In its most recent report, BofA Merrill Lynch Global Research sees the sharp equity selloff in Dubai as a reflective of broader macroeconomic systemic issues. Dubai’s economic recovery has become more entrenched, and the World Expo 2020 bid provides upside potential. Vulnerabilities remain around maturing restructured debt from 2015 onward and potential for real estate overheating. [wpsr_linkedin]
Equity selloff not justified by changed macro fundamentals
The Dubai stock market recent sharp selloff in the past week extended the market’s losing streak and brought the market about 25% off its May highs. The selloff raises the question as to whether the selling is justified on the basis of changed macroeconomic fundamentals or acute vulnerabilities.
The poor equity performance was not matched in the credit space, as Dubai 5-yr CDS widened by just 20bps over mid-June levels, while sovereign bond prices held steady. Also, equities rebounded strongly yesterday.
BofA’s equity strategy team is now turning more constructive on both the UAE and Qatar within the framework of positioning, valuations and macro catalysts. The team notes that the selloff in the UAE and Qatar has come about as the catalyst of MSCI inflows waned while GEM and Frontier investors cut positioning in markets trading at extreme valuations with little support from key macro drivers.
Economic recovery is gaining pace
Dubai’s recovery from the excesses that led to the 2009 bust is well entrenched, broadening and gaining pace. Recovery is helped by high oil prices, support from the external sector, accommodative monetary policy, the rebound in the real estate sector, steady yet uneven progress on GRE restructuring and a mild fiscal consolidation drive. The 2020 Expo win further provides upside growth potential.
After averaging 10% annual growth from 2000-10 and a slump in 2009, real GDP growth was 4.6% in 2013. Dubai’s externally driven sectors (tourism, manufacturing) led the increase. With a fading drag from construction and real estate activity, growth is likely to accelerate toward 5% in 2014/15, in BofA’s view.
Dubai government remains committed to fiscal prudence
The Dubai Department of Finance (DoF) indicates the preliminary outturn for the 2013 fiscal deficit (DoF presentation) has likely outperformed the target of AED1.5bn (0.4% of GDP). The 2014 budget also targets to narrow the deficit to AED880mn (0.2% of GDP). Although spending is set to increase by 11% yoy, revenues are budgeted to increase by 13% yoy due to increased fee revenue collection (increase in Salik toll gates and hike in property registration fees). We estimate the primary balance is back to surplus after deficits following the crisis.
Government debt sustainability improves
The research team observes that Dubai sovereign debt appears to be stabilizing, in line with our view that the growth recovery and fiscal consolidation would ease deleveraging trends at the sovereign level. This is, however, accompanied by a concurrent shift toward less transparent domestic borrowing (which could mask support to weak GREs, in our view). The tentative slowdown following explosive debt dynamics in the aftermath of the crisis remains fragile. As of March 2014, BofA estimates the government debt stood at US$56.1bn (57.2% of GDP).
Dubai Inc likely to muddle through
There is steady, yet uneven, progress in Dubai GRE deleveraging. The real estate recovery and improved banking sector liquidity have given breathing space to GREs. However, the recent Limitless and Drydocks difficulties highlight this is perhaps not yet enough for non-systemic or weaker entities, in our view.
However, the Dubai Group restructuring was finalized, Amlak has finally proposed a restructuring plan to creditors, and Nakheel is in the process of prepaying bank debt. Some healthy GREs issued and upstreamed proceeds.
Given the still large overall indebtedness, the current GRE refinancing strategy remains vulnerable if there are dislocations to global funding markets or shocks to growth. To grow out of its debt overhang, we think Dubai needs a combination of internal cash generation, asset sales, refinancing, decent global outlook and liquidity, banking support as well as potential Abu Dhabi support.
On current trends, the key question to monitor for maturities from 2015 onward will be asset sales. Questions remain on the likelihood, structure or necessity of repeat bailouts of systemic entities. ICD’s successful bond raising (US$1bn in two tranches) lessens concerns about Dubai World’s upcoming maturity.
Banking on support
Banks are more liquid and better capitalized compared to pre 2008, and have been able to support Dubai Inc refinancing needs. The UAE central bank expects NPLs could have peaked in 2013 at 8%. Credit growth to the private sector has started to pick up to levels around 10%, compared to rampant credit growth in the lead-up to the crisis. The increased domestic banking sector support to Dubai Inc has brought exposure to the public sector as percent of capital to the highest level since the late 1970s (110%). Vulnerability to foreign bank funding has however moderated, as the banking sector’s net foreign position turned positive last year.
Real estate sector needs monitoring
BofA’s research team expects policymakers to monitor closely the developments in the real estate sector to guard against unsustainably rapid price rises and risks of a sharp correction. Analysts take comfort in the low rise in leverage and credit growth to the real estate sector this time around. New stock is coming on to the market at a more measured pace, with the exit of second-tier developers from the market after the crisis, and developers have used the market rebound to sell their stock and inventory. The central bank suggestion that foreign, cash-based, non-GCC investors are a driving force behind renewed strength of the residential market suggests a speculative element and vulnerability to the global liquidity cycle. Also, for this reason, macroprudential regulations are more likely to be effective if imposed by other entities than the central bank (higher fees, transactions tax, flipping restrictions), or in tandem with it (mortgage lending, sectorial capital requirements, debt-to-income and sector concentration limits).