from Follow the Money

Abu Dhabi’s tentative bailout of Dubai …

February 24, 2009

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The UAE’s central bank will apparently use $10 billion of its foreign exchange reserves to buy $10 billion of a (planned) $20 billion Dubai debt issue. That will provide Dubai with $10 billion in foreign exchange (Dubai gets the UAE’s dollar reserves in exchange for an IOU, the UAE gets a dollar-denominated claim on Dubai … ) to repay $10 billion of its external debt. Lex writes:

Dubai’s $10bn cash injection from the United Arab Emirates’ central bank has eased concerns about the struggling emirate’s ability to make good on $13bn in debt payments due by the end of this year. Just as important as the deal’s dollar figure, however, is the political message it sends. After weeks of uncertainty, Abu Dhabi, the Emirates’ oil-rich sugar daddy, has demonstrated its willingness to stand behind its poorer relation. ... Strictly speaking, the UAE central bank’s purchase of $10bn of five-year Dubai bonds – part of $20bn in new bonds priced at 4 per cent interest – was agreed at the federal level. But at its core, the move amounts to a bail-out by proxy of Dubai by its wealthier neighbour, Abu Dhabi, which is the biggest contributor to the UAE’s federal budget thanks to a quirk of geography that left it holding 8 per cent of the world’s oil reserves.

I find it interesting that the financing for Dubai came from the Emirates (the confederation), not Adu Dhabi (the richest emirate). As Lex notes, it arguably is the same thing: Abu Dhabi’s oil ultimately backstops the federal government. But it nonetheless suggests:

a) Abu Dhabi - meaning the large investment funds of Abu Dhabi -- itself may not be all that liquid. Abu Dhabi may be kind of like Harvard: very wealthy, but caught between ambitious plans to invest some of its resources at home (Harvard is planning a new science campus, Abu Dhabi is a lot wealthier and is planning a lot more ... ), falling inflows, falling asset values and growing calls on its capital from various illiquid funds it has invested in.

B) Abu Dhabi doesn’t want to sell its existing foreign assets at distressed prices to finance Dubai. Tapping on the central banks existing liquid reserves is a way to avoid selling other assets …

Of course, financing Dubai through the central bank means that the quality of the assets on the Emirates central bank balance sheet will deteriorate. The central bank has traded $10 billion of liquid foreign assets for $10 billion of Dubai’s illiquid bonds. Dubaican notes that the coupon on the bonds looks well-below market, adding to their illiquidity. And, well, if other demands for liquidity materialize, Abu Dhabi could well have to meet them out of its own resources.

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