By Neil Irwin
Washington Post Staff Writer
Saturday, November 28, 2009
Global markets were jolted in recent days following the threat by a state-owned company in Dubai to default on its debt, as investors reawakened to the risks posed by mammoth debts in developing economies.
Dubai World, an investment company weighed down by real estate losses, asked creditors this week to accept delayed repayment. That led investors to doubt the financial reliability of nations even beyond the Arab world, deflating stocks in emerging markets by 2.1 percent.
Officials in Washington and European capitals continued to closely monitor financial markets Friday, worried that the Dubai debt problem would spiral into a global crisis. But those fears dissipated during the day as markets in the United States fell modestly, with the Standard & Poor's 500-stock index off 1.7 percent. European markets gained Friday, following steep losses Thursday, when American markets were closed for the Thanksgiving holiday.
While most analysts predict that a solution will ultimately be found for Dubai's debt, the unexpected events have highlighted lingering hazards that could imperil a global economic recovery. Despite a boom in financial markets over the past eight months and a return to growth across much of the world, many nations still face a vast overhang of debt from the boom years.
"The actual losses out of Dubai may be fairly limited, but it shows that we're not out of the woods, yet," said Rachel Ziemba, a senior analyst at Roubini Global Economics who tracks the Middle East. "We may be out of recession, but some of the underlying fundamentals that caused the credit crisis, those still remain."
There has been an outright boom in stock markets around the world in recent months, with valuations of emerging market stocks up more than 100 percent since March 2. But this week's events are forcing investors to revisit the risks that still lurk.
Besides a threat of default in Dubai, the Greek government is grappling with a fiscal crisis, and several Eastern European governments increasingly appear in perilous financial shape, including Hungary, Poland and the Baltic states. Western European banks have lent heavily in those nations, meaning any collapse could send tremors across the continent. Moreover, Vietnam devalued its currency, the dong, by 5 percent Wednesday, aiming to prop up its rapidly growing export industries but causing new tensions with other Asian nations that also depend heavily on exports.
While the threat of default by Dubai World may be little more than a negotiating strategy, the events have underscored the inherent uncertainty of investing outside the industrialized world.
"This will bring attention to the risks that remain by being overly exposed to emerging countries," said Bernard Baumohl, chief global economist at the Economic Outlook Group. "What we might see in the next few weeks is more differentiation between emerging countries that took on too much debt, versus those with truly stronger economies, which are on a much better footing."
Dubai, one of seven princely states that make up the United Arab Emirates, is weighed down by massive overinvestment in glitzy real estate projects, and the bill is just beginning to come due. Aiming to be the predominant financial and commercial center of the Middle East, the government has invested heavily in a jaw-dropping array of hotels, resorts and office towers that make Las Vegas seem quaint by comparison. Among the attractions: An indoor ski slope and a manmade island shaped like a palm tree.
Dubai World funded much of that investment boom and is among the world's largest investment groups. It made U.S. headlines in 2006 when one of the companies it owns, Dubai Ports World, was set to manage American ports -- but had to back off after a popular outcry over possible security concerns.
Investors have long assumed that the government of Dubai would ultimately back Dubai World's $60 billion in debt, rather than allow it to default. That assumption allowed the company to borrow at cheaper rates than it would have otherwise.
But late Wednesday, the company, which has suffered steep losses in its real estate subsidiary Nakheel, asked creditors to allow it to delay any payments until May 30 while it restructures its operations. Nakheel, which was responsible for many of the city-state's most elaborate construction projects, has a $3.5 billion bond coming due Dec. 14. The request for a repayment delay undermined investor faith that the government would back the firm.
The company's appeal for a standstill agreement was disclosed in a terse announcement followed by little official explanation. The resulting confusion was compounded by the difficulties of communication during holidays in both the Muslim world and the United States.
Analysts said they suspected the situation would ultimately be resolved without the company defaulting. They think it unlikely the government of Dubai would be willing to suffer such a hit to its reputation. And Abu Dhabi, another emirate that is flush with oil wealth, might yet bail out Dubai, perhaps partnering with other wealthy Gulf nations.
Some European banks have done extensive lending to Dubai, and analysts name British firms HSBC and Standard Chartered as those with the greatest exposure. American banks have less involvement; Citigroup has about $1.9 billion in exposure, small relative to the size of the bank.
"Dubai is very much a reminder that the lingering effects of the credit bubble are still with us," said Barry Knapp, of U.S. equity investments at Barclays Capital. "While there no real direct linkages to U.S. markets and our direct exposure is small, we have plenty of our own bad debts in the U.S."