2011 when it clarified the four entities that had explicit government support: Tourism Development and Investment Company (TDIC), Mubadala Development Company, International Petroleum Investment Company (Ipic) and Abu Dhabi National Energy Company (Taqa). While this meant that four entities had guaranteed support, other firms were left in a more uncertain position.
There is no new policy. The statements simply clarify how and when Abu Dhabi will guarantee debts
Bashar al-Natoor, Fitch Ratings
Some degree of clarity was better than none, and the move was welcomed at the time by the bond market. Previous assumptions of state support were untested and not legally binding. These were challenged after Dubai’s Nakheel and Dubai World restructured about $25bn of debt in 2009. The firms’ debt was assumed as sovereign and therefore would always be honoured. As one bond trader said at the time, investors finally woke to the reality that “implicit state guarantees were not worth the paper they are not written on”.
Dubai’s debt crisis was only averted when Abu Dhabi handed it a $20bn bailout package. Not long afterwards, Abu Dhabi started to bail out its own indebted firms. Real estate developer Aldar Properties was granted the biggest handouts, receiving about $10bn in 2011. Fitch says the total amount of support given to state firms through shareholders’ loans and equity injections peaked at $24bn.
Sources in Abu Dhabi say by this point the government had already started to worry about losing track of all the contingent liabilities it was taking on. Efforts to tighten the process are also seen by some bankers as a sign the Executive Council is taking a conservative line on spending. These have been driven to some extent by the appointment of Sheikh Hazza bin Zayed al-Nahyan in December 2010 to the Executive Council. His appointment was followed by a significant reassessment of Abu Dhabi’s spending.
“Since early 2011, following the changes at the Executive Council, we have really seen things start to shift in terms of the government’s priorities,” says one senior executive in Abu Dhabi.
“What Sheikh Hazza has been doing is really very sensible,” says a banker in the emirate. He adds that the government needed to gain control of firms that were telling the market they deserved cheaper borrowing costs because of implicit state support, without any agreement on their plans with the Department of Finance.
By formalising the role of the DMO and outlining the process of applying for explicit backing, Abu Dhabi has shown international bond investors that it is taking control of its finances and state-owned firms. This is also evident in the dearth of new debt issues from the emirate, although several are in the pipeline. “A lot of the big borrowing has been done now, for better or worse, and most entities are in a deleveraging mode, or at least slowing the pace of their expansion,” says another Abu Dhabi banker.
So far, the prospect of a stronger DMO has not had much impact on the trading prices of outstanding Abu Dhabi debt issues, indicating that investors had either already priced in what is now more explicit, or they believe that if another distressed situation arises, the government will act to protect its reputation.
“Maybe they will let bondholders sweat for a while, but the common assumption is that if it is required, the government will provide support,” says a banker at a local lender.
Greater transparency regarding what obligations have government backing is to be welcomed. But it will still be up to investors to consider whether to force Abu Dhabi firms lacking a state guarantee to pay more to borrow funds. It should also encourage greater scrutiny of the commercial viability of investment plans if the era of subsidised borrowing ends.