* Heavy demand for bonds underlines Dubai's rehabilitation
* Budding recovery in real estate market is key
* Bonds may still be undervalued relative to other markets
* But corporate, economic risks have not disappeared
* Another boom-and-bust cycle cannot be ruled out
By Mala Pancholia
DUBAI, Jan 23 A $1.25 billion bond issue by
Dubai this week underlined the spectacular recovery of the
emirate's reputation since its debt crisis. But some investors
are wondering whether the world is once again getting a little
too optimistic about Dubai.
The flamboyant emirate attracted over $9 billion in bids for
a $750 million, 10-year sukuk (Islamic bond) on Tuesday, paying
little more than 1 percentage point above what gas-rich Qatar
would have paid to issue debt.
Demand for Dubai's debt was so strong that it in addition to
the sukuk, it unexpectedly sold a $500 million, 30-year
conventional bond at the request of investors.
It was an impressive performance for an economy that a
little over three years ago was engulfed in crisis. State-owned
conglomerate Dubai World announced a $25 billion debt
restructuring, triggering a chain of restructurings, and Dubai
needed a $10 billion bailout from Abu Dhabi to avoid default.
This week's bond issue was in high demand partly because
Dubai is making progress working through its debt pile and its
economy is recovering faster than expected. But the demand is
also due to global factors that will not last forever.
"We agree with the view that risks have declined markedly,
and are believers in the Dubai success story," said Gabriel
Sterne, economist at investment bank Exotix Limited in London.
"But we think yields have tightened by more than risks have
declined. Dubai still remains vulnerable to the usual risk-roll
call. Rising tensions with Iran; a decline in oil prices;
slowdown in Asia."
He added that Dubai's banking system, where non-performing
loans were still high, remained a risk. "It's not the worst
value in the world, but hard to get excited at these yields,"
The single biggest boost to Dubai has been the start of a
recovery in its real estate market. Property prices plunged more
than 50 percent over several years but rose in some districts
last year, partly because of a flood of foreign investment.
Dubai is also enjoying a tourism and retail boom, with
passenger traffic through its airport rising at double-digit
rates. The economy is growing at a rate of about 4 percent.
Economic growth is easing the slow, agonising process of
redeeming and restructuring debts at state-backed companies.
Outstanding provisions for bad loans set aside by banks in the
United Arab Emirates fell in October for the first time since
2008, central bank data showed last month.
"Dubai Inc has built confidence among international
investors in the last year by addressing redemptions in a timely
and proactive fashion," said Dilawer Farazi, bond portfolio
manager at Invest AD in Abu Dhabi.
Dubai's five-year credit default swaps, used
to insure against a government default, have halved in price
over the past year to their lowest level since 2008, before the
debt crisis erupted.
As much as anything, Dubai's sheer exuberance in a worried,
risk-averse world may be improving its image among investors. In
the past several months the emirate has announced plans to
build, among other things, the world's largest shopping mall,
five theme parks, a canal by its business district and a $1
billion replica of the Taj Mahal.
The spread between the yields of Dubai's outstanding 10-year
sukuk maturing in 2022 and Qatar's 10-year bond
maturing in 2023 has shrunk to 114 basis points
from 220 bps six months ago. Qatar is rated AA by credit
agencies, the highest rating in the Gulf; Dubai has not arranged
to be rated, which is usually a disadvantage in investors' eyes.
Historically, bonds in the Gulf have tended to carry higher
yields than those in other areas of the world, partly because
the Gulf's debt market has been illiquid and partly because of
geopolitical risks in the region.
Although the gap in yields between Dubai and other emerging
market bonds has narrowed in the past six months, there is room
for it to narrow further as the emirate's image improves and the
Gulf's debt market matures, some investors argue.
"If we assume that Dubai is an implied BBB rating and given
the improved credit fundamentals, and economic indicators as
well as the positive technicals in terms of increased liquidity
with local banks and corporates, Dubai government bonds still
offer value on a relative basis compared to other BBB or even BB
bonds in other emerging markets," said Saeb Elzein, managing
partner at Spinnaker Capital (Middle East).
For example, a sukuk maturing in 2022 and
issued by Indonesia, rated BBB-, is trading at 3.08 percent,
compared to the Dubai bond's 3.88 percent.
But predictions that Dubai will continue closing the gap
with other emerging market bonds depend on many assumptions.
One is that restructuring Dubai's corporate debt will
continue to go smoothly, without major defaults or a loss of
confidence among investors. This is not inevitable - since 2009,
much of the debt has not been cut but merely had its maturity
dates pushed several years into the future.
The International Monetary Fund estimates Dubai's
government-linked entities will need to repay about $9.4 billion
of maturing bonds and syndicated loans in 2013 and $31.0 billion
in 2014. It calls refinancing these amounts "a challenge".
Another risk is any change to the global conditions which
are pushing money towards Dubai. The emirate is a safe haven for
investors fleeing unrest in the Arab world, and as economic
gloom in the West has forced down interest rates there, Dubai
debt has looked attractive.
In the future, a return of political stability to other Arab
countries could cause safe-haven money to leave Dubai. And when
U.S. Treasury bonds again offer significant yields, Dubai debt
may start to seem less attractive.
A third risk may be the sheer level of optimism in Dubai. As
it resumes spending on glitzy real estate and speculators once
more queue at property developers' officers to buy apartments,
some believe a fresh boom-and-bust cycle may be starting.
Last month the United Arab Emirates central bank said it was
imposing limits on mortgage loans, a step to prevent another
property bubble from forming. But this month it backed away from
enforcing the limits after banks protested.
"We hope that new government plans for new cities and
infrastructure spending...will be well funded, and are not build
on new excessive borrowing," said Elzein.