Monday 30 November 2009

The Crisis: Goodbye To Dubai? By Gareth Milliams

It has been a while since I last posted on my blog. I’m not good at writing just for the sake of it. For me, there has to be a reason for doing it and context to write about. November was also comparatively uneventful and I was busy, so nothing got done. The last three days have seen that dynamic turned upon its head.

The attempt to become the Singapore of the Middle East has failed. The ultimate city of bling and excess, Dubai, is going broke. Unable to service its massive loans, it has asked for a six month moratorium on debt repayment and an extension in order to arrange a restructure.

On Friday morning , as Dubai languished in potential bankruptcy, its head of state, Sheikh Mohammed spent £335,000 on three foals at the Tattersall’s sales. This as his city state draws nearer to being reclaimed by the desert from whence it came.

The effect of the collapse of Dubai World is not yet fully known. That will unfold within the next few weeks. The immediate danger could be for highly exposed British Banks such as RBS and HSBC.

Banks across the globe are researching the extent of their relationship with Dubai this weekend, and more information should emerge on Monday. As it does, markets will surely respond – as global markets sunk on Thursday and Friday, bad information could put banks further into a tailspin and risk widespread panic.

Meanwhile, question marks hang over the fate of thousands of Britons employed by companies under Dubai's control. The emirate's investment vehicles hold interests in Alton Towers, the London Eye, P&O, Travelodge and the London Stock Exchange.

There are fears that Dubai will have to launch a fire-sale of assets as it struggles with restructuring its debts.

Abu Dhabi has already said that it is unwilling to provide a blanket bailout of Dubai, preferring to be selective with its largesse. The reason for this is simple: It is not the Dubai debt per se, but the ‘Dubai Effect’ cascading into governments, companies and institutions associated directly or indirectly with them.

So what could the ‘Dubai Effect’ be? Just how black is this black swan?

From The Wall Street Journal:

“The price of a $3.5 billion sukuk, or Islamic bond, issued by a subsidiary of Dubai World, plunged to 57 cents on the dollar Friday from 110 cents on Wednesday, according to two investors.

Dubai's troubles resonate far beyond the desert fantasyland that its borrowing created, fueling concerns that financially stretched nations like Greece and Hungary may struggle to pay off debts.

Investors and analysts say they're worried about the health of Greece's heavily indebted economy and banks, which could suffer as the European Central Bank moves to pull away some of its financial-support measures. These measures have included ultra-cheap bank funding.

The gap between the yield on a Greek government bond and relatively-safe German debt -- a key gauge of market fear -- jumped to a peak of 2.2% Friday, before falling slightly. When the pan-European Stoxx 600 index fell 3.3% on Thursday, Greece's market fell twice that amount, over 6%.

Dubai's debt restructuring drove up the cost of insuring against default in other countries as well

Another window into the growing concern about government creditworthiness is the credit-derivatives market. Investors are now paying much higher prices to insure themselves against bond defaults in countries like Turkey and Bulgaria.

When Dubai announced its debt standstill on Wednesday, the cost of insuring against a Dubai debt default more than doubled. The cost of debt-default insurance also rose for a range of countries, including Hungary, Brazil, Mexico and Russia.

While the cost of debt insurance for stressed countries hasn't hit levels seen at the height of the financial crisis, "the recent rises are altogether more sinister in our view, as they reflect genuine concerns about default within the euro-zone," said Steven Barrow, a currency analyst at Standard Bank in London, in a note Friday.

Dubai itself demonstrates how quickly countries can veer off the road to recovery and into trouble”.

So could Greece or Hungary default upon their loans? Is sovereign debt the new sub-prime? It all depends upon what happens this week. The markets have now had three days to absorb the bad news and will react accordingly.

On Sunday, the UAE Central Bank and Abu Dhabi intervened to underwrite all banks, whether domestic and foreign in the Emirates. The crisis for the moment has been averted. However, the larger questions regarding emerging debt are still unresolved. Not every nation can call upon it’s cousins in Abu Dhabi, Qatar and Bahrain to bail it out. Who would Turkey or Bulgaria turn to?

This is the point. It doesn't matter a jot that Dubai was rescued by an intervention of various Emirates from around the gulf. Dubai just got lucky. What matters is that it happened. What matters is that we have yet again been exposed to the fragility of the system. Should this happen again, I doubt whether that beleaguered nation will have easy access to 'family money'.

I think that there could be an opportunity to bottom fish. Should any of the South East European nations default, there could be a fire sale on decent quality debt. If that’s the case then we should consider purchasing a nominal amount.

No comments: