Could low-yield, long-term bonds and higher inflation be the final solution to Dubai’s debt mountain?Posted on 24 January 2013 with 1 comment from readers
Having been almost bankrupted by a crippling short-term debt mountain just over four years ago Dubai is not only back in the bond market but borrowing at incredibly low interest rates despite still being unrated by the credit agencies.
This week the emirate successfully tapped bond markets at lower interest rates than those currently available to Italy. A $750 million sale of 10-year Islamic bonds sold at a yield of just 3.875 per cent while a $500 million issue of conventional 30-year bonds was also placed at low rates after institutional investors asked for longer dated paper.
Dubai got into a debt crisis in late 2009 because it had borrowed short-term for high interest tates and invested that money in long-term projects that went belly up. If the emirate can now refinance those debts as they come due with long-term bonds then this is a cause for celebration indeed, especially with the cost of borrowing fixed at such a low rate.
Bloomberg reported that Emirates Airline is preparing to follow the Dubai Government back into the bond markets with a $500 million issue.
It makes excellent business sense to tap this low-cost funding while it lasts. Many observers think it cannot last forever and is just a byproduct of the Federal Reserve’s money market operations to keep interest rates low.
The risk is that artificially depressing interest rates will eventually blow up into much higher general inflation, and that will mean higher interest rates again. However, that would also be great news for a major debtor like Dubai, provided that it fixes its interest rates at current levels and allows bondholders to pick up the losses when global interest rates go up and bond prices go down.
Inflation coming soon?
What happens in a period of global inflation is that the nominal price of everything from food to fuel and housing goes up while the nominal value of debt remains the same. A big debtor will see its borrowings effectively devalued in real terms by high inflation.
Could Dubai be about to get the best of both worlds? A year or two to re-fix its borrowings at low-yield, long-term fixed rates, and then a period of high inflation to devalue those same debts? Admittedly there is supposed to be no inflation now, that is why bond yields are so low, but money printing by central banks will bring inflation back soon.
Have you tried to rent an appartment in Dubai recently or been out to dinner? Supermarkets are already warning food prices must go up this summer. Oil prices remain high.
The buyers of these Dubai sukuk and bonds are investing at the tail end of the biggest bond bubble in history and heading for an enormous fall. With a bit of nimble footwork Dubai can take advantage of this monumental stupidity that can only be compared with the buying of US subprime mortgage debts just before the global financial crisis.
Dubai should get on with refinancing its debt while this opportunity lasts.