Archive for November 28th, 2009

Dubai, Greece and Venezuela, three countries, three different debt profiles

November 28, 2009

(In Spanish here)

The news that Dubai World, a private company owned by the Government of Dubai, shook the world’s financial markets this week. The move was surprising more than anything else. Everyone knew that Dubai World.founded in 2006, was overextended, it accumulated US$59 billion in debt, which was used mostly to develop spectacular real state projects in Dubai and buy properties across the world, including part of chip company AMD, of an MGM casino project and the Fontainebleau Hotel in Miami Beach.

The problem was that everyone assumed that Dubai World would not default despite the problems, because it was almost like sovereign (country) risk, a so called quasi-sovereign, implying that Dubai itself would bail out the company, which did not happen. But moreover, people also assumed that in the worst case Abu Dhabi, one of the seven Emirates (and the richest!) of the United Arab Emirates, would come to the rescue (which may still happen and I expect to happen).

Clearly, the Government of Dubai, with total debt of US$80-90 billion, decided not to back the company, a clear sign of discrepancies on how things were managed, letting the company function like one and forcing it to face the harsh realities of restructuring and asset selling.

But I don’t think it will come to that. This was a signal to Dubai World, but it is likely that Abu Dhabi will come to the rescue, the Arab world has too much at risk to let it go. To begin with, most of the bonds are so called “Islamic Bonds” (sukuks), structured to not pay interest, which is forbidden by Islam, by sharing in profits. Thus, the investors in most of these bonds come from the region and there will be pressure to do something and even other Arab countries beyond the Emirates make come in and help.

Then let’s look at size. The debt is large for Dubai. Dubai’s GDP is US$ 32 billion, so that the country’s debt and the company’s debt is large. The worst part is that it is too concentrated in real state projects which are not generating cash flow yet or have poor cash flow. Dubai produces a scant 250,000 barrels of oil a day, which represents 6% of revenues, so oil will not save the day as many think.

European banks have lent Dubai lots of money, but in terms of size this is not large, because Dubai is not saying it will not pay, but that it seeks to delay payment in two bonds, two Islamic bonds that come due on Dec. 14th. (US$ 3.5 billion) and in May (US$ 1.2 billion), so there will not be immediate impact on European banks.

It is thus a problem more of complacency than anything else. People thought Dubai Corp was like a sovereign and we all know sovereigns don’t default, unless …you are Argentina in 2002, Russia in 98, Ecuador in 2008 or now Dubai in 2009.

Or Greece in the next couple of years…

Because Greece’s problems are much larger (US$ 500 billion with Greece having a GDP of around US$ 360 billion) than Dubai’s and therefore they would have a much larger impact. But more importantly, only the European Community can continue saving Greece as the usual solutions for getting out of the problem don’t work: Greece can’t devalue or print euros as it would violate EC rules. The only way out would be a disaster: Leave the EC, which would give Ireland, Italy and Spain ideas. Having the EC aid them would create a bad precedent, more so when Eastern European countries also have problems. Damn if you do it, damn if you don’t.

So far, Greece has been solving the problem by issuing more and more short term debt and having the European Community fund it cheaply, but this can’t go on forever. Everyone thought Greece’s problems were much worse than Dubai’s and Dubai defaulted first. Thus, even if Abu Dhabi comes in and rescues Dubai this weekend, the bond markets will remain nervous for a while, as that possibility lingers in the air.

Which brings us to Venezuela. Venezuela’s dollar debt is around US$ 80-90 billion, smaller than its US$ 300 GDP, which gives us at first sight some comfort. Except that that GDP is measured at Bs.2.15 per US$ and we all know that is as artificial as you can get. It obviously is not Bs. 5.5 per US$ (which would give you US$ 117 billion for the GDP), but somewhere in between. which still looks comfortable, except that…

The Venezuela Government has huge financing needs unless oil goes up sharply, implying more and more debt will be coming down the pipeline. Thus, the size of the debt will look bigger and bigger compared to GDP and GDP is unlikely to grow in US$ in the next couple of years.

But the real problem is political. While people have grown accustomed to believe that sovereigns and quasi foreigners don’t default, Dubai World did, it was a political as well as financial decision. And Hugo Chavez could make a similar decision (PDVSA is quasi-sovereign), although I do not expect that yet.

First of all, PDVSA has CITGO, which generates a lot of cash flow for PDVSA and any default could tangle up CITGO in US Courts for years. Second, the Venezuelan Government can still save foreign currency in many places, like the travel allowance at the official rate (Please fellow countrymen, don’t scream at me) which amounts to US$ 4.5 billion a year sold at Bs.2.15 er dollar to well to do Venezuelans.(Debt service (interest) is only US$ 3 billion per year so far) Or it could devalue. But in the end the decision is a political one and Chavez could get up one morning in a bad mood. Nobody knows.

In the end, I expect the Dubai problem to go away as Abu Dhabi and others help Dubai or reach an agreement to help it as long as Dubai World gets rid of some properties. But the Greek problem will not go away anytime soon and that may the next real crisis. For Venezuela jittery markets make it more difficult for the Government go issue a new PDVSA or Sovereign bond this year.

As for Venezuela, I don’t see a debt crisis in the short term, there are too many quick solutions like a devaluation, removal of subsidies and the like that can still be implemented.

Unless Hugo realizes he can stir up the pot by threatening to default, but even that I don’t see coming any time soon, he still thinks he can achieve his local political goals without going that far. We shall see…