Op-Ed Contributors

Dubai offers lessons to China

By Huang Yiping (China Daily)
Updated: 2009-12-18 07:53

China needs to learn lessons from the Dubai debt crisis to avoid a similar catastrophic economic consequence despite the different economic weights of two countries. Although the Abu Dhabi government - the largest of the seven emirates including Dubai which comprise the United Arab Emirates (UAE) - has agreed to fund Dubai $10 billion, it is too early to say the crisis has been overcome.

After the Dubai government announced late last month that Dubai World, its flagship conglomerate, was unable to repay a $3.5 billion debt on time, the global capital market was rocked and share prices around the world dropped sharply. As a result, some international rating agencies lowered their credit ratings of other state-run UAE companies and international investors rushed to sell UAE bonds. Because of its huge impact on global markets, some financial experts have even warned of a second round of the global financial crisis.

Dubai World, which is mainly engaged in real estate and ports business, was ranked first among the emirate's state-run investment corporations. With the gradual recovery of world trade, Dubai World's port business has performed well, but its real-estate subsidiary, Nakheel, has been affected badly because of poor market conditions - and directly triggered the latest debt crisis.

Since the outbreak of the debt crisis, Dubai home prices have dropped by an average 50 percent. The steep drop in home prices has resulted in a severe contraction in the asset values of Dubai World and Nakheel. To placate frightened investors, Dubai World announced that the main problem it currently faces is a liquidity crunch, adding the company's asset liability is controllable given its $100 billion asset value in comparison with its $60 billion debt.

In fact, Dubai World's financial risks were exposed a few months before the outbreak of its debt crisis in late November. However, investors chose to ignore the potential risks because of the confidence that the Dubai government would step in to restructure the debt of the state-run corporation. It was also their belief that Abu Dhabi would lend a helping hand to its neighbor. Only a week before the revelation of the debt crisis, HSBC Holdings Plc and Royal Bank of Scotland (RBS), Dubai World's two main creditors, were assured that their debts would be repaid on time.

As a local debt default mainly triggered by insufficient liquidity and whose scale is limited, the Dubai World crisis is unlikely to spark a new financial crisis. Also, the UAE government has expressed willingness to offer more liquidity to banks involved. However, the crisis has exposed the malaise in countries that have long pursued a real estate-propelled economic growth model.

Despite it's economic might compared to the small Middle East country, China should learn from the lessons of the Dubai World crisis and reflect on its decades-long GDP-obsessed economic growth model under which investment is regarded as a crucial engine of the national economy.

Like Dubai, China also possesses an enormous current account surplus and has pushed for large-scale investment. The country has also pinned high hopes on the development of the real estate market as a pillar industry to drive high-paced economic growth. Its property prices have also kept rocketing in recent years. Similar to the Arab emirate, China also has a large number of state-run conglomerates which play a crucial role in some of its pivotal economic domains. These enterprises perform well but lack a transparent system despite the fact that both China and Dubai have been witness to a construction boom in the past years.

Despite enjoying superficial prosperity brought by a booming real estate market, a question also arises: How can an investment-driven economy ensure high returns on investment and how can it promote sustainable high-paced growth?

In China, soaring real estate prices have led to deep concerns over expanding bubbles. Especially, against the backdrop of the world economic slowdown, some local authorities have turned to the real estate market to fuel the local economy. Both the ratio of home prices to per capita incomes and the ratio of vacancies are indications that bubbles in the Chinese real estate have expanded to a dangerous position. The Dubai experience tells that once bubbles emerge, they are sure to bust, which will inevitably lead to steep declines in home prices.

China has long talked about transforming its extensive and investment-fuelled economic growth model and improve its economic quality. But rapid economic speed has stopped decision makers from performing major surgery on its long-controversial economic model and structure.

The Dubai world crisis also indicates that a country's economy could be under threat of collapse if it depends excessively on real estate investment, a high current account surplus and a handful of monopolistic enterprises.

It is expected that the Dubai crisis will sound an alarm bell for China and prompt the fast-growing economy to speed up its overdue economic structural adjustment and take viable measures to lower economic risks and promote sustainable development.

The author is a professor in the Chinese Center for Economic Research at Peking University.

(China Daily 12/18/2009 page8)