Dubai kickstarts bond plan

28 October 2009

Dubai is starting to deal with the challenge of repaying the debt it owes banks. It is going to ask them to lend the emirate more. One of the world’s oldest jokes is that the best way to avoid having to repay banks is to owe so much that they cannot afford to let you go bust.

So there should be no surprise that Dubai is dealing with debts that could total more than twice its GDP, by borrowing more.

On 21 October, documents were released detailing the Dubai government’s plan to raise $6.5bn in bonds in two parts: one for up to $4bn in a conventional medium-term note programme and the other for $2.5bn in sukuk.

It will soon be clear what the response from the market will be. But it is likely to be strong, even though the bonds do not have credit ratings. The yield is expected to be at least 6 per cent. This compares with the London interbank offered rate (Libor) on 12-month dollar deposits of 1.2 per cent on 26 October and interest on most dollar deposits that are effectively zero.

Sophisticated readers will recognise that this apparent perversity makes complete sense. Dubai businesses will, by the end of 2009, have repaid almost $10bn in borrowings in less than 12 months. This has only been possible by gathering fresh credits.

Despite a spread approaching 5 per cent, the likely interest on the bonds is low by historic standards. They will have maturities of up to five years, which would represent a significant increase in the average time Dubai has to repay what it owes.

This does not mean, however, that everyone will be delighted. The documents show the government of the emirate is resiling from making firm commitments to the Dubai businesses that are believed to be the most heavily in debt. They say it is “not legally obliged” to provide financial support to government-related entities. What these are is not explicitly stated. But they definitely are not the Department of Finance, the Department of Civil Aviation and the Investment Corporation of Dubai (ICD) which owns 100 per cent of Emirates, Dubai Aluminium, Dubai World Trade Centre and Emirates National Oil Company; 60 per cent of Borse Dubai, 50 per cent of Dubai Cable Company and 25 per cent of Noor Islamic Bank. In other words, Dubai World and Dubai Holding don’t have Dubai government support and are, in effect, on their own.

The documents show the debts of recognised Dubai government companies are $19bn plus $2.4bn in guarantees to the Dubai Electricity & Water Authority (Dewa). This is less than 25 per cent of Dubai’s estimated 2008 GDP and would make the emirate one of the world’s less indebted places.

But only someone with rose-tinted spectacles would accept these figures as a complete description of Dubai’s financial condition. The debts of Dubai government entities are estimated to be more than $60bn. And despite the statement that the government itself is not obliged to help them, the expectation is, nevertheless, that it must and will.

The passages in the bond documents that deal with state firms are carefully phrased to keep those expectations in check. The government has established the Dubai Support Fund (DSF) “to provide support to strategic entities which require financial assistance but are able to demonstrate sustainable business plans, the ongoing support of their existing financial creditors and realistic prospects of fulfilling their payment obligations”.

That is one of the biggest buts in banking.

The support fund’s resources come from the proceeds of the $10bn, five-year bonds issued to the Central Bank of the UAE in March. It is not unambiguously stated, however, that the fund has all of it. The government of Dubai is said to be “in advanced discussions” about the second $10bn tranche of bonds but, it is not clear when they will be issued.

The bond programmes, nevertheless, are evidence Dubai is beginning to get a grip on its finances. The emirate should have enough money to resume work in 2010 on key infrastructure projects, including power and water capacity, the road network, the next phase of Dubai Metro and the new Al-Maktoum International airport.

But what needs to be addressed is how Dubai plans to extricate itself from the morass that engulfed it in the autumn of 2008 when the credit crash brought its real estate programme to a standstill. Hundreds of companies are owed millions for work they have done for Dubai state firms. The sight of banks feasting on a lucrative bond issue will do nothing to improve their temper.

They want to see another injection of money into the support fund or directly into the entities themselves. They want it to be big and they want it sooner rather than later.

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