What went wrong in Dubai?

The boom years of the early 21st century were good for many people, but perhaps no one enjoyed them more than Sheikh Mohammed bin Rashid al Maktoum, the ruler of Dubai. Stripped to its essentials, Dubai is a sweltering strip of sand blessed with a natural harbour known as the creek, which has been an entrepot for merchants and smugglers for centuries. Building on his father's vision, Sheikh Mohammed turned Dubai into a 21st Century boomtown, luring western financiers and tourists with gleaming steel and glass towers, vast beaches, and green golf resorts.

Now Sheikh Mohammed is calling for a standstill on debt repayments at one of his most important companies, Dubai World, least temporarily rocking world markets and raising huge questions about the future of Dubai.

Dubai was always a momentum play. Unlike Saudi Arabia or Abu Dhabi, the hugely wealthy emirate to the West, Sheikh Mohammed had scant oil production to fuel his grandiose ideas. Instead he sold the world on his vision of Dubai as a hub for the Middle East, western Asia, and Africa, attracting investment from his wealthier neighbors—both Arabs and Iranians—and increasingly, from the West and Russia.

For a while, it worked. Western bankers fell over each other to book space in his Dubai International Financial Center, a handsome if somewhat over-the-top real estate project aimed at being the Wall Street of the Gulf. The cream of technology companies and media companies, from Cisco Systems (CSCO) to Microsoft (MSFT), set up shop in Dubai's Internet City. CEOs and politicians came to Dubai to pay court to the ruler, whom they treated like a sage.

Sheikh's subordinates competed rashly

Sheikh Mohammed patronized a corps of young technocrats, who worshiped "The Boss" and raced to enact his visions. He told them there was nothing they couldn't do if they put enough imagination and energy into it. When Mohammed Alabbar, the chairman of developer Emaar Properties, came to the Sheikh with a plan to build a skyscraper in what was becoming the new downtown of Dubai, the ruler urged him to build the tallest building in the world. That's exactly what Alabbar did; today the Bourj Dubai is nearly completed, soaring above an artificial lake that boasts an elaborate set of fountains that cost $250 million. For a relatively small place, Dubai has acquired an extraordinary collection of futuristic towers—some of them unfinished or empty. The cityscape looks like something out of Buck Rogers.

A man in a hurry, Sheikh Mohammed created rival building arms and investment managers and spurred them to compete with each other for land and capital. At one point he had at least three private-equity operations going at once under his aegis. These units invested heavily outside of Dubai at the top of the market, using borrowed money. Banks, too, bought into the Sheikh's vision, or at least wanted to be included in the charmed circle.

When the credit crunch came, Dubai was badly exposed to known debt of $80 billion to $90 billion, and possibly even more. The Sheikh and his lieutenants, who had seemed masters at selling Dubai to the world, suddenly seemed inept. That Dubai has a serious problem has been well known for more than a year. Little progress has been made to resolve it.

It almost seems as if the ruler and those around him are in denial, not wanting to acknowledge the extent of their troubles—even to themselves. Earlier this year the ruler appointed a frank-speaking young finance minister, Nasser al Shaikh, who tried to force some of Dubai's big companies to sort out their problems. He was promptly fired.

A mystery: Abu Dhabi's $10 billion

In another sign of stress earlier this month, Omar bin Sulaiman, the well-regarded governor of the financial center, was also ousted. Three of the Sheikh's closest advisors were removed from the board of the Investment Corp. of Dubai, which manages the government's stakes in some of the big companies such as Emirates Airline. These moves may have been designed to appease critics in Abu Dhabi and Dubai's own worried merchant community.

Worried backers of Dubai always assumed that Abu Dhabi would come to Sheikh Mohammed's rescue if he got into real trouble. That has been true to an extent. Earlier this year the central bank of the United Arab Emirates, which is mostly funded by Abu Dhabi, the wealthiest of the emirates, loaned Dubai $10 billion. What has happened to the money is something of a mystery.

This all came to a head on Nov. 25, when Dubai rocked world markets by announcing that it would seek a standstill on debt repayments of ports operator and real estate developer Dubai World, the most troubled of state-controlled Dubai Inc. companies. The timing was horrendous, coming on the eve of an Islamic holiday, as well as the U.S. Thanksgiving. Worried investors—who only recently had begun putting new money into Dubai on the presumption that the worst was over—scrambled for information. Little was forthcoming. Reporters raced around the city, chasing press conferences that were never held. In a bizarre statement on Nov. 26, Sheikh Ahmed bin Saeed Al Maktoum, a Dubai official, said: "The government is spearheading the restructuring of this commercial operation in the full knowledge of how the markets would react."

What prompted the Dubai leadership to behave this way? There has been much speculation that an increasingly sceptical Abu Dhabi had refused to come to Dubai's rescue. But Abu Dhabi appears to have been blindsided by the debt gambit. Only hours before, two Abu Dhabi banks agreed to subscribe to $5 billion in Dubai bonds. Dubai's conduct looks more likely to stem from a combination of lack of awareness and denial, which may well be making things worse than they need to be for Dubai and its ruler.

What happens now? Abu Dhabi will come under pressure to provide more help to avoid being tarnished by a meltdown next door. Sales of Dubai's overseas assets, such as New York clothier Barneys, may be accelerated to raise funds. Sheikh Mohammed will try to preserve his independence and dignity. But already—in what some interpret as a sign of Abu Dhabi's growing influence—Sheikh Khalifa, that nation's ruler, is now pictured with Sheikh Mohammed on a huge poster at a traffic circle in Dubai.

Source: economictimes.com

Bank of England Poised to Sustain Crisis Aid

Chief Mervyn King Seen Keeping Measures to Nudge Economy Into Growth, While Other Central Banks Weigh Paring Programs

The U.K.'s top central banker, Mervyn King, faces a tough call at a pivotal meeting this week: Whether to continue showering money on Britain's troubled economy while other countries consider dialing back emergency relief measures.

View Full Image

BLOOMBERG

Mervyn

Many signs suggest Mr. King and officials on the Bank of England's interest-rate policy committee will expand their sweeping bailout of the economy. Growth prospects are dimmer for Britain than nations such as France, Germany and the U.S. The British economy, heavily dependent on the financial-services industry and fueled by high levels of consumer debt, is seen by some as acutely vulnerable to the aftershocks of the global crisis.

A manufacturing survey out Monday raised hopes that Britain might finally see economic growth in the fourth quarter. But investors have been spooked recently by a third-quarter gross domestic product report that showed Britain still in a recession that dates back to early 2008.

To rescue the economy, the Bank of England has slashed interest rates to record lows and launched a program of buying government securities with freshly printed money. Critics say while these policies may have averted economic Armageddon, they come with huge costs; some worry that such money-pumping exercises, known by some as "quantitative easing," could spark an outbreak of inflation.

As the Bank of England weighs continuing extraordinary measures, other central banks are acting differently. The U.S. Federal Reserve, which also meets this week, recently completed a program of buying $300 billion of government bonds, though it is still buying mortgage-related debt. The European Central Bank is expected to keep interest rates on hold without introducing new measures.

"This is not an easy decision for the Bank of England," says Malcolm Barr, an economist at J.P. Morgan Chase in London. "Bank officials realize the global outlook is improving."

Mr. King's decision -- and its effects -- could determine how easily Britain emerges from its worst economic downturn since World War II, and provide a first crucial test of the U.K. central bank since it became independent from the government 12 years ago.

The Bank of England's Monetary Policy Committee will vote Thursday on whether to expand, halt, or pause its bond-buying program. So far, the bank, through quantitative easing, has bought £175 billion ($287.85 billion) of mostly government securities, or roughly 30% of the entire conventional government bond market.

Many economists expect the nine-member Monetary Policy Committee to keep interest rates at 0.5% and expand the eight-month-old program by £25 billion or £50 billion. The reason: The U.K. economy is still contracting. By contrast, France, Germany and Japan returned to growth in the second quarter. Early readings show the U.S. economy grew at an annualized pace of 3.5% last quarter.

"The GDP figure was a game-changer," says Simon Hayes, chief U.K. economist at Barclays Capital in London.

The BOE programs have had an effect and some data have shown signs of economic pickup. The benchmark 10-year U.K. government bond yield is 3.66%, down from 3.85% on Feb. 10, the day before Mr. King first suggested the bank would start buying government bonds. Quantitative easing also may be helping to stir U.K. stock and bond markets.

Many economists don't see Mr. King's efforts, including low short-term interest rates, having a significant effect on the economy yet, which is why the bank may do more.

The bank hoped that its efforts would boost the supply of credit to companies and households and increase spending. But data out last week show that a key measure of the money supply actually fell £14.6 billion in September from August.

Further extensions of quantitative easing run the risk of shaking investor confidence by underscoring the severity of Britain's economic challenges.

Many economists also note that the BOE efforts come against a deteriorating fiscal backdrop. The International Monetary Fund predicts the U.K. government's budget deficit could hit 13% of GDP in 2010. Such deficits are likely to lead to reduced public spending and higher taxes, which could crimp growth.

Why currency keeps fluctuating

The rupee movement against major world currencies is in the limelight again since the last few weeks. The rupee appreciated sharply against the US dollar this month, by almost four percent, from Rs 48 per dollar to Rs 46 per dollar, in a span of four weeks.

One of the main reasons for the appreciation of the rupee against the dollar, and other major currencies, is the funds coming in from large global players. Foreign investors have invested around 13 billion dollars this year.

These funds coming in since the middle of September have triggered an appreciation in the rupee against major world currencies. Here are some of the major reasons behind large foreign players pumping funds into the markets:

There is surplus liquidity in most of the large economies of the world. One of the main reasons for this liquidity is the large economic stimulus packages given by governments and the liberal monetary policy adopted by central banks.

In the recent G-20 nations' meet, it was decided to continue the liberal monetary measures. This has increased the money flow from large financial players into emerging markets which have better potential for growth in the medium term.

Some expect the Reserve Bank of India (RBI) to hike policy rates in this quarter to control inflation. This is another reason why funds are flowing into the domestic markets. The softer interest rate regimes in developed countries are attracting foreign funds to the domestic debt market.

Another reason for currency fluctuations is speculation. Some large funds and major traders are pumping money into emerging markets to make arbitration profits due to currency fluctuations.

As more businesses are expanding their operations around the globe there is a widespread impact of sharp currency fluctuations.

In simple terms, it shrinks the receivables of exporters and makes life easier for importers as the prices of imports get cheaper.

A sharp fluctuation in the currency hits the small and mid-cap companies harder than their larger peers, as the larger players can manage the situation through actively managing (hedging) the currency and working with the scale.

The rupee appreciation would also have an impact on investors in international commodities funds (for example, gold exchange traded funds).

Although gold prices are rising in international markets in terms of dollar, it translates to lower gains due to rupee appreciation against the dollar.

Theoretically, currency movements should be driven by the economic fundamentals and progress of the economy. But modern communication systems and globalisation have made active management of large funds easy which in turn has increased the shortterm currency volatility.

This short-term currency volatility (upward or downward) is not good for business and hence the central banks in many countries allow controlled/managed currency movements by actively intervening from time to time. Here, the RBI smoothens the short-term currency fluctuations by buying/selling dollars in the market.

Outlook

Analysts expect capital inflows to continue and even increase in the short to medium terms due to the huge increase in global liquidity conditions. There are large financial institutions and funds that are accessing offshore markets for debt and equity. Analysts believe there is a huge amount of money waiting to come into the domestic markets. This will ensure a steady stream of dollars and hence keep the rupee moving in an upward direction.

Dropping the shopping

Rebalancing the world economy: America

Jul 23rd 2009 | WASHINGTON, DC
From The Economist print edition

Can America wean itself off consumption? The first of a series on how the world’s four biggest economies must change to ensure sustainable global

http://www.economist.com/businessfinance/displaystory.cfm?story_id=14098372

Reducing Reducing procyclicality

APART from immediate fire fighting, longer-term structural reforms are required in response to the financial crisis. Although there have been many crises, this one is unique in its size and impact, suggesting it had a specific cause: the promarket era, following the collapse of the Soviet Union, made markets more procyclical. But controlled systems and regulatory discretion also created severe problems. The right combination of regulation and markets requires an enabling regulation that works with the psychology of markets, creating better incentives to moderate cycles of greed and fear.
The features that distorted incentives and encouraged excessive risk-taking are now well understood. Among these were procyclical bonuses, securitisation, uniform mark-to-market accounting rules, conflicts of interest for rating agencies, and reliance on risk models based on market prices, so that systemic risk and diversity of views were neglected. Regulation was weakened both in law and in practice.
Greenspan and Rubin strongly rebuffed attempts to increase regulatory oversight over derivative markets and mortgage lenders, since they believed markets were self-regulating, while regulators would damage innovation and the ownership society, since their natural inclination was to prevent activity. After the US Glass-Steagall Act, which separated investment and commercial banks, was repealed in 1999 commercial banks also were able to underwrite and trade asset-backed securities, etc., through off-balance-sheet structured investment vehicles. The US Securities and Exchange Commission (SEC) was now the regulatory authority for securities and brokerage operations of investment banks.
To escape threatened regulation in the EU, investment banks sought a bargain in 2004 that gave the SEC voluntary regulatory oversight over the parent holding companies as well. In return, the SEC allowed higher leverage, relaxing the ceiling of twelve times capital on borrowing. Capital adequacy requirements, such as those the Federal Reserve (Fed) imposed on deposit accepting banks, were now missing, but the window the SEC had been given on the bank’s risky investments was never used.
The Commodity Futures Modernisation Act of 2000 exempted credit default insurance from regulation by calling them swaps. The post-Enron 2002 Sarbanes Oxley Act allowed off-balance-sheet activities so long as other entities held the risks and rewards, thus encouraging the “originate and distribute” model. Amendment to the Community Reinvestment Act in the midnineties allowed securitisation of subprime mortgages to make home loans possible for low-income categories, since the Clinton administration wanted to expand home ownership. A laudable objective was driven to excess in the Bush era where loans were pushed without documentation, to parties with no collateral except rising housing prices. Tax breaks such as deduction of mortgage interest payments from household taxable income further encouraged leverage. The boom psychology of greed and euphoria took hold.
A consequence of light regulation was high leverage: 30:1 compared to 15:1 for a commercial bank. Investment banks made money by borrowing short in the wholesale retail market, leveraging the borrowing many times and lending long. This kind of strategy is extremely susceptible to a fall in asset values and is not viable if stricter regulatory norms reduce leverage. This is one reason the remaining investment banks have been forced to become bank holding companies, which have now been put under the Fed’s regulation.
WITHOUT any central netting or regulatory knowledge, the chain of securities and structures financing subprime mortgages was opaque. This meant investors could not determine the location and extent of risk when housing prices began to fall. When the ABX index introduced showed a rapid fall in the price of subprime bonds, the lack of knowledge of where the risk lay led to worry about counterparties, a freeze in intra-bank markets, and spreading crashes in the prices of structured products as banks were forced to sell them. The fear-driven collapse had begun before, but was intensified after, Lehman Brothers was allowed to fail.
The contribution of low interest rates to the liquidity build-up was tiny compared to that due to lax regulation. BIS estimates that notional amounts outstanding in derivatives grew from $100 trillion in 2002 to $516 in April 2007 — an annual compound rate of growth of 33%. Compared to this, the broadest measure of US money supply is about $15 trillion with an annual growth rate of about 6%. Monetary policy’s first priority must be the real sector and cycle, since countercyclical prudential regulation is available to target financial bubbles. Clever financial solutions probably prevented the required real adjustments.
Regulators need good information flows to be alert to distortions, risky behaviour and fraud. Oversight must be strong enough to detect criminals, but better incentive structures may be sufficient to induce better behaviour from the average participant, and reduce information and oversight load while protecting the energy and innovation of markets. Principles for regulatory restructuring include reducing excessive risk-taking, increasing the diversity of views in the market, factoring in systemic risk, improving transparency, attaching conditionality to public money, and universal application of basic rules to prevent regulatory arbitrage.
Globalisation has reduced taxes on finance compared to labour because of capital’s much greater mobility. Huge bailouts are carrying this one step further, forcing taxpayers to subsidise finance. But bailouts must be conditional on stronger counter-cyclical regulations. Taxes imposed in good times would function as an insurance premium against the risk that taxpayers might have to finance bailouts in bad times. Incentives for pro-cyclical risk taking would reduce. But a tax-based solution has to be adopted as a global norm since one country adopting it alone would suffer from capital flight.
Asian countries had asked for more transparency of hedge funds after the East-Asian crisis — but the opposite was done, to the world’s cost. More representation and voice for emerging markets in international bodies will allow other views also to be heard, moderating the dominant finance view. A change in power is a precondition for real reform.