The thesis on Dubai we must not buy: Financial Express:Dec 03, 2009

The emirate meltdown can pose a big problem for India, and others:
There is a feeling of déjà vu in our official reaction to the Dubai crisis when we say that India will not be affected. If one recollects, we had said the same thing in 2007 when Bear Stearns went down as we scrambled to find out how securitisation and CDOs worked. We retained our high position when Lehman came down and it was only when the meltdown took place that we realised that even though our financial sector had stayed indoors all the time, our feet still got wet; and the rest, as the cliché says, is history.
The Dubai crisis, once again linked with real estate, means that the state does not have money to repay $59 billion that Dubai World owes. One is not really sure of the guarantee provided by the state, as the stance now is that the government was not a party to the bonds issued by the government-owned company. There are two aspects here. The first is that the government has the money but is not willing to help its own company, in which case the future of government-run companies will be questioned, as it is normally assumed that when we put our money in a public sector bank or undertaking, the government provides a guarantee somewhere. The other is that the government is distancing itself merely because it does not have the dollars, which is more serious. The issue is either of credibility or solvency, or a little of both.
The question is what would happen in case the government defaults. Dubai will seek help from the other Emirates, especially Abu Dhabi, and if it succeeds, the problem will become less acute. However, the broader issue is one of confidence, considering that Dubai was touted as being a global financial and gold hub given its natural advantages. Singapore will surely score in this respect and there is a major reputation hit for Dubai.
Did we see this coming? Not really, because while everyone knew that there were repayments due and that the economy was not insulated from the global meltdown, its inability to service debt was never seriously discussed, even though there were some feeble signs thrown by the rating agencies earlier in the year when the credit rating of several banks and government-backed issuers were put on the negative list.
Is India isolated? Absolutely not, because we are going to be affected quite clearly, though the.magnitude could be a matter of conjecture. First, we have over $50 billion of remittances coming in every year, with this region supplying over a quarter of it. Second, we have over 4.5 million Indians staying in the Gulf and several jobs will be in jeopardy in case of a default and its backlash. Third, our trade with the UAE may not be very significant at around $30 billion per annum, but given that exports are primarily food products being consumed by the Indian population, there will be some impact. Fourth, while construction and project companies claim to be secure, it must be remembered that several of our engineering and construction companies have contracts in the GCC region, which will be affected either directly by defaults or indirectly through lower business in the future. Fifth, banks lending to companies in Dubai, either directly or to companies which have projects lined up in this country, would have to revisit their accounting books.
There are two other areas that have to be explored. The first is that if repayment is sought by off-loading US federal bonds, there would be reverberations in the US, which will mean excess selling that can drive up rates, something which the Fed has been trying to eschew for a long time. The other is whether there are similar bubbles elsewhere in the world where the Dubai model of rapid growth through the creations of world’s ‘first’, ‘tallest’, ‘largest’, ‘only’ landmarks through high leverage exist. The creation of such empires, admittedly in retrospect, is a reflection of financial opulence with little character.
The lessons are the following. The first is that one needs to examine closely any fast growth story that is based on high growth sponsored by leverage. The second is that overseas investors will be wary of putting their money even in state-owned outfits as government guarantees appear to be porous. The third relates to rating agencies, which will again have to constantly send out signals to the world and warn of a crisis. The fourth is more of a question, and it is a puzzle with no answer—the latest issue of Economist talks of the high levels of debts in some developed countries. How is one to view them now against the backdrop of this seeming crisis? ..