Unfolding Dubai’s Debt Crisis

Interview by IslamOnline.net. Dec 2, 2009

Unfolding Dubai’s Debt Crisis
By Amr Taha, Staff Writer-IslamOnline.net

On November 25, 2009, the Dubai Government asked Dubai World, a government-backed conglomerate, to agree to delay its repayments until May 2010.

With the number is so much unconfirmed, Dubai reportedly owes the world more than $60billion of external debts.

Dubai’s economy that has been built on real estate and luxury tourism industries has caused the bubble, fueled by oil boom and unregulated markets soaked in speculation, to burst.

Al-Nakheel, a subsidiary of Dubai World, is due to pay its $3.5 billion Shariah-compliant bonds (Sukuk) in December 14, triggering many to ask with suspicion about possible scenarios if the company defaults on its payments.

IslamOnline.net’s Politics in Depth interviewed Dr. Parvez Ahmed, associate professor of finance, Coggin College of Business of the University of North Florida, and a US Fulbright scholar to shed light on the consequences of the crisis, the misuse of Islamic finance, and the way out.

IslamOnline.net (IOL): How far the debt crisis will affect Dubai in the short and long terms?

Dr. Ahmed: With $60 billion debts, Dubai could consider defaulting. The debt is a sovereign [one], borrowed by [Dubai].

There have been other countries that defaulted because of debt. In the case of Dubai, $60 billion is a large amount of money, but not that large compared to other nations who defaulted.

A decade ago, Argentina had defaulted on $ 141 billion. Moreover, the external debt of the United States is $15 trillion. Yet, the United States is not at any danger of default.

There is a concern and a silver lining of the debt crisis in Dubai.

The silver lining is that the situation is not as grave as some commentators said.
Economists will look at the ratio of the debt to the GDP when evaluating the debt crisis of any country.

The United Arab Emirates’ debt is relatively smaller than those of the United States, the United Kingdom, and many Western nations.

In Dubai, the debt at a special ratio to the GDP is 37 percent. In the United States, it is 75 percent. The ratio of debt to the GDP in the United Kingdom is 375 percent. In Ireland, it is alarmingly at 960 percent.

Therefore, the United Arab Emirates, in the long run has the capacity to service that debt.

However, in the short run, the danger comes from two sources.

Firstly, if Abu Dhabi will pay off Dubai’s debts, Dubai will default and Abu Dhabi will rescue it.

Then, this creates economics of moral hazard; it is created when an economic action has been taken to help defaulting entities, causing systemic problems to the economy.
Will this lead other countries to default on their debts, hoping other countries could help?

In the United States, [economics of moral hazard posed the question] whether it encourages other banks to take risky positions, even wrong, hoping that somebody will [bear the brunt of the risk and help them]?

It creates an unfair situation when banks and financial institutions benefit from their successful risks while they do not have the responsibility for unsuccessful ones.

In the short run, bail out may be beneficial, but in the long run it will create moral hazards. In this way, one could expect what would happen if Ireland defaults.

The second source is that many Western powers, like the United States, the United Kingdom, are facing problems at home, like huge public deficits.

The United States is embroiled in two wars in Afghanistan and Iraq, and it suffers a lot of debt; it is $15 trillion.

In terms of external debt per person, every person owes $930 of debts in the United Arab Emirates while in the United States, every citizen owes $2000 in debt. In Egypt, it is $1000.

IOL: How far has Dubai’s debt crisis affected Islamic economy, especially with concerns that Sukuk creditors may not be protected?

Dr. Ahmed: The default of sukuk (Islamic financial certificate or bonds) will deal a severe blow to the development of Islamic finance.

In the middle of 2008, when the world economic crisis hit the world, Islamic products were not affected as other conventional ones.

Therefore, many people, experts, and economists look at the Islamic finance as the solution.

Yet, I found that this assumption is too hasty.

The current situation of Islamic finance is not that different from the conventional one. It is different in form, not function.

When one strips away externalities, the core of Islamic finance is not that different from[those of the] conventional finance, thus subjeted to the same kind of problems facing conventional banks.

In the eyes of the laws, Islamic finance is not very different in terms of the process of default.

Sukuk bonds are subjected to the same standards of default. The difference between Islamic banks and conventional ones is a matter of semantics.

What happened in Dubai put the chill on the transaction of sukuk bonds.
It will affect the Islamic finance industry. Although the Islamic finance has many good sides, it is similar to conventional ones.

This encourages researchers, experts, economists, and businesspersons to find out a more holistic approach of Islamic finance.

It is wrong to focus on one aspect of Shari`ah while neglecting its other aspects. [Many tend] to focus only on issues like riba (interest), with less attention on issues of transparency, fighting corruption, social equality, and the like.

In Dubai, there are many questions about how the money flow — and where it was spent. Much of the investments in Dubai while spectacular appear to be very wasteful.

When people live beyond their means and in an extravagant manner, they really do not due justice to Shari’ah.

The goal of Shari`ah and Islam is to promote justice and equity, not to a small group of people, but to the majority of them.

Many are obsessed with riba, but not sustainable development, equitable development, social equality, transparency, and other issues, whichgives a negative image of Shari’ah.

IOL: What are the options for Dubai to repay its debts?

Dr. Ahmed: The available options are not very good. Default will happen, affecting properties prices.

Dubai’s economy is [based] on luxury tourism and real estate. The default will hit economic activities.

This is a great time for big financial centers to develop a much more holistic and sustainable financial market globally.

Many notable Noble Prize laureates, like Stiglitz, called for the restructuring of the world economy.

If the basic problems are not properly addressed, we will see more defaults, and we already saw Iceland defaulting.

IOL: So, in your opinion, what is the way out?

Dr. Ahmed: I think we need fundamental changes.

Firstly, we should understand that the basics of the free capital system are not wrong. At the same time, there has to be much more emphasis on transparency — on how companies are investing their wealth.

Governments will have to take a much more educative role. Agencies (governmental or quasi-governmental) have to take on the responsibility of educating investors.

The Securities and Exchange commissions in the United States usually has that mandate. We need to give these agencies more power, not only in terms of law enforcement, but also the role of educating about markets.

More people are investing in markets and cannot afford big losses. At the same time, if not educated, they could face more problems. Therefore, the government should take the role of educating people about economy, its dangers, and the benefits of investments.

We need robust regulations and governmental actions in regulating the markets.
Secondly, we need anti-corruption measures. There is a fair amount of greed and corruption, especially in the developing economies.

Corruption can be in many forms, like concentration of wealth at the expense of the poor, which could potentially lead to social unrest.

Islamic finance can play a role, if it adds to its portfolio the dimension of fighting corruption, transparency, sustainable development, and social equality.

Amr Taha is a staff writer for the Politics in Depth section of IslamOnline.net. A graduate of the American University in Cairo, he holds a BA in political science with a specialization in international law and international relations. Contact him at politics.indepth [at] iolteam [dot] com