Shaken by the sheikhs

30 NOVEMBER 2009

The rabbit is a restless and nervous animal.

And investors, like frightened rabbits, went scurrying to safer haven on news that Nakheel, a real estate development company owned by the government of Dubai, would seek a 6-month moratorium on the payment of their interest and debt. Monies due in December 2009 by Nakheel would now be paid after May 2010.

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As the Thanksgiving weekend broke in USA, investors rushed back into the US Dollar and government bonds issued by "safe" countries like USA and Germany. The MSCI Emerging Market Index of stocks declined by -5%. It had gained about +65% so far this year.

Long praised for its spectacular growth, Dubai has proven itself to be just another wonder of the era of free money - without a game plan on what to do the day the era of free money would end.

The "growth-by-debt" junkies
In many ways, Dubai is like a Citibank - built on the illusion that being "large" is the solution to every possible risk.
Just as Citibank saw every global citizen as a potential customer, Dubai saw every grain of sand as the foundation of a new real estate development project.
Just as Citibank added customers and businesses to get a larger share of your wallet, Dubai was busy building the largest buildings, the largest man-made islands, and the largest indoor ski-slopes.

"Build and they shall come" is the policy that the Chinese followed in the late 1990's. Eventually the Chinese got hit by the write-offs in their state controlled enterprises (like the PSU companies in India).

And don't forget the dusty business plans of private banks like ICICI Bank and most of the real estate firms in India.
Many of the private sector banks wanted to "acquire customers" so that they could increase market share and have a "large" loan book.
Maybe these Indian companies have learnt their lessons and will be more careful in the future.

Those managements that built their businesses on excessive debt and weak risk assessment were under severe strain after the bankruptcy of Lehman Brothers in September 2008. Dubai is a minor - but necessary reminder - on how a failure in one corner of the geographical world can shut down global credit markets.
And hurt companies that rely on sucking money from any corner of the world to fund their growth.

But Dubai is by no means the only place being built on dreams.
The real estate firms in India saw every square foot of agricultural land as a way to use their political connections to sell you 0.6 square feet of property at exorbitant prices - and charge you on a per square foot basis. The real estate robber barons lived off their unabashed use of debt and the art of pricing on a super built-up area.

The US consumer must also have been a role model for Dubai's ambitious debt-fuelled plans. Every item in a store was a "must-own" on the shopping lists of US consumers. And the same Citibanks of the world were willing to lend the US consumers money for their insatiable demand. The financial geniuses at Lehman, Goldman, and Merrill only did what any good financial engineering firms would do - found ways to trade that debt and make fees on it. The rating agencies - blinded once again by glamour and the fees they get from the issuers of debt - were once again behind the curve.

Why is it shocking?
Any visitor to Dubai knew that the end was near.

Dubai knew it was in trouble
Source: Bloomberg

There were the newspaper articles on how people were leaving their debt-financed cards and unpaid credit cards at the airports and flying away to safety.
I guess the fine for not repaying debt must be pretty severe in Dubai.
Businessmen in Dubai knew that business was slow.
The fact that the government of Dubai was in trouble was not new.
It was as public as could be without really being written about in the press.(click here to read.)

But the surprise may have been in the fact that Abu Dhabi, the energy and cash rich Emirate "allowed" Dubai to make its statement on debt restructuring.
Or, worse, is it possible that Abu Dhabi was not even aware that its neighbour was about to seek a debt rehabilitation package?

Over the past few years, Abu Dhabi has seen its glamorous neighbour build monuments to the gods. With no energy reserves to speak of, Dubai was keen on establishing itself as the financial capital and trading capital of the Middle East and Africa. It was also presenting itself as the gateway to Pakistan and India.

Not a bad objective.

But, because it was funded by debt, the business plan was susceptible to cracks in global financial markets and to the changing sands of lending policies of nervous rabbits.
And, like the US consumers buying 5,000 square feet atrocious Mac Mansions for a family of three people, Dubai's grand sizing was probably a bit idiotic.
As author Jim Krane noted on CNN, the tall buildings meant that every time someone on the top floor flushed the toilet, the water pumps had to send water half a mile up to refill the tanks for the next flush. A few tall buildings and a Palm complex, Krane noted, could use as much electricity as an entire city.
Not very efficient for a country short of energy.

Should we sell Indian stocks?
Dubai is geographically closer to India than Lehman Brothers was.
And we have more business links to Dubai than to Lehman.

Millions of Indians work and live in the Middle East and send their money back home. Indian banks lend money to some of these India-connected businesses. And Non-Resident Indians deposit their money in NRO and NRE accounts.
Yes, Dubai is more real and closer to us than Lehman was.
And will have more of an impact on the Indian economy.
But the negative fallout will be minimal.

Here is an extract from a comprehensive report in Economic Times: "Over 5 lakh Indians have returned from Dubai since September 2008, of which two lakh are Malayalees. Almost 60% of these people are technical or non-technical skills professionals. 'Over 50 lakh Indians work in the Middle East of which 20 lakh are from Kerala. We do not expect large number of returnees now,' K V Mohankumar, CEO of Kerala NRI group, Non Resident Keralites' Affairs (Norka)."

Kerala has an estimated 20% of the total Middle-East exposure in terms of remittances. So there could be some localised problems in that state.

And there will be company specific problems: banks with loans to the sheikhdoms and companies with projects in the Middle East will declare their potential exposures in the next few days.

But the Dubai debt issue pales when compared to the Lehman bankruptcy.
Lehman shocked global markets - the Dubai bankruptcy will re-price risk for companies in emerging markets. That is the big difference in the financial aspect of things. Lehman's bankruptcy made all the rabbits around the world run for cover - they refused to lend money to anyone. The Dubai bankruptcy will make the rabbits search for patches of grass where they can eat their carrots in peace. India will be one such patch of grass where they will continue to chew away.

So, don't sell Indian stocks because of what happens in Dubai.

And gold?
Gold will have a 2-way pull.
The flight to safety will move people towards gold.
But the flight to safety will also move people towards the US Dollar and weaken other currencies like the Indian Rupee.

So, while the price of gold in dollars may decline its value in Indian Rupee may stay the same (see Table 1 below). A Rs. 20,000 per 10 gram price of gold can be achieved in a combination of ways. A permutation of the USD price of gold and the INR/USD fx rate.

Table I: Gold price a function of the Indian Rupee / USD fx rate
INRGOLD PRICE IN INR PER 10 GRAMS   (Fine Gold content in 10 grams equals0.3199troy ounces of (0.995 purity)
* Gold prices in INR are inclusive of all the duties and taxes applicable in Mumbai (The above given table is only for information purposes.)
Source: Quantum Gold ETF research by Quantum AMC

Well, the sheikhs have caused quite a stir.

Dubai's government-controlled Nakheel went out to build the famous Palm Islands. Abu Dhabi - whether it likes it or not - will have to help build a Calm Island.

Moral: a mirage, built on debt, is still a mirage.
And a bunch of nervous rabbits looking for carrots in a mirage is a recipe for disaster.

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
Quantum Long Term Equity Fund Quantum Gold Fund
Quantum Liquid Fund
Why you
should own
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 20% Keep aside money to meet your expenses for 6 months to 2 years
Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)

Quantum Long Term Equity Fund, Quantum Equity Fund of Funds, Quantum ESG India Fund Quantum Gold Savings Fund Quantum Liquid Fund
Why you
should own
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% in total in both; Maybe 15% in QLTEF, 10% in Q ESG and 75% in QEFOF 20% Keep aside money to meet your expenses for 12 months to 3 years
Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

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15 Responses to "Shaken by the sheikhs"


Dec 6, 2009

Well analysed but cannot but disagree with "Build they will come"

This is the only way to build planned cities, else cities world over will be like the Indian cities. I dont advocate blind capacity creation with no takers. Towards that end, New Bombay probably was better the capacity creation always kept ahead of the inherent voracious acquisition of Mumbaikars but it definitely took longer time to build it compared to what China has build.

Quality wise, the new Bombay was nowhere near what china has managed to build.

I advocate careful Capacity creation that can lead growth. But Quality is something we need to preserve.

Tough balance but as in all things PRUDENCE is a difficult trait



Dec 1, 2009

All your articles are excellent.
Request-Please make it very brief.


Nitul Bhatt

Dec 1, 2009

Excellent article. I work in Bahrain. Last few years have seen rapid growth in gulf especially in property market. There were huge ques to buy property and till early 2008 property were sold off before a brick was laid. It was ridiculous and so obvious that bubble is forming. Common knowledge/logic tells us that people buying property in gulf are mainly investor/speculator and there is no need for so many buildings as end users are few. Also the law for expat are weak and ambiguous. One day dubai sheikh makes announcement about giving resident permit to foreigner who buys property and then later reverses it. These countries are no more than personal fiefdom of sheikhs and rules and law can be changed on their mood and fancies. So it was always a risky proposal to invest in these countries andI wonder how so many white people have got stuck with their investment in gulf!



Nov 30, 2009

Superb Review!The best I have read on the Dubai Crisis.Keep it up!



Nov 30, 2009

What you have said about Kerala is very much true. Majority of the income is from abroad. 25% is what I read recently from Middle East alone. With pity I say, People in Kerala seems to be living a US style of life :
- Big houses with huge debts on each Keralites
- Majority of the households have Vehicles(minimum a 2-
wheeler) and Credit Cards with ongoing Debts.
- Money sent in by the NRI's are enjoyed lavishly by
their relatives at home in Kerala. The cost of living
is very high. Products are thrice as expensive than
in developed cities like Mumbai but people still buy
without bargaining. 'Bargaining is considered as a
shameful attitude in Kerala'.
- Decreasing agriculture production and increasing
dependancy on neighbouring states for even the basic
food and vegetables,
- Increasing drunkards among the teenagers (kerala has
the highest alcohol consumption record and each year
it leaps to new highs),
- Decreasing industries with no much new factories
being allowed to come up and closing existing ones by
way of labour strikes (More no. of bandhs than any
other state),
- More teens getting into politics to avoid daily tont
of not going for jobs. Highest political instability
and crime rate in politics. The police has no value
since people take advantage of political connections
to overcome the powers of Police.
- Decreasing quality in education material making a
student from Kerala less competitive in outside world
etc.. etc..

The politicians too do not want to improve this scenario and that makes it more worse. They don't want to do it because if people in Kerala improve then there would be nobody at their back to hold and shout for their flag/party. Pitiful isn't it? It pains when I write this. But it is essential to be highlighted and I would really appreciate if this scenario could be brought to lime light by you. Thanks!!!



Nov 30, 2009

The article should read the Shaken Sheikhs and reflects reality .Dubai has always escaped unhurt by default in the past, inspite of its going against the financial rule book in the recent past more out of who cares approach than financial prudence & planning. Ironically the "Shut up" remark could not stop the cat jump out of the bag on an auspicious thursday. "Build and they shall come" was quite relevant for all the dirty money bags of India and Pakistan to be deployed shamelessly. Jaise Karni vaise bharani!!!


Sanjay Kumar

Nov 30, 2009

as skr and shreedhar ji point out - dayal lives off debacles, and his performance is best when he has the luxury of hindsight. Then his prose comes out in full flow. Like most Indian second-raters, the way to "feel good" is to pull down everyone else. The glee with which he pronunces on the "big bad world" is positively ghoulish. This is the best way to hide his own funds' performances.
Ultimately, no different from the millions of sarkari babus and politicos.

And in the name of research, what does he offer - an excel spreadsheet with a slew of numbers. Drown them with a spreadsheet, and they will lap it up as research, he seems to think.


G N Das

Nov 30, 2009

Not only Dubai, One should not invest in any of the gulf countries - there is hardly any law as it is in our country, hardly any justice or personal freedom that we enjoy in India,Our country has the resources to brave any financial or war storm. Like Kuwait( under Iraq)all these pigmy countries can disappear any day. There the govt. may loot you away and you will not be able to do anything as most of the poor workers have witnessed for years now.


N.M.R Shreedhar

Nov 30, 2009

Interesting read.Very crisp and pithy commments.Only suggestion is would,nt it be great to have posted such articles earlier rather than a post-mortem exercise?


Nabi Shaikh

Nov 30, 2009

I think is better? but after claimed money how's responsibility.

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