THERE was plenty of Schadenfreude when, in late 2009, Dubai was forced to admit it had trouble paying its debts. The brash emirate's Gulf neighbours quietly hoped to tempt bankers and business people to their rival financial hubs. Now, irritatingly for many, Dubai is showing signs of recovery. A $10 billion bail-out by Abu Dhabi staved off the threat of a big default. The emirate returned to the bond markets in September. Although the issue was unrated, it was heavily oversubscribed.

Certainly, the property market is still suffering. New apartment blocks and office buildings appear with few new occupiers to pay for them. The Burj Khalifa, the world's tallest building—formerly known as Burj Dubai but renamed in honour of Sheikh Khalifa, Abu Dhabi's ruler, after the bail-out—is reported to be largely empty. Rents in the Dubai International Financial Centre (DIFC), a glitzy zone for offshore banks, were slashed in December.

But the real economy is not doing badly. Tourists are returning. Trade is apparently growing, particularly with India and China, although sanctions have made it trickier to export to Iran. The expatriate executives who manage most of the private sector are defensive about Dubai. They focus on the positives: thinning traffic jams, lower rents. Local media provide a stream of good news. So what's the worry?

One concern is how Dubai will meet its future payments. In 2010 debt was rescheduled rather than repaid. In 2011 Dubai's state-owned and quasi-sovereign entities are due to repay $18 billion of principal. Abu Dhabi was willing to help when crisis hit, but it is tightening its purse-strings and some of its own property companies are struggling. “Ultimately these maturities can't be met without asset sales,” says Tristan Cooper, a sovereign-risk analyst at Moody's. Dubai has some impressive assets, but so far has been reluctant to sell those that are successful or strategic, such as docks, hotels and its airline. Moreover, some state-owned enterprises have most of their assets tied up in property that is now of questionable value.

The picture is complicated by the lack of data on the emirate's total debt, which is spread over hundreds of different state-owned companies. Most are controlled by three government-owned investment conglomerates: Dubai World (DW), which sparked the debt worries in late 2009; Investment Corporation of Dubai; and Dubai Holding. One of DW's subsidiaries, Nakheel, a property firm famous for its palm-shaped artificial islands and its bright pink Atlantis hotel, is of particular concern: it came close to defaulting on a $4 billion sukuk issue of Islamic securities, until Abu Dhabi stepped in.

Getting down to the core

In October DW reached an agreement with its creditors to restructure $25 billion of debt. It was “relatively orderly”, says Jan Plantagie, the Middle East managing director of Standard & Poor's. Nasser Saidi, the DIFC's chief economist, says the DW restructuring is encouraging other emerging-market countries that have spent heavily on infrastructure to take “a more centralised approach” to financial management, for instance by establishing debt-management units within finance ministries. Dubai's borrowing had become so decentralised that it took months for officials to work out the level of DW's debts.

DW has said it could raise up to $19.4 billion over eight years by selling assets: its holdings range from core assets like DP World, a ports business that acquired P&O, a shipping firm, in 2006, to flashy investments such as a casino venture in Las Vegas. Sales are beginning. But overall DW's valuations may be optimistic. JPMorgan puts the worth of its assets at around $11 billion, valuing its property companies at roughly zero. Nakheel's debts are usually reported as being “over $10 billion”, though some estimates double that figure. Some properties that Nakheel sold before they were built may never materialise.

Nakheel has offered its numerous trade creditors 40% of what they are owed in cash and 60% in the form of Islamic paper. Most have accepted, having few other options. A handful of claims against DW are being pursued through a special tribunal set up under the DIFC, but jurisdictional disputes are blighting progress.

Investment Corporation of Dubai is seen as the most solid of the three conglomerates. Its assets include the Emirates airline, which reported profits of $925m in the six months to September 2010. The government has been reluctant to sell a stake to a single investor: the more likely option is a partial share offering. There are more serious questions about the future of Dubai Holding, with an estimated $12 billion of debt. Three of its subsidiaries quietly postponed debt repayments in 2010.

Few creditors have complained. It appears that international banks, which have written off billions around the world since the onset of the financial crisis, are prepared to grin and bear a haircut in Dubai, rather than risk losing future business there and elsewhere in the emirates; after all, Abu Dhabi still has one of the world's largest sovereign-wealth funds and will be one of the most important markets for financial services in the Middle East for years to come.

Dubai is now being forced to change a development strategy which, during the Middle East oil boom of 2003-08, relied heavily on property, construction and finance. The property business is generally expected to remain a drag on growth. State-owned companies in other businesses will have to work harder. And the emirate will refocus on its traditional strengths: trade, logistics and tourism. A team of four newly empowered economic policymakers, including Sheikh Ahmed bin Saeed al-Maktoum, the founding chairman of the Emirates airline (who now chairs DW among his 20 or so policy roles) are speaking of going “back to basics.”

The emirate still has advantages as a business hub with good infrastructure and a critical mass of professionals, making it somewhere expatriates like to live, rather than Abu Dhabi and Qatar (seen as boring) and Saudi Arabia (too austere). Partly for this reason, the DIFC's role as the Gulf's financial hub is unchallenged for now.

Dubai's longer-term worry will be how to keep this edge in the face of rising competition from its neighbours, which are trying to build their way out of boringness. Abu Dhabi has its Guggenheim, Qatar new museums by I.M. Pei and Jean Nouvel (see article), not to mention the 2022 football World Cup.

But so far only Dubai seems to have licence to purvey total brashness, recently boasting the world's largest shopping mall and most spectacular array of fountains among other attractions. In contrast, when Abu Dhabi's poshest hotel, the Emirates Palace, boasted that it had collared the world's most expensive Christmas tree, a conifer encrusted with precious stones valued at over $11m, it was forced to apologise for its tastelessness on the state news agency's website.