9-709-043 REV: FEBRUARY 25, 2009 RICHARD H. K. VIETOR NICOLE FORREST Dubai: Global Economy "A leader should lead, and be able to lead his people by positioning himself in front of them and not behind them. A leader should take control and tell his people: 'Here is our goal, follow me towards it, and not: Go ahead, and we will be right behind you.'" — His Highness Sheikh Mohammed Bin Rashid Al Maktoum Introduction In January 2009, Dubai faced considerable economic challenges. The impact of the global financial crisis had reached its shores, but its severity was still unknown. On January 20th, the national government pushed a new media law past the first legislative hurdle. If approved by the cabinet and president, the new law would restrict freedom of press. Any journalist who criticized the royal family or published information damaging the economy would be fined up to one million dirhamsa.: The proposed law highlighted a lack of transparency and raised questions of economic vulnerability. Nonetheless, Dubai had seen an average annual growth rate reportedly in excess of 13% between 2000 and 2006 and had become an international financial and logistical hub in less than 10 years.2 The question now was whether the foundation of development had created a sustainable model. Dubai is located on the southern coast of the Persian Gulf, on the Arabian Peninsula. The city-state was one of seven emirates comprising the United Arab Emirates (UAE). The UAE was established as a constitutional federal state in 1971. The Supreme Council of Rulers, composed of the emirate Sheikhs, elected a President for a five-year term. A Prime Minister also led a council of ministers. A Federal National Council served as advisors to this combined leadership. At approximately 2,414 square miles, Dubai is second in size only to the emirate of Abu Dhabi. Dubai and Abu Dhabi, an emirate rich in oil, were the most influential in UAE decision-making. Since 2006, the constitutional ruler of Dubai was Sheikh Mohammed bin Rashid Al Maktoum. In 2009, he continued to serve as the U.A.E. Vice-President as well as Prime Minister. According to one expatriate businessman, "the United States was a melting pot and Dubai was a salad bowl."3 The official language was Arabic although most businesspeople spoke English. The official religion was Islam. Other religions coexisted with both Christian churches and Hindu temples within Dubai. Israeli passport holders, however, were not permitted entry to the UAE. Emiratis, a Dirham is the Dubai currency fixed at 3.67 to the dollar. Professor Richard H. K. Vietor and Research Associate Nicole Forrest prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. 709-043 Dubai: Global Economy mostly Sunni Muslims, generally adhered to traditional Islamic and cultural norms, with women in abayas and men in dishdashas. In stark contrast, it was not uncommon to see women in miniskirts next to women in abayas - one not much noticing the other. The Islamic influence was evident in daily practices such as broadcasting the call for prayer (athaan) in shopping malls. Although cultural and religious restrictions remained, all women were allowed to drive. Nightclubs, movie theaters and alcohol catering to foreigners were permitted. As the population expanded and the demographics shifted, the emirate attempted to "globalize, not westernize."4 The Dubai population had increased from 183,200 in 1975 to 1.5 million in 2008.5 Emiratis composed less than 10% of the local population. Indians, Pakistanis, Iranians, and dozens of other nationalities had migrated in large numbers. (Exhibit 2) Labor protection presented a challenge to the government. Dubai had signed agreements with labor exporting countries to ensure some labor protection, but was still working to meet the United Nations' recommendations regarding human rights. Economy For much of the 1900's, Dubai was a trading post dealing primarily with pearls. Trade brought early international influence from Persia, East Africa, India, Pakistan and even the United Kingdom but the economy remained weak prior to UAE unification. Oil was discovered in Dubai in 1966 and the exports followed in 1969. In the late 1970's, HH Sheikh Rashid bin Saeed Al Maktoum - who remained ruler until his demise in 1990 - used this oil revenue to expand the city's global orientation and set out to create a "hub of hubs" by liberalizing local laws.6 He initially focused on hydrocarbons and petrochemicals. In 1985, oil still comprised almost half of Dubai's GDP. His successor, HH Sheikh Maktoum bin Rashid Al Maktoum who was Vice President and Prime Minister of the UAE and rule of Dubai until 2006, followed the same policy towards greater diversification. By 1993, oil revenue had dropped to a less than a quarter of GDP.7 Strategically located between Asian and European economic centers and near rapidly emerging markets, Dubai was well positioned geographically to become a regional powerhouse. The Dubai government created Emirates Airlines in 1985 to augment superior coastal connectivity. In the early 1990's, the government adopted Michael Porter's cluster strategy for development. In addition to becoming a logistics and transportation hub, the government established free trade zones that concentrated similar industry activity. These clusters contained synergistic companies and co-located regulators and support services. Laws within these zones provided customized incentives to attract entrepreneurial, as well as established, foreign companies. Among the most prominent were Dubai Media City and the Jebel Ali Fee Zone for manufacturing. By 2008, Dubai had become the third largest re-export center in the world.8 The Dubai International Financial Center (DIFC) capitalized on emerging market activity in the region stretching from the western tip of North Africa to the eastern part of South Asia, comprising North and East Africa, the Levant, the Caspian, the Indian subcontinent, and the GCC states. In a time zone between the well-established Hong Kong and London markets, DIFC offered a local financial services base for privatization/IPO's, brokerage, wealth management and Islamic finance. The zone adopted a legal system modeled after that of the United Kingdom. It offered opportunities for 100% foreign ownership and a 0% tax rate of income and profits for fifty years. The Dubai Financial Services Authority (DFSA) and the Nasdaq Dubai stock market were also created. By 2009, the DIFC hosted over 750 companies, of which over 450 were in the financial services sector.9 The physicality of the clusters was remarkable. One hundred and ten acres downtown, for instance, were dedicated to the DIFC. Approximately four million square feet of office space were expected to be constructed for this zone, alone.10 The proliferation of the clusters led to a radical, physical transformation of Dubai. Concentrated economic growth, combined with a 2002 real estate 2 Dubai: Global Economy 709-043 law permitting freehold ownership for foreigners, ignited a construction boom. Since then, the real estate boom has produced almost $500 billion in construction. In 2009, developers were constructing the tallest building in the world. The previous year, the Dubai Mall became world's largest shopping center at 12 million square feet. The real estate industry became an economic driver itself; it was the largest sector of the Dubai economy at 8% of GDP.11 According to the Dubai Statistical Center, the number of companies in the construction sector increased 32% per year between 2003 and 2006.12 Dubai's vitality and transformation further drove tourism. At a 22% annual growth rate in 2006, it was the fastest growing sector of the economy.13 Of six million tourists in 2007, 34% were Europeans and 27% from the Middle East.14 Dubai developed extravagant attractions, such as indoor skiing, to cater to wealthy tourists. To meet this need, substantial infrastructure had been constructed. The international airport boasted the largest terminal in the world at over 16 million square feet. Living in Dubai was expensive and frequently required two incomes. Some expatriates were sending their families back home due to the cost of living rise.15 The local banking industry's orientation towards the Middle East partially mitigated the impact of the 2008 global financial crisis. Exposure to assets from the United States was limited. Dubai, nevertheless, was not immune to economic vulnerability. Foreign Direct Investment fueled much of the growth over the past decade. The erosion of global wealth was expected to reduce this figure. Despite a 33% year-on-year increase in real estate villa prices and a 16% year-on-year increase for apartments, property prices declined 23% for the last quarter of 2008.16 Various sources estimated a further drop of 20% to 60%. The stock for Emaar Properties, one of the largest real estate developers in the Middle East, plummeted 62% from the beginning of 2008 to November of the same year.17 Many construction cranes had stopped moving altogether and buildings stood unoccupied. Some Dubai contractors faced possible bankruptcy due to unpaid fees and dwindling work. "Contracts are not worth the paper they are written on... There is a sense among the big developers that because they are linked to the government, they can do what they want."18 Debt levels caused the economy to suffer further. Dubai's foreign currency debt was $120 billion, or 152°% of GDP, in 2008. High leverage had been used to finance the burgeoning economy, real estate and infrastructure. With the fall in real estate and a 48% decline in the stock market over 2008, underlying asset values were questionable. Constricted credit markets and local illiquidity threatened the ability to refinance and restructure this debt. The extent of the challenge was unclear given opaque lines of public-private ownership and limited information flow. For example, $74.5 billion of Dubai's foreign currency debt was "contracted by non-bank quasi-sovereign entities." Many private companies were indeed majority owned by the government. Individual consumer debt levels were also high. Some analysts predicted that Dubai would need to turn to the central bank in Abu Dhabi for capital, although the government of Dubai had denied the need to do so. Official economic figures had been contradictory. Dubai's GDP rose somewhere between 13% and 16% in nominal terms, between 6% and 7% in real terms. Wholesale and retail contributed 37%.19 Oil revenue represented only 3% of GDP in 2008.20 But, in February 2009, HSBC reported that $75 billion worth of construction projects had been cancelled or delayed; Morgan Stanley reported the number to be $263 billion.21 "The market is largely being driven by panic, mainly due to lack of transparency and information, which is preventing people from making a good assessment of the market situation, and is stopping them from facing economic recession with confidence."22 Dubai needed to demonstrate the sustainability and viability of its development plan. The government planned to increase spending by 11%, including a 42% increase in infrastructure, transportation, and social services.23 Would this still be possible? Would it be enough to stem an exodus of human capital and foreign investment? Or, would over-leverage and lack of transparency prove the emirate too vulnerable? 3 709-043 Dubai: Global Economy Exhibit 1 Map Source: Courtesy of the University of Texas Libraries, The University of Texas at Austin, http://www.fib.utexas.edu/maps/cia08/united_arab_emrrates_sm_2008.gif, accessed February 2009. Exhibit 2 Country of Origin as Percent of Total Exhibit 3 GDP Growth, Estimates and Projections Population, 2005 Census (United Arab Emirates) 9% 13% Source: Adapted from George Washington Center for the Study of Globalization, http://www.gstudynet.org/ gum/UAE/Dubai2005.htm, accessed February 2009. References: UAE Ministry of Labor. Emirati % of total population is disputed. Number of expatriates in country has reportedly increased between 2005 and 2009 although updated census numbers have not been collected. 2008 2009 Citigroup 6.7% 2.7% EFG-Hermes 6.6% 0.04% Economist Intelligence Unit 7.7°% 1.5% Standard Chartered n/a 0.5% Source: Compiled from Haseeb Haider, "UAE Economy to Record 2.7pc Growth: Citigroup," KhaleejTimes, 29 January 2009. Issac John, "UAE Economy to Shrink this Year, Rebound in 2010: EFG-Hermes," Khaleej Times, 12 January 2009. Economist Intelligence Unit. Travis Pantin, "Gulf growth forecasts cut down," The National, 8 January 2009. 4 709-043 -5- Exhibit 4 Financial Indicators (United Arab Emirates) US$ million (unless noted) 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008e Nominal GDP (mn dirham) 123,600 156,902 257,979 254,236 272,856 321,752 386,535 485,513 624,623 729,732 815,318 Real GDP (mn dirham) 162,959 188,845 257,979 262,353 269,304 301,351 330,582 357,690 391,160 421,073 453,578 GDP (% real change pa) 17.5 6.7 12.3 3.5 2.6 11.9 9.7 8.2 9.4 7.6 7.7 GDP per head ($ at PPP) 20,390 20,530 22,690 22,410 21,740 23,080 24,370 25,520 26,970 27,840 29,060 Exchange rate AED:US$ (av) 3.67 3.67 3.67 3.67 3.67 3.67 3.67 3.67 3.67 3.67 3.67 Stock of money M1 10,762 20,824 34,067 39,464 47,054 58,262 80,818 104,449 120,020 181,664 279,944 Consumer prices (% change pa; av ) 4.32 1.35 2.70 2.90 3.24 7.00 12.50 13.50 13.30 14.40 Goods: exports 21,664 30,400 49,600 47,605 52,199 67,137 90,997 117,287 145,586 180,897 200,420 Goods: imports (10,181) (24,871) (30,800) (33,500) (37,559) (45,843) (63,458) (74,526) (88,086) (116,642) (141,137) Trade balance 11,483 5,529 18,800 14,105 14,640 21,294 27,539 42,762 57,500 64,255 59,283 Services: balance (1,553) (3,100) (6,430) (6,127) (7,721) (9,058) (12,074) (14,575) (18,031) (23,854) (27,887) Income: credit 3,154 5,696 5,500 6,414 3,197 2,340 4,476 9,025 14,129 16,458 18,926 Income: debit (1,084) (896) (1,700) (1,350) (2,271) (2,379) (4,321) (6,139) (8,384) (10,604) (10,026) Income: balance 2,070 4,800 3,800 5,064 926 (38) 155 2,886 5,745 5,854 8,900 Current transfers: balance (5,138) (3,389) (5,138) (7,230) (3,413) (3,383) (3,359) (3,389) (8,747) (9,875) (10,740) Current-account balance 6,863 3,841 11,032 5,812 4,431 8,814 12,262 27,684 36,468 36,380 29,555 Inward direct investment n/a 399 500 1,200 95 4,255 10,002 10,900 12,806 13,253 11,150 Outward direct investment n/a (10) (2,100) (400) (441) (991) (2,208) (3,750) (10,892) (6,625) (4,000) Inward foreign direct investment/gross fixed n/a 3% 3% 7% 0.5% 21% 45% 43% 39% 33% 23% Net portfolio investment flows n/a n/a (10,500) (6,980) (4,850) (14,400) (18,900) (33,700) (37,500) (885) (56,800) All Other Capital Flows n/a n/a 7,028 992 1,838 2,100 2,286 1,346 5,725 7,499 (10,905) Stock of International Reserves 4,765 7,653 13,613 14,237 15,310 15,088 18,530 21,010 27,617 77,239 46,239 Dirham million 1999 2000 2001 2002 2003 2004 2005 2006 2007 Total Revenues 44,738 74,386 68,633 57,218 77,012 94,751 143,905 201,166 228,750 Tax Revenues 6 5,035 6,274 6,881 7,044 9,566 6,810 8,027 13,833 Non-Tax Revenues 38,900 69,351 62,359 50,337 69,968 85,158 137,095 193,139 214,917 Oil & Gas 28,054 59,978 51,648 40,926 56,738 73,322 111,377 164,775 176,265 Other 10,846 9,373 10,711 9,411 13,230 11,836 25,718 28,364 38,652 Total Expenditures 74,265 84,066 95,459 86,616 91,433 96,274 104,430 125,977 159,726 Current 57,666 71,187 77,005 72,602 74,253 80,984 84,255 103,907 121,314 Development 13,692 11,156 13,283 12,470 16,028 15,207 14,042 15,225 17,271 Loans & Equity 2,907 1,723 5,171 1,544 1,152 83 6,133 6,845 21 ,141 Overall Surplus/Deficit (29,527) (9,680) (26,826) (29,398) (14,421) (1,523) 39,475 75,189 69,024 Source: First table compiled from Economist Intelligence Unit, www.eiu.com, accessed February 2009. References: UN, UAE Central Bank, and IMF. Second table compiled from Table 40, page 58, data from Ministry of Finance and Industry and Local Finance Departments, www.uae.gov.ae/mofi/default.htm, accessed February 2009. Note: 2008 numbers are estimates. 709-043 Dubai: Global Economy Exhibit 5 Debt Financing Official reserves External debt External Reserves/ _($bn)_($bn)_debt/GDP external debt UAE 46 211 84% 22% UAE (incl. SWF's) 396 211 84% 188% Dubai n/a 115 152% na Dubai: Non-bank foreign currency debt ($bn) Total 74.4 Quasi-sovereign publicly guaranteed 3.2 Nonbank private 20.9 Non bank quasi-sovereign* 50.2 Source: Compiled from "UAE: The Dubai debt problem," Barclays Capital, 9 January 2009, pp. 1 and 3. References: Deal Logic, Bloomberg, Barclays Capital, and Central Bank of UAE. *Quasi-sovereign refers to entities in which Dubai or wholly owned entities have a majority stake. Endnotes I Mirna Sleiman, "U.A.E. Tightens Press Rules Amid Financial Downturn," The Wall Street Journal, 22 January 2009. Dubai Chamber of Commerce and Industry director Hamad Buamin, "Dubai's GDP growth to slow to 6% in 2009," , 26 November 2008, Accessed February 2009. 3 Interview with Senior Government Official. 4 Interview with Senior Government Official. 5 Dubai.com website, , Accessed January 24, 2009. 6 DIFC website, , Accessed February 2009. 7 "Doing Business in the Dubai International Financial Centre" booklet, Dubai International Financial Centre/PricewaterhouseCoopers, p.6. 8 Ibid. 9 Information in paragraph largely drawn from "Doing Business in the Dubai International Financial Centre" booklet, p.4-8 and Discussions with the DIFC. 10 "Doing Business in the Dubai International Financial Centre" booklet, p. 7. II "Dubai's GDP growth to slow to 6% in 2009," , 26 November 2008, Accessed Feb 2009. 12 Dubai Statistical Center, , 15 December 2008, Accessed January 2009. 13 "Doing Business in the Dubai International Financial Centre" booklet, p.6. 14 Dubai Statistical Center, , Accessed January 2009. 15 Rajendra Aneja, "Agenda for Dubai," Khaleej Times. 16 "Dubai property prices slump 23%," HSBC report, , Accessed January 2009. 17 "Real Estate Agents: Dubai Boom Is Ending." The Wall Street Journal blog, . October 27, 2008, Accessed February 2009. 18 18 Jason Benham, "Dubai contractors face bankruptcy as cash dries up," Reuters, 3 February 2009. 19 Joanna Hartley, "Dubai's GDP up 13% last year shows official data," Arabian Business, 27 January 2009. 20 United Arab Emirates Yearbook 2008, , Accessed January 2009, p.80. 21 "UAE property sector worsens, says Morgan Stanley," , 3 February 2009, Accessed Feb 2009 and Martin Morris, "UAE projects suspended or cancelled hit $75 bn," Arabian Business, 1 February 2009. 22 "Dubai property prices to reach lowest levels by later-half of this year," EstatesDubai website, , 26 January 2009, Accessed February 2009. References: Shuaa Capital analyst, Roy Cherry. 23 Statistics from Mirna Sleiman, "Dubai Plans 11% Increase in Spending," The Wall Street Journal, 12 January 2009 and Haseeb Haider, "UAE Economy to Record 2.7pc Growth: Citigroup," Khaleej Times, 29 January 2009. 6