Dubai’s economic miracle (literally and figuratively) built on sand

Cracks are starting to appear in the the economic miracle that was Blingopolis, otherwise known as Dubai.

The over-stretched and hugely ambitious desert emirate, led by the al-Maktoum family, last week received an $15 billion emergency bail-out from its near neighbour Abu Dhabi (see this column by BreakingViews’s Una Galani).

This is one of several warning signs that Dubai has been over-dependent on leverage for far too long and is probably headed for the economic intensive-care ward.  As I have pointed out earlier the emirate’s frothy property market has been overdue a correction for some time.

Despite the lack of a free press, even the locals are beginning to realise it. They’re also getting exasperated by the inability of Dubai’s infrastructure to cope with over-development — including the raw sewage that is said to be spewing out onto Jumeirah beach. Higher inflation (Merrill Lynch recently put U.A.E. inflation at 13%) is also undermining the cost competitiveness of locating in the emirate.

It was inevitable that Dubai would start to feel the pinch from the global credit drought. Now it is happening.

In the past three months, the spread on Dubai’s credit default swaps (CDSs) has doubled to 300 basis points, almost three times that of its oil rich and better-positioned neighbour, Abu Dhabi. Basically this means that global lenders and funders have become increasingly reluctant to lend to the emirate, which unlike Abu Dhabi, has no natural resources to speak of. Soon, this source of funding is likely to dry up.

Dubai’s hubristic property developers are going to struggle to service the debt piles they have accumulated in recent years — and they’re almost certainly going to have to rethink their approaches. Existing mega-projects in Dubai will have to be mothballed, while new ones will probably have to be strangled at birth.

Nakheel, the Dubai-based developer behind tasteful and probably transient projects such as the archipeligo of artificial islands off Dubai’s coast, has $3.5bn of debts to refinance. I expect it is going to find this a struggle.

Bizarrely, given the precariousness of its financial position, Nakheel has just announced plans to build a $35 billion tower — al Burg or Nakheel Tower — which, at one kilometre high (3,280 feet), could be the tallest in the world, dwarfing the emirate’s already absurdly tall Burj Dubai project.

This counter-cyclical hubris appears to have been  prompted by Saudi Arabia’s plans for a similarly high 1km tower in Kingdom City, near the Red Sea port of Jeddah. However it is almost certain to be followed by nemesis.

Dubai is unlikely to experience a total economic meltdown, at least for now. It’s big sister down the road — Abu Dhabi — will probably be willing to continue to bail it out, at least for the time being. But I suspect that Sheikh Mo will have to display more humility when talking to his better-off counterparts along the road. I also suspect that many of the emirate’s overseas ventures are going to come unstuck as the global slowdown intensifies.

This ought to be an opportune moment for the army of white-collar westerners who continue to enjoy a sometimes hedonistic lifestyle in Dubai, largely at the expense of 700,000 migrant labourers from India, Bangladesh and Pakistan, to reassess their commitment to the emirate?

Read this earlier article by Ian Fraser on Dubai: The astonishing hubris, questionable taste and environmental naivete of the Al-Maktoums

This blog post was published on 6 October 2008