Dubai Expo 2020 Finance

Dubai

In November, 2013, Dubai won the rights to the World Expo 2020, setting into motion a major project that will make a substantial contribution to Dubai's economy and be a catalyst for what the emirate hopes will be the continuation of the economic boom that began two decades ago.

Dubai expects that the Expo 2020 will attract 25 million visitors to the emirate over the six months that the Expo will run. This will make it the largest such project in the history of Dubai, and in size the Expo will in all likelihood eclipse the Qatar World Cup as the largest event in the history of the Middle East. Linked to the overall strategy to make Dubai a world-class destination, the World Expo 2020 is going to be part of a larger tourism centerpiece that is expected to propel that sector to become one of the largest revenue-earners for the emirate, and attract new visitors from all over the world who would otherwise not visit Dubai (Serkal, 2014).

This paper will examine the financial effects of the World's Fair in Dubai. This is a tricky endeavor, given the fact that no concrete budget has been set out for the Dubai World's Fair -- the best figure announced by the government is $6.8 billion (Sleiman & French, 2014), but there are analyst figures available that outline the likely financial implications of the fair. This gives us a starting point for analyzing the fair. There are other critical issues with respect to the finances of the Expo that will need to be addressed as well. The first of these is what the Expo will do with respect to Dubai's role in the global economy. World's fairs are natural revenue-generators, but the larger objective with the Dubai fair is to improve the country's standing in the world. There are also questions about how it will affect the quality of life in Dubai, especially since the Expo is tied to a larger strategy to build out Dubai as a destination for tourism and for expat living.

There is also the issue of actually paying for the fair. Dubai is not a petro-economy; its revenue streams are in services and are more diverse. This means, however, that Dubai does not necessarily have the sort of capital required to pay for the fair, in light of its recent default (Saidi, 2014). The structure of Dubai's debt comes into play in this discussion, and the type of arrangements that will need to be made to ensure that there is no financing gap will be discussed.

Overview

A world's exposition is an officially-sanctioned event, governed by the Bureau International des Expositions. Fairs occur every few years, and tend to be spread around the world, though the Dubai fair will be the first in the Middle East. A typical Expo will run for six months on a very large parcel of land. There will be pavilions, usually for different nations, along with rides and other amenities. A recent Expo was held in 2010 in Shanghai, with 73 million visitors and 246 countries and organizations represented. The next Expo is in 2015 in Milan, and then 2017 in Astana, the capital of Kazakhstan. An Expo is almost always a strong domestic tourism draw, and some of them have been successful at drawing international tourism. Expo 86 in Vancouver, for example, put that city on the global tourism map, and tourism has been a major industry ever since.

Dubai similarly sees Expo 2020 as a springboard to take its tourism industry to new heights at the world level rather than just the regional level.

Dubai is one of seven constituent emirates that make up the United Arab Emirates. Each emirate is ruled by an emir, a traditional Arab leader with absolute power that is passed down by heredity. Though they form a federation, each emir sets most laws within his own emirate, which leads to significant divergence of policy between them. For example, Dubai has relatively liberal laws with respect to alcohol -- it is available widely in the city's hotels -- but in next door neighbor Sharjah alcohol is banned. Sharjah, incidentally, does not have a strong tourism business.

Economically, Dubai is on a radically different course than many of the other emirates, which have chosen to remain economically and socially conservative. The largest emirate, Abu Dhabi, has most of the UAE's oil, and is therefore very wealthy. Dubai does not have these same oil resources, and has therefore needed to develop its wealth using a different path. With very little in the way of natural resources, Dubai has chosen service industries as its engine of growth. The basic growth strategy is that Dubai wants to have a diversified set of service industries, competing globally as a shipping and transportation hub, in education, as a tourism and shopping center, and as a leader in Islamic banking.

The economy in Dubai remains largely run by the government, which controls most of the major companies. This is common in the Arab states, but Dubai has sought to become more open and encourage foreign direct investment in a number of sectors, tourism being one of them. Part of the economic strategy is that Dubai will sell bonds to foreign investors through its state-owned enterprises, which in turn will use that money on development projects There is even talk that Dubai will begin to loosen foreign ownership rules, allowing for a massive influx of FDI outside of state control (Arnold, 2012).

The reliance on the state for economic growth has both been a boon and a hindrance for Dubai. The state has provided excellent infrastructure -- a modern airport, fresh tarmac and a couple of metro lines, but the heavy hand of the state also means that business is dependent on the state. In 2009, Dubai World, one of the state-owned enterprises, defaulted on debt. Though technically a private company, Dubai World had the implicit backing of the emirate, and the debt had been priced with this implicit guarantee in mind. The default shattered the confidence in Dubai's finances. Dubai World had been a heroically ambitious tourism project. The financial crisis had basically frozen new investment in Dubai, all but killing Dubai World and paralyzing the country's real estate sector overall. The company needed emergency borrowing from the UAE central bank just to remain solvent, and opted to roll over the debt in February to free up capital for the Expo 2020 project (Sleiman & French, 2014).

Dubai's Finances

Dubai's finances are the big wild card in this project. The project is entirely reliance on the emirate for its financing, and there is reason to be concerned even with the rollover about the emirate's ability to pay. It is estimated that Dubai has $78 billion in debt coming due between 2014 and 2017. It is expected that the next maturities, totaling $10 billion to a pair of Abu Dhabi-based banks, will also be rolled over. Analysts suggest that because the rollover did not occur in the market, that the market is unlikely to be concerned about it, as the rollover if nothing else leaves Dubai with liquidity and the ability to invest in projects while its real estate market is heating up again (Sleiman & French, 2014).

Dubai plays an interesting role in the global economy. On one hand the emirate has a fairly small economy. It is only 25% of total UAE output (Reuters, 2014), which puts it around $67 billion, which is around the same level as Lithuania, a middle-income country with 50% more people. The IMF has a different number, listing the country's debt as 102% of GDP, at $142 billion (Torchia, 2013). The level is still very high, and there are concerns that Dubai is experiencing another real estate bubble -- the country could suffer another recession that cripples its ability to add to its already high debt load (Torchia, 2013). Dubai already pays an emerging market premium on its debt, and the state enterprises (known as GREs) should pay a further risk premium still after the Dubai World fiasco, so concerns about the emirate's ability to pay its debts going forward are legitimate. It is worth considering that a lot of its debt is held either by Abu Dhabi or the UAE central bank, both of which are more likely to lend on friendly, non-market terms. Dubai may have a distorted market for its debt as a result, something that allows it to operate with such a high debt-GDP ratio.

Global Economy

Given that Dubai's economy is not big enough to move international markets, and its capital markets are considered to be high risk. Thus, if there are major problems with Dubai, in particular with its debt, that does not mean that the global economy is going to move all that much. Most investors in Dubai are quite well aware of what they are getting into, especially since the Dubai World scandal. There are, however, some potential knock-on effects of the World Expo 2020, both good and bad.

On the bad side, there is the risk that this project will result in default. It is more likely that the global economy will be moved by default. Many external investors have bought into the Dubai dream, and default would wipe out billions of dollars in value for these investors. If combined with another shock, this could create significant problems. However, this risk might well be overstated. Dubai World is still being felt locally, but global markets readjusted pretty quickly to the new risk levels inherent in Dubai and Dubai GRE debt.

Global financial markets were shaken by the Dubai World default, but not in a way in which they could not recover. A lot of the shock came from realizing that Dubai would not back all of its GRE debt, something that changed the pricing dynamic of this debt, but also of the debt for Dubai as a whole. The global financial markets are still trying to put Dubai into context. It has no particular assets beyond its own ambitions, it is highly leveraged, and while its plan has seen moderate success thus far with respect to building out a sustainable, diversified economy, there is genuine cause to question the long-run sustainability of Dubai. The global financial markets have rethought their views on Dubai a little bit after the Dubai World scandal, and the impact on the global financial markets is not as likely to be as significant should another default occur.

On the good side, Dubai aims to grow its economy even further with the World Expo 2020 project. It seeks to gain more of the world's investment capital and more of its tourism dollars as well. This will have effects on the countries with whom it is competing both for capital and for tourists. Dubai is targeting 25 million visitors in 2020, whereas last year it attracted only 11 million, which was up 10% from the previous year (Reuters, 2014). The UAE wants to increase its share by taking from many other destinations, though this will only cause minor reshuffling of the global economy. Dubai also hopes that a successful Expo will allow it to draw more investment in its other sectors as well -- the Expo is going to located near some of the emirate's free trade zones (Saidi, 2014). This competition is probably not going to make significant dent in world markets, and it will mostly represent competition for money already going to the region. Growth in Dubai is generally going to be good, but the more lasting impact would be if the Dubai model for economic transition is a success. Right now, it's less-splashy neighbor Abu Dhabi, and the decidedly unsplashy Norway are the world leaders in economic diversification models, and the influencers for other countries, while Dubai remains more of a curious experiment, and one that today is less likely to move markets than it did in 2009 (Arnold, 2012).

Sustainability

One of the most important aspects of this project is ensuring financial sustainability. In the context of a single project, this means that Dubai needs to secure financing and not put itself in a position where the project goes off the rails. While Expo 2020 is much smaller than Dubai World, there is still significant risk associated with the project, and given the position that Dubai is presently in, sustainability is a genuine concern.

The initial budget for the Expo is $6.8 billion, and Dubai is expected to acquire $7 billion in debt financing. If its current leverage is 102% of GDP, this additional $7 billion will equal 105.7% of GDP. This is assuming that none of the pending maturities will be paid -- all indicators are that they will be rolled over. The challenge for Dubai is that megaprojects like this, especially with a finite deadline, almost always go over budget. Recent Olympic games have averaged 47% over budget, and historically they are worse at 179%. Taking the optimistic figure, that means that the actual cost of Expo 2020 is more likely to be $10.1 billion, and the conservative figure is $19 billion. That would change the debt situation in Dubai to 109% of GDP at a minimum, a figure that could rise upwards of 116% of GDP. There is significant question as to whether these levels are sustainable. This can be seen in Appendix A.

There are a few reasons that cost overruns are common. The first is simply that construction costs escalate quickly when there is a shortage of workers, as construction of the event competes with private projects during the same period. The government simply loses its price elasticity and outbids the private sector. In this case, the government still has a significant hand in construction, for example in permitting. Dubai is motivated to continue building at a rapid pace, however, and will need to fill this need with qualified foreign workers. One of the competitive advantages that Dubai has is that its state-owned enterprises work closely together towards a common goal. That should help Dubai control costs somewhat, but there is significant risk that Dubai will need to begin paying a premium for qualified engineers and workers to bring the Expo to fruition in just six years. The project is expected to require a massive influx of labor, estimated at 277,000 and while 40% of those will be in the tourism sector, most of the rest (166,000) will be in construction (Saidi, 2014). The emirate experiences an average of around 4.2% population growth each year (Serkal, 2014), which will add around 600,000 more people to Dubai, so it is possible that Dubai is prepared to bring in these workers. However, housing costs will be tight, especially given soaring property values caused by rampant speculation in the market (Torchia, 2014). It is reasonable to conclude, given the strong need for an influx of qualified workers, housing constraints and other factor input constraints such as for construction material, that Expo 2020 will go over budget, and possibly by a significant amount. While Dubai has some pricing power over these inputs, it is not completely insulated from the realities of the market.

There is also the question of Dubai's financing. Credit ratings on Dubai's debt and that of its state-owned enterprises varies. Banks and real estate tend to have investment grade ratings, but not all enterprises do (Menon, 2014). The emirate pays a risk premium compared with Sharjah (which has less debt), Abu Dhabi (which has oil) and the UAE as a whole (also oil). Dubai's high debt level, the Dubai World debacle and the city's higher degree of volatility are all concerns for investors. Paying a risk premium, however, further increases risk because the debt service is higher. Dubai has been forced to lend from the UAE and from banks in Abu Dhabi because they are willing to give lower rates -- the recent rollover with the UAE government is at 4%, lower than what Dubai should be paying. The ability of Dubai to remain solvent long enough to see revenues from the Expo is going to be dependent on its ability to roll over the $64 billion in debt that is maturing in the next few years, and on its ability to finance the Expo at below-market rates.

The other risk factor is the looming bubble in the Dubai real estate market. Intuitively, the presence of a bubble makes little sense. Dubai has nearly limitless land supply, since there is nothing but desert surrounding it. While it has added 320,000 new residents in three years -- a gain of 17.3% - it can continue to expand the city to accommodate this growth. The physical size of Dubai is expected to grow by 26% by 2020, to match the 26% gain in population. This does not create the conditions for a rapid rise in real estate prices. A surplus of low-cost money around the world looking for good investment opportunities, however, does. While the price of real estate in Dubai should be rising, the rate of the rise is more akin to previous bubbles, which led to previous crashes (Serkal, 2014).

If there was to be a crash in the Dubai real estate market, the results would be devastating for this project. The last crash brought about a spike in risk premiums, and a reduced investor appetite for debt. Already, Dubai is borrowing from the UAE and from its own banks -- little different than using one credit card to pay off another. The last crash in Dubai cause a tremor in the global markets, not only for its size, but because it signaled a different risk level on state-owned enterprises, something that cannot be repeated -- investors today do not assume implicit government guarantee. However, there is little doubt that if Dubai's current creditors lose faith it in, the emirate will have a lot of trouble paying for this Expo -- it will have trouble paying its existing debt.

In the long run, the financial sustainability of this project is tied to Dubai's ambition to become a global city. Dubai projects substantial growth in its physical size, population and economy. Its view of 25 million visitors in 2020 is more than double current tourism rates. This cannot all come from filling in existing hotel capacity, either -- more construction is going to be needed. What this means is that Dubai has a bigger plan. It estimates that the World Expo will attract more investment, and solidify Dubai's position as a global travel hub. There are factors with respect to that that remain out of Dubai's control -- it is still not easy to obtain alcohol, there is no competition for flights into Dubai, the weather is awful six months of the year and other such issues. Overcoming some of these obstacles is going to be critical to generating value from this investment.. One source has the value of the Dubai brand improving $8 billion as the result of the exposure that Expo 2020 will bring to the emirate (Saidi, 2014). This only represents an increase of 3%, however, and represents a low ROI on the project. If the ROI on this project is at that level -- almost surely adding $8 in value will result in a de facto loss for Dubai on the project -- then there is good cause to genuinely question the sustainability of Expo 2020 from a financial point-of-view. While Dubai is planning aggressive growth, and Expo 2020 fits into this strategy, it will need to add a lot more than $8 billion in brand value in order to recoup its investment in the Expo.

Quality of Life

The Expo 2020 project cannot be seen in isolation when considering its impact on Dubai. Part of the attraction of an Expo is that it increases the quality of life of the city, which in turn helps to attract more residents. Much of the current growth in Dubai seems to be coming from immigrant labor, secondary homes and speculative real estate investment -- there does not appear to be a massive influx in wealthy new residents coming to Dubai to spur growth. There are elements of a higher quality of life in Dubai -- a good transportation infrastructure, shopping and dining -- but many other elements remain lacking. The question, of course, is what Expo 2020 will contribute to this. The Mercer Quality of Living survey has Dubai at 73rd, the highest rating in the Middle East and Africa, but hardly the envy of the West (Mercer, 2014). Dubai still needs to invest in critical infrastructure, not just malls and hotel nightclubs. Arguably, Expo 2020 will help with none of these things. Dubai already has the money it needs to develop its cultural industries, improve its education and provide jobs for locals. Expo 2020 might attract more foreign investment, but it is reasonable to think that Dubai would attract this investment by lowering its debt load, thereby lowering its cost of capital, and loosening its restrictions on FDI.

The Expo 2020 itself will of course be a nice party. There is little doubt that people will enjoy it, and that it will add some value to Dubai, but there are many, much more affordable, ways that Dubai can improve its quality of life, in particular if quality of life is something that the emirate wants to trade on. It probably does -- building long-term population growth is important to Dubai, and diversifying the economy is as well. However, once the construction jobs dry up, there will be mainly service sector jobs in the tourism industry coming from the Expo. There will be many people looking for work, and there will be excess capacity in the tourism sector. It is going to be a significant challenge for Dubai to convert the Expo into a long-term sustainable tourism industry that will result in an overall improvement in quality of life. More likely, this project is a flashy show, but nothing that will attract a different customer base to Dubai than already is there, having been attracted by previous flashy shows. This remains the challenge for Dubai -- to utilize different approaches to building a better quality of life, instead of going back to the same well over and over, from one glamor investment to the next, never really adding anything of long-term sustained value. Once you sweep away the hype, there is not much in Expo 2020 that indicates it will result in any sustained improvement in the quality of life in Dubai.

Cost-Benefit Analysis

The Expo 2020 project has upfront costs and relatively unknown benefits. It is important to get a rough estimate of the benefits in order to understand what sort of financial motivation there might be for this project. It would not be beyond Dubai to have an ego-driven project -- Shanghai was certainly that -- but there may be a rational case for Expo 2020. The key is to understand the multipliers. But first, a quick overview of the cost side.

The current estimate of the cost is $6.8 billion. On one hand, this seems conservative given the $60+ billion that was originally slated for the ill-fated Dubailand, as though a $60 billion theme park was going to be even remotely profitable. The aforementioned Shanghai Expo in 2010 checked in at $45 billion (Branigan, 2010), and while Expo 2020 is not expected to go near that level, it does provide an indication that a high-level Expo is probably going to cost more than $6.8 billion. If attendance figures are to be used as the means of prorating, the cost of Expo 2020 is going to be more in the $16 billion range, which is within the conservative scenario laid out earlier. This points to a much higher cost than the original budget. Dubai has similar labor and land economics to Shanghai, with rising wages and rapidly rising property values. And, as with Shanghai, there is likely to be a labor crunch that will only really be alleviated with government intervention on a number of fronts, not the least of which will have to be outbidding other projects for labor in order to meet the project's deadlines. While nobody doubts that Dubai can execute the Expo, it will not come in on budget. If we take the $16 billion figure, the cost-benefit logic looks a little less rational than if we take the $6.8 billion figure.

The direct benefits of the Expo will not pay for it, nor is that the plan for Dubai. While the Expo is expected to create 277,000 jobs, Dubai's low taxes will mean somewhat restrained economic impact from these jobs, especially given that most of those jobs will go to immigrant labor. A lot of that money will make its way back overseas. Some estimates have the economic impact from the Expo as follows: 0.5% from 2016 to 2019, 2% during 2020 and 2021 and then declining economic impact thereafter. The following table illustrates what these numbers look like in nominal terms: