Dubai - Saving the day

Dec 14th 2009From Economist.com
Abu Dhabi rescues Dubai after all

DUBAI, one of seven members of the United Arab Emirates (UAE), is now in the middle of its international film festival, which includes “City of Life”, a film set in Dubai and directed by a local. But the most gripping cliff-hanger is playing out in Dubai’s debt markets. On Monday December 14th Abu Dhabi, the wealthiest member of the UAE, arrived on the scene at the last moment to rescue its neighbour from the brink of default.
It provided $10 billion to Dubai’s government, more than enough to repay the $4.1 billion due on Monday to holders of a sukuk, or Islamic bond, issued by Nakheel, a prominent developer. Nakheel belongs to Dubai World, a holding company owned by the Dubai government, which less than three weeks ago requested a standstill on repayments of $26 billion of debt, perplexing investors and panicking global markets.
Just as every film-goer knows that the damsel in distress will be saved in the end, so Dubai’s creditors had long assumed that the emirate would be saved by its oil-rich neighbour. But the standstill announced on November 25th departed from this script, creating genuine suspense.
Investors knew Abu Dhabi could not let its neighbour fail without damaging its own economic interests. They assumed that Abu Dhabi knew this too. Therefore when it let Dubai walk to the edge, it was deeply unsettling. Either Abu Dhabi's policymakers did not know the damage this would do, or they did not care. The announcement on Monday suggests that Abu Dhabi did care. It just did not anticipate quite how badly creditors would react.
Nakheel’s creditors can now be repaid, but Dubai’s credibility cannot be repaired so easily. Its solvency rests on a relationship with its neighbour that is impossible to fathom. At least this latest handout dropped the fig leaves that disguised Abu Dhabi’s previous gestures of support. It was given directly from one government to the other, unlike the $10 billion routed through the UAE’s central bank in February and the $5 billion lent in November through two commercial banks partly owned by the Abu Dhabi government.
Even now, Dubai’s creditors cannot expect every claim to be redeemed in full. The money left over after the Nakheel sukuk is repaid will go to Dubai World’s suppliers and contractors, who endured a standstill on payments long before the company asked the same of its creditors. The money will service Dubai World’s other debts only if the group is “successful in negotiating a standstill as previously announced,” the statement says.
If those negotiations falter, Dubai World’s fate will be governed by a brand new “reorganisation law”, unveiled on Monday. The UAE already has a bankruptcy law, but almost no one uses it. Any creditor foolhardy enough to test the regime can expect to recover just ten cents on the dollar, the World Bank calculates.
The new decree instead appoints three judges from the Dubai International Financial Centre (DIFC), a 110-acre “free zone” with its owns laws, written in English and based on common-law principles. The judges include one who formerly sat in the High Court of England and Wales and a Singaporean who previously served on his country's Supreme Court. They will apply DIFC law, with some tweaks, including a provision to allow for an automatic stay on creditors’ claims.
Their expertise will not be needed if Dubai World’s creditors now come to terms. The chances are good that they will. The shock they have suffered over the past three weeks may have softened them up. And the underlying case for a restructuring of Dubai’s debts has some merit, even if the government has so far handled it abysmally. Dubai, one might say, has had one life. Now it must make a success of its second.