The widely predicted mass exodus of thousands of expatriates from Dubai over the summer months did not materialise in the end. When Ramadan ended in late September, for many it was business as usual.

But while there is a general sense among the Dubai public that the worst effects of the financial crisis that hit the emirate in late 2008 have now passed, for the UAE economy, the road ahead is far from smooth.

Saudi investment bank Samba forecasts the UAE’s real gross domestic product (GDP) will shrink by 1 per cent this year, before rebounding by 2.9 per cent in 2010.

But in late September, the downgrading of seven UAE banks and two Dubai government-linked companies – Dubai Electricity & Water Authority and Dubai Holding Commercial Operations Group – by ratings agency Fitch Ratings sent a strong warning signal that there will be aftershocks.

In particular, the huge debt mountain accrued by Dubai to fuel its real estate boom continues to cast an uncertain shadow over the emirate and its prospects for a swift recovery.

Fitch’s downgrades were the result not of the Dubai government’s unwillingness to support the emirate’s banks, but rather of a concern that there is pressure on the Dubai government and the Central Bank of the UAE as they restructure the $65bn of debts owed by Dubai and its state-owned companies.

Debt burden

News of the scale of Dubai’s debt emerged in November last year. In a bid to silence speculation, Dubai’s Executive Council reluctantly revealed that state-affiliated companies had taken on about $70bn of debt, while the emirate’s own borrowings amounted to $10bn.

The combined total is equivalent to Dubai’s annual GDP of about AED301bn ($82bn).

Despite playing down the significance of this debt and emphasising the value of its assets, as the financial situation worsened in the region, the Dubai government was forced to initiate a $20bn bond programme to cover its short-term liabilities. In February, Dubai sold $10bn worth of bonds to the Central Bank of the UAE, and a second $10bn issue is due before the end of this year.

“The feeling is that over the next year or so, Dubai is fairly comfortable in managing its debt burden, but there is a lack of clarity thereafter,” says Farouk Soussa, head of Middle East government ratings at ratings agency Standard & Poor’s. “There is way too much money coming due – $50bn in the next few years. It is too much for Dubai to just pay off.”

According to estimates by Egyptian investment bank EFG-Hermes, Dubai has $13.1bn in credit maturing in 2010, $19.5bn in 2011 and $15.7bn the following year. For 2009, the emirate’s debt obligations are put at $9.7bn, which includes state-owned property developer Nakheel’s $3.5bn sukuk (Islamic bond), which is due to expire on 14 December.

“The $20bn will help the refinancing of companies such as Nakheel, but it does not mean the real estate market will return to the old heights of summer 2008 and [that] Nakheel can settle its debt in the long term,” says Eckart Woertz, economics programme manager at the Dubai-based Gulf Research Centre.

Dubai’s economic troubles are directly attributable to the collapse of its real estate sector. The emirate’s recovery will be contingent on an upturn in the property market, but this is unlikely to happen in the near term. Buyers remain cautious, defaults on off-plan property transactions continue to be reported, and sales and rental prices have yet to bottom out, despite sales prices having dropped by up to 50 per cent over the past 12 months. 

Dubai is already suffering from an acute oversupply of office and residential space, and even though half of all planned real estate projects in the emirate have been delayed or cancelled because of the financial crisis, a wave of new stock is due to be completed over the next couple of years, which will likely depress the market further.

Up to 90,000 new residential units and more than 3 million square metres of new office space is expected to enter the market by 2011. Vacancy rates in Dubai’s commercial real estate currently average 20 per cent, compared with 2 per cent in June 2008.

Furthermore, analysts suspect that the full extent of the emirate’s exposure to the property sector has not yet emerged. “The big question mark is over the real estate sector, simply because of all the contracts and debt exposure that such a market has on individual investors, companies and banks,” says Woertz.

Even Abu Dhabi, where the real estate sector enjoys much more robust fundamentals than in Dubai because of its historical undersupply of property, is likely to find its growth constrained if Dubai’s economic downturn is protracted. “If the Dubai economy continues to shrink, I don’t think Abu Dhabi can surge,” says Mahdi Mattar, head of research and chief economist at local investment bank Shuaa Capital. “The two are extremely interlinked. We know there is a housing supply shortage in Abu Dhabi, and yet rents went down there when rents fell in Dubai.”

Cautious approach

Furthermore, despite having adopted a comparatively cautious growth strategy, Abu Dhabi, through its role as chief contributor to the UAE federal government’s budget, has found itself materially affected by Dubai’s profligate spending.

Financial analysts have so far largely praised the federal authorities’ response to the financial crisis and their provision of support to the local banks. But with so much more debt needing to be serviced over the next couple of years, the question being asked is whether the UAE government will be able to keep stepping in.

“As the big brother of the emirates, Abu Dhabi has a strong interest in ensuring that the northern emirates’ economy is maintained, and that means ensuring that Dubai’s economy remains viable,” says Soussa. “The strong net worth of the government of Abu Dhabi, which is asset-rich and has few liabilities of its own, is unchanged.

“What has slightly deteriorated is Abu Dhabi’s position regarding its contingent liabilities of, namely, how deep it will have to dig into its pockets to support emirates like Dubai, Sharjah and others as they go through a sharp economic contraction.”

Hydrocarbons-rich Abu Dhabi, with more than 94 per cent of the UAE’s oil reserves, is more than able, should the need arise, to provide financial assistance to its sister emirates, which do not have significant oil and gas reserves to cushion them.

“If the Dubai economy continues to shrink, I don’t think Abu Dhabi can surge. The two are extremely interlinked”

Mahdi Mattar, chief economist, Shuaa Capital

But such handouts will inevitably have a bearing on behind-the-scenes relations between the federation’s seven members. Dubai’s economic autonomy has diminished following the central bank’s intervention. Whether this diminution is permanent will not be apparent until the economic recovery has taken place.

“We will never know the details, but of course this bailout comes at a price, and the price is that Abu Dhabi probably has a much larger role in economic decision-making,” says Woertz.

“It is like when General Motors gets bailed out by the government. The government wants to know about its business decisions from then on. Every time [Dubai ruler] Sheikh Mohammed [bin Rashid al-Maktoum] wants to launch a large project now, he might need to go to Abu Dhabi and ask if he is allowed to do it.”

The financial crisis has highlighted the weaknesses inherent in Dubai’s economic model, which was built on the assumption of continued demand for real estate. The legacy of debt with which it and the UAE will have to contend over the coming years will serve as a stark lesson for other Gulf states that have sought to emulate Dubai’s growth. 

But the slowdown in Dubai’s economy has had some positive effects. At the height of the construction boom in the summer of 2008, the emirate’s competitiveness was rapidly being eroded, as property values and rental prices soared by up to 50 per cent for large villas.

The sharp correction in real estate prices over the past 12 months means Dubai is once again an affordable city in which to live. With its well-developed infrastructure, it will be well positioned to benefit from a resurgence in the economies of the Middle East when it happens, and will be able to reassert itself as an attractive regional hub for trade and finance. 

But despite the growing sense of optimism on the street, it is still far too soon to say that recovery is genuinely on its way. Significant challenges still lie ahead for Dubai, and for the UAE as a whole.