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What the Dubai debt fears really mean

Allister Heath

So Dubai has become the latest country to be engulfed in a sovereign debt crisis. It won’t be the last, with mounting fears about the creditworthiness of Greece and others. The markets are panicking, for many reasons: first, they had got dangerously used to the bailout culture; second, because it suggests that the recovery in global property markets may well be premature; and third, because sovereign debt (the kind that is issued by countries) could turn out to be the new-sub prime, worth much less than everybody thought.

A wave of countries being forced to renegotiate their debts over the next few years, with downgrades to trillions of dollars of sovereign and corporate debt, could tip the world back into recession. Dubai World’s subsidiary Nakheel’s bond prices fell to 70 points yesterday; the debt, due to mature on 14 December but now postponed unilaterally, traded as high as 110 a few days ago. Such losses on a much wider, global scale would be devastating. There is no such thing as a safe investment; governments can default. It is not a one in 100 years event; it hapens much more regularly. It is a tragedy that most City folk are far too young to remember the great developing country debt crisis of the 1980s, which almost took out many of the big banks.

There are other, even deeper reasons for the malaise: emerging economies are meant to be doing better than the West, yet the first country to be forced to renegotiate some of its debt – albeit, in Dubai’s case, that of a state owned firm rather than the government itself – has turned out to be a Middle Eastern trading hub. This is different to what happened in Iceland, where private firms went bust.

There were huge communications issue in this case, with local officials arguing for months that all would be good and that Abu Dhabi, Dubai’s neighbouring emirate would come to the rescue. Yet it was not to be. Part of the problem is that Westerners have a very limited grasp of pan-Arab politics and the way affairs are conducted in the Gulf states. We don’t speak or read Arabic, at least not properly; and we have no sources of any consequence within the local Gulf ruling class. The local English-language media does its best but is only able to skim the surface of what is really going on. It is difficult therefore for outsiders to gauge risk accurately.

Coming in the wake of an opaque debt restructuring in Saudi Arabia that has left overseas banks exposed to billions in losses – and allegations that Saudi creditors are being treated better – there are growing worries about the health of the entire region. Sterling and London are already suffering, partly because all of the big City players are exposed to Dubai and because there will be sales of UK assets to raise foreign currency to help repay the emirate’s dollar-denominated loans. The influx of funds into UK office buildings is bound to reverse.

It would be wrong to panic: while creditors to Dubai World, the emirate’s largest state-owned firm, will have to take a painful haircut, not all Western interests in the emirate will be affected. There still remains a good chance that Dubai will be able to pull through all of this and return to growth. We should wish it all the best: if it fails, the lesson that many in the Middle East will draw from the crisis is that openness to foreigners, peace and trade don’t work. The only winners would be the extremists – and then we would really be in trouble.
allister.heath@cityam.com