Should we worry about Dubai?

Posted on: 07 December 2009 by Mark O'haire

After a recent scare, we ask if Dubai's growth has a firm foundation?

The initial fallout from the announcement from Dubai that state-owned Dubai World wanted a debt "repayment standstill" of six months was a stark reminder that last year's global events have not fully washed through.

Investors were left high and dry by the news, which was made without revealing any core information and was also ahead of the region's Eid al-Adha holiday, with markets shut since close of play on Wednesday, and the US Thanksgiving holiday, where the market was closed on Thursday.

This meant markets initially couldn't react to the news. The UK market took a 3% hit on Thursday (although it recovered some poise on Friday), while the US dropped 1.5% as soon as it opened on Friday. Meanwhile markets in the United Arab Emirates tumbled 6 to 7% on Monday.

European banks were the hardest hit, being those most exposed to the region, on fears that further capital writedowns would inevitably follow.

Rich states but risky loans

The real powerhouse and capital of the UAE is Abu Dhabi. There is little doubt that Abu Dhabi has the resources to repay debts on behalf of its neighbour.

The question is whether it is willing to do so, having seen the reckless expansion the region has undergone over recent years now coming home to roost. The question now becomes political (and to some extent, given the region's strong religious society, moral) as to whether Dubai should be seen to reap what it has sown.

Nonetheless, it did make some soothing noises in order to restore some order to what was becoming an embarrassing situation for the region, with the central bank setting up a liquidity facility.

The official line was reportedly that it would "look at Dubai's commitments and approach them on a case-by-case basis". However it added that this "does not mean that Abu Dhabi will underwrite all of their debts".

How big is the problem?

The exposure of international banks to Dubai World is estimated to be over £7 billion. This is a lot of money but pales when compared with some of the numbers the markets had to digest during the financial crisis.

As can be seen by the more recent reaction of the markets to the news, it is increasingly hoped that the losses are containable, particularly with regard to any wider implications for the global economy.

Bigger questions

Even so, it is another reminder of the fact that markets hate uncertainty. "It's not what you know, it's what you don't know," has long been the attitude of investors.

Bad news can be factored in to prices and therefore dealt with, whereas surprises such as the Dubai announcement are unwelcome at the best of times.

The manner in which the news was broken was certainly not ideal and left markets rattled and unhappy that they had little opportunity fully to analyse the implications.

Taking a breather

There has also been an increasing view that after the 50% plus rise in the UK market since March, traders are looking for an excuse to take a pause, which this could have provided.

By the same token, it provided a timely reminder that investment jitters remain, potentially for the rest of the year, as investors have now locked in the profits made during 2009, with little intention of opening new positions before the New Year.

It is also another example of the very real market implications of geopolitical tensions, which is why the situation in Iran may well move nearer centre stage over the next few months.

Lastly, it is a reminder for those who have kept faith in developed economies that - despite the recent difficulties - you are less likely to be surprised if you invest in what you know.

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