Thursday, November 26, 2009

Will Dubai defaults set off chain reaction?

Fears that Dubai may not be able to meet the payments on its massive foreign debt sparked a sell-off on stockmarkets around the world as investors worried about the health of the once-booming emirate and scoured their portfolios for exposure.





Most of the concern is focused on Dubai World, one of the Persian Gulf emirate’s flagship conglomerates, with total debt of about US$59-billion, about twice the size of the gross domestic product. On Wednesday the Dubai government asked for permission to postpone payment on part of the debt, sending lenders scurrying to try to get a better understanding of the situation.



The nightmare scenario is that a default by Dubai World could set off a “cascading effect” as banks across the world buckle from losses, in the same way that the failure of Lehman Brothers Holdings Inc. last year nearly collapsed the global financial system, said Brian Eby, a portfolio manager at Connor, Clark & Lunn in Vancouver.



“I think that is unlikely but there is still not enough known [to be sure],” he said.



The S&P/TSX Composite Index Thursday fell 200 points, or 1.7%, to 11,436.8, the biggest drop in almost a month.



In London, the FTSE 100 declined 171 points, or 3.18%, while Germany’s DAX slumped 189 points, or 3.25%.



Analysts said it is unlikely Canadian lenders have significant exposure to Dubai despite the drop on the TSX.



“The market is still trying to figure it out and there is a lot of uncertainty, but really I think the issue is European and U.K. banks,” Mr Eby said .



Shares in all the Canadian banks declined with Bank of Nova Scotia falling the most with a drop of $1.15 or 2.3% to $47.91.



Manulife Financial Corp. and Fairfax Financial each went so far as to put out a press release stating they have no exposure to Dubai World.



Banks outside of Canada that are creditors to Dubai World include HSBC Holdings, Barclays, Lloyds Banking Group, Royal Bank of Scotland, and Credit Suisse.



Over the last decade Dubai World has been engaged in an ambitious effort to transform the city of Dubai into a global capital, partly through its Nakeel Group subsidiary, whose credits include world’s tallest building and an artificial island of luxury homes in the shape of a palm tree.



While the economy was booming, banks and pension funds in other parts of the world were happy to bankroll the expansion binge.



But the taps were turned off when the financial crisis hit, sending ripples through the global financial system as lenders worried the strength of the company and its owners.



Before the financial crisis, Dubai benefitted from soaring oil prices even despite having little oil wealth of its own as neighbouring states bought into the idea of a Persian Gulf financial centre and invested in its real estate. But with oil trading well below its peak, countries like Saudi Arabia have less wealth to spend and limited incentive to help out Dubai.



If the emirate is unable to reach an agreement with its creditors, it may be forced into a restructuring.



Because Dubai is a monarchy, the ultimate owners of Dubai World are the ruling royal family.



When concerns about the viability of the company first emerged in the aftermath of the crisis the government was able to persuade banks that the debt would be repaid, but analysts said this time around the outcome is less clear.



A top Dubai financial official said in a statement on Thursday that he understands the concerns of creditors but that “decisive action” must be taken to deal with Dubai World debt burden.



Analysts said a key concern it that if Dubai is unable to meet its obligations, it set off a chain reaction of defaults across the region.

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