Bond market delivers vote of confidence in Dubai model
Dubai, June 26, 2014
Bond investors' confidence in Dubai is surviving two tests at once, with bond prices staying strong even as the stock market tumbles and concern mounts over volatility in the real estate sector.
Wild swings in the Dubai stock market have erased about a quarter of its value, roughly $30 billion, over the past six weeks and prompted fund managers to complain about standards of corporate disclosure.
Meanwhile, both the International Monetary Fund and the United Arab Emirates central bank warned this month of the risk of Dubai's real estate market overheating, which could eventually lead to a crash.
Both issues evoke memories of Dubai's financial crisis in 2009, when a collapse of its property and stock prices pushed the emirate to the brink of default, sending yields on Dubai-related bonds soaring.
But this time, the bond market is delivering a vote of confidence in Dubai. Yields have barely moved and the cost of insuring the emirate's sovereign debt against default is near its lowest level since mid-2008.
Several factors are responsible. Dubai is benefiting from a shift in risk perceptions; in contrast to five years ago, it is serving as a safe haven not only in the region but also within the emerging market universe.
Investors think the emirate has learned lessons from its crash and can now manage its markets better. And for many investors, the economic strategy which Dubai has developed since the crash, based heavily on tourism, trade, regional business services and banking, looks compelling.
"The fact remains that Dubai still has the region's most diverse economy, whose reliance on hydrocarbons is significantly lower than peers, both in terms of public finances and headline growth drivers," said Raza Agha, emerging market sovereign debt analyst at VTB Capital in London.
"Bond investors appear comfortable with their Dubai positions, and this is being reflected in how Dubai has been trading in credit markets."
Bond yields and CDS barely moved this week as the stock market tumbled.
The spread between the Dubai government's $750 million, January 2023 sukuk, which is unrated, and Abu Dhabi's dollar bond maturing in April 2019, which at Aa2 is one of the Gulf's top-rated credits, actually narrowed this week, by 6 basis points to 207 bps. The spread has narrowed from around 300 bps in late 2013.
Five-year Dubai credit default swaps, which during the emirate's financial crisis hit levels above 600 bps, edged up just 2 bps from Monday's multi-year low to 147 bps.
One reason for the bond market's calm was its belief that Dubai's stock market plunge was to some extent an inevitable pull-back after huge gains over the past 18 months. The trigger for the plunge - management turmoil at Dubai builder Arabtec , which pricked a bubble in the stock - is being seen as essentially a company-specific problem, not a sign of weakness in the outlook for the emirate's companies in general.
"CDS moved a touch but it was nothing significant," noted Abdul Kadir Hussain, chief executive at local financial firm Mashreq Capital.
"The fact that the credit markets in the region and in Dubai in particular did not react strongly to the volatility shows that it had more to do with market technicals, and was not a fundamentally driven sell-off."
Also, perceptions of Dubai risk relative to other emerging markets have shifted over the past three years.
Since the Arab Spring uprisings of 2011, Dubai has emerged as a major safe haven for money fleeing political instability in the Middle East. And over the past year, it has come to be viewed - perhaps surprisingly, given its history - as a safe haven among emerging markets globally.
While countries such as Turkey and Indonesia have been punished by markets for their current account and budget deficits, Dubai has been sheltered by the region's huge surpluses, as well as the UAE dirham's peg to the U.S. dollar, which is backed by Abu Dhabi's oil wealth.
There is also a perception that Dubai is handling its recovery from the 2009 crash well, juggling the debt maturities of state-linked firms which were forced to restructure tens of billions of dollars worth of debt.
That perception got a boost this week when local property developer Nakheel announced it would repay all its outstanding debt to banks by August, four years ahead of the schedule mandated by its restructuring plan.
While some investors remain nervous about Dubai's volatile real estate market, where prices are back near pre-crash levels, others think the government has done enough to ensure that it does not overheat.
Yaser Abushaban, executive vice-president for asset management at Portuguese financial group Espirito Santo, said the current property boom looked more like one that occurred in 2005 than 2008, when the market got ahead of itself and then plunged from very high valuations.
"The economy is not overheated at present, so there is no bubble or catalyst for a bursting 'bubble'," Abushaban added.
The main risk to Dubai appears to be U.S. interest rates, which when they start to rise could quickly transmit themselves to Dubai's economy through the currency peg.
Higher rates would complicate the financing of Dubai's restructured debt; the IMF has estimated about $64 billion of debt held by Dubai and government-related firms will come due between 2014 and 2016. Any worsening of the global market environment could also make it harder for Dubai to complete asset sales which are still needed to pay off some of that debt.
But with the U.S. Federal Reserve signalling that any rate rises probably won't come before next year and will then be gradual, that risk does not loom large at present.
Instead, some investors are focusing on Dubai's success in diversifying its economy since the crash. The real estate industry is still a big driver, but the government has been putting a lot of effort into developing other sectors, which may reduce the risks of a boom-bust cycle.
Official economic data is published with a long lag but the latest gross domestic product numbers, from the first quarter of 2013, show manufacturing contributing 13.2 percent of growth, up from 10.6 percent in 2007, and the financial sector at 13.0 percent, up from 10.6 percent.
The contribution of the real estate sector has shrunk to 13.9 percent from 18.0 percent. Its share may have increased over the past year as the property market has boomed, but even so, Dubai's growth looks somewhat more healthy than it did at the height of its last boom.
"With Dubai's structural story, a trade and tourist hub with an unassailable lead over regional rivals and a centre for regional refugee capital, the recent equities sell-off should provide an opportunity" to consider buying Dubai blue chips again, said Hasnain Malik, head of frontier markets strategy at investment bank Exotix in Dubai.
He added that if international economic sanctions on Iran were lifted - something which could happen if Tehran negotiates an agreement on its disputed nuclear programme by a July 20 deadline - Dubai, as a traditional hub for Iranian business, would look even more attractive.-Reuters