ECONOMIC RESEARCH – NATIXIS ASSET MANAGEMENT Philippe W AECHTER – DIRECTOR - 01 78 40 36 68 - philippe.waechter@am.natixis.com
THE DUBAI ISSUE The situation of Dubai has radically changed. On November 25, the emirate announced that the property company Nakheel, a subsidiary of the Dubai World conglomerate, had to delay $3.5 billion of loan repayments due on December 14 until May 10. Dubaï World is a government-owned conglomerate. Such an announcement hardly comes as a total surprise. The rating agencies had already been worried about Dubai’s spectacular property developments of the past few years. In October 2008, for example, Moody's issued a warning on the burgeoning debt and the Dubai property frenzy. However, while there were concerns about the situation in general, the financial strategy did not appear to raise any major worries with the Dubai emirate effectively raising capital recently. In wrong-footing everyone, the announcement of the delay in debt repayment has had a significant impact. This shock can be seen in the chart opposite which shows the CDSs of the different Dubai entities. Dubai World’s CDS has widened by 250 basis points in two days while the emirate’s CDS has widened by 223 basis points over the same period. The levels reached by the CDSs are high but lower than those witnessed in the autumn of 2008 and in early 2009. (A CDS is a financial asset which gives a measure of the risk premium of an issuer bond: the higher the premium, the greater the perceived risk.)
Dubai – 5-year CDS 2000 Dubai World 1800 1600
Dubai Holdings Dubai Emirates
1400 1200 1000 800 600 400 200 0 2-Jul-2007
2-Nov-2007 2-Mar-2008
2-Jul-2008
2-Nov-2008 2-Mar-2009
2-Jul-2009 2-Nov-2009
The key points on Dubai Dubai is one of the seven members of the United Arab Emirates (UAE). The largest is Abu Dhabi with more than 80% of the country’s oil reserves. UAE debt has risen very significantly since the mid-2000s, quadrupling since 2005 to $123 billion in the second quarter of 2009 and representing more than 50% of UAE GDP compared with less than 25% in 2005. Dubai’s share of this debt is around two-thirds. Of the banks owning these UAE loans, the British banks have a share of around 40% compared with 9% in the United States, Germany and France. The important point is that there is regional solidarity between the seven UAE members. This implies that, faced with difficulties in one member State, the others have a duty to intervene. This may be the case for the Abu Dhabi Investment Authority (ADIA) which is a sovereign fund of around $500 billion. Nakheel’s $3.5 billion was hardly an issue. Consequently, if there has been no direct intervention it is because there is in all likelihood a struggle for influence within the UAE between the Abu Dhabi and Dubai governments and the practices implemented in the Dubai World conglomerate. The equation can be resumed as follows: Dubai is now in recession. The problem of the property boom and the management of an excessive debt means it is currently in difficulty. The looked-for help has clearly reignited possible strains between Abu Dhabi and Dubai. The former has oil wealth and significant sovereign funds and has de facto been inclined to push for the implementation of new management rules. An explicit announcement effectively enables the negotiation issue to be forced through and accelerated.
The contagion issue The increase in the risk indicators relating to the reversal in Dubai’s fortunes has had a significant impact on all the financial markets. The stock markets witnessed a marked correction (-3.4 % in Paris) and long-term Euro-zone reference rates fell fairly sharply (around ten cents on the German 10-year interest rate which returned to a little over 3.1%). At the same time, however, Greek and Irish interest rates increased. Greek rates rose by a little over 10 basis points while Irish rates increased by just over 3.5 basis points. This tightening in the Euro-zone is specific to these two countries since the interest rates of the other European countries all fell to a greater or lesser extent. This sensitivity is consistent with what we have seen in recent weeks within the Euro zone. Greek and Irish rates have
Monday, December 1, 2009
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ECONOMIC RESEARCH – NATIXIS ASSET MANAGEMENT Philippe W AECHTER – DIRECTOR - 01 78 40 36 68 - philippe.waechter@am.natixis.com decoupled from the trend witnessed in the other countries as seen in the chart. Their sensitivity to market events is thus logical. Within this context, the question of contagion necessarily arises. If a significant risk emerges in a whole which remains fragile, to what extent will this wash over into other markets?
10-year interest rate in 2008-2009 6.5 6
Allemagne Germany France
5.5
Austria Autriche Belgique Belgium
5
Finland Greece Grèce
4.5
Irlande Ireland
In order to get an idea of this phenomenon, I have taken the 5-year CDSs of the different States liable to be impacted by this reversal in Dubai (second chart). The CDSs of the Middle Eastern countries bordering Dubai have been the most affected. Those of Abu Dhabi, Qatar and Saudi Arabia have seen a moderate widening: 60 basis points for Abu Dhabi, 33 for Saudi Arabia and 20 for Qatar. These moves are incommensurable with the moves seen in Dubai.
4
Italie Italy Hollande Holland
3.5
Portugal Portugal Spain Espagne
3 2.5 Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Trend in the 5-year CDS for the different States to November 26 1200
The other point to note is that there is a significant difference between the CDSs of these three countries and that of Dubai. Before this news broke, the spread on the Dubai emirate CDS was more than 310 basis points whereas that of Abu Dhabi stood at just 100 and Saudi Arabia at 75. The risk apprehension of the financial market vis-à-vis Dubai was already priced in.
1000
Dubai Abu Dhabi
Greece Grèce
800
Hongrie Hungary Islande Iceland
600
Irlande Ireland Léttonie Latvia Lithuania Lituanie
400
Qatar 200
There was little reaction from the fragile European markets. This was true for Iceland, whose CDS widened 20 basis points, for Greece where the widening was also 20 basis points, for Latvia where the spread increased by 25 basis points and for Lithuania (+16). Ireland was little affected at +7.5 points as were the Central Eastern European countries (Poland, Czech Republic and Romania) except perhaps for Hungary which is a little more fragile than the others. The calculations shown in the two charts opposite show a relatively low correlation between the Dubai CDS and those of the other countries in the sample (the correlations are calculated on the daily spreads between the Dubai CDS and those of other countries, the calculations being for a rolling 30-day window). The two last points take into account the data of November 25 and 26, the correlation increasing very significantly since CDS spreads widened for all the countries in the sample. The reading of these correlations suggests that the link between the dynamic witnessed in Dubai and that of the other countries is generally limited. The correlations increased only very recently due to the shock wave and questions raised by the new situation in Dubai. The reversal witnessed in Dubai is consequently unlikely to have a sustainable impact on other markets unless we suppose that Dubai’s specific situation continues to see a long-term, dramatic deterioration. This is not our assumption.
Romania Roumanie S. Arabia Arabie S.
0 1-Jan
26-Feb
23-Apr
18-Jun
13-Aug
8-Oct
Correlation between the daily CDS spreads of the Middle Eastern States and that of Dubai for 2009 1.2
30-day window for the correlation calculation
1 0.8 0.6 0.4 0.2 0
Abu Dhabi Qatar
-0.2
S. Arabia Arabie S. -0.4 1-Jan
1-Mar
1-May
1-Jul
1-Sep
0.6
0.4
Tchéquie Czech Rep. Grèce Greece
0.2
Hongrie Hungary Islande Iceland Irlande Ireland Latvia Lethonie Lithuania Lituanie Poland Pologne
0
-0.2
-0.4
30-day window for the correlation calculation
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1-Nov
Correlation between the daily CDS spreads of the different States and that of Dubai
-0.6 1-Sep
Monday, December 1, 2009
3-Dec
21-Sep
11-Oct
31-Oct
20-Nov
ECONOMIC RESEARCH – NATIXIS ASSET MANAGEMENT Philippe W AECHTER – DIRECTOR - 01 78 40 36 68 - philippe.waechter@am.natixis.com Conclusion Dubai has seen very rapid development notably on the back of property financed by a growing debt burden. This had enabled Dubai to record robust growth well in excess of that of the other UAE members and particularly Abu Dhabi. Dubai is, however, now in recession with resources in retreat, a less buoyant property market and a very substantial level of debt. The solidarity of the other UAE members must come into play. However, given Dubai’s situation, this will probably be subject to conditions. Abu Dhabi will intervene but will wish to make its mark. This is effectively what has happened. The news of the delay in debt repayment by Dubai unleashed a shock wave in the markets that we have captured in the CDS trends. The Dubai CDS widened significantly but those of the neighboring countries saw a marked but limited impact, while the fragile European countries have seen a widening, albeit hardly excessive, in their CDS spreads, an increase that is, in any event, hardly commensurate with that of a few months ago. Note also that the correlation between the daily CDS spreads of the different States and that of Dubai is low. At the time of the announcement, the shock wave mainly spread to countries which were already fragile but the low previous correlation and the handing of the situation within the UAE itself since solidarity will prevail should mean that there is no long-term impact on the markets.
Written on Friday, November 27, 2009
Monday, December 1, 2009
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