As low oil prices cast a shadow over Gulf Arab economies, investors are betting that lifting sanctions on Iran will boost Dubai - a view that is causing the emirate's debt to outperform the rest of the region.

The outperformance may be surprising to some investors. Dubai recovered only in the last few years from a 2009 debt crisis, and as a trade and business centre for the Gulf, it will not escape a regional slowdown caused by cheap oil.

Dubai real estate prices are falling and its equities index is down 41 percent from last year's peak.

But bond prices and credit default swaps, used to insure against the risk of a sovereign default, have barely moved in Dubai, even though cheap oil has dampened investor sentiment toward the rest of the region.

The spread of a May 2022 U.S. dollar sovereign sukuk from Dubai over an April 2019 sovereign bond from Abu Dhabi narrowed to 1.83 percent from 1.97 percent at the start of this year.

Five-year Dubai CDS are down 65 points from the end of last year to 210 points, according to Markit data. The CDS of most sovereigns in the six-nation Gulf Cooperation Council are lower in absolute terms, but all of the region's CDS except Dubai have risen this year.

A major reason is expectations that Dubai will quickly reclaim its traditional status as a hub for trade with and investment in Iran after international economic sanctions, imposed over Tehran's nuclear plans, are lifted early next year.

"Lifting sanctions against Iran is a point that Dubai will benefit most from. Dubai has a strong history of close trade interaction with Iran and should be the key beneficiary among all GCC credits when Iran opens its market - this is what CDS are pointing to," said Sergey Dergachev, senior portfolio manager for emerging market debt at Union Investment Privatfonds in Germany.

RISKS

One factor bolstering confidence in Dubai is that its economy, which is strong in areas from finance and real estate to trade and tourism, is much more diversified than the rest of the Gulf. Oil and gas output accounts for an almost negligible fraction of Dubai's gross domestic product; for other Gulf states, it is around a third or more.

"Dubai is an outlier and not really that impacted by the oil price slump - Dubai would be more hammered by a global growth and trade slowdown, and here the situation still looks not bad," Dergachev said.

However, the composition of Dubai's GDP understates the extent to which it is vulnerable to an oil-related slump in the region.

Tourism-related industries account for 20 percent or more of the economy, and roughly a fifth of international visitors to Dubai come from the GCC. Around a fifth of real estate purchases are estimated to be by GCC buyers from outside Dubai.

Meanwhile, market interest rates in the United Arab Emirates have started rising as less oil money flows through the banking system, and the start of U.S. monetary tightening as early as this month could boost rates further.

This, combined with a regional economic slowdown, could make it harder for Dubai and its government-related enterprises (GREs) to finance the $143 billion debt overhang left over from their financial crisis.

"Imprudent risk-taking and re-leveraging by Dubai GREs and private companies could prop up short-term growth at the expense of medium-term stability," the International Monetary Fund warned in a report in August.

But for many investors, the prospect of an Iran-related boom at least partly outweighs that risk. The IMF estimated that removing sanctions on Iran could add 1 percentage point to the UAE's GDP growth between 2016 and 2018, simply by boosting non-hydrocarbon exports. Dubai, with its sophisticated trading infrastructure, could grab most of that benefit.

The emirate would also profit from increased Iranian demand for services exports such as trade finance, transport, tourism and hospitality. The number of Dubai hotel guests arriving from Iran has almost halved since 2010; it could now recover.

"If sanctions are lifted, the additional indirect impact of spending by tourists and business travellers in the broader economy could be significant," the IMF said.IR