By ADRIAN LOWCOCK 27/11/2009
On November 25th 2009, the eve of the Muslim Eid al Adha holiday, Nakheel the Dubai Government linked property developer asked creditors for a freeze on debt payments. Nakheel is 100% owned by Dubai World, the Governments flagship holding company and such a request has been viewed by many investors as a technical default. The FTSE 100 fell 3.2% on the news as investors fretted over banks direct exposure to the region, and a possibly greater impact on lending activity.
Why has Dubai defaulted?
Dubai has grown into a major commercial hub in the Middle East. The rate of expansion and economic growth has been hectic; it rode the credit wave and invested in massive building projects including celebrity haunts such as Palm Islands. Dubai was hit hard by the financial crisis; local property prices have halved and contractors have gone unpaid. Nakheel was due to repay $3.5 billion next month. The level of Government support available along with its ability to raise funds from its oil rich neighbours is not clear, and with Dubai debt totalling $80 billion dollars, the cost of insuring the debt has risen rapidly.
Keeping it in the family
The United Arab Emirates is dominated by two families. The family that runs Dubai has been very successful in building up the city despite the lack of oil revenues. From time to time, they have had to be bailed out by the family that runs Abu Dhabi, and has all the oil money. Dubai World has only drawn down a portion of the bailout money given to it by Abu Dhabi institutions. It would prefer to find the money elsewhere rather than give most of the "city-state" to the rival family. So the cash is probably there, but emotions and politics are clearly aggravating the situation and this event is spilling over to other potential default stories.
Market reaction
Just as the western markets started to see some signs of economic recovery, the news coming out of Dubai sends a stark reminder that financial crises are never simple. Riskier asset prices fell and the US stockmarket opened nearly 200 points down today, having been closed for thanksgiving yesterday. Investors moved into more cautious assets and as a result we saw gilt yields fall and the dollar rise.
Our view
Dubai is unique; we do not think that this situation will spread into a systematic breakdown, although banks there are clearly more exposed than the likes of the UK banks. However the news could raises risk premiums across the board, forcing other defaults and bankruptcies, banks could be hit by more write downs. Market have suffered setbacks in recent weeks, before recovering to new highs. We recommend investors hold tight and ensure they are well diversified.
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