Dubai’s debt woes may worsen to become a “major sovereign default” that roils developing nations and cuts off capital flows to emerging markets, Bank of America Corp. said.
“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,” Bank of America strategists Benoit Anne and Daniel Tenengauzer wrote in a report.
A default would lead to a “sudden stop of capital flows into emerging markets” and be a “major step back” in the recovery from the global financial crisis, they wrote.
Emerging-market stocks around the world have slumped for two days on concern a debt restructuring by Dubai World, with $59 billion of liabilities, will add to the $1.72 trillion of losses and writedowns from the global credit freeze. The MSCI Emerging Markets Index fell 1.9 percent to 940.30 as of 1:55 p.m. in New York, extending this week’s decline to 2.6 percent.
Dubai, which borrowed $80 billion in a four-year construction boom to transform its economy into a tourism and financial hub, suffered the world’s steepest property slump in the recession. Home prices fell 50 percent from their 2008 peak, according to Frankfurt-based Deutsche Bank AG.
The story's actually pretty simple. Dubai was a playground for the major players,sort of a Middle East Switzerland.Because of their bank secrecy laws, relatively Western-friendly atmosphere and the free-spending ways of the Sultan, Not only was capital flowing in from all of the Middle East (Iran, for example) but from Europe and America as well.
As a consequence, the Persian Gulf Emirate borrowed billions to build itself into a tourism and trade mecca. Dubai boasted indoor ski slopes manmade islands, casinois the world's tallest Office building tower and the up and coming Dubai World, a tourist complex designed to rival Disneyland and Vegas combined.
What happened is that increased scrutiny of tax havens in Europe and America cut into the offshore banking trade, oil prices plunged, and and the Emirate was faced problems with people paying them for various services. Property prices have plunged by 50 percent since last year, the Emirate canceled ongoing projects, and expatriate workers without jobs simply left, leaving buildings unfinished, apartments sitting empty with no buyers and infrastructure to service them incomplete.
So as a consequence, DubaiWorld - which like all other commerce in the Emirate is owned by the ruling Al Maktoum family - asked for a restructuring of about $80 billion worth of debt with a suspension of payments for six months. The effect this had on hedge funds and companies invested in Dubai can be imagined.Oil prices went down to $74 per barrel, and the Dow plunged 150 points.
So, why is this so important?
First it's another shock to an already weakened global financial order...an remember, Dubai isn't some third world hellhole, but about as close to Belgium or The Caymans as anything in that part of the world is likely to become.
Second, the US has an arrangement with countries like Dubai - we protect them militarily, and they continue vote in OPEC to allow the oil trade to continue in dollars, thus importing our inflation. If Dubai needs to exercise its power in the UAE to vote stop doing that to get their own financial house in order, the effect on the dollar can be imagined.