Did somebody forget to copy Dubai on the ‘global recession’ memo? The UAE’s largest city has long possessed audacity in excess – but you’ve got to hand it to the Persian Gulf statelet when, in the midst of worldwide economic disaster, it boasts the largest fireworks display ever at a $20m, Kylie Minogue-headlined bash to celebrate the opening of Atlantis, a 1,539-room resort perched on the end of the Palm Jumeirah, the world’s largest man-made island.

With the world economy sputtering and oil prices falling, many say the bubble is finally bursting for the energy-rich sheikhdoms. You wouldn’t know it from a party like this. Dubai is still publicly committed to a staggering range of projects, including a $64bn (€50bn), 280km2 tourism and entertainment development called Dubailand, featuring a cluster of seven theme parks built in the desert. In October, Nakheel, the mega-developer behind Palm Jumeirah and The World announced plans to out-do crosstown rival Emaar, the builder of the 160-storey Burj Dubai, with an even taller skyscraper called Al Burj, or simply ‘The Tower’.


Cracks in the edifice are showing, though. Property prices in Dubai and Abu Dhabi are falling for the first time in recent memory. Fear has gripped the local markets. Concern has grown over the level of indebtedness of Dubai especially, which lacks the massive oil income of Abu Dhabi. A number of large local developers, including Nakheel, have announced layoffs. Signalling a possible rethink of some of its more fanciful projects, Nakheel also announced it is delaying, for an unspecified length of time, work on several developments including The Universe, a collection of reclaimed islands slated for a spot next to the World archipelago.


“With the worldwide liquidity crisis turning into an economic crisis, I don’t think this region will be spared – or that the real estate market will be spared,” says 
P. Krishnamurthy, chief executive of Dubai International Securities. Concern is rising over the balance sheets of UAE banks, most of which are state-owned. Lending soared in 2007 and early 2008, with loan portfolios growing an eye-popping 49% year-on-year in June. 


Then, in a development that had more to do with bad timing than anything else, billions of dollars in speculative ‘hot money’ cashed out of the local currency at the end of summer. Speculators had bet the UAE government would depeg the dirham from the dollar, but fled when it failed to do so. That led to a sudden freeze in bank liquidity, and despite a government injection of cash, skittish banks have yet to start lending again. 


With property prices falling, local banks’ exposure to real estate is a worrisome unknown. Following a 12-month period in which some values rose as much as 80%, prices started plummeting in September when credit froze, as many investors found themselves unable to pay their next installment on property purchases. In the Burj Dubai itself, apartment prices have fallen as much as 50%, according to The National, a daily newspaper owned by the Abu Dhabi government. Most analysts agree that local real estate needed a cooling off period, but the question remains how far prices will drop before the market begins functioning again. Developers’ solvency may be at stake – and with it, the vaunted Dubai miracle. 


“I think we need a correction in property prices to bring back transaction volumes,” says Raj Madha, director of equity research at regional investment house EFG Hermes. “For the moment, the only transactions seem to be sellers who need emergency liquidity and buyers that are coming in to buy distressed assets. What we haven’t seen is a discount in prices in the mainstream market. We’ve seen a precipitous drop in transaction volumes in the secondary market, however.”


It used to be that asking too many questions of Dubai’s major state-run concerns was taboo, but people are increasingly – and openly – expressing concern over the health of major developers, even ones deemed ‘too big to fail’. To allay concerns about the banking sector’s exposure to real estate, Madha says the UAE government should offer an explicit guarantee of major developers’ debt. “We believe there is an implicit guarantee [for major developers], but there’s a big difference between an implicit guarantee and an explicit one – and an explicit federal guarantee would be best of all.”


Such guarantees should include a promise to finance, if needed, real estate projects that are nearing completion but have yet to be sold, he adds. Developers that budgeted for new buildings assuming continued sky-high prices will face a need for more (and increasingly dear) working capital if prices drop too far. “All developers are exposed to this issue,” Madha says. “They are used to being able to sell projects at very early stages with a minimum of investor protection, but going forward it will be much more difficult for them to make those sales. This is what is going to be driving up the amount of working capital the companies need to have for their existing commitments. They will not be able to sell early phase projects without significantly more investor protection.”


The problem is that lenders lack a clear line of sight into highly leveraged developers like Nakheel, whose bonds and certificates of sukuk – the Islamic equivalent of a bond – have been trading at levels that resemble distressed debt. “When you look at the credit market for bank debt, the market is assuming significant credit risk for Nakheel debt,” says Madha. “We don’t have the visibility on revenues to see how Nakheel debt is going to be paid off.” 


Dubai may well have overreached. But predictions of a massive crash need to be tempered with a bit of perspective. To begin with, a period of tighter credit gives an opportunity to clean up an economy that was by all accounts overheating in early 2008. Few economists predict the country will go into recession. Moreover, even if incoming tourism nosedives – and it now contributes about 30% of Dubai’s GDP – there’s more to the emirate than Disneyland in the desert.


In fact, during the peak boom years of 2000 to 2005, when the Dubai averaged double-digit economic growth, the biggest gainer in terms of GDP share was not tourism, real estate or construction, but trade. Dubai is now the world’s third largest re-export hub after Singapore and Hong Kong, with movement of goods centred on the city’s massive Jebel Ali Port, soon to be the site of Al Maktoum International Airport – yet another ‘world’s largest’ – with nearby Dubai Logistics 
City designed to handle 12m tonnes of air cargo annually. 


“Property is one part of the story,” says Philippe Dauba-Pantanacce, senior economist for the Middle East and North Africa at Standard Chartered in Dubai. “It’s important to a lot of people, but [the UAE’s] exposure is much more diversified compared to other countries. It doesn’t only depend on oil or property; it relies on retail, hotels, manufacturers and exporters. The economy is growing more sophisticated, and this brings balance. 
I don’t want to make it sound completely rosy, but everything should be put into 
perspective.”


Sceptics point to Dubai’s overall level of external debt – $80bn, or 148% of GDP. That’s indeed a staggering amount of leverage, given that asset prices are falling and the cost of refinancing has risen to near prohibitive levels. But it’s nowhere near the 10-times-GDP leverage racked up by Iceland, now all but bankrupt. The truth is, even given the unspoken rivalry with Abu Dhabi, a Dubai bust would hardly be in the nation’s best interest, and the state – meaning the Dubai, Abu Dhabi and federal governments – is well positioned to prevent it. 


The emirates have long functioned as quasi-capitalist autocracies. As Western governments intervene in areas long reserved for the private sector in an effort to stave off disaster, the UAE has no need to do so, simply because the hands of the state have always been deep in the pie. Dubai’s ruling Al Maktoum family has a strong influence, if not outright control, over most of the emirate’s major corporations, and it can adjust a number of spigots to calibrate markets to its liking. The federal government has already set aside $32.7bn to help local banks, and if property prices fall too much, local governments could curb supply by slowing the delivery of new projects – or with less orthodox measures like cracking down on flat sharing, which is technically illegal in Dubai. 


Finally, if Dubai’s war chest sounds like it’s perilously close to empty, consider that the Al Maktoums’ royal compatriots in Abu Dhabi, the Al Nahyans, are sitting on the world’s largest sovereign wealth fund. Though its exact size is unknown – some say it’s as big as $1 trillion, others a mere $500bn – it dwarfs Dubai’s total debt. Rumours are now circulating that Abu Dhabi might take a piece of Emirates Airline, Dubai’s pride and joy, in exchange for a bail-out. In fact, the balance of power between the emirates may well change, but if Abu Dhabi comes to Dubai’s rescue, there’s a good chance the public will be none the wiser. The UAE’s public finances are unpublished, and the workings of government here are as opaque, if not more so, than company balance sheets. 


Is the party over? It’s obviously time to turn the music down, with rating agency Moody’s now predicting “a significant portion” of Dubai’s planned projects will need to be shelved unless debt capital market conditions improve. In any case, that’ll be enough fireworks for now, thanks.