Dubai Inc well placed to meet commitments: Morgan Stanley
Dubai Government will have sufficient funds to refinance all its financial commitments for the rest of the year, Morgan Stanley said in a statement sent to Emirates Business.
Thanks to the launch of the $20 billion (Dh73.4bn) bond programme, the cost of debt to Dubai's entities is also expected to drop significantly.
According to the New York-based bank's holding company, the $10bn bond issuance along with the remaining proceeds from a $6bn syndicated loan launched by the Investment Corporation of Dubai back in September should provide the Dubai Government with sufficient funds to meet most of its refinancing commitments in 2009.
According to market estimates, $12bn to $16bn of Dubai's debt is due to be refinanced by the end of 2009. Thus, the announcement from the UAE Central Bank that it has fully subscribed to the first tranche of the $20bn programme will "go a long way towards easing market concerns about the future solvency of the emirate's large quasi-public institutions", said Morgan Stanley.
Market concerns about the availability of external financing, coupled with uncertainty about potential federal support, had driven up the cost of Dubai's debt and inflated the cost of insuring against defaults. CDS (credit default swap) spreads on Dubai's five-year sovereign bonds had gone up from about 150bp in October to around 900bp by the end of last week.
But investors' reaction to Sunday's announcement has notably been very positive.
Morgan Stanley says the yield on the December 2009 bond of Nakheel dropped from about 85 per cent on February 20 to around 40 per cent on February 23. Moreover, Dubai's sovereign CDS spread narrowed by about 150bp-200bp on the day.
This newspaper on Monday reported that right after the announcement the UAE stocks went up, Dubai CDs rates fell, and even emerging market stocks reacted positively.
Even the once-gloomy Moody's said if there were no restrictions on how proceeds are used, the bonds could support its debt ratings of six Dubai firms.
Moody's also said statements carried by Wam suggest that there will be no restrictions on how the Dubai Government uses the proceeds of the funds.
Moody's Investors Service, which is reviewing the ratings of six government-owned companies, says the news is clearly "supportive for the ratings".
However, although a further tightening of these spreads is expected over the coming days, the former investment bank says they won't return to their October levels anytime soon. This is due to the continued global risk-aversion to emerging market credit, as reflected by the relatively wide spreads on other sovereign debt in the region. In addition, the potential need for additional fiscal and monetary measures to strengthen market confidence address the remaining downside macro risks and catalyse economic growth.
There is also the likelihood of having to offer the second tranche of the bond programme at more attractive terms in order to generate sufficient interest from investors.
And it is not clear at this point whether the second tranche will indeed be tapped or whether it would be open to public participation should that happen.
The $10bn unsecured bond, issued at a fixed rate of four per cent will also push up consumer and investor confidence, says the report "The United Arab Emirates: Meeting Doubters Head On".
In turn, this could potentially increase market confidence in the solvency of the emirate's quasi-public entities; ease their access to additional external financing; re- energise domestic capital expenditures; and help increase consumer confidence, it said.
But its impact on domestic demand may be limited, it added, noting that the overall economic impact of this large issuance – equal to almost 97 per cent of the Dubai Government's budgeted spending for 2009 – may be dampened by most of the bond receipts may be reused to refinance outstanding debts.
"As such, they are not likely to have a significant impact on domestic spending, given that beneficiary institutions will not be able to use these funds to finance new investment projects," it said.
More so, the monetary impact of the central bank's subscription to the bond issuance will depend on where the Dubai Government decides to hold the funds.
"Given that the bond issuance is in US dollars, we do not expect any initial impact on the overall size of the central bank's balance sheet," it said. "Technically, the transaction should lead to a reduction in the size of the central bank's foreign assets and to an equal increase in the size of its dollar-denominated domestic holdings."
If the Dubai Government were to decide to place its bond issuance receipts abroad, the transaction would have no significant impact on the UAE financial sector, it said.
However, if the Dubai authorities were to deposit these funds in domestic financial institutions, then the net economic effect might be non-trivial.
Based on recently released January 2009 statistics, this would be equivalent to increasing total deposits in the banking system by about 4 per cent. This, the report said, could hypothetically provide UAE banks with additional liquidity and allow them to reduce their loan to deposit ratios from the current 1.13 per cent to around 1.08 per cent.
The effect on individual banks may be even more significant if these deposits were to be placed exclusively within Dubai-based financial institutions.
"Interestingly, the new dollar-to-dirham swap facility that the central bank introduced last December could potentially serve the banks well in this respect. However, we believe that the potential costs of depositing these funds in domestic banks may preclude the government from doing so," it said.
Given the debt refinancing needs of Dubai's public entities, it is highly probable that the government will need to withdraw the majority of these funds over the next 12 months. This may prove to be systemically risky if these funds were deposited within domestic financial institutions.
"Based on this, we believe that the funds will most likely be held outside domestic banks, with little net impact on domestic liquidity," it said.
Reduced systemic risk
The debt issuance also reduces the systemic risk attached to Dubai's large quasi-public institutions and provides them with much-needed breathing room.
Over the past six months, the pressure on these institutions rose significantly as concerns about their relatively high level of indebtedness increased. Given Dubai's scarce oil resources, it had relied on relatively inexpensive external credit to finance massive real estate projects and facilitate the growth of a diversified economic base.
In the process, however, it has also managed to accumulate a significant amount of foreign debt. Although relatively high, the size of this debt would have been manageable under normal circumstances. However, following the dramatic turn that international credit markets have taken since mid-2008, the cost of servicing and refinancing Dubai's debt has risen significantly.
"We have consistently argued in the past that Dubai's systemically important quasi-public entities, such as Nakheel and DP World, would not be allowed to fail," it said.
"We had also proposed that in order to reduce market speculation and ease investor anxiety about these companies, greater transparency was needed with regard to the amount of financing that these firms required over the medium term; and the availability of alternative funding sources should the cost of non-governmental financing remain prohibitive.
"To this end, Sunday's bond issuance will go a long way towards reducing the ambiguity surrounding the latter constraint and underlining the federal government's readiness to provide support to Dubai-based institutions, should they need it."
To further boost investor and market confidence and catalyse economic growth, Morgan Stanley said a higher level of disclosure would be needed.
Overall, the announcement provides an unequivocal show of support of the Abu Dhabi government for the Dubai Government and its institutions.
Although the bond issuance was subscribed to by the central bank, which is a federal authority, it also provided a strong show of support by the emirate of Abu Dhabi.
Abu Dhabi funds about 50 per cent of the federal budget and provides for $8bn to 10bn in federal services annually.
The emirate also accounts for about 95 per cent of the UAE's oil production and controls most of the country's massive stock of official foreign assets. Abu Dhabi's implicit backing of this deal should thus help to ease market speculation about whether the emirate would support the government of Dubai if it were to run into funding constraints.
"Given the strong and symbiotic relationship between these two emirates, we have consistently maintained that Abu Dhabi would indeed provide the necessary support to its northern neighbour," Morgan Stanley said. "Moreover, we have argued that the benefits to Abu Dhabi from maintaining a strong federation far outweigh the costs of providing Dubai with temporary financing by using a fraction of its massive reserves. The central bank's actions have reinforced our conviction in this regard."
Still, a "clear and unambiguous" official stand on this issue by the federal or Abu Dhabi may still be required if market speculation does not significantly subside.
"In sum, there is a need for a greater degree of transparency on the part of both public and private entities during these times of heightened speculation and investor anxiety," it said.
"Moreover, a clear and concerted effort by all levels of government in the UAE is necessary in order to tackle the challenges facing the federation and to avoid any further fallout from the global financial crisis."
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