A bailout for Dubai, but at what cost?

The Jebel Ali port in Dubai boasts of being the largest man-made harbor in the world. Its "quad-lift" cranes can hoist four 20-foot containers at once. The port's second terminal will raise its capacity to 14 million containers. But plans for a third terminal look premature. Dubai is suffering from a slump in the trading, lending, holidaying and profiteering that buoyed this remarkable emirate for so long.

On Feb. 22, Dubai was hoisted out of its financial trouble by its oil-rich neighbor, Abu Dhabi. The central bank for the United Arab Emirates (UAE) bought $10 billion worth of Dubai's five-year bonds. The bailout confirmed everyone's assumption that Abu Dhabi would not let the second-biggest member of the UAE fail. But its benefactor waited long enough to plant a seed of doubt in people's minds. In recent weeks, the spreads on credit-default swaps for securities issued by Dubai's government and several of its biggest corporations have widened alarmingly.

Having long ago depleted most of its oil reserves, Dubai has reinvented itself as a "sell-side" emirate, dreaming up ingenious schemes for other people to invest in. Chris Davidson of Durham University, who has written a history of the emirate, describes it as a "spongelike economy," designed to absorb foreign money.

The government imposes few levies (Dubai has no income tax) and accounts for only $10 billion of the emirate's debts. But its rulers sponsor an extended family of companies. Among them, these corporations have amassed about $70 billion of liabilities, adding to a debt pile that almost matches the emirate's 2008 GDP of $82 billion.

On the other side of Dubai's ledger, the government claims to have $90 billion in assets on top of the $260 billion held by its corporations. But it has not revealed the composition or liquidity of its holdings. The very fact that it had to turn to its neighbor for help suggests that its own family silver is not that easy to sell.

Quid pro quo?

The bond proceeds will allow Dubai to meet its obligations this year (which amount to about $10 billion to $15 billion) and probably next. But what will Abu Dhabi ask in return?

But Davidson thinks the unstated price of Abu Dhabi's support will be stiff indeed.

"It is the end of the second emirate's economic autonomy, which it has fiercely protected," he said. Why else did Abu Dhabi put Dubai through "months of pain and humiliation," if it did not see some long-term gain from chastening its neighbor and strengthening the UAE federation, Davidson said. Dubai will now have to be more accommodating of its neighbor's wishes. It will, for example, have to forgo its independent foreign policy, which had seen it become Iran's outlet to the world, even as Abu Dhabi kept a careful distance.

Dubai will also have to "lose its ambitions to become the Monaco of the Gulf," Davidson said. Abu Dhabi will insist on greater prudence and Dubai's go-getting rulers may also now feel defeated. Their economic ambitions were driven partly by their political insecurities. "A lot of the urgency we saw in the last 10 years was fueled exactly by Dubai's need to keep its autonomy," Davidson said.