Dubai Crisis – Its impact on India.
On 25th November 2009 Wednesday, Dubai said it would reschedule debt on two state owned entities delay payments for six months.
On 26th November 2009 Thursday, rumors of a possible default on Dubai sovereign debt started to hit markets. The same day, the Dubai ruling family clarified concerns but credit default swaps reflecting the chances of a default kept rising.
The result was a sharp turn in sentiment which led to investors selling risk assets across equities, commodities and currencies and forcing regulators across the world including India to sit up and take notice.
On 27th November 2009 Friday, Dubai's debt crisis rattled world financial markets Friday, raising concerns that some banks could further tighten lending and stall the global economic recovery.
The possible spillover effects centered on fears that international banks could suffer big losses if Dubai's investment arm defaulted on its $60 billion debt. Stock and commodity markets tumbled in New York, London and Asia as investors flocked to the U.S. dollar as a safe haven. But earlier concerns that the crisis might trigger another financial meltdown seemed to ease after some analysts downplayed the risks for U.S. banks, which are thought to have little exposure to the Middle Eastern city-state. U.S. stocks fell sharply but rebounded from their lows as investors concluded that the damage might be contained. The Dow Jones industrial average lost about 155 points, or roughly 1.5 percent, in a shortened trading day, and other stock averages also sank. Oil prices plunged as much as 7 percent before recovering some ground later in the day.
European banks appeared to be at most risk if Dubai World can't pay its bills. London-based lenders HSBC Holdings and Standard Chartered could face losses of $611 million and $177 million respectively, according to early estimates from analysts at Goldman Sachs. Both have substantial Middle East operations.
South Korea estimated the country's financial institutions have just $88 million in exposure. Construction firms from Japan, Australia and South Korea behind Dubai's recent development boom also might be on the hook.
Among U.S. banks, Citigroup Inc. had $1.9 billion in exposure to the United Arab Emirates as of 2008, according to a JPMorgan research note. But it's unclear how much of that was related to Dubai.
What went wrong?
Dubai is part of the United Arab Emirates, seven city-states which have separate ruling families, separate budgets, but security, immigration and foreign policies in common. Abu Dhabi has nearly all the UAE's oil. To keep up, Dubai from the 1950s on diversified its economy into ports, trade, services and finance, largely successfully. But its liquidity-fuelled real estate and tourism binge in the last decade may have been one step too far.
The property crash hit Dubai at the time - house prices fell 50 pc in six months. Nakheel was known to be in trouble. But investors assumed that as a state-owned company it would not default on its debt. The government refused to issue detailed statements of how it was to handle Dubai World's debt problems, and rounded on those who said that the crash had undermined Dubai's development model. This encouraged a belief that a rescue package was already in place, probably funded by Abu Dhabi. The statement on Wednesday that the government was asking for a six-month standstill on repayments implied the rescue was in doubt.
The emirate has said it has $80bn of debts, though some analysts say the true figure could be double that. Dubai World, the state-owned holding company whose bail-out plans triggered the current crisis, has liabilities of about $60bn, though only part of that is debt. The main problem is its real estate subsidiary Nakheel, which has huge bonds coming due, including an Islamic bond for $3.5bn in December. It appears to have little cash flow to meet payments - as well as relying on debt, it also sold most developments off-plan, with new developments now on hold.
As the first chart shows, Dubai’s sovereign credit default swaps (CDS) are soaring in the wake of the news that Dubai World wants a standstill agreement on roughly $60 billion of debt. Even though Dubai World is a corporation seeking the agreement, the markets are clearly treating this as a sovereign debt issue.
As the second chart shows, this is causing a “contagion” among the credit worthiness of other gulf sovereign debt.
Dubai Crisis and its effect on India:
India is supposed to have a very less impact as far as the Dubai Crisis is concerned. India will continue to grow at 6.5%, the reason being Indian economy is driven primarily by the domestic demand.
Effect on Banking Sector:
Banks understood to be having lending exposure to Dubai — Bank of Baroda, ICICI Bank and State Bank of India — said their exposure to real estate firms in the Gulf region was either nil or insignificant.
"We have only 7-8 per cent of our total loan-book in the entire Gulf region, which amounts to Rs 10,000 crore. These accounts are well maintained and are unlikely to cause any kind of impact on the balance sheet,” - Bank of Baroda's Chairman and Managing Director M D Mallya.
Country's largest lender, State Bank of India, also clarified that it did not see any concerns emerging on account of the Dubai crisis as the bank has only minimal exposure in the UAE, bulk of which are short-term loans.
Effect on Real Estate Sector:
A majority of big real estate developers in India said they are insulated from the financial crisis in Dubai and it will not have any impact in the country's property market.
DLF, Unitech, Parsvnath Developers and Emaar MGF all said they have no exposure in Dubai, while Omaxe said it has an investment of Rs 40 crore which it has asked for refund.
Effect on Indian workers in Dubai:
It's well known that when Dubai sneezes, south India, especially Kerala, catches more than just a cold. Last September, when Lehman Brothers collapsed triggering the great recession, the arrivals at Chennai, Hyderabad and Thiruvananthapuram airports wore a grim look. The news of Dubai World's inability to repay the $59 billion debt has triggered similar fears among the relatives of immigrants back home.
UAE is the favorite destination for a maximum number of overseas Indian workers - 3.4 lakh people went to the country in 2008 - but the number has been fast declining as Indian workers are unable to get new contracts or extensions in the country that's in the grip of recession. Over 5 lakh Indians have returned from Dubai since September 2008, of which two lakh are Malayalees. Almost 60% of these people are technical or non-technical skills professionals. Over 50 lakh Indians work in the Middle East of which 20 lakh are from Kerala.
To sum up Dubai effect on India, we can say that the real impact will be limited. Remittance flows from Dubai, which account for about 10 per cent of overall remittances, could see a slowdown in the short term. Capital flows may see a mild reversal turning the equity and currency markets volatile but corporate exposure to Dubai appears to be limited to a handful of realty and infrastructure companies. And barring a few banks like Bank of Baroda which has operations in Dubai, the Indian banking sector seems relatively insulated.
Can Dubai Survive?
Dubai is still seen as the premier place to do business in the Middle East and beyond. It is a preferred base for not just Arab but Pakistani, Iranian and even Indian businesses, due to the wider region's political uncertainty. Its reputation for liberal attitudes helps. But events like this will have damaging effects on its reputation for economic competence, which the emirate's rulers will now have to work hard to restore.
However, what will be the real impact of the Dubai issue will depend upon how the newly appointed Dubai World's chief Aidan Berkett will handle the restructuring of this investment and property giant. But it has triggered much awaited correction in global equities, which can last longer then expected. So traders be cautious, lighten the long positions and wait for situation to calm down or let the restructuring happen or help to flow in from friends and neighbors of Dubai. For now, extreme caution is warranted.
"We shouldn't react to instant news like this. One lesson that we learnt from the (global financial) crisis is that we must study the developments and measure the extent of the problem and hence study the impact on India,"
-- By Dr D Subbarao, Governor of RBI.
