A bailout by neigh­boring emi­rate Abu Dhabi has appar­ently sta­bi­lized Dubai’s finan­cial crisis. But the longer-​​term eco­nomic impact—on Dubai and other nations—could grow more serious. Pro­fessor of Finance and Insur­ance Jef­frey Born says the pos­si­bil­i­ties range from a pro­longing of the reces­sion in some Western economies—especially the United Kingdom—to a more serious credit crisis for Islamic economies.


When people think of Dubai, they think of extrav­a­gance. Can you give us a brief his­toric per­spec­tive on the finan­cial rise of the United Arab Emi­rates?

On an area of the Ara­bian Penin­sula on the south coast of the Per­sian Gulf lie seven sheik­doms that formed a con­fed­er­a­tion known as the United Arab Emi­rates (UAE) in 1971, when a 100– year pro­tec­tive treaty with Great Britain expired. Dubai is the second-​​largest emi­rate and it takes its name from the major port city located on the Gulf. The con­fed­er­a­tion mem­bers use a common cur­rency, the UAE dirham, but each has its own legal system and con­sti­tu­tional monarchy. Oil, dis­cov­ered in the early 1960s, accounts for 25 per­cent of the UAE’s total GDP, which rose to $206 bil­lion in 2008. For com­par­ison, when formed, the UAE had a GDP of approx­i­mately $1.5 bil­lion. Linkage of the UAE dirham to the U.S. dollar has led to sig­nif­i­cant infla­tion, but nonethe­less, real growth rates have been amongst the highest in the world since the mid 1970s, and the cre­ation of OPEC.


Dubai World is the invest­ment con­glom­erate that many blame for the cur­rent eco­nomic crisis. What is their role in the down­fall?

Dubai World [DW] is a royal family-​​controlled holding com­pany that is the vehicle for devel­op­ment in the Dubai Emi­rate and its efforts to diver­sify the economy. For example, DW is a 50–50 partner with the MGM Mirage in the $8.5 bil­lion “City Center” devel­op­ment in Las Vegas that has had sig­nif­i­cant trou­bles, and DW bought the New York City-​​based retailer Bar­neys for $850 mil­lion in 2007. Amongst its sub­sidiaries is the real estate devel­op­ment com­pany Nakheel, which is best known for its palm tree– shaped housing devel­op­ment in the Gulf that can be seen from space.

It was the announce­ment by this sub­sidiary that a sched­uled repay­ment of $4.1 bil­lion of Islamic Bonds would not be made—and that nei­ther the emi­rate nor the emir planned to rescue DW—that trig­gered the crisis. At the last moment, the largest emi­rate, Abu Dhabi, announced that it would loan $10 bil­lion to Dubai (which would then loan funds to DW in order to pay off the debt) to avert the col­lapse of the holding company.


There has been spec­u­la­tion that Dubai might face a double-​​dip reces­sion in 2010. What does this mean for the region? For the West?

Notwith­standing the suc­cessful debt repay­ment, DW is going ahead with plans to ask lenders for a “stand-​​still” (no accrual of interest) on nearly $26 bil­lion of real estate-​​related debt. In the short run, this is causing real estate investors to look toward Abu Dhabi as a safer haven within the UAE, which will almost cer­tainly depress values in Dubai even more. With real estate devel­op­ment accounting for about a quarter of GDP in Dubai, con­tinued soft­ness in real estate will no doubt extend or worsen the reces­sion. United Kingdom-​​based banks have made large loans to DW, increasing con­cerns about an already fragile finan­cial system there and per­haps extending their reces­sion even longer. Japan, China, and the U.S. are the major exporters to Dubai (and the UAE), and fur­ther belt-​​tightening may reduce the speed at which these economies rebound. But Dubai is a very small market. Our exports amount to just $1.4 bil­lion out of a total of more than $1.8 tril­lion annually.


How is the crisis in Dubai affecting the rest of the world today, and what might its impact be longer-​​term?
The short-​​term response to the DW crisis was to create the second “flight to quality” in less than 12 months. Ner­vous inter­na­tional investors dumped risky assets, con­verted their funds to U.S. dol­lars and bought U.S. Trea­sury secu­ri­ties. The flow of funds toward the U.S. caused the dollar’s value to rise and yields on short-​​term U.S. gov­ern­ment bonds to plummet. Now that the crisis is sub­siding, the cap­ital is flowing back out of the U.S., causing the dollar to give up some of its recent gains and Trea­sury yields to rise slightly.

Long-​​term, the near-​​default of an Islamic Bond has caused investors world­wide to con­tem­plate the risk­i­ness of these secu­ri­ties. Under Islam, as applied to finance, bor­rowers and lenders are more like “part­ners,” and pay­ments to investors (not referred to as ‘interest’) are not guar­an­teed. Any dis­putes would almost cer­tainly be adju­di­cated locally. Thus, the huge growth in Islamic debt that has taken place in the past decade may slow sub­stan­tially, to the detri­ment of many Islamic economies.


Is Dubai, in the well-​​worn phrase of the day, too big to fail?

It is impos­sible to know the full extent of bor­rowing that has taken place in Dubai, but esti­mates are that the amount (including DW) exceeds $100 billion—roughly three times the GDP of the emi­rate, making it one of the most lever­aged states in the world. With small and rapidly dwin­dling oil and gas reserves, Dubai needs to be suc­cessful in its efforts to trans­form itself or its income levels could fall.

U.S. firms such as EMC, IBM, and Microsoft have a large pres­ence in Dubai, UK-​​based banks have made large loans to DW, and the debt secu­ri­ties have been pop­ular invest­ments of oil-​​rich coun­tries in the region. With so many pow­erful and vested eco­nomic inter­ests in Dubai, some form of bailout was vir­tu­ally assured. The Abu Dhabi funds appear to come with sig­nif­i­cant “strings” attached, sig­naling a slow-​​down in what has been very rapid growth area in the world.

To learn more about the Col­lege of Busi­ness Admin­is­tra­tion at North­eastern Uni­ver­sity, visit: http://​www​.cba​.neu​.edu/