After Dubai World debt panic, UAE guarantees all bank deposits

The United Arab Emirates' central bank sought to reassure investors rattled by the debt woes of the politically-connected conglomerate Dubai World on Sunday with an announcement that it was backing all deposits in locally owned and foreign banks.

Asian markets were cheered by the news, rising more than 3 percent on Monday after falling by between 3 and 5 percent last Friday, though UAE stock markets fell by up to 8 percent on Monday on concerns over a deepening local recession.

"The statements of the federal government contributed to bringing confidence back into the global marketplace," says John Sfakianakis, chief economist at Banque Saudi Fransi-Credit Agricole Group based in Riyadh, Saudi Arabia.

The drastic step was taken because depositors were growing worried that defaults by Dubai World, which has sprawling port and property investments, could undermine much of the banking system. Dubai World said last Wednesday it could not make scheduled interest payments on $60 billion of debt.

While the property and investment bubble that drove the emirate of Dubai's prosperity in recent years has burst, Abu Dhabi – the oil-rich emirate where the UAE's central bank and government is based – remains one of the wealthiest spots on the planet, with enough financial clout to protect the country's banking system.

But analysts say that a careful parsing of the bank's statement also reveals that a full bailout for Dubai World itself may not be in the offing.

The company's chairman, Sultan Ahmed bin Sulayem, has been close to Dubai's ruling Al-Maktoum family and he had served on the board of the government's Investment Corporation of Dubai, which often led analysts to predict government help would be available if his businesses ever ran into trouble. But last week, Mr. Sulayem was fired from his post at the investment corporation.

Investors are likely to view a decision not to bailout Dubai World as reassuring, says Sfakianakis, since it would be a sign that the financially powerful Abu Dhabi will not throw good money after bad.

"I think they are seeing the selective kind of approach as a wise approach," said Sfakianakis. "Had they seen a blanket statement, maybe they would say Abu Dhabi is making another blunder."

Dubai has long been known as the profligate "younger brother" to more conservative Abu Dhabi. In February Dubai received a $10 billion bailout from the UAE's central bank.

Dubai World's holdings range from a man-made island shaped like a palm tree to Barneys New York to global ports operator DP World, though not all of these are struggling.

Its next repayment, a $3.5 billion Islamic bond owed by property development subsidiary Nakheel, is due Dec. 14.

Panic reaction?

Some analysts say last week's stock market reaction was overblown. Dubai World's debts pale in comparison to the trillions of dollars American banks lost last year and these analysts argue that Dubai's problems are unlikely to spread to other highly indebted countries such as Greece or Spain.

"It was a kind of exaggerated in many ways to expect that Dubai is going to bring the global economy to it's knees again," says Sfakianakis. "Some of the speculators took advantage of the news and forced markets to sell."

Major western banks appear to have limited exposure to Dubai World.

British-based HSBC may have the most risk in the UAE, with $17 billion in loans, according to JP Morgan Chase & Co. But its potential losses on Dubai World may amount to $611 million, Goldman Sachs estimated – a relatively small sum for the global giant.

Abu Dhabi is somewhat shielded from its neighbor's troubles, as it possesses the fourth-biggest reserve of natural gas in the world and one of the largest sovereign wealth funds. Still, it remains vulnerable because many businessmen based in Abu Dhabi have invested heavily in Dubai. Dubai's debt could also make it harder for the entire country to obtain credit.

For now the economic fallout from Dubai World may be exacerbated by the emirate's continued lack of transparency about its financial health. Investors have expressed frustration that Dubai hid its debt problems – even from Abu Dhabi, which was caught off guard by last week's announcement. It refused to reveal its total debt, estimates for which range from $80 billion to $150 billion.

Officials continued to suppress information over the weekend, blocking distribution of the Sunday Times, a British paper, which offered a two-page spread about Dubai's debts.

The crisis, however, could lead to stricter financial monitoring by Abu Dhabi on major creditors like Dubai.

"It would seem that Dubai had an unlimited ability to borrow with the implicit guarantee coming from Abu Dhabi. I think that's an unsatisfactory situation," says Peter Treadway, a consultant with Historical Analytics LLC based in Hong Kong. "They may have some objectives in terms of controlling Dubai in the future, preventing this from happening again."

With Dubai in desperate need of its funds, Abu Dhabi has a strong negotiating position and Mr. Treadway says he hopes that what aid does come will come with strings and caveats. "The markets will respect them more in the long-run if they show a little toughness in negotiating."