Dubai gets backing from United Arab Emirates. Just a 'first step'?

The United Arab Emirates has pledged to stand behind foreign and domestic banks in Dubai, offering additional money while extolling the strength of the Gulf nation's financial sector as world markets brace for a potential day of reckoning Monday over Dubai's crushing debt.

The UAE's immediate priority was arguably to avert any run, however unlikely, on banks by panicked depositors. But the promise of cheap funds also signaled to global investors that the country's federal government -- backed by oil money -- will do what it can to limit the fallout from its indebted emirate's woes. In a statement Sunday, the UAE's central bank said it had sent notice to Emirati banks and foreign banks with branches in the country making clear they would have access to "a special additional liquidity facility."

The offer comes after Dubai World, the conglomerate that has long been the chief engine behind Dubai's explosive growth, on Wednesday announced it needed at least a six-month reprieve from paying its roughly $60 billion debt. The news sent global markets tumbling. Mideast markets were unaffected because of an extended Islamic holiday, but they reopen Monday.

"There is concern," says John Sfakianakis, chief economist at the Riyadh, Saudi Arabia-based Banque Saudi Fransi-Credit Agricole Group. "They're trying to take preventive measures in order to lower the risk of a run on the local banks. Depositors could very well panic ... and they could decide to take their money out of the banking system."

Projects Scrapped or Delayed

The UAE has been guaranteeing bank deposits since October 2008, but the pledge for new help at generous terms stems from concern that UAE banks have some of the biggest exposure to Dubai World's debt. Several have been downgraded by international ratings agencies or been placed on review for downgrades. It also comes as Dubai officials, who have sought to play down the semiautonomous emirate's financial woes in the wake of the world's worst recession in over six decades, are shuttling to and from Abu Dhabi, the oil-rich home to the UAE's federal government.
Ostensibly, the discussions, which have not been made public, are about how to move forward after a year that saw Dubai's economy plummet. Real estate prices in the emirate have fallen by 50% over the past year. Many of the multibillion dollar projects for which Dubai became famous were either scrapped or delayed, and people started losing their jobs.

As the global credit crunch hit last year, it dried up the cheap cash on which Dubai -- the Middle East's version of Las Vegas, Disneyland, Wall Street and sometimes Sodom and Gomorra -- had built its fortunes. In place of mile-high dreams epitomized by Burj Dubai, the world's tallest tower now nearing completion, Dubai's new reality appeared to be that it had simply overreached.

Economists believe its widely cited debt of $80 billion is probably understated. If this was a tale of one emirate's woes months ago, Dubai World's news turned it into a national crisis.

"This Is Free Money"

The central bank's announcement Sunday is the latest indication that Abu Dhabi is not about to allow its high-flying neighbor to derail after a decade of economic growth. The funds would be offered at 50 basis points -- a half-percentage point -- above the Emirates interbank offered rate. "This is free money," says Sfakianakis, referring to the low interest rate. But "in the midst of a crisis, you don't really think of the cost of money. The first priority is to maintain liquidity and then worry about everything else."

It is also aimed at mitigating any negative fallout on the country as a whole -- and prevent Abu Dhabi from being tainted by the pessimism that could plague Dubai for years.

The UAE's banking system is "more sound and liquid than a year ago," the bank said in its statement. "If there might be some withdrawals because of the [Dubai World] affair, I would expect full backing" from the UAE, says Eckart Woertz, program manager for economics at the Gulf Research Center in Dubai. "The central bank will do everything that is necessary."
Even if a bank-run is averted, however, UAE officials have plenty of other worries. "It's a good first step, but markets will be looking for much more," says Sfakianakis. The Dubai and Abu Dhabi stock markets are likely to take a routing on Monday, analysts say. Dubai's could be particularly hard hit. Elsewhere in the region, the bourse in Saudi Arabia, the Arab world's largest economy, will be spared for a few more days because of the holiday there.

Abu Dhabi to Step In?

The lingering uncertainty about how Dubai officials will deal with this crisis is another sore point. A top Dubai official on Thursday said more details about the company's plans would be announced in the coming days. But a lack of transparency is endemic both in Dubai and throughout the Gulf. One option is a fire sale of the conglomerate's assets, though that seems less likely.
The most probable scenario, according to analysts, is that Abu Dhabi will step in with a bailout, perhaps cherry-picking the strongest assets to support. There is precedent for this, with the central bank having bought up the first half of a $20 billion bond program launched by Dubai earlier this year. And, on the day Dubai World announced it needed a debt reprieve, the emirate's government announced that two banks, majority-owned by Abu Dhabi, had each decided to buy up a $5 billion bond issue from Dubai. Dubai World pointed out, however, that the money was not earmarked to pay its debt.

That only served to fuel speculation about what the federal government and Dubai would do. "Abu Dhabi needs to send clear signals because the Dubai World debt mess is not just Dubai's problem, but a UAE problem," says Woertz.

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