Dubai Financial Crisis - Causes, Bailout and After - Case Study Example

Case study analysis: Dubai Financial Crisis - causes, bailout and after Table of Contents Introduction 3 ment of the problem 3 Objective of the problem 4 Areas of consideration in the real estate crisis of Dubai 4 Over Speculation by investors 5 Involvement of investment rating agencies 5 Absence of proper regulatory framework and transparency in governance 5 Alternative course of action by Dubai Government to combat the crisis 6 Analysis of alternative course of actions taken by Dubai government 7 Conclusion and Recommendations 8 Works Cited 10 Name of the Student Name of the Professor Course Number Date Introduction The United Arab Emirates (UAE) was formed in 1971 after the United Kingdom ended its age-old treaty relationship with seven crucial coastal states. The three largest constituent or emirates of the country are Dubai, Abu Dhabi and Sharjah. All these emirates are governed by an Emir, responsible for all administrative controls. UAE is one of world’s fastest growing economies and has urban civilization based on western culture. Dubai is an emerging cosmopolitan metropolis, which has become a hub of international culture and business in the Middle East. The steady growth of Dubai has attracted global attention through several innovative development projects and sport related events. Despite its historical dependence on oil revenue, the emirate has diversified its business in tourism, airlines, financial services and most importantly, real estate (Hasan, “Dubai financial crisis: causes, bailout and after - a case study”). This paper is an analysis of the case study, “Dubai financial crisis: causes, bailouts and after” in order to determine the problem, consider areas that led to the problem, investigate the alternative course of action taken by the government for overcoming the problem and provide recommendations, if any. Statement of the problem In Dubai, all projects across different industries are managed and supervised by the Dubai World. It is a government-owned investment company, which is responsible for handling various business portfolios necessary for promoting the emirates as an international trading and commerce hub. To position Dubai as a centre of international finance, tourism and sport, projects related to skyscrapers, high rise buildings, luxurious hotels and resorts were funded by the Dubai World. Property price were sky-high until the onset of global meltdown in 2008. During the period of 2007-10, real estate market of Dubai came to a sudden halt when demands for luxurious properties and services in the international market dwindled as a result of financial crisis in United States and Europe. It was observed that declining demand of property was responsible for crash of Dubai economy, rather than the country’s financial overspending (Hasan, “Dubai financial crisis: causes, bailout and after - a case study”). Objective of the problem The real estate market crash in Dubai resulted in declaration of debt standstill by Dubai World and its subsidiaries such as, Nakheel. The proposal of delaying repayment of debt by Dubai World caused drop in market indices and oil price. Moreover, the debt scenario upshot anticipation of risks associated with government default. The government requested various financial institutions (its debtors) to extend the debt payment period (Salah 1-19). The paper focuses on discussing factors that were responsible for recession in the construction industry of Dubai; involvement of investment rating agencies in the predicament; and bailout activities undertaken by the government to recuperate the crashed property market. Areas of consideration in the real estate crisis of Dubai This section discusses various facets of the Dubai financial crisis so that bailout strategies discussed in the latter sections of this paper can be understood clearly. Dubai, before the financial slowdown, had become a synonym for ‘extravagant’. The bubble burst of booming real estate sector in Dubai occurred around the middle of 2008. The financial crisis of the United States affected directly or indirectly all emerging markets worldwide and Dubai was no exception to this. While supply in the real estate sector of Dubai grew exuberantly, the global slowdown caused demand to plummet. As a result, average price of property dropped by more than 40% by 2009. The real estate development of Dubai was funded mostly by foreign fund, especially from European banks such as, Royal Bank of Scotland and Standard Chartered. The sharp declining sale and vanishing profit generated panic in the financial world and a sharp drop in share value of numerous financial institutions of UAE and Europe (Ellaboudy 180-193). The Dubai market crash did not affect the developing economies of Asia directly, but caused high unemployment as bulk amount of skilled and unskilled labors from Asian countries were employed in Dubai (Davidson 15-85). The following sections help in developing a clear understanding about the areas of consideration: Over Speculation by investors In Dubai, major property investors were mere speculators, rather than end users. These speculators were from different countries and increasing speculation led to excessive rise in price of properties and high profit for initial investors. The continuous growth in real estate and its price was a natural assumption for many investors who sold their existing business or source of income in their respective countries in order to invest in Dubai. In addition, even banks delivered uncontrolled financing to investors and developers, which greatly exposed these banks to financial risk (Renaud 51-77). Involvement of investment rating agencies Two of the major credit rating agencies were also held responsible for consequences of the US crisis, followed by recession in Dubai’s real estate sector. Standard & Poor’s and Moody’s Investors Services were criticized heavily all over the world for their biasness towards affluent companies, inefficiency in evaluating financial instruments and failing to warn investors and misleading them. As the government of Dubai announced their debt status, these agencies downgraded several government debt entities related to property, commodity, utility and commercial operations, which were previous overrated by these agencies as good investment (Davidson 15-85). Absence of proper regulatory framework and transparency in governance During growth of real estate sector, lack of appropriate regulatory framework led to uncontrolled growth in the sector and allowed entry of even small players in the market. A complete absence of regulation together with greed had made even the low earning segment to invest in the real estate sector. Alongside, lack of law regarding freehold property and residence visa made many investors assume that owning a property is a key to residence visa. In addition, the government also used residence visa as an incentive to invite non-residents to invest in the market, but had not clarified details related to its validity. Once the market crashed, the government withdrew the incentive and cost of renewal and extension of validity of residence visa were charged unreasonably high. Apart from that, there were a number of cases pertaining to fraud and embezzlement, which brought in losses for investors as well as companies. By the time Dubai government established real Estate Regulatory Authority, all major projects were launched and investors had already made their share of investments (Hasan, “Dubai financial crisis: causes, bailout and after - a case study”). Alternative course of action by Dubai Government to combat the crisis The government of Dubai claimed to have suffered comparatively less damage with respect to other countries during the global credit crunch of 2008 and highlighted various alternative measures that they had taken so as to overcome the crisis. However, the Dubai government was supported by that of Abu Dhabi and the Bank of UAE with $ 10 billion bailout offer; half of this amount was used to meet immediate debt obligations related to Islamic bonds of Nakheel and rest of the amount was utilized to repay creditors and contractors worldwide (Hasan, “Dubai financial crisis: causes, bailout and after - a case study”). The department of finance outlined the following actions: In the fiscal year 2009, the department approved a sum of Dh (Dirham) 41.36 billion for budgeting purpose, which is so far the largest budget to be approved by the Dubai government. The government chose to complete all ongoing projects with foremost priority being given to Dubai Metro project, which was inaugurated in September 2009. Hence, strict deadline was maintained. The government activated a number of policies related to public spending to improve efficiency of operating expenses. Further, the government also increased the amount of capital expenditure to improve quality of its services. All the operating expenses have been complied with standardized public finance policies so as to facilitate growth, macro-economic stability and reduction in poverty. As a part of the policies, e-government initiatives were undertaken. The aim of this initiative was to provide innovative services to public as well as private sector of Dubai. Various taxes related to goods and services were reduced as well as subsidies were provided. Information and communication technologies were employed to improve the public services. The government placed a policy whereby individuals and companies can pay the government fees in installments, without overburdening themselves. The Dubai government further established a debt management system and revised activities of Real Estate Regulatory Agency. To support and restructure struggling companies such as, Nakheel, Dubai Financial Support fund was established. Besides that, a supreme fiscal committee and executive financial team were introduced for regulation purposes. The government increased its involvement and strictness of regulations in restructuring the country’s banking and financial institutions, which include merging of local banks to form a strong entity (Abbas, “Dubai Government reveals how it overcame the global financial crisis”). Analysis of alternative course of actions taken by Dubai government The decision of offering a bailout by the government of Abu Dhabi and Bank of UAE is noteworthy as it resulted in mitigation of major external debts. Approval of a large budget is useful in meeting internal debts and immediate fund crisis. Post crisis, budget was one of the most important strategy requirements for determining future plans of the country. The government decision of completing all on-going projects before initiating new ones is appreciated as too many unfinished projects delay the return on investment as well as can clutter fund allocation. Improvement in government services and public spending policy helps in better allocation of resources and cost. In addition, it also helps in understanding the problem area and provides necessary way-outs (Abbas, “Dubai Government reveals how it overcame the global financial crisis”). The crisis affected corporate houses as well as individuals; so, reduction in government fees and introduction of subsidiaries were highly needed so that expenses are not overburdening. It is worth appreciating that the Dubai government introduced an installment method for paying the taxes and other fees. The uncontrolled lending policies of the banks needed to be monitored, thereby calling for government’s involvement. At international level, the Basel committee was formed to regulated various banking institutions and prevent defaulting. Moreover, the traditional banking of Dubai needed restructuring and reduction of unnecessary operation cost; hence, the decision of merging local banks to establish a strong entity was a notable development (“MENA case studies on Governance and Public Management”). The incidence of residence visa highlighted the problem related to transparency in governance. To meet this problem, the government launched e-government services through which investors and general public can avail information about investment criteria, regulations pertaining to non-resident investors and the country’s financial structure. Furthermore, being regulated by the government itself, credibility and authenticity of the information is expected to be high, unlike report presented by foreign agencies. The government took initiatives such as, establishment of financial committee and executive financial team, in order to work upon problems related to liquidity and financial risks, misleading information to investors, market discipline and over-spending of public finance. The presence of a supreme financial committee also helps in preparing country’s financial budget as well as ensuring that the budget is followed accurately (Abushaban, “Dubai economy back on track since the property bubble”). In order to improve perception of investors and regain their confidence, the government of Dubai has initiated systematic management of debt. As a good debt management system results in timely payment of obligations, improvement in credibility saves considerable amount of future costs. The government has also revised the norms of Real Estate Regulatory Agency so that a transparent and effective legal framework can be provided. Moreover, the agency provides license to various real estate agencies and activities. It also regulates and supervises various owners association and rental agreements. The main purpose of revising the regulatory activities related to real estate by the Dubai government was to oversee and control growing speculation that had led to real estate bubble burst (Abbas, “Dubai Government reveals how it overcame the global financial crisis”). Conclusion and Recommendations As concluding remark, Dubai is one of the major emirates of UAE, which is growing steadily. The nation is becoming increasingly popular as an international center for sport, tourism and business. The real estate bubble of Dubai grew as investors were lured by greed and high level of speculation. Also, unregulated legal framework of Dubai had generated misconception among individuals. The real estate market crash of Dubai affected the European market the most as majority of fund was availed from Europe. Additionally, many international credit rating agencies were also responsible for the market crash as they provided misleading information to investors. The period of 2007-2010 was quite difficult for Dubai, yet it was able to recover by availing help from Bank of UAE and government of Abu Dhabi, along with strategic changes in the regulatory framework related to real estates and other associate sectors such as, banking and public finance. The case study explained that infrastructure sector is overwhelmingly dependent on foreign market, especially Europe. Also, in UAE, Islamic finance plays a significant role in the financial sector, which is rather stable in nature. Hence, it is highly recommended that the government stresses more on national source of funding such as, Islamic bonds and reduce dependence on foreign countries. Although the government has undertaken various measures to improve the economy of Dubai, strategies and control measure need to be revised so as to prevent occurrence of similar crisis. Works Cited Abbas, Waheed. “Dubai Government reveals how it overcame the global financial crisis.” Emirates 24/7. Dubai Media Incorporated, 27 February, 2014. Web. 23 May 2014. Abushaban, Yaser. “Dubai economy back on track since the property bubble.” The National. The National, 22 January 2013. Web. 23 May 2014. Davidson, Christopher M. Dubai: The vulnerability of success. New York: Columbia University Press, 2008. Print. Ellaboudy, Shereef. "The global financial crisis: economic impact on GCC countries and policy implications." International Research Journal of Finance and Economics 41 (2010): 180-193. Print. Hasan, Zubair. “Dubai financial crisis: causes, bailout and after - a case study.” Munich Personal RePEc Archive. MPRA. July 2010. PDF file. “MENA case studies on Governance and Public Management.” Government of Dubai. Government of Dubai, 2014. Web. 23 May 2014. Renaud, Bertrand. "Real estate bubble and financial crisis in Dubai: Dynamics and policy responses." Journal of Real Estate Literature 20.1 (2012): 51-77. Print. Salah, Omar. "Dubai debt crisis: A legal analysis of the nakheel sukuk." Publicist 4 (2010): 1-19. Print. Read More