What's Behind the Dubai's Financial Crisis?

Dubai announced last Wednesday that it would ask creditors of Dubai World, the conglomerate behind its rapid expansion (it built the world's tallest building), and Nakheel, the builder of its palm-shaped islands, to agree to freeze debt repayments for six months.

Some commentators are of the view that banks that have lent money to Dubai World could suffer significant losses if the company were to default on all or part of its $59 billion debt. Duabi's total debt stands at $80 billion. If creditors were to reject proposals to postpone debt repayments for six months, the Dubai government could be forced to hold a fire sale of its international real estate assets.

Analysts however are of the view that other emirates of the UAE - United Arab Emirates -such as Abu Dhabi are unlikely to be affected by Dubai's crisis significantly since their funding is derived from exporting oil and gas.

The key factor behind the crisis is the boom-bust policy of the UAE central bank. After closing at 4% in October 2006 the yearly rate of growth of the central bank's balance sheet (the pace of monetary pumping) climbed to 177% by December 2007. In response to this pumping the yearly rate of growth of UAE's monetary measure AMS jumped from 6% in October 2006 to 62% by April 2008. This massive pumping has given support to various activities that without the money pumping wouldn't have emerged. In short these activities cannot stand on their own feet without support from monetary pumping.

Since January 2008 the pace of pumping by the central bank has been trending down. In January this year the yearly rate of growth of the central bank's balance sheet plunged to minus 36.5%. As a result the yearly rate of growth of money supply fell to minus 12.5% by July this year. It is the fall in monetary pumping that is currently putting pressure on various activities that sprang up on the back of previous massive monetary pumping.

We suggest that other emirates are unlikely to escape the effects of the boom-bust policies of the central bank. Also, in other emirates loose monetary policy set the platform for new activities and the expansion of existing activities. As a result of a decline in monetary pumping by the central bank these activities are currently also under pressure.

Conclusion

A possible debt default by Dubai's two large government sponsored conglomerates sparked worries in financial markets of another round of global economic turmoil. Dubai has requested a freeze on payments of some of its $80 billion debt for six months. We suggest that the key factor behind the crisis in Dubai is the classical boom-bust policies of the UAE central bank. The phenomenal expansion in various structures in Dubai was mostly on account of massive monetary pumping. Thus in December 2007 the yearly rate of growth of the central bank's balance sheet stood at 177%. The bursting of the bubble came on account of the strong fall in money pumping. Since January 2008 the pace of pumping by the central bank has been trending down. In January this year the yearly rate of growth of the central bank balance sheet had plunged to minus 36.5%.

Frank Shostak

Frank Shostak is a former professor of economics and M. F. Global's chief economist.

Also by Frank Shostak