Looking at charts of financial markets here lately, one might be tempted to conclude that it is the UAE, not the US, that is in a property-driven crisis. Falling stocks and rising borrowing costs seem to fly in the face of the nation's economic boom. Seasoned bankers, economists and analysts have expressed bafflement that investors have allowed stock prices to fall so far relative to corporate earnings and robust economic growth.
Much of the confusion stems from a tendency to conflate the performance of equity markets with economies. There is a vigorous debate going on as to whether emerging markets like the UAE's have broken free of the US economic cycle, but no one questions the fact that financial markets have become more, not less, interdependent. The recent decline in UAE and Gulf markets has been led in large measure by a lower tolerance for risk among international investors, who have been dumping emerging-market assets worldwide despite strong growth prospects. As tempting as it is to dismiss falling equities as foreign malaise, if stocks here were so obviously undervalued, someone, somewhere, would find a way to buy them.
The fact is that the apparent value in UAE stock markets does not yet compensate for the perceived risk - in particular, analysts say, the risk that property prices might fall. This is particularly true when the nation's market capitalisation is dominated by property developers and banks. Perhaps the clearest warning came last month in a controversial report from Morgan Stanley warning that a glut of new apartments could send Dubai property prices down by 10 per cent by 2010.
There is considerable disagreement about this forecast. Many believe that demand from new immigrants will more than compensate for new construction. Others say the bigger threat is that new regulations to control unregulated sales of properties still under construction, or still only in blueprints, will kill so-called "off-plan sales" or "flipping". Yet the practice is likely to continue as long as the UAE's policy of pegging the dirham to the dollar keeps interest rates lower than inflation. "We have negative real rates," said Marios Maratheftis, a Standard Chartered economist. "You're encouraged to borrow and penalised when you're saving."
Recent allegations of fraud at property developers do not help. Neither does the turmoil in markets abroad. An increasing number of economists and fund managers are predicting a global recession. While some in the UAE believe the economy here will be unaffected and continue to draw new residents, it seems clear that the destruction of savings abroad is going to hurt the ability of newcomers to buy housing here. Inflation poses another risk.
"If prices continue to increase at this pace, people will decide to go live somewhere else," said Mr Maratheftis. The real question is to what extent corporations and banks are exposed to a decline. There is a widespread perception in the local business community that without significant oil revenues Dubai's ambitious expansion is being financed largely by property sales and debt, with land the primary collateral.
Analysts say that Dubai's developers are less exposed than many fear. Most sell their developments as they build them and use the proceeds to pay for construction and pay down debt. "So in that sense, the risk has been passed on from the developer to the buyer," said Farouk Soussa, an analyst at Standard & Poor's ratings agency. Or to the banks that lend to them. While many analysts say UAE banks are not overexposed to property, doubts persist. Many believed local banks had little or no exposure to the subprime mess in the US, until Abu Dhabi Commercial Bank admitted to losing at least US$250 million (Dh918m) on mortgage-backed securities.
Whether prudent regulations on lending are adhered to or strictly enforced is also the subject of speculation. Many banks appear to exceed limits on the amount of money they can lend as a percentage of deposits or net equity. Banks are supposed to limit property-related lending to 20 per cent of their loan portfolio, and central bank statistics show that just 17.8 per cent of their loans are classified as for either construction or mortgages. But analysts say the way that UAE banks classify loans is somewhat fuzzy.
It is unclear, for example, whether many commercial and consumer loans might not also be used to finance property investments. Banks have been circumventing limits on property lending by creating property subsidiaries, and analysts say their real exposure is probably 25 per cent of all loans. "If prices fall, they would have to reel in credit," said Amr Abol-Enein, an analyst at ABN Amro. Banks are also supposed to lend only 80 per cent of a property's value, but anyone here knows that many banks offer to finance a much greater portion - a feat they accomplish, analysts say, by packaging consumer loans with mortgages. The absence of a robust domestic credit bureau, moreover, means they cannot tell if the same individual is borrowing from other banks, or pledging the same piece of property as collateral. Last year, however, the International Monetary Fund ran stress tests of the UAE's banks and found that even if the number of non-performing loans doubled, only five banks would fall below the minimum capital level, and only two would be rendered insolvent.
Analysts also say distinction should be made between Abu Dhabi, where the risk of oversupply is low, and Dubai. Abu Dhabi also earns higher credit ratings thanks to its oil reserves, which if it needed to could be used to bail out its banks. But would Dubai have to struggle through a property correction alone? With billions of dollars in refinancing needs this year, the question is the subject of much debate among investors watching Dubai Inc's bond yields and credit default swaps rise.
"Will Abu Dhabi come to the rescue in a worst-case scenario for Dubai?" asked Merrill Lynch in a report earlier this month. "Considering the political and historical ties, the Federal Constitution and the contingent liabilities in the UAE, our answer is a clear 'yes'." The good news, analysts say, is that thanks to swelling oil revenues, Abu Dhabi has more than enough cash to handle the job. "Were the banks unable to absorb losses on their own," said Charles Seville at Fitch Ratings, "the costs of bailing out the banking system would be well within the UAE Central Bank's capabilities, and would be small in relation to the Abu Dhabi Government's assets." warnold@thenational.ae
