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What Is Our Credit View Of Dubai?

(Editor's Note: This article, published on Sept. 3, 2019, was republished later on Sept. 3, 2019, to correct the ratings of Damac Real Estate Development Ltd. A corrected version follows.)

Macroeconomic conditions in Dubai have deteriorated since 2013 in part due to lower oil prices and the deterioration in regional political relations. What's more, residential property prices in Dubai have been declining over the past few years and are approaching levels last seen at the depth of the 2009-2010 property crash. Investors are asking S&P Global Ratings how we view weakening economic fundamentals in Dubai from a credit perspective. Dubai's credit fundamentals are important to the creditworthiness of the Dubai-based issuers we rate. Here, we explore some topics that have surfaced frequently in recent discussions with investors, including our view about Dubai's growth prospects and potential risks from high public-sector debt. As we do not rate Dubai, our views are based on publicly available information.

Growth Prospects To Remain Relatively Soft

We expect a marginal pickup in economic growth to 2.4% in 2019, with support coming largely from the construction and real estate sectors. We expect the completion of Expo 2020-related infrastructure projects and additional residential housing supply to enter the market from existing projects this year. A boost to tourism and related spending linked to Expo 2020 should drive somewhat stronger growth in 2020. However, after the Expo, economic growth will likely to ease in our view to around 2% through 2022, sustained by traditional growth engines such as trade and transportation (see chart 1).

Chart 1

image

Downside risks to growth have risen from trade and the real estate sector. The United Arab Emirate's imposition of an embargo on Qatar and compliance with U.S. sanctions on Iran continue to weigh on Dubai's transshipment trade. Overall, Dubai's economy grew by just under 2% in 2018, the slowest expansion since 2010. In our view, relatively low oil prices, accompanied by slower regional demand and rising protectionism in the U.S. and China, could further slow Dubai's transshipment trade flows, which have been sluggish since 2016.

S&P Global Ratings expects real estate prices in Dubai to fall by another 5%-10% in 2019 (See "Dubai Real Estate Downturn To Continue: Projections And Ratings Impact," published on Feb. 18, 2019.) However, a longer and deeper downturn in the real estate market than we currently anticipate could significantly dampen economic activity and increase pressure on government finances. About 70% of Dubai's government revenues are from nontax sources, with part coming from land transfer and mortgage registration fees, housing and municipality fees, alongside real estate-related income in the form of dividends from the key developers it controls such as Emaar Properties PJSC (BBB-/Stable/--) and Nakheel Properties.

Although we expect demand created by Expo 2020 to ease the pressures temporarily, Dubai's commercial real estate might suffer from oversupply afterward, further reducing the financial cushion of real estate developers. We recently lowered the long-term issuer credit rating on Damac Real Estate Development Ltd. to 'B+' from 'BB-', reflecting our expectation of weakening credit metrics over the next two years as declining prices for residential properties in Dubai lowers presales, operating margins, and profitability (see "Dubai-Based Damac Real Estate Development Downgraded To 'B+' On Weak Market Prospects; Outlook Negative," published on Aug. 28, 2019).

Nevertheless, new economic stimulus plans to promote small and midsize enterprises and public-private partnerships, announced recently by the government, could gradually increase Dubai's long-term growth potential. A new law to allow full foreign ownership of companies outside existing free economic zones should also encourage private investment and improve the business climate.

UAE's Growth Momentum Will Ease After 2020 On the Back Of Modest Growth in Dubai

The performance of Dubai's economy and its role as a regional trade hub is important for the UAE federation as a whole. Dubai contributes a significant amount to the nonhydrocarbon sector of the UAE, which represents about 70% of UAE real GDP. According to our estimates, Dubai's external trade accounts for about 72% of the UAE's total non-oil trade.

We expect the UAE's economy will continue to face challenges in the medium term partly because of softer growth momentum in Dubai. The UAE's economic growth will pick up to 2.6% by 2020 from 1.7% in 2018 in part due to increased economic activity associated with the Expo.

Despite our base case scenario that the real estate downturn will continue in Dubai in 2019, we believe that UAE banks will be more resilient than in the last real estate cycle in 2002-2008, due to stronger regulation and more conservative lending to real estate developers and mortgagors. Regulations created in 2013, which cap the loan-to-value ratio, are positive for the stability of the banking sector (see "Banking Industry Country Risk Assessment: United Arab Emirates," published on April 17, 2019).

Weakened Economic Fundamentals Constrain The Dubai Government's Potential To Support Its GREs

In our view, credit conditions in Dubai have deteriorated in recent years, constraining the government's ability to provide extraordinary financial support to its government-related entities (GREs) if needed. Dubai's income level, as measured by GDP per capita, has declined annually to an estimated $36,000 in 2019 from a peak of $45,000 in 2013. We view this decline as an indicator of weakened macroeconomic fundamentals. For that reason, we downgraded government companies Dubai Electricity and Water Authority (DEWA) and DIFC Investments LLC last year (see "Government Companies DEWA And DIFCI Downgraded On Weakened Economy In Dubai," published on Sept. 4, 2018).

The Public Sector Is Highly Indebted

Dubai's public-sector debt burden remains high at about 108% of Dubai's GDP, according to IMF data, split almost equally between central government and GREs.

Dubai government debt

The Dubai government's direct debt is largely concentrated on domestic sources. Estimated at $65 billion, equal to 56% of 2018 GDP, central government debt is mainly lending from Emirates NBD (owned by the government via its sovereign wealth fund ICD) and Abu Dhabi authorities. Dubai received financial support of $20 billion from the UAE central bank and two banks owned by the government of Abu Dhabi during the 2009 debt crisis. These outstanding facilities have since been rolled over, and we expect will continue to be rolled over in the future. We understand that these loans are on concessional terms.

GRE sector debt

Downside risks to debt sustainability could stem from large GREs. Indebtedness of GREs has fallen by 20% of GDP over the past 10 years. However, we estimate GRE debt at about $59 billion, equal to 52% of 2018 GDP, and about $44 billion (38% of 2018 GDP) of which is due to mature in 2019-2022. We understand that three large GREs--Investment Corporation of Dubai, Dubai World, and Dubai Holding and subsidiaries--account for the vast majority of total GRE debt. The amount maturing includes about $10 billion of Dubai World's outstanding debt that was restructured in 2015 with an extension granted for principal repayment from 2018 through 2022.

High levels of GRE debt raise contingent risks for the government of Dubai that could materialize should market perceptions of the emirate significantly deteriorate, perhaps due to a further significant downturn in the real estate market (not our base case), a sharp decline in trade or tourism flows due to even higher geopolitical risks, and rising protectionism. However, according to Bloomberg data, market perceptions of the Dubai government's credit risk, informed by spreads on five-year credit default swaps, have improved significantly since the corporate debt crisis in 2009 and remain relatively contained. The cost of insuring Dubai's sovereign bonds against default fell by about 850 basis points (bps) from a record high of almost 1000 bps in February 2009 and has ranged from 120 to 140 bps in recent months (see chart 2).

Chart 2

image

Abu Dhabi-Backed Financial Support

Although it is not our base case, were the Dubai government to fall into financial distress, we expect extraordinary financial support for Dubai would come from the UAE (with Abu Dhabi's backing). We estimate external liquid assets of Abu Dhabi at about 260% of its GDP, equal to 140% of the UAE's GDP. Under a stress case, however, rated Dubai-related entities might still experience a negative credit transition as evidenced by the 2009 crisis.

S&P Global Ratings did not rate the GRE, Dubai World, and its subsidiaries, nor their financial obligations, which were restructured following the 2009 crisis. Generally, for rated issues in this type of situation, S&P Global Ratings would look at the nature and amount of the sovereign support extended to a GRE and assess whether investors may receive less under the restructuring than under the original terms of the securities (see "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published on May 12, 2009).

Related Research

  • S&P Global Ratings Lowered Its Henry Hub Natural Gas Price Assumption For The Rest Of 2019 And For 2020, 2021; Long-Term U.S. Natural Gas, Canadian AECO, And Crude Oil Price Assumptions Unchanged, July 29, 2019
  • Report Says U.S.-Iran Tensions Could Drag On Investor Confidence And Sovereign Ratings In The Gulf, July 22, 2019
  • How U.S.-Iran Tensions Might Affect Gulf Corporate And Infrastructure Issuers, July 15, 2019
  • Summary Analysis: Emaar Properties PJSC, July 3, 2019
  • Summary Analysis: Abu Dhabi (Emirate of), May 31, 2019
  • Research Update: Dubai Electricity and Water Authority 'BBB' Rating Withdrawn At The Company's Request, May 22, 2019
  • Dubai Real Estate Downturn To Continue: Projections And Ratings Impact, Feb. 18, 2019
  • Government Companies DEWA And DIFCI Downgraded On Weakened Economy In Dubai, Sept. 4, 2018
  • Dubai-Based Damac Real Estate Development Downgraded To 'BB-' On Weak Market Prospects; Outlook Stable, Feb. 18, 2019

This report does not constitute a rating action.

Primary Credit Analyst:Shokhrukh Temurov, CFA, Dubai + 97143727167;
shokhrukh.temurov@spglobal.com
Secondary Contacts:Trevor Cullinan, Dubai (971) 4-372-7113;
trevor.cullinan@spglobal.com
Zahabia S Gupta, Dubai (971) 4-372-7154;
zahabia.gupta@spglobal.com
Sapna Jagtiani, Dubai + 97143727122;
sapna.jagtiani@spglobal.com

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