x Abu Dhabi, UAEFriday 19 January 2018

Capital's economy has been built on solid foundations

Foreign investors may be inclined to view Dubai and Abu Dhabi as a package deal, two halves of a whole.

Foreign investors may be inclined to view Dubai and Abu Dhabi as a package deal, two halves of a whole. It's understandable; these emirates are the principal members of the UAE federation, and benchmark stock indices popular overseas, such as MSCI Barra UAE, lump together stocks listed on the two bourses. That may seem like no big thing. The ADX General Index in Abu Dhabi had a 16.1 per cent gain this year as of December 17; the corresponding figure for the Dubai Financial Market General Index was 14.8 per cent.

Abu Dhabi also holds a minute performance edge over the last five years. That period corresponds roughly to the expansion and contraction of the Dubai property bubble, a tumultuous development that created much greater volatility for Dubai shares along with slightly worse returns. The Abu Dhabi stock market may maintain its advantage, and even build on it, in the months to come, if not for longer.

As events during the last few weeks make clear, there is no imminent resolution to the problems besetting Dubai. Even after one is reached - a deal is made with creditors, real estate prices stabilise - investors may find that the crisis left a more persistent and damaging legacy than they had anticipated. A fact of economic life in the UAE is that Dubai owes money, and Abu Dhabi has it. The announcement in late November that Dubai World, a commercial enterprise owned by the emirate's government, wanted to delay debt payments for six months should have been a reminder of that key distinction. Instead, there was indiscriminate selling.

The ADX and DFM each fell about 12 per cent in two trading days as sellers evidently adopted the package-deal theory and acted accordingly. I made the case here two weeks ago that Abu Dhabi shares had seemed especially hard done by. Traders apparently reached the same conclusion, as the DFM kept falling and the ADX began to recoup its losses. Dubai shares began catching up after the announcement on December 14 that Abu Dhabi would come to its neighbour's rescue to the tune of US$10 billion (Dh36.7bn). It may be tempting to conclude from that latest act of largesse that the glitzier emirate is close to turning a corner and heading in the right direction toward financial soundness.

There are good reasons to avoid investing heavily in Dubai based on that idea, however. For one, it may not happen. It didn't earlier in the year when the consensus was that the first round of assistance, also $10bn, would do the trick. There is unlikely to be an event that announces that Dubai's debt problems are firmly in the past or that is taken that way by the global investment community. Abu Dhabi has shown that it won't write a blank cheque, and given the reputation of bondholders, as opposed to banks, for prickliness and obstinacy, no single big deal with creditors can be expected.

More important for the long haul, once the crisis is resolved - however and whenever - Dubai's access to global credit markets could be curtailed. Much criticism has been directed at the emirate for its handling of Dubai World's troubles, and future requests for credit are expected to be greeted with great circumspection. "Their ability to raise money internationally has been tarnished," said Joe Kawkabani, managing director for asset management at Algebra Capital. "In the future it's going to make them be 100 times more transparent, but the cost of funding will be much higher."

For an economy like Dubai's that was built on leverage and easy access to credit, and whose key industries - property, finance and construction - depend on a continuous supply of capital, that almost ensures years of so-so growth. That is likely to mean softer profits and weaker returns for stocks, especially if companies used to raising money through the debt markets have to issue equity instead, creating a surfeit of supply and depressing valuations.

Abu Dhabi, whose economy hinges on a sector, energy, whose outlook is considered stable to strong, is on much firmer footing, and the emirate has earned a reputation for fiscal conservatism. It must rank near the top of any league table comparing the capital that countries have with what they need. During the last two turbulent years, investors all over the world have put a premium on markets in countries with sound finances and prudent economic policies.

With global recovery still far from assured and doubts hanging over economies and companies that rely on extensive use of credit to achieve growth, that trend is likely to hold, including in the UAE. Conrad de Aenlle is a freelance investment and personal finance writer based in the US