Abu Dhabi's Big Gamble

Although Shardul already discussed a little the financial mess that Dubai World seems to have created for itself, I wanted to probe this development a little bit further. Although it certainly has been interesting to watch Dubai slowly sink into a bog of debt (in my opinion, portending a much more modest decade for Dubai than the current one has been), I have been more intrigued by the response from the Emirate's smaller but far richer neighbor to the South -- Abu Dhabi.

Abu Dhabi is not only the political capital of the UAE but (more importantly) controls the majority of the country's oil and gas production. Revenues from sales of these resources has allowed the city to accumulate a massive amount of wealth, estimated by some to be close to $500bn. Dubai, on the other hand, has no oil and so has had to base its frantic growth primarily on debt raised in international markets.

The question that has puzzled me is why Abu Dhabi (or the UAE central government, which is essentially the same thing) does not step up and bail out its sinking twin sister. While the government made a weak statement saying they would "pick and choose" which debts to underwrite, the real news was what it didn't say -- it did not guarantee Dubai World's total debt, nor did it offer to extend an emergency line of credit (as it did earlier this year). Is there no sense of national solidarity in the UAE whereby one Emirate is expected to help out its neighbors? And even if there isn't, certainly there are reasons grounded in self-interest for Abu Dhabi to step up to the plate. Abu Dhabi's stock market opened 8% down today and surely the press has been bad enough already to scare creditors away for months to come or even longer. Abu Dhabi should not so much be worried about saving Dubai World...it should be worried about saving itself.

So here are the three best explanations I have heard for why Abu Dhabi has been so reticent thus far:

Glee. Frankly I think it is very likely that the Nahyans and the rest of the Abu Dhabi elite are watching all this with something of a twinkle in their eyes. For years they have watched grouchily as Dubai grew and grew and grew some more, catching headlines, drawing in foreigners, and projecting its glitzy image around the world. Pithy sayings like "Shanghai, Mumbai, Dubai, or goodbye" infuriated those in Abu Dhabi, who thought that Dubai was gaining undeserved credit and recognition, when they were the ones with all the oil and wealth. Now, the tables have turned quite abruptly and Abu Dhabi might just want to savor the moment for a little; the more the image of Dubai as a high-flying city of superlatives is undermined, the more Abu Dhabi can hope to be able to appropriate some of that sexiness for itself.

Political control. Another rationale, somewhat connected to the one above, is that Abu Dhabi may be using the occasion to consolidate its political hold over the UAE. The country is remarkably decentralized and much of its recent development has been characterized by both economic and political competition between Dubai and Abu Dhabi. While the Nahyans have explicitly denied that there is any bad political blood between themselves and Sheikh Mo (Dubai's enigmatic ruler), there is much historical evidence of tension between the two camps. Abu Dhabi may therefore use this opportunity to beef up the authority of the UAE central government and permanently rein in Dubai.

Moral hazard. In addition to the base calculations of power and politics, there is a relatively sound economic argument to be made for not bailing out Dubai World. The issue is one of moral hazard. Abu Dhabi has already bailed out Dubai to the sum of $10bn and guaranteeing Dubai World's debt could potentially put it on the hook for $35bn more. Even for Abu Dhabi, that is a lot of money. The greater problem, though, is if Dubai starts to get the impression that Abu Dhabi will always be there to watch its back when it behaves irresponsibly. If Abu Dhabi cannot make Dubai feel the pain now, there is no reason to expect that during the next boom-cycle Dubai will not ramp up its leverage once again and get itself mired in another debt quagmire. If Abu Dhabi cannot convince Dubai (and foreign investors) that it has no appetite for underwriting its debt (either explicitly or tacitly) then it could end up backing even more than $35bn sometime in the future.