The whole world is concerned about what is happening in the city state Dubai, for some reason or another. Tiny Dubai has built an economic miracle in a relatively short period of time and attracted the world’s attention. We Arabs living in the West often met business people, scientists, academics etc who expressed their admiration of Dubai’s achievements and wished to visit Dubai. I myself never visited Dubai. This economic miracle should not be wasted. It would be like the Arabs losing another war to their enemies. Moreover, its collapse will have grave fall-outs on other Arab and emerging economies. The collapse is contagious.
We all understand that the economic miracle was built on gigantic amounts of debt that are tied to the price of oil, and was advanced in a rush. It is a miracle because of the high speed that characterized its development and the amounts of money it needed to be achieved. Many people including good people have strong doubts over the way this miracle has been achieved. Five years ago, I expressed my concerns of the sustainability of an economic miracle in this era, particularly by a small city state that does not have many resources of its own. Not only because the miracle was founded on a huge mountain of debt but also because it went out of balance with its own reality. We heard and read reports in the internet, newspapers and TVs of labor exploitation, social tension, traffic jam, graft and fast profit. At that time, this economic miracle reminded me of the Maya civilization that, at its peak, was one of the most densely populated and culturally dynamic societies in the world, but went out of balance with its environment and then was choked by nature . I wanted to write about the ample ways where the Dubai economic miracle and the Maya civilization compare. But then I was concerned that this idea of giving advice may be exploited to attack more than just Dubai. There is no doubt that the problems that Dubai is facing call for change in the course of its economic development process.
First, Dubai cannot continue multiplying the economic miracle. Now it is time for seeking survival and then consolidation, and not continuing leaping ahead on higher mountains of debt. All grandiose projects that are in the planning stage by the Dubai government's companies should be scrapped and the successful existing ones should be supported.
Second, Dubai’s economic strategy should not only change from “forging ahead” to “consolidation”, but it should also change to rely more on real diversification, away from total dependency on the banking, real estate and hospitality industries to adoption of more defensive industries such as medical care, education, and services industries that are suitable to microscopic states. Dubai’s economic miracle has depended too heavily on cyclical projects that benefit greatly from rising oil prices during economic upturns. Such a strategy deprives Dubai from cash flows during economic downturns when the price of oil drops to say $30 or $40 a barrel.
Third, Dubai's conglomerates like Dubai World and Dubai Holding are at odds with the reasons for opting for conglomerates. In the textbook that I use in teaching MBA students the course Managerial Economics, the advantage of establishing conglomerates is "to improve firms’ cash flows because revenues derived from one product at a time when it has a high demand can be used to generate working capital when demand for another product is low. This reduces the variability of a firm’s earnings and gives it better access to capital markets". Dubai World and Dubai Holding embed cyclical companies that are tied to higher but not lower oil prices.
Fourth, there should be recognition that there are limits to government rescues. It seems that Dubai's government is distancing itself from its GREs and Abu Dhabi is not showing signs of immediate support for Dubai's GREs. There should be a more important role for the private sector which cares more about risk than government companies. Those GRE companies will also rely on the government support and raise the bar for risk-taking than the private sector.
Fifth, survival of the economic miracle is now the responsibility of the UAE federal government and the neighboring countries. It is not the $58 billion debt that Dubai government that has accumulated over the years that scares the region and the world, but the fallout from Dubai to the whole confederation, the other Gulf’s states and emerging economies. Dubai’s government total debt is about $80 billion. This pales when compared to the $3 trillions that world banks had to write down as a result of the credit crisis.
Sixth, the Dubai government now has the responsibility to be more transparent and work in harmony with its big sister in the confederation. This should strengthen the confederation. There are those in Abu Dhabi who strongly disagree with Dubai’s strategy and they feel they have to come to the rescue when danger looms but they are not consulted in good times. There are reports that the federal government officials and debtors were not informed of Dubai’s decision of asking for standstill on its debt payments. Learning from George Bush’s adventure in Iraq, there should be an exit strategy when we embark on huge initiatives. We know that Abu Dhabi’s sovereign wealth fund (SWF)has more $850 billion in foreign assets which can be used in this time but this may not be possible in the future, particularly when the price of oil is much lower than $80 a barrel. Abu Dhabi's SWF can buy equities in DW Ports and Nakheel at market prices with a provision that these two companies can buy them back in the future at the same price after paying an agreed-on return. Other technical details can be left to both emirates. Let me go further by saying that the GCC SWFs should have a change in philosophy to include in addition to sound investing globally, a provision to support the national economies during crises. How good are these SWFs if their national economies are in trouble?
Seventh, Dubai should learn from its own crisis and from the crises of other countries. Southeastern Asian countries learned a big lesson during the 1997 Asian crisis that they can not keep financing long-run investments with short-term capital. Dubai government seems to abhor long-term financing perhaps because of its faith in higher oil prices, the lower cost of short-term debt and the stronger desire of controlling its own affairs to speed up economic growth according to its vision. Dubai should learn now, as the southeastern Asian countries did in 1997, that there should be an optimal balance between short-term and long term debts. When oil prices go down, it is very difficult to finance short-term with more short-term debt. Dubai should also learn that there is an optimal capital structure balance between debt and private equity financing. Corporate Finance textbooks have plenty of literature on this subject.
Eigth, Dubai and other GCC states should have a legal procedure that deals with individual and company bankruptcies. They need a well-denied legal system that is similar to chapter 11 and chapter 7 bankruptcies that exist in the United States.
Ninth, the Islamic Sukuks seem to have been discredited in the Dubai debt crisis as a reliable debt instrument. They have been exposed as unsecured financial tools. Some people also believe that their success is tied to the oil boom as is the case with Dubai economy. This is a double Whammy for oil based Dubai. These instruments must change to make them fit during distress times.
Tenth, there should be a change in the guard at the top management of Dubai World and its subsidiaries in the spirit of accountability and assuring the world capital markets. There are news reports of negligence right at the top of the holding company and problems started to gather dust. The new management will be responsible for making the change and the world capital would like to be reassured that change will take place. We should not waste this crisis.
Let me conclude by saying that we have lost many wars in the past. The current situation in Dubai is the economic equivalent of a war which we can not and will not lose because we have all the means to win it. We will not repeat it if we learn big lessons from it. Still, it requires Dubai to take a second look and re-evaluate its economic strategy. Real change is required and time has come for it. I have now offered several ideas to help Dubai start the change.
This kind of war we should fight together and stand hand in hand to win, and this is not the kind of war that is raging in Yemen.
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Community Comments (2)
Just today, I wrote an article about Islamic Finance and Dubai crisis (to be published tomorrow in Tribune de Genève-Switzerland). In this article I mentioned the same points you came through. I added one point which is a transparent communication. I think that a clear statement about the links and relations between the differents players, the sizes and eventually the responsibilities later.
This is the first major crisis in this region, dealing with this crisis will set the rules and will forge the impressions about how serious Arabs, rulers or local financiers deal with such issues.
As for Islamic Sukuk part of the crisis, it would be a school case, since that is the first serious crisis of such size. This crisis is also a clear signal that Islamic Finance is not preserved from financial crisis as many may think or promote (something I repeat to my students at the uniiversity), regardless of the origin of the crisis whether internal to the products or to its mechanisms -including governance- or external to the islamic system since we are living and dealing within an internconnected global economy.
I would like to share with you a comment on this post that I received by an email from a European professor who lives in Europe.
"I read your new piece and agree 100%. A lot of what we hear and see is simply bloody mindedness. It comes from people who cant stand to see or think of highly successful Middle Eastern countries."
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