Dubai May Trigger Major Sovereign Default

Alex Messenger
Dubai’s announcement on Wednesday that it would be delaying by “at least” six months the maturity date of $59 billion in bonds issued by the city-state’s largest state-owned company, Dubai World, has sent global shares tumbling. The market reaction to Dubai’s massive debt default is partly explained by the exposure of European and Asian banks to DP World and its tourism subsidiary, Nakheel.

The real reason for the falls, however, is that Dubai’s apparent insolvency confirms that default by hyper-indebted government borrowers is now a real risk right across the globe, especially in the Middle East and Eastern Europe. Such a default would not only mean an immediate worsening of the already brutal post-crash conditions suffered by millions of workers in defaulting countries, but would usher in a second, and probably worse, phase in the global financial crisis.

A note published by Bank of America strategists warned of the possibility of a major sovereign default. “One cannot rule out—as a tail risk—a case where this would escalate into a major sovereign default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s,” the note said.

An editorial in today’s Financial Times noted that while markets were not expected to return to the panic of September 2008, because the financial sector had state backstops, “fearful investors have started to worry about how safe sovereign debt is,” citing Ireland and Greece as two examples.

The Dubai meltdown represents only a small sum in terms of total global indebtedness. Nevertheless it indicates that despite talk of global economic recovery, the world remains on a knife-edge. Attempts at reassurance by British prime minister Gordon Brown indicate that financial and government elites are already fearful. Brown this morning acknowledged the risk that Dubai posed to the global economy but, with careful understatement, told reporters “I think we will find this is not on the scale of the previous problems we have dealt with.”

Market falls on news of the Dubai crisis were sharpest in Japan, where a number of banks (including Mitsubishi UFJ and Semitoro Mitsui) are directly or indirectly exposed. Japanese shares plummeted 3.2 percent yesterday—the market’s largest one day decline in 8 months. A 2.9 percent fall in Australia the same day reflected the fact that a Dubai World subsidiary, stevedoring company DP World, carries one third of Australia’s sea cargo. In New York, the share index opened 2 percent down and only partially recovered those losses. Forty-four billion British pounds has been wiped off the London market, the largest single day loss since March. Shares in UK bank HSBC fell 7 percent. HSBC is reported to have lent Dubai $17 billion. Other UK banks with a Dubai exposure are Standard Chartered, Citigroup UK, Lloyds and Royal Bank of Scotland, an institution now majority-owned by the UK government, which has received more bailout money ($67 billion) than any other bank in the world.

Dubai World accounts for three quarters of the $80 billion borrowed by Dubai’s state-owned companies to fuel the emirate’s property boom. That boom—which came to an end when property values halved in a period of weeks from October 2008—was an expression of the global elite’s fantasy of endless wealth, with Dubai’s ruling family creating a desert playground for the global rich. Its most notable features were the world’s tallest building, a giant indoor ski slope and a series of vast man-made islands in the shape of palm trees and stars. Dubai World, which manages billions in construction projects, also used its foreign borrowings to diversify into global transport, especially ports and shipping. DP World is the largest port operator in the Middle East.

It is testimony to the anarchy and irrationality of the global financial system that although the scale of the Dubai crisis has been apparent for months, the government’s default announcement still caught global markets unawares. Banks had apparently assumed the existence of an implicit government guarantee of DP World’s debt, if not by the Dubai government, then by Dubai’s sister emirate, oil-rich Abu Dhabi. But there was no guarantee—Dubai World is a limited liability company owned by the Dubai government. The expectation that Abu Dhabi would rescue foreign investors was just idle hope.

Along with worldwide share market falls, the immediate effect of the Dubai default has been a surge in the insurance costs for national borrowings, especially by poorer countries. That cost is represented in the price of credit default swaps (CDS) on government bond issues. Greek CDS costs in particular have skyrocketed, raising fears that Greece, with public debt levels at a staggering 130 percent of GDP, will follow Dubai within weeks. CDS costs for Hungary have also soared since Wednesday, and there have been CDS price increases of about 11 percent for Malaysia, South Korea and Qatar.

These developments are by no means unforseen. Rather, the Dubai default is a lit match for ready-to-burn tinder, namely global sovereign debt levels. The key response of capitalist institutions to the global financial crisis has been to transform the toxic debts and unsustainable borrowings of private institutions into public debt via bail outs, guarantees and other stop-gap mechanisms. According to new estimates by Moody’s, the credit rating agency, the total stock of sovereign debt worldwide will have risen by nearly 50 percent between 2007 and 2010 to $15.3 trillion.

This ballooning of sovereign debt has been so fast and so immense that there is little chance of debtor governments, mired in unemployment and low growth, repaying either in the short or long term. As borrowing costs increase because of the perception of increased default risk (also called ‘long tail’ risk), the situation for indebted countries becomes worse. Global funds available for such borrowings are also drying up. While Greece, Hungary, Latvia, Estonia and Turkey are at the top of the global watchlist, default is also an eventual likelihood for the United States, which has public debts of $12 trillion. The key difference between the United States and smaller states, in this regard, is that the US is currently deemed by its bondholders, including the Chinese government, as ‘too big to fail’.

The Dubai default also pierces claims that allegedly well-managed and well-regulated national portions of the world economy can escape the effects and aftershocks of the financial crisis. Government and the corporate press have claimed that Australia, for example, is immune. But it is now likely that DP World’s Australian ports—a substantial piece of that country’s infrastructure, currently worth $1.5 billion—will have to be sold in the near future. Early reports indicate that there is unlikely to be strong interest and there may be no buyers. Few local companies have funds of that scale to invest in what is now, in the context of an uncertain future for global trade, a very risky asset.

Dubai Govt owns 21 per cent of London Stock Exchange

Image via Wikipedia

timesonline
Dubai World, the state-owned corporation that began the panic on Wednesday by demanding a standstill on its interest payments, worsened the mood when it postponed a teleconference for its bond holders, saying the phone lines were overwhelmed.

Gerard Lyons, chief economist with Standard Chartered, said: “The market reaction shows how vulnerable some economies are to the aftermath of the debt binge. This highlights how fragile confidence is.”

The Eid al-Adha religious holiday in the Middle East, and the closure of financial markets in the United States for Thanksgiving, exacerbated the sense of uncertainty in markets that were open for business.

A computer crash at the London Stock Exchange, which by coincidence is 21 per cent owned by the Dubai Government, left dealers unable to trade for three and a half hours.

Shares in HSBC slumped by 5 per cent, wiping £6.2 billion from its value. According to the United Arab Emirates Banks Association, HSBC has £11 billion of loans outstanding to the UAE, of which Dubai is one of seven emirates. HSBC declined to comment.

More than £2.6 billion was slashed from the value of Barclays, while Lloyds and Royal Bank of Scotland, both partly owned by the taxpayer, saw their values fall by £1.7 billion and £1.5 billion respectively.

Keiser on Dubai: the World is entering Phase Two of the global economic crisis

Fresh fears over the size of Dubai's debt have sent shock waves through international markets, with major stocks and oil prices falling sharply. Dubai World, the country's largest conglomerate, wants to suspend payment on its sixty billion dollar debts until next May at the earliest. RT's financial contributor Max Keiser says the World is entering the Phase Two of the global economic crisis.

Dubai World may be forced into a fire sale of assets

Image via Wikipedia

timesonline
The Government of Dubai said on Wednesday that it was seeking a standstill on debt repayments for Dubai World, the vast conglomerate that bought P&O (minus the American ports) for £3.9 billion in 2006.

Dubai World has liabilities of $60 billion (£36 billion) and the standstill announcement, made just before most of the Arab world stopped work for the Eid religious festival, has stunned stock and credit markets.

The standstill raises the possibility that Dubai World could default on its debt. The fear in Western markets is that banks risk losing billions, causing more paralysis in the lending markets. Dubai World’s difficulties also raise the prospect that it may be forced into a fire sale of its assets, which include some famous names in the UK. Leisurecorp, one of the many subdivisions within Dubai World, bought Turnberry, the golf course that hosted this year’s Open Championship, for £55 million last year. It also owns the Chris Evert tennis centres and more than 200 golf courses across the US — all assets that could be sold quickly to help to repay debt back home.

Dubai World’s Istithmar investment fund has $3.5 billion in businesses as diverse as Irish textbook publishers and aerospace companies. Last year Istithmar also bought a 20 per cent stake in Cirque du Soleil and the Canadian circus performers have since established a permanent base in Dubai.

In the less glamorous world of ports, DP World became the third-largest operator globally after its acquisition of P&O. It owns Dubai’s Jebel Ali port and various other container terminals around the world.

In Britain DP World operates container terminals at Tilbury, near London, and Southampton, and is building a port called London Gateway. Many of the goods that are imported into Europe are, therefore, transferred through ports owned or operated by Dubai — the source of US concern when the P&O deal was struck. The Arabian group bowed to pressure after buying P&O and sold the American ports to another company. Dubai World yesterday ring-fenced DP World from the rest of the company’s debts. This was seen as an attempt to protect the profitable ports division from potential creditors.

It is Nakheel, Dubai World’s property developer, that has been causing the difficulties. The company, which built the Palm Islands in the Gulf, was due to repay a $4 billion Islamic bond on December 14. Most investors had assumed that there would be no difficulty doing so as Dubai World, the Government of Dubai and Sheikh Mohammed bin Rashid Al Maktoum, Dubai’s billionaire ruler, were assumed to be supporting the developer. It now appears that nobody has the money to repay or refinance the bond and so the other $56 billion of Dubai World’s liabilities are also at risk.

This triggered a run on international bank stocks as investors worried about their exposure to Dubai World, which accounts for nearly three quarters of Dubai’s state debt. Falling share prices wiped £14 billion off the UK banking sector alone.

Credit Suisse has estimated that European banks could have €40 billion (£36 billion) in loans to Dubai and much of this could be at risk if the Gulf emirate defaults. Banks including HSBC and Royal Bank of Scotland have helped to finance Dubai’s acquisitions and are now on the hook if the state cannot repay its debts.

Dubai enjoyed a bubble that made the boom years in the UK seem like postwar rationing. But the boom was built on debt and when credit markets tightened and the emirate’s growth slowed the property bubble burst. Prices have fallen by up to 60 per cent and more than 400 construction projects worth more than $300 billion have been shut down or postponed.

Many expatriates facing negative equity and ballooning credit card bills have skipped the country rather than face debtors’ prison and Dubai’s reputation has taken a battering.

If Dubai is forced to raise money to meet its debt repayments, the impact will be felt far wider than Cirque du Soleil and Turnberry golf course.

In recent years, the various investment companies owned by Sheikh Mohammed and the Government of Dubai have been buying up numerous Western assets. Dubai International Capital, the $12 billion sovereign wealth fund, bought Travelodge, the budget hotel chain. It also has a 16 per cent stake in Merlin Entertainments, which owns the London Eye, Madame Tussauds, Legoland and Thorpe Park.

Sheikh Ahmed bin Saeed Al-Maktoum, of Dubai’s Supreme Fiscal Committee, said that the Government acted in full knowledge of how the markets would react and that further information would be given next week.