Shaken by the sheikhs - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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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.
Maybe.

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
GOLD PRICE IN US DOLLARS PER TROY OUNCE
  1,000 1,050 1,100 1,150 1,200 1,250 1,300 1,350 1,500
INR GOLD PRICE IN INR PER 10 GRAMS   (Fine Gold content in 10 grams equals 0.3199 troy ounces of (0.995 purity)
43.00 14,130 14,826 15,522 16,218 16,914 17,610 18,306 19,002 21,090
44.00 14,453 15,166 15,878 16,590 17,302 18,014 18,727 19,439 21,576
45.00 14,777 15,505 16,234 16,962 17,691 18,419 19,148 19,876 22,061
45.50 14,939 15,675 16,412 17,148 17,885 18,622 19,358 20,095 22,304
46.00 15,101 15,845 16,590 17,335 18,079 18,824 19,568 20,313 22,547
46.50 15,263 16,015 16,768 17,521 18,273 19,026 19,779 20,532 22,790
47.00 15,425 16,185 16,946 17,707 18,468 19,229 19,989 20,750 23,033
47.50 15,586 16,355 17,124 17,893 18,662 19,431 20,200 20,969 23,275
48.00 15,748 16,525 17,302 18,079 18,856 19,633 20,410 21,187 23,518
48.50 15,910 16,695 17,480 18,265 19,050 19,836 20,621 21,406 23,761
49.00 16,072 16,865 17,658 18,452 19,245 20,038 20,831 21,624 24,004
49.50 16,234 17,035 17,836 18,638 19,439 20,240 21,042 21,843 24,247
50.00 16,396 17,205 18,014 18,824 19,633 20,443 21,252 22,061 24,489
50.50 16,558 17,375 18,193 19,010 19,827 20,645 21,462 22,280 24,732
51.00 16,719 17,545 18,371 19,196 20,022 20,847 21,673 22,498 24,975
* 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.

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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.


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15 Responses to "Shaken by the sheikhs"

Krishna

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

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PANKAJ AJMERA

Dec 1, 2009










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

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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!

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Joseph

Nov 30, 2009

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

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Prejish

Nov 30, 2009

Ajit,
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
shoulder,
- 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!!!

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Prabhu

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!!!

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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.

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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.

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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?

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Nabi Shaikh

Nov 30, 2009

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

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