Nakheel, the developer of Dubai's world famous Palm islands, has two months left to raise the funds needed to repay what has become the most watched Islamic bond in the Middle East. The US$3.5 billion (Dh12.85bn) sukuk, plus profit, is just one of several major repayments coming due over the next year, and the market is watching it for clues to the emirate's ability to repay its debts. It has become a yardstick of Dubai's credit worthiness in the eyes of international investors. But what happens after December 14, when the bond that was issued just three years ago comes due? The emirate has an estimated $85bn in debt and must repay an average of $12.5bn annually over the next three years. In addition, Dubai still requires funding to expand its road network, public transport systems, and power and water plants, as well as other infrastructure that is now approaching completion after a six-year building boom. Unlike Abu Dhabi, which has encouraged the use of project finance or public-private partnerships despite ample oil-fuelled revenue streams, Dubai has relied heavily on short-term financing during a period when cash was cheap and funds ample. That approach is changing fast as lenders instead look to tie borrowing more closely with future cash flow. Philippe Aroyo, who heads BNP Paribas's activities in the UAE, says infrastructure projects should be financed over 10, 15 or 20 years instead of being refinanced every two years. "All projects have to be supported by the basic principles of finance," he says. "The right way is to look at the cash flows ensuring the repayment, that the maturity of the loans is in line with the economic viability, and that there is the right balance between equity and debt. No corporate on earth could grow with 100 per cent of debt and the same should apply when it comes to any sovereign country or entity." Mr Aroyo says Abu Dhabi's approach is a good example that "would probably set benchmarks for future financing of projects in Dubai". Barely five months after Nakheel's sukuk comes due, the Dubai Government-controlled developer will face a second $1bn bond in May. Several other Dubai Government-related entities must also repay borrowing in the months ahead, including the Dubai Civil Aviation Authority, with a $1bn sukuk that is due on November 4. Dubai World must repay a $2.1bn loan next June, while Dubai International Capital will also need to repay $1.7bn at around the same time. The Nakheel sukuk has become the most prominent example of the pitfalls associated with using short-term funding to pay for long-term projects. Its repayment is expected to usher in a new approach to fund-raising, where the debt is more aligned to the specific duration and needs of a project. "It is unlikely that the Dubai Government can continue to raise $20bn every year," says Christine Grady, an economist at Deutsche Bank, referring to the emirate's external funding this year. In the latest example of creative financing, Etihad Airways last week signed $1bn in loan guarantees from the governments of the Organisation for Economic Co-operation and Development, which will help the airline gain access to more affordable financing. The financial crisis put a sudden brake on Dubai's highly leveraged push to become a global hub for trade, tourism and finance. The sharp decline in property prices, down by as much as 50 per cent from their peak last year, has put several large-scale projects on hold and led banks to reduce lending. State-controlled companies such as Dubai Electricity and Water Authority (DEWA) are under pressure to deliver new power plants. At the same time, financing for many government entities remains constrained, according to experts. "Given the existing commitments, things are already pretty tight and companies such as DEWA don't have much leeway to operate," says Robert Bryniak, the chief executive of Golden Sands, a management consultancy. DEWA has said it would invest about Dh72bn to keep up with rising demand for power and desalinated water. Securing funding for this type of large-scale infrastructure development will be the next big challenge for the emirate, and selling more bonds may not be the answer. In the meantime, Dubai has to deal with its current obligations. Restructuring or extending publicly traded bonds is generally much harder than dealing with syndicated loans, because bonds may have thousands of investors who may or may not be known, while a syndicated loan is typically held by a significantly smaller number of banks. They can be more easily convinced to roll over, repackage or restructure payments. "The capacity of the Dubai Government to support the corporate sector is constrained by its small and narrow revenue base and limited financing flexibility," the ratings agency Fitch said in a report last month. Last year, the Dubai Government allocated 45 per cent, or Dh65bn, of its overall budget to the Roads and Transport Authority (RTA), Ports Dubai and Dubai Municipality. But many infrastructure projects being delivered by these organisations are costing much more than planned. The recently opened Dubai Metro had been forecast to cost Dh15bn, but that figure almost doubled to Dh28bn. The RTA has until now been fully financed by the Government, although analysts say that could change. Abdul Mohsin Younes, the chief executive for strategy at the RTA, said recently that the agency would look at public-private partnerships for any future major projects. "RTA has not been borrowing publicly, but we don't know the federal or government mechanism," says Philipp Lotter, an analyst at Moody's Investors Service, the ratings agency. Other RTA projects include upgrading Al Khail Road, which is expected to cost Dh1.3bn, the roadworks around the Trade Centre that will cost Dh690 million and the Dubai Bypass Project costing an estimated Dh363m in its first phase alone. The Al Sufouh light rail project, which aims to link landmark developments including The Palm and Burj Al Arab Hotel, comes with a Dh4.5bn price tag. Dubai could invest as much as $20bn in desalination projects in the next decade alone as it increases its water output by 2.72 billion litres a day, according to Leon Awerbuch, the past president of the International Desalination Association. And DEWA, for its part, has indicated it plans to add plants with a capacity to produce 14,405 megawatts by 2017, especially if the regional economy picks up. Construction costs for those new plants amount to $11.6bn, while infrastructure costs, including substations and transmission lines, will be about $3bn. As well, the infrastructure support, pumping stations and pipelines, for example, will cost another $1.5bn, according to calculations by Mr Bryniak. "In my view, DEWA will need to introduce public partnerships and rely on the private sector to deliver these requirements in much the same way as Abu Dhabi does," he says. "I believe this is the only practical way forward for Dubai." Despite the contraction in global credit markets, it is still possible to secure capital expenditure financing for classic infrastructure projects such as power plants and ports. Some analysts say that industries and businesses with a track record, such as DP World or DEWA, will continue to attract funds in the medium term. "Once the noise surrounding it has disappeared they will be the very first to be able to attract outside financing," says Mr Lotter. By contrast, financing is far more difficult for big property projects and infrastructure. "It is a big question mark where that kind of financing will be coming from, because we don't know where that has been coming from so far," he says. Much of Dubai's infrastructure development has been based on property sales. "Compare this to Abu Dhabi, which went through the cumbersome process of [project finance] despite having lots of cash," says Jean-Christophe Durand, the regional director for the Middle East at BNP. There could also be a renaissance for structured project finance, where the debt repayment is guaranteed by the operating cash flow of the project. The same is true for structured bonds with securitised payment streams, such as from electricity income. "Plain corporate money is no longer easy to get. If you have a private initiative for a power plant with 20-year financing, it is far more difficult to go to a committee," says Mr Durand. So far, the take-up of structured project finance in Dubai has been slow, if not almost non-existent. The recent $1bn DEWA financing deal backed by several European export credit agencies may be a first sign that things are changing. With a maturity of 13 years, it is the first major export agency-backed financing for a UAE sovereign and the first foreign currency financing through regional bank markets to go beyond 10 years. And as Dubai moves from building massive projects to operating them, its financing requirements are also changing fast. "Dubai borrowed heavily to fund the development of an infrastructure that is now the best in the region by a long way. Because much of that development work is now done, its requirement for new capital should be much lower going forward," says Simon Williams, the chief economist at HSBC. But Dubai's debt as a proportion of GDP remains high. Excluding Government-owned entities, the emirate's debt will have tripled to $30bn at the end of this year, or 40 per cent of GDP, according to Fitch. Ultimately, much hinges on the pace of recovery locally and internationally. "The key is that the economy starts growing again. Then you have to assume and hope that access to international capital markets will open again," says Tim Fox, the chief economist at Emirates NBD. "Growth will boost confidence and lower spreads will foster its ability to once again issue new debt." firstname.lastname@example.org
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