The debt standstill has dashed recent optimism that the once-booming city state was getting its house in order, write ROULA KHALAFand SIMEON KERR

SEPTEMBER WAS an important month for Dubai, as schools reopened and the city started counting how many of its expatriates, stung by the global financial meltdown, had left.

To everyone’s surprise the classrooms were not empty and the exit was not as dramatic as expected.

For many residents, the city state might have been burdened by an $80 billion (€53.5 billion) debt mountain, but with a diversified economy and a more liberal culture than many of its neighbours, it remained the place to be.

The economic slowdown had even enhanced the lifestyle; it meant less traffic and fewer construction projects.

However negative the sentiment today, the rise of the emirate, and its claim to be the region’s business centre, had a convincing foundation.

Analysts pointed to lingering concerns about the real estate market but confidence was returning. Passenger numbers at the airport showed double-digit growth in the past five months and hotels had been busier, though occupancy rates remained down on last year.

“As the region’s only provider of world-class services, Dubai should . . . see export demand strengthen as activity strengthens elsewhere,” HSBC said in an October report.

But Wednesday’s announcement of a debt standstill at Dubai World, the government flagship property holding company, has raised questions about the city’s recovery.

Much of the optimistic business sentiment in recent months had rested on the assumption that Dubai was getting its house in order and would meet debt obligations. “While we have seen some improvement in the [United Arab Emirates’] confidence since mid-2009, rescheduling of Dubai World’s debt will provide a setback to sentiment,” said Monica Malik, economist at investment bank EFG-Hermes in Dubai.

Though she still expected to see a gradual improvement in Dubai’s economy over the next year, she added that, given “the high level of leverage by both individuals and corporates and exposure to the property sector, the UAE will have one of the weakest non-oil economic outlooks in the region”.

Dubai does not consolidate the finances of its various entities, and data is difficult to come by, a source of frustration for analysts. Statistics are often compiled for the whole UAE and not for Dubai alone.

According to a prospectus issued to investors last month, nominal gross domestic product (GDP) growth fell to 18 per cent in 2008 from 27.4 per cent the previous year. Many economists expect the UAE economy to have contracted this year.

It is the debt burden that has raised the most concern about Dubai’s future. After the heyday of borrowing, the government was, even before the crisis, trying to regroup companies under the leadership of the International Corporation of Dubai (ICD) to ensure it had a better handle on finances.

Dubai’s total debt of about $80 billion includes about $19 billion owed by the department of finance and ICD, as well as the $22 billion owed by Dubai World. Some $13 billion to $17 billion is thought to be due next year, and ratings agency Standard Poor’s estimates as much as $50 billion will have to be repaid by 2012.

That debt pile is the result of Dubai’s aggressive expansion in recent years. With much of the UAE’s oil wealth concentrated in Abu Dhabi, Dubai adopted an aggressive diversification strategy, developing trade, transport and tourism businesses, some of which, such as DP World, were then able to make their mark on the international stage.

By setting up a series of free zones, each dedicated to a specific sector, Dubai attracted foreign companies and established itself as the regional provider of services. Allowing foreigners to buy real estate in some of the gated communities brought more money into the economy.

In 2008 oil accounted for only 2 per cent of GDP, with wholesale and retail trade, real estate and business services making up much bigger shares.

But Dubai got carried away with its own success, with many projects in the fiercely competitive business environment financed with debt. With an over-ambitious ruler, Sheikh Mohammed bin Rashid, dreaming of bigger things and instituting a fiercely competitive business environment that encouraged his lieutenants to come up with new ideas and projects, many financed with debt, the emirate was heading for trouble.

Some of the biggest conglomerates created real estate and investment companies that competed with each other and then established subsidiaries that were also pushed into rivalry. As the real estate projects became more exuberant, the government lost track of the finances of entities it controlled. That the lines between the assets of the ruler and those of the government were blurred further confused the picture.

When the financial crisis hit, one of its first casualties was the realestate market. HSBC said in a recent report that the market lost 50 per cent of its value, compromising the quality of bank assets. – (Copyright The Financial Times Limited 2009)