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Dubai: There has been greater risk premium attached to Dubai lately with the fall in oil prices since July. However, the concern is exaggerated, as Dubai's risk is no greater than that of many emerging markets, Merrill Lynch says.
Investors have recently differentiated more between Dubai and Abu Dhabi, resulting in a sharp widening of Dubai's sover-eign credit default swap spread over Abu Dhabi. Dubai's five-year CDS stands at 225 basis points (bps), with an all-time high 160 bps spread over Abu Dhabi.
A CDS is a credit derivative contract between two counterparties in which the buyer makes periodic payments to the seller in exchange for the right to a payoff if there is a credit event (default).
Though not rated, Dubai's five-year CDS trades below investment grade (BB range), compared to Abu Dhabi's AA.
"We share the concerns over Dubai's real estate sector, but macro fundamentals are still relatively strong, and the sharp pick-up in Dubai risk is difficult to justify in our view," said Turker Hamzaoglu and Ceren Coskun, economists with Merrill Lynch, in a strategy note.
Merrill analysts expect Abu Dhabi to come to the rescue of Dubai in the event of a stress situation.
"First of all, as Dubai is part of the UAE, revenue-sharing via the federal budget is embedded in the Federal Constitution, and the UAE's huge net external assets are also a supporting factor for the Dubai government," Merrill said.
Although dirham funding costs have risen more than 130 basis points since mid-June, that is applicable to the whole country.
An important factor that requires premium over Abu Dhabi is Dubai's increasing reliance on the debt market given the funding constraints at home and abroad.
Economists see the UAE's huge external surpluses, favourable demographics and relatively diversified economy as big pluses for the country's macro outlook. Although oil prices have fallen nearly 30 per cent from their July peak, Merrill said the UAE's current account and budget surpluses would likely remain sizeable as the breakeven budget oil price is estimated at $40 per barrel for 2008.
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